Economist's View

'Freedom: Three Varieties and a Caveat'

Highlighting something from yesterday's links:

Freedom: Three Varieties and a Caveat, by Peter Dorman, Econospeak: What follows is a very brief summary of an appendix in my micro textbook that addresses the libertarian case for free markets. It was triggered by the comment of Tyler Cowen that the left needs more Mill.

There are three kinds of freedom, each valid. The first is negative freedom, “freedom from”, which means simply freedom from external coercion.  This is what underlies the libertarian attachment to free markets.  The second is positive freedom, “freedom to”, which seeks to provide people the means to realize their (feasible) objectives. Traditionally the left has seized on this notion to justify redistributive institutions and policies. The third is “inner freedom”, freedom from habit, custom, and unreflected assumptions, which was the core message of German idealism, English and French Romanticism and American Transcendentalism (and, at its best, rock and roll).

In a perfect world we would bask in all three of them. Unfortunately, each makes demands on the others, and there is no universal criterion for striking a balance. The first step toward a reasonable politics of freedom, however, is to simply recognize that no one conception is sufficient by itself.

Finally, it’s important to recognize that freedom, according to any interpretation, is always limited by obligation. In particular, we have obligations toward children, the very old or disabled and others who depend on us for the necessities of life. One way collective action can widen the domain of freedom is by helping us to meet these responsibilities more efficiently. Consider, for instance, how public education and pension systems (like Social Security) widen the scope for parents and children of their elderly parents to be freer in other aspects of their lives.

Comments?

Links for 01-31-16

• Freedom: Three Varieties and a Caveat - EconoSpeak
• How to Re-Evaluate the FOMC's Goals and Strategies - Narayana Kocherlakota
• Internet access, voting patterns and government policy - VoxEU
• Smith's Wedge: The Invisible Mishandling - Ziliak, Barbour
• My review of Robert Gordon's *Rise and Fall of American Growth* - Tyler Cowen
• Replacing dual employment protection with a single labour contract - VoxEU

5 to 4

Narayana Kocherlakota:

5 to 4: On Friday, the Policy Board of the Bank of Japan decided to lower its deposit rate into negative territory for the first time.  The vote was five to four.  In this post, I argue that US monetary policy would be stronger if the Federal Open Market Committee (FOMC) were willing to issue statements and take actions that were supported by such narrow margins.

As is well-known, the FOMC operates by consensus.  No decision has had more than three No votes in at least twenty-five years.  There has not been a No vote by a governor in ten years, and there has not been more than one No vote by a governor at a meeting in over twenty years.  (See this great article by Thornton and Wheelock for a deeper review.)  

This decision framework is not statutory.  Rather, it is a Committee norm.  The norm is buttressed by Fed watchers and the media, who often refer approvingly to the absence of dissents at a meeting.  (Even today, this FT article refers to the lack of dissents at the December 2015 meeting as being a sign of a successful liftoff.)

This tradition of consensus has three main deficiencies. 

First, consensus creates a strong status quo bias that reduces the sensitivity of monetary policy to incoming data.   The current Committee norms imply that it requires a super-majority of the FOMC to implement a change in direction.  Without that super-majority, the Committee tends to stick to its prior course.   This automatically makes monetary policy relatively insensitive to incoming information.  

Second, the tradition of consensus opens up the possibility that relatively small minorities of FOMC voters can have a disproportionate influence  on monetary policy decisions.   For example, the above history suggests that the FOMC is following a practice under which all decisions need near-unanimous support from the governors.  If so, it becomes theoretically possible for a bloc of one or two governors to exercise veto rights over changes in the direction of monetary policy.

Finally, and perhaps most troublingly, the desire/need for consensus tends to strip collective Committee statements of their clarity.   (See a recent Wall Street Journal op-ed by Charles Plosser for a similar concern.)  For example, here’s how the current FOMC statement describes the conditionality of the path for the fed funds rate: 

“In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.”

This length of this list of conditioning variables helps create consensus, but it also serves to reduce the public’s understanding of the overall FOMC strategy.  This uncertainty can be a drag on the effectiveness of policy. 

Bold policy moves often engender significant disagreement.   Policy-making bodies must have cultures that can allow those decisions to get made, despite that disagreement.   Clearly, the Policy Board of the BOJ has that kind of culture.   I worry that the FOMC, with its emphasis on consensus, does not. 

I’ll write more about the potential economic importance of the BOJ’s move in a later post.  For now, I’ll simply say that, given the challenges facing the global economy, I applaud Governor Kuroda’s willingness to lead the BOJ in this new direction.

'Networks and Macroeconomic Shocks'

Daron Acemoglu, Ufuk Akcigit, and William Kerr:

Networks and macroeconomic shocks, , VoxEU: How shocks reverberate throughout the economy has been a central question in macroeconomics. This column suggests that input-output linkages can play an important role in this issue. Supply-side (productivity) shocks impact the industry itself and those consuming its goods, while a demand-side shock affects the industry and its suppliers. The authors also find that the initial impact of an industry shock can be substantially amplified due to input-output linkages. 

How shocks propagate through the economy and contribute to fluctuations has been one of the central questions of macroeconomics. We argue that a major mechanism for such propagation is input-output linkages. Through input-output chains, shocks to one industry can influence ‘downstream’ industries that buy inputs from the affected industry, as well as ‘upstream’ industries that produce inputs for the affected industry. These interlinkages can propagate and potentially amplify the initial shock to further firms and industries not directly affected, influencing the macro economy to a much greater extent than the original shock could do on its own.

Introduction

The significance of the idea that a shock to one firm or disaggregated industry could be a major contributor to economic fluctuations was downplayed in Lucas’ (1977) famous essay on business cycles. Lucas suggested that due to the law of large numbers, idiosyncratic shocks to individual firms should cancel each other out when considering the economy in the aggregate, and therefore the broader impact should not be substantial. Recent research, however, has questioned this perspective. For example, Gabaix (2011) shows that when the firm size distribution has very fat tails, the power of the law of large numbers is diminished and shocks to large firms can overwhelm parallel shocks to small firms, allowing such shocks to have a substantial impact on the economy at large. Acemoglu et al. (2012) show how microeconomic shocks can be at the root of macroeconomic fluctuations when the input-output structure of an economy exhibits sufficient asymmetry in the role of some disaggregated industries as (major) suppliers to others.

In Acemoglu et al. (2016), we empirically document the role of input-output linkages as a mechanism for the transmission of industry-level shocks to the rest of the economy. Our approach differs from previous research in two primary ways.

• First, whereas much prior work has focused on the medium-term implications of such network effects (e.g. over more than a decade), we emphasise the influence of these networks on short-term business cycles (e.g. over 1-3 years).
• Second, we begin to separate types of shocks to the economy and the differences in how they propagate.

We build a model that predicts that supply-side (e.g. productivity, innovation) shocks primarily propagate downstream, whereas demand-side shocks (e.g. trade, government spending) propagate upstream. For example, a productivity shock to the tire industry will tend to strongly affect the downstream automobile industry, while a shock to government spending in the car industry will reverberate upstream to the tire industry.  We then demonstrate these findings empirically using four historical examples of industry-level shocks, two on the demand side and two on the supply side, and confirm the predictions of the model.

Model and prediction

We model an economy building on Long and Plosser (1983) and Acemoglu et al. (2012), in which each firm produces goods that are either consumed by other firms as inputs or sold in the final goods sector. The model predicts that supply-side (productivity) shocks impact the industry itself and those consuming its goods, while a demand-side shock affects the industry and its suppliers. The total impact of these shocks – taking into account that customers of customers will be also affected in response to supply-side shocks, and suppliers of suppliers will also be affected in response to demand-side shocks – is conveniently summarised by the Leontief inverse that played a central role in traditional input-output analysis.

The intuition behind the asymmetry in propagation for supply versus demand shocks relates to the Cobb-Douglas form of the production function and preferences. If productivity in a given industry is lowered by a shock, firms in that industry will produce fewer goods and the price of their goods will rise. Due to the Cobb-Douglas structure, these effects cancel each other out for upstream firms, leaving them unaffected, while downstream firms feel the increase in prices and consequently lower their overall production. On the other hand, if demand in a certain industry increases, firms in that industry increase production, necessitating a corresponding increase in input production by upstream firms. Because of constant returns to scale, however, the increased demand does not affect prices, and so downstream firms are not changed.

We also incorporate into the model geographic spillovers, showing that shocks in a particular industry will also influence industries that tend to be concentrated in the same area, as shown empirically by Autor et al. (2013) and Mian and Sufi (2014). The idea is that a shock to the first industry will influence local demand generally, and therefore will change demand, output, and employment for other local producers.

Empirics

We test the model’s prediction by examining the implications of four shocks: changes in imports from China; changes in federal government spending; total factor productivity (TFP) shocks; and productivity shocks coming from foreign industry patents. The first two are demand-side shocks; the latter two affect the supply side. For each of these shocks, we show the effects on directly impacted industries as well as upstream and downstream effects. Our core industry-level data is taken from the NBER-CES Manufacturing Industry Database for the years 1991-2009, while input-output linkages were drawn from the Bureau of Economic Analysis’ 1992 Input-Output Matrix and the 1991 County Business Patterns Database.

For brevity we focus here on the first example, where changes in imports from China influence the demand in affected industries. Of course, rising import penetration in the US for a given industry could be endogenous and connected to other factors, such as sagging US productivity growth. We therefore instrument import penetration from China to the US with rising trade from China to eight non-US countries relative to the industry’s market size in the US, following Autor et al. (2013) and Acemoglu et al. (2015). Chinese imports to other countries can be taken as exogenous metrics of the rise of China in trade over the last two decades.

The empirics confirm the predictions of our model. A one standard-deviation increase in imports from China reduces the affected industry’s value added growth by 3.4%, while a similar shock to consumers of that industry’s products leads to a 7.6% decline.

• In other words, the upstream effect is nearly twice as large as the effect on the directly hit industry in a basic regression.
• Downstream effects, on the other hand, are of opposite sign and do not change in a statistically significant manner, confirming the model’s prediction.

Figure 1 shows the impulse response function when our framework is adjusted to allow for lags and measure multipliers. Again, a one standard-deviation shock to value added through trade produces network effects that are much greater than the own effects on the industry.

• We calculate that the effect of a shock to one industry on the entire economy is over six times as large as the effect on the industry itself, due to input-output linkages.

Similar effects are found for employment, and the findings are shown to be robust under many different specification checks.

Figure 1. Response to one SD value-add shock from Chinese imports

The other three shocks – changes in government spending, TFP shocks and foreign patenting shocks – also broadly support the model’s predictions, with the first leading to upstream effects and the latter two leading to downstream effects. Similarly, extensions quantify that geographical proximity facilitates the propagation of the shocks, particularly those on the demand side. 

Conclusions

Shocks to particular industries can reverberate throughout the economy through networks of firms or industries that supply each other with inputs. Our work shows that these shocks are indeed powerfully transmitted through the input-output chain of the economy, and their initial impact can be substantially amplified. These findings open the way to a systematic investigation of the role of input-output linkages in underpinning rapid expansions and deep recessions, especially once we move away from simple, fully competitive models of the macro economy.

References

Acemoglu, D, U Akcigit, and W Kerr (2016), “Networks and the Macroeconomy: An Empirical Exploration”, NBER Macroeconomics Annual, forthcoming. NBER Working Paper 21344.

Acemoglu, D, V Carvalho, A Ozdaglar, and Al Tahbaz-Salehi (2012), “The Network Origins of Aggregate Fluctuations”, Econometrica, 80:5, 1977-2016.

Acemoglu, D, D Autor, D Dorn, G Hanson, and B Price (2015), “Import Competition and the Great U.S. Employment Sag of the 2000s”, Journal of Labor Economics, 34(S1), S141-S198.

Autor, D, D Dorn, and G Hanson (2013), “The China Syndrome: Local Labor Market Effects of Import Competition in the United States”, American Economic Review, 103:6, 2121-2168.

Gabaix, X (2011), “The Granular Origins of Aggregate Fluctuations”, Econometrica, 79, 733-772.

Long, J and C Plosser (1983), “Real Business Cycles”, Journal of Political Economy, 91:1, 39-69.

Lucas, R (1977), “Understanding Business Cycles”, Carnegie Rochester Conference Series on Public Policy, 5, 7-29.

Mian, A and A Sufi (2014), “What Explains the 2007-2009 Drop in Employment”, Econometrica, 82:6, 2197-2223.

Links for 01-30-16

• The Persistence of Technology - Dietrich Vollrath
• My Classified Life - Paul Krugman
• The U.S. is not in a recession - Econbrowser
• A Renewable Feast - Paul Krugman
• ­Elizabeth Warren: One Way to Rebuild Our Institutions - Elizabeth Warren
• The Job Market for Recent College Graduates - Liberty Street Economics
• Financial Risks: Views from the Office of Financial Research - Tim Taylor
• Shrinking Labor Market Opportunities for the Disabled? - macroblog
• Tiered negative interest rates and required reserves - Nick Rowe
• Uncertainty and macroprudential tools - Bank Underground
• Economic Growth Isn't Everything - Noah Smith
• The Anti-Fed Two-Step - Paul Krugman
• Vaccines, drugs, and Zipf distributions - VoxEU

'Downward Nominal Wage Rigidity in the United States During and After the Great Recession'

"...we find evidence of a significant amount of downward nominal wage rigidity in the United States":

Fallick, Bruce C., Michael Lettau, and William L. Wascher (2016). “Downward Nominal Wage Rigidity in the United States During and After the Great Recession,” Finance and Economics Discussion Series 2016-001. Washington: Board of Governors of the Federal Reserve System: Abstract Rigidity in wages has long been thought to impede the functioning of labor markets. One recent strand of the research on wage flexibility in the United States and elsewhere has focused on the possibility of downward nominal wage rigidity and what implications such rigidity might have for the macroeconomy at low levels of inflation. The Great Recession of 2008 - 09, during which the unemployment rate topped 10 percent and price deflation was at times seen as a distinct possibility, along with the subsequent slow recovery and persistently low inflation, has added to the relevance of this line of inquiry. In this paper, we use establishment - level data from a nationally representative establishment - based compensation survey collected by the Bureau of Labor Statistics to investigate the extent to which downward nominal wage rigidity is present i n U.S. labor markets. We use several distinct methods proposed in the literature to test for downward nominal wage rigidity, and to assess whether such rigidity is more severe at low rates of inflation and in the presence of negative economic shocks than in more normal economic times. Like earlier studies, we find evidence of a significant amount of downward nominal wage rigidity in the United States. We find no evidence that the high degree of labor market distress during the Great Recession reduced the amount of downward nominal wage rigidity a nd some evidence that operative rigidity may have increased during that period.

Paul Krugman: Plutocrats and Prejudice

Where does all the "political ugliness" come from, and what does it mean for Democrats?:

Plutocrats and Prejudice, by Paul Krugman, Commentary, NY Times: Every time you think that our political discourse can’t get any worse, it does. ... But where is all the nastiness coming from?

Well, there’s debate about that — and it’s a debate that is at the heart of the Democratic contest. ...

To oversimplify a bit — but only, I think, a bit — the Sanders view is that money is the root of all evil. Or more specifically, the corrupting influence of big money, of the 1 percent and the corporate elite, is the overarching source of the political ugliness...

The Clinton view, on the other hand, seems to be that money is the root of some evil, maybe a lot of evil, but it isn’t the whole story. Instead, racism, sexism and other forms of prejudice are powerful forces in their own right. ...

As you might guess, I’m on the many-evils side of this debate. ... But ... the question for progressives is what all of this says about political strategy.

If the ugliness in American politics is all, or almost all, about the influence of big money, then working-class voters who support the right are victims of false consciousness. And it might — might — be possible for a candidate preaching economic populism to break through this false consciousness ... by making a sufficiently strong case that he’s on their side. ...

On the other hand, if the divisions in American politics aren’t just about money, if they reflect deep-seated prejudices that progressives simply can’t appease, such visions of radical change are naïve. And I believe that they are.

That doesn’t say that movement toward progressive goals is impossible — America is becoming both more diverse and more tolerant over time. Look, for example, at how quickly opposition to gay marriage has gone from a reliable vote-getter for the right to a Republican liability.

But there’s still a lot of real prejudice out there, and probably enough so that political revolution from the left is off the table. Instead, it’s going to be a hard slog at best.

Is this an unacceptably downbeat vision? Not to my eyes. After all, one reason the right has gone so berserk is that the Obama years have in fact been marked by significant if incomplete progressive victories, on health policy, taxes, financial reform and the environment. And isn’t there something noble, even inspiring, about fighting the good fight, year after year, and gradually making things better?

Dean Baker: Consumption Growth Keeps GDP Positive in Fourth Quarter 2015

"The overall picture of the economy going into 2016 is one of weak growth, albeit with little risk of recession":

Consumption Growth Keeps GDP Positive in Fourth Quarter 2015: Productivity growth will be near zero for 2015.

The economy grew 0.7 percent in the 4th quarter, bringing its rate for the full year (4th quarter to 4th quarter) to 1.8 percent. That is a substantial slowing from the 2.5 percent rates of the prior two years.

By far the major component boosting growth was consumption, which grew at a 2.2 percent annual rate, driven largely by continued strong growth in durable goods consumption, which grew at a 4.3 percent annual rate. Consumption of services grew at 2.0 percent annual rate and non-durables grew at just a 1.5 percent rate.

Housing was also a big contributor to growth, expanding at an 8.1 percent annual rate and adding 0.27 percentage points to growth. Housing growth has averaged 8.5 percent over the last seven quarters. While this component is likely to continue to grow in 2016, the pace will probably be somewhat slower.

Investment and trade were both big negatives in the quarter. The trade deficit, measured in constant dollars, increased by $20.4 billion in the quarter, subtracting 0.47 percentage points from growth. The trade deficit is likely to continue to grow in 2016 as the dollar has risen further and we probably have still not felt the full effects of the prior increase.

Spending on equipment and non-residential structures both fell in the quarter, subtracting 0.3 percentage points from growth. Equipment spending has been hard hit both due to the impact of the trade deficit on manufacturing and also due to the collapse of investment in energy related sectors. There has been some overbuilding in office buildings and retail space which could be a drag on non-residential construction in 2016.

Another factor depressing growth in the quarter was the slowing of inventory investment, which subtracted 0.45 percentage points from growth. The growth in final demand in the fourth quarter was 1.2 percent.

The government sector added modestly to growth, with a 2.7 percent increase in federal spending slightly offsetting a 0.6 percent fall in state and local spending. Both figures are slightly anomalous (federal spending is growing more slowly and state and local spending is growing), but the net impact on growth of 0.12 percentage points is roughly what we can expect in future quarters.

Health care spending continues to be very much under control. Spending on health care services, which accounts for the overwhelming majority of total health care spending, rose at a 5.2 percent nominal rate in the fourth quarter. This brings the increase over the last year to 4.8 percent.

Inflation continues to be nowhere in sight. The core PCE grew at just a 1.2 percent annual rate in the quarter, bringing the increase for the year to 1.4 percent, well below the Fed's 2.0 percent target.

Non-farm business value-added grew at just a 0.1 percent annual rate. Given the strong growth in employment over the last three months of 2015, this implies that productivity growth will be negative for the quarter and barely positive for the year as a whole.

One of the striking aspects of the recovery had been the sharp and completely unpredicted collapse of productivity growth. This has been a positive in that employment growth would have been near zero if productivity growth had remained in a range of 1.5–2.0 percent over the last five years. On the other hand, if productivity growth remains stuck at the slow pace of the last five years, it will impose a serious limit on the ability to raise living standards.

A possible explanation is that the weak labor market itself is acting as a drag on productivity as workers are forced to take low-paying, low-productivity jobs. We will only know if this is true if the labor market tightens enough to give workers more bargaining power and the ability to move to higher paying jobs.

The overall picture of the economy going into 2016 is one of weak growth, albeit with little risk of recession. Consumption growth is likely to remain moderate, especially if energy prices stay low. Investment is likely to be a small negative in 2016 as is trade. However, residential construction and government spending will both be modest positives. The biggest risk is that a set of bad events elsewhere in the world could cause the trade deficit to deteriorate further.

Links for 01-29-16

• Economics in the Age of Abundance - Brad DeLong
• Bank of Japan to Lower Interest Rate Below Zero - NYTimes
• Single Payer Trouble - Paul Krugman
• Paul Krugman, Bernie Sanders and Medicare for All - Dean Baker
• Confusion About the Financial Crisis Won't Die - Barry Ritholtz
• What’s happened to U.S. housing inequality? - Equitable Growth
• Is Ted Cruz Right About the Fed and the Great Recession? - Mike Konczal
• Against Multiple Regression--And Experiments Have Issues, Too - Tim Taylor
• Sanders, Corbyn and the financial crisis - mainly macro
• Back to the 60's Phillips Curve? - Robert Waldmann
• Wage Moderation and Productivity in Europe - INET
• Long-term effects of job training on human capital - VoxEU
• Why Measure GDP? - askblog

'Migration’s Economic Positives and Negatives'

Branko Milanovic:

Migration’s economic positives and negatives: I was always a strong believer that geography determines one’s worldview. (I think it is de Gaulle who is credited for saying that “history is applied geography”.) When you spend one month in Europe traveling to various places, you just cannot avoid the biggest issue in Europe today:  migration. So let me go briefly over some key issues (again). ...

To an economist, it is clear that most (not all; I will come to that later) economic arguments are strongly in favor of migration.  ...

It must be a force for the good and if there are problems or objections to it, they must stem from extra-economic reasons like social cohesion, preference for a given cultural homogeneity, xenophobia and the like.

However, I think that this is not so simple. There may be also some negative economic effects to consider. I see three of them.

First, the effect of cultural or religion heterogeneity on economic policy formulation. ...

Second, cultural differences may lead to the erosion of the welfare state. ...

Third,  migration might have important negative effects on the emitting countries. ...

We have, I think, to take into account also the negative economic effects of migration. I do not think that the three effects I listed here (and perhaps there could be others) are sufficiently strong to negate the positive economic effects. But they cannot be entirely disregarded or ignored either.

'We Desperately Need Major Tax Reform! Or Maybe Not…'

Jared Bernstein:

We desperately need major tax reform! Or maybe not…: It is an article of faith in national politics that the reform of the federal tax code is what’s standing between us and faster growth, higher productivity, better jobs, and whatever other good outcome you want to ascribe to this endeavor. ...

The changes in the Federal tax code since 1986, including the substantial increases to the EITC and CTC…boosted the aftertax income of households in the first two quintiles of the income distribution by about seven percent without even counting any benefits from the additional labor force participation... These gains are an order of magnitude larger than the estimated gains from fundamental tax reform, which are generally measured in the tenths of a percent.

So, let’s stop being distracted by the “fundamental reform fairy,” and pursue incremental reforms:

— Close the carried interest loophole that privileges the earnings of investment fund managers. ...

— Block corporate tax inversions, where U.S. companies merge with overseas companies just to move their tax mailbox to a low tax country.

— End the “step-up basis” provision by which the wealthy can pass capital gains on to their heirs tax free.

— Stop incentivizing multinationals to keep, or at least book, their profits overseas by letting companies repatriate their foreign earnings after paying a minimum tax (the Obama administration suggest a 19 percent minimum rate).

— Increase the EITC for childless adults, who now get very little from it, an idea supported by both Obama and House Speaker Paul Ryan (R).

Above, I called these “tweaks” as opposed to major reforms. Though the contrast is apt, it’s the wrong word, as any such changes are hugely heavy lifts. But heavy lifts are at least in the realm of the possible. And that’s the right realm to be in if we actually want to improve our tax code.

Fed Watch: FOMC Recap

Tim Duy:

FOMC Recap, by Tim Duy: The FOMC held steady today, as expected. The reaffirmed their basic forecast, but gave a nod to current global economic and financial economic uncertainty. That is all that should have been expected.

Still, there is a deeper story.

Puzzle over the opening paragraph for a moment (thanks to the WSJ FOMC Statement Tracker):

I feel like I will soon be going down the hall and grabbing an English professor to help me translate these statements. I hate to do this sort of thing, but notice that they brought the labor market forward and pushed the overall economy back? I think there are two things going on here. First is that the FOMC, on average, has a Phillips Curve view of the world. They aren't going to let go of the labor market until it turns. And turns hard given that the unemployment rate is hovering near their estimate of NAIRU. Hence they will tend to emphasize the labor data.

But something else is going on. Next week we get the fourth quarter GDP number. No one is expecting miracles. I would be totally unfazed by a negative print. Considering the normal variance in quarterly GDP numbers in the context of a two percent potential rate of growth, you are going to see more negative prints during expansions. Get over it.

The Fed isn't expecting miracles either. But what they are confused by is that in the first quarter of 2015, GDP growth slowed sharply:

And with it, job growth accelerated:

Now they have slow GDP growth and fast employment growth. That will make brains explode on Constitution Ave. They don't know what to do with that when unemployment is at 5%. You see where it cuts either way. If the recessionistas are correct, then they already made a mistake in December. If the optimitistas are correct, they will fall behind the curve if they hold in March.

And that is without the uncertainty of the financial markets. Did the Fed release a little steam by shifting into a tightening cycle, the avalanche control of Mark Dow? Or did they set in motion the next financial crisis?

And recognize that this is within the context of a no-win political situation. If they miss on the upside with higher inflation, they will be pilloried by the right (and ultimately, I suspect, the left). If they miss on the downside with recession, they will be pilloried by the left and right. Rock, meet hard place.

So, considering all this, you can't really blame the Fed for taking a pass on quantifying the balance of risks. From their perspective, there is no way to answer the question. And that's how the absence of a balance of risks should be interpreted. Neither as a intention to downgrade further in March, nor to upgrade. It is what is it. Pure, absolute uncertainty. White noise.

Yeah, I don't find that comforting either. Get over it.

So do we know anything more about March? A little. We know from the December SEP is that, on average, the FOMC expected to raise rates in March. What we know now is that they are less certain of that outcome. My guess: If job numbers remain sufficient to put downward pressure on unemployment, first quarter GDP trackers look solid, and financial markets calm, they will hike rates. If only one of those conditions in met, then they will pass. If two, then it is a tossup. Tossups usually go to the doves.

Bottom Line: The Fed got lucky this month. They weren't expected to do anything, which takes the pressure off. But in March they might have a real decision to make. We have only six weeks of data to digest. Even assuming that labor markets hold solid, will that be enough? Doubtful. They will need more.

Links for 01-28-16

• China’s Bumpy New Normal - Joseph E. Stiglitz
• Health Wonks and Bernie Bros - Paul Krugman
• Jobs Are Under Attack, But Not by Robots - Robert Gordon
• Are Economists in Denial About What's Driving Inequality? - INET
• Environment vs. Economy: A Shift in American Opinion - Tim Taylor
• Economists Get Closer to Spotting Recessions - Noah Smith
• Subprime Reasoning on Housing - The New York Times
• Fiscal cost of refugees in Europe - VoxEU
• Downside Inflation Risk - Carola Binder
• Twitter needed strategy - Digitopoly
• The Global Economy’s Marshmallow Test - Jeffrey Sachs
• Why GDP fails as a measure of well-being - CBS News
• Why GDP fails as a measure... period - EconoSpeak

'Monetary Policy is Not About Interest Rates'

Narayana Kocherlakota:

Monetary Policy is Not About Interest Rates: The Federal Open Market Committee has a problem.  The problem is not that it raised rates by a scant quarter percentage point in December.   The problem is the overall policy framework that led the Committee to take that action.  The Committee needs to switch to a framework that is less focused on a particular time path of interest rates, and more focused on the achievement of its goals.    

The FOMC’s current policy framework goes back to at least mid-2013.   It can be defined by two key words gradual and normalization.  Both words refer to the level of monetary accommodation.  In terms of the target range for the fed funds rate, the word “gradual” is generally interpreted by those who watch the Fed closely to mean about four increases of a quarter percentage point.   The word “normalization” is generally interpreted to mean “returning to about 3.5 percent”.   

To be fair: the evolution of the macroeconomy does enter into this framework.  But it only matters to the extent that it might lead the FOMC might tweak the pace of interest rate increases up or down.  The main mission is still defined by those two key words: gradual and normalization.

Unfortunately, this mission of gradual interest rate normalization seems increasingly inconsistent with the FOMC’s being able to achieve its macroeconomic objectives over the medium-term.  In terms of the FOMC’s employment mandate: the fraction of those aged 25 to 54 who have a job remains well below what Americans should view as “normal”. The nation needs above-trend growth for several more years to cure this problem - and that’s certainly not my forecast for 2016. 

The above is somewhat arguable (because some see the low labor force participation rate as either desirable and/or beyond the reach of monetary policy).  But the inflation picture is clear.  Inflation has run below the FOMC’s target of 2% for almost four years.  Like many others (including, as the December minutes indicate, the FOMC’s own staff), I don’t expect it to return to target for several more years.  

Both the inflation situation and (perhaps more arguably) the employment situation seem to call for more monetary stimulus, not less.  But the FOMC is set on gradual normalization of interest rates.   This framework seems grounded in a troubling aversion to both low interest rates and interest rate volatility.   Markets have taken note of the FOMC’s aversion to unusual levels of monetary stimulus.  We see clear signs that investors have increasing doubts about the FOMC’s ability/willingness to keep inflation as high as 2% over the long run - especially during periods of low growth. 

The Committee needs to change its basic policy framework.  Monetary policy is not about targeting the level and volatility of interest rates. The FOMC needs to have a framework in which the fed funds rate (and its other tools) are much more responsive to its medium-term forecasts of inflation and employment shortfalls.  Markets would then have to adjust to the possibility that interest rates might have to change rapidly, at any time and in either direction, if the FOMC believes that change is necessary to achieve its macroeconomic objectives more rapidly.   

And, yes: this goal-oriented framework would imply that the FOMC should undo its December rate increase.  But that’s not my point.  No given quarter percentage point move matters all that much in monetary policy.   What matters is the overall monetary policy strategy - and the FOMC's is flawed.

If the Committee keeps its current policy framework, I believe that the FOMC is running a significant risk of a persistent decline in long-term inflation expectations.  Such a decline would feed into the long-run level of interest rates, thereby reducing the recession-fighting capacity of the Fed, and increasing financial stability risks.  Unfortunately, as Japan has shown us all too well, such declines are very hard to undo.

FOMC Press Release on today's monetary policy meeting (no change in rates...).

''There is No Reason to Believe that Tax Cuts are an Elixir for Economic Growth''

William Gale, Aaron Krupkin and Kim Rueben in the Milken Institute Review:

There is No Reason to Believe that Tax Cuts are an Elixir for Economic Growth: Many folks, and from time to time, majorities in Congress, apparently believe that the cure for what ails the economy is lower taxes – in particular, lower tax rates for high-income earners. Now this enthusiasm has spread to state governments that are led by conservatives, offering new tests of a proposition that has generated scant evidence of success elsewhere.

Failure of this idea at the federal level does not necessarily imply that tax cuts would fail to increase output and jobs at the state level. For one thing, lower taxes in one state might lure existing businesses (and jobs) from other states, even if they yield no overall increase in employment or output. But it’s also worth noting that the stakes are higher for the states. Washington can finance shortfalls in revenue by selling bonds to the public or by borrowing from the Federal Reserve – in effect, printing money. States are far more constrained by the skepticism of the private credit markets or constitutional prohibitions against deficit finance, or both. Thus, any failure of supply-side economics to work its magic could force punishing cuts in state programs. ...

At the core of supply-side economics is Arthur Laffer’s back-of-the napkin curve illustrating the undeniable reality that, at some point, higher tax rates will lead to lower revenues as well as fewer jobs and slower growth. But this does not imply there are many realworld examples of tax rates so high that cutting them would have much impact on jobs or growth. That has been amply demonstrated at the national level, where tax cuts have eroded revenue without discernible effect on economic activity.

The states have no good reasons to believe that tax cuts will bring the desired manna. Yet some continue to erode their tax bases in the name of business growth in an era in which few states can afford to cut critical services (that businesses care about) ranging from education to infrastructure repair. Some ideas live on and on, no matter how much evidence accumulates against them. States that accept them as gospel anyway do so at their peril.

Fed Watch: On The Dispersion, Or Lack Thereof, of Economic Weakness

Tim Duy:

On The Dispersion, Or Lack Thereof, of Economic Weakness, by Tim Duy: Gavyn Davies writes:

It is true that much of the weakness in the nowcast is identified by economic variables that relate to the industrial sector. But these variables have, in the past, been very closely correlated with activity in the economy as a whole, and are therefore usually among the best indicators of overall activity. It is dangerous to ignore weakness in these industrial variables that persists for a long period, which is what is happening now....The full model, including the industrial sector data, estimates that the recession probability has been hovering around 15-20 per cent (above right graph), no longer an entirely negligible risk. If the weak industrial data are excluded, on the grounds that they are “transitory” – a word often used by Fed officials – then the recession probability drops to about 10 per cent.

He adds this picture:

Recession odds of just 10% would hardly be worth getting out of bed for. So how much weight should we be placing on the manufacturing data? I often see claims that manufacturing is already in recession. And Andrew Levin, former advisor to Federal Reserve Chair Janet Yellen, places much weight on the industrial production slowdown:

Unfortunately, the latest economic data underscore the risk that the economy may now be heading into another recession. Last Friday, the Federal Reserve Board reported that its index of industrial production sank further in December and was down 1.8% from a year earlier. Indeed, as shown in the accompanying chart, this pace of contraction has only occurred during prior recessionary periods. In some instances, the fall in industrial output was a harbinger at the onset of a recession. In other episodes, the industrial sector had been booming previously and turned downward after a recession was already underway. But since 1970 there has never been a case where the industrial sector shrank nearly 2 percent on a 12-month basis and the broader economy was left unscathed.

I think it is important to be very cautious with this aggregate data. What makes a recession a recession is that the decline in activity is felt widely throughout the economy. From the National Bureau of Economic Research:

During a recession, a significant decline in economic activity spreads across the economy and can last from a few months to more than a year.

With this in mind, I direct you to my fellow Oregon economist Josh Lehner, who correctly notes that in comparison to past recessions, the decline in manufacturing activity is not well disbursed across the sector. My version of Josh's chart:

The point is that during a recession, the vast majority of manufacturing industries (or all!) are declining. We are nowhere near that point. In other words, even manufacturing - arguably the most distressed sector of the US economy - is not recession. And if manufacturing is not even in recession, it is difficult to see that the US economy is in recession. Or even nearing it.

Initial unemployment claims across states tells a similar story:

In this version, I count the sates experiencing a 5% or greater change in year-over-year unemployment claims (I used 5% to account for the fact that as the cycle matures, claims will flatten out for more states and thus you would expect a wider dispersion of marginally higher claims). As is evident, recessions are characterized by rising claims across a wide swath of sates. In other words, a recession in Texas does not a US recession make. Note also that the economy can experience a fairly widespread increase in claims but not a recession. See 1995. Which means that while I think initial claims is an excellent leading indicator, it by itself is not infallible.

Aside from the recession risk, there is another important aspect of Davies's chart - discounting manufacturing, it indicates growth of just 2% in the US. This is fairly close with the Federal Reserve's estimate of potential growth, and I suspect that is the direction we will be heading by the end of the year if not sooner. Key sources of growth, such as autos, multifamily housing, and technology, that helped propel the economy closer to fully employment are likely leveling off. If so, that means the economy is at an inflection point as it transitions back to trend. The Fed expects that process will require addition tightening. The financial markets aren't so confident.

Bottom Line: The lack of widespread economic weakness across the economy indicates that the US is not currently in recession. It is not even evident manufacturing is in recession. If the economy were heading into recession, expect the dispersion of weakness will spread further across the economy, both geographically and sectorally.

Links for 01-27-16

• The Anti-Fiscal Bubble - Paul Krugman
• Goodbye, Golden Age of Growth - Robert Gordon
• The Latest  Fad: Asymmetric Inflation Targeting - David Beckworth
• China’s capital flight and US monetary policy - VoxEU
• The economic losers are in revolt against the elites - Martin Wolf
• Free Trade With China Wasn't Such a Great Idea - Noah Smith
• The Dollar Keeps Rising, for Good or Evil - The New York Times
• Estimating Equilibrium in Health Insurance Exchanges - A Fine Theorem
• The Pause that Refreshes - Jon Faust
• Interview with Larry Summers - TIE
• Potemkin Ideologies - Paul Krugman

'The Five Scenarios Now Facing the Federal Reserve'

Tim Duy:

The Five Scenarios Now Facing the Federal Reserve: Federal Reserve policymakers are likely enjoying this month about as much as market participants are.

Central bankers at the Fed don’t like fast-moving markets to begin with, and they especially won’t like the implication that their supposedly inconsequential 25-basis-point interest rate hike in December was a mistake. The only saving grace for the Fed is that January was off the table for a rate hike anyway, so the volatility on Wall Street will have little impact on this week’s policy outcome, due to be announced on Wednesday... Continue reading at Bloomberg ...

You Say You Want a Revolution?

New column:

You Say You Want a Revolution?, by Mark A. Thoma: What, exactly, does Democratic presidential candidate Bernie Sanders have in mind when he asks on his website if we are “Ready to Start a Political Revolution?” He has proclaimed unabashedly that he is a socialist, a statement that has raised eyebrows about his electability. He wants to turn us into the Soviet Union!! Is that what he has in mind?

Far from it. He has qualified his statements to make it clear that he is a democratic socialist, but that term fails to convey what he really has in mind, or at least I think it does. ...

'Reality Check in the Factory'

This is from Peter Dizikes at MIT News:

Reality check in the factory: When the globalization of manufacturing took flight a few decades ago, the problem of industrial workplace safety also became fully globalized. As many scholars, human-rights advocates, and labor leaders have observed, that challenge consists of more than just persuading developing nations to create labor laws — it is also a matter of enforcing those labor laws.

Indeed, enforcement may be the greater challenge, as new factories continue to spread across vast distances in Asia, Central America, and other regions. Problems include unsafe buildings, inhumane hours, pollution, unpaid wages, and more. A common enforcement scenario today involves an underfunded regulatory agency with a small staff, and hundreds of potential cases to examine. Where do regulators even begin?

Matthew Amengual, an assistant professor at the MIT Sloan School of Management, started investigating that question on the ground in Argentina nearly a decade ago — talking to regulators, union bosses, firm managers, and key players with knowledge about labor conditions. Over time, he interviewed hundreds of people, watched inspections occur, and catalogued Argentina’s intricate regulatory politics as deeply as any outside observer has.

What Amengual found surprised him. A large thread within political science theory, drawing from the German sociologist Max Weber, holds that states can best enforce labor laws when they act as politically neutral arbiters of regulations. But such neutral arbiters largely did not exist in Argentina. There, many regulators only learned where to find malfeasance by working closely with non-neutral parties, say, union leaders, or immigrant groups. The process of regulation needed to be politicized to happen at all.

In other cases, active regulators came from the ranks of business managers who were using their knowledge to clean up their own industries. None of this was textbook political science theory. But it was how things worked. ...

A “watershed moment” in Amengual’s research occurred in the Argentine province of Cordoba, when an inspector he knew met up with a union leader representing metal workers. Soon the two of them, and Amengual, were driving off in the union leader’s car to a factory.

‘The labor unions have all kinds of information and resources that allow the inspectors to do their jobs,” Amengual says. In Cordoba, he notes, the regulators “didn’t even have cars to be able to go out and do the inspections. They didn’t have time. They didn’t have strong training.”  

But the regulators did have information they could act on, courtesy of the unions — and so they did. Enforcement would not have been possible otherwise.

That said, while regulators were busy inspecting the metal industry, they were less watchful over small-scale brickmakers, an industry where many kinds of violations may have been even more abundant, but which lacked union organizing.  

“You have enforcement, but it’s happening where the unions are present, not [always] where it’s most needed,” Amengual says.

It wasn’t just labor advocates driving regulation, however. Surprisingly, in the province of Tucuman, where sugar mills that produced ethanol were polluting the water, the move toward legal compliance occurred thanks in part to business managers who joined the government and pushed firms to meet environmental regulations.

The government hired regulators “right out of industry, they gave them short-term contracts, and some of them went right back into industry afterwards,” Amengual says. “It was a recipe for disaster, according to [political science theory]. But those were the guys who were actually doing something to enforce environmental laws.” 

How could that happen? Amengual attributes it partly to the presence of environmental groups, in conjunction with the gradual increase in regulators’ ability to assess the pollution problems. “Industry actually wanted regulators between it and the social movement pressure,” Amengual observes.

In turn, Amengual says, he would like political scientists and policymakers alike to recognize these realities of regulation. Instead of regarding politicized enforcement as a tainted form of state action, he thinks, people should realize that labor regulations are always going to be political. The question is how to let the politics spur enforcement, while not totally capturing the process.

“If this is the way policies are being enforced in much of the world, it does matter,” Amengual asserts. “I don’t think Argentina is unique.” ...

Links for 01-26-16

• How a (Bayesian) Hawk Can Quickly Turn Into a Dove - Narayana Kocherlakota
• Hotbeds of genius and innovation depend on key ingredients - PBS NewsHour
• Paul Krugman Reviews ‘The Rise and Fall of American Growth’ - NYTimes
• Potential supply, the output gap and inflation - Bank Underground
• Can Margin Requirements Improve Resilience? - Cecchetti & Schoenholtz
• John Taylor on auditing all the world’s Feds - longandvariable
• The Price Americans Pay for Slow Growth - Noah Smith
• ‘Metrics Monday: Type III Errors - Marc Bellemare
• Family welfare cultures: evidence from Norway - Microeconomic Insights
• Balance Sheet Recession That Never Happened: Australia - David Beckworth
• Bernie, Hillary, Barack, and Change - Paul Krugman
• NAWRU VI Arbitrary Restrictions on Paramaters - Angry Bear
• Under-investment in Public Clubs - Nick Rowe
• Europe’s migration crisis of 2016 - VoxEU
• Delusions of Moderation - Paul Krugman
• The corporate savings glut - Nick Bunker
• Attention and saliency on the internet - VoxEU

Borjas 'On Mariel'

George Borjas is blogging again:

Hello World (again): About 10 years ago, I had a blog that ran for about a year or so. It quickly began to consume too much of my time, and I realized that I could not be a heavy blogger and a full-time researcher at the same time. So I stopped blogging after a while.

Immigration is back big time. I’ve been dragged into a public debate over some work I did last summer. And I have a book coming out in the fall that hopes to clarify many of the issues in the immigration debate.

So I’m going to try blogging one more time. I’ve learned my lesson; I don’t expect to be blogging daily. But I suspect that the book will provoke some reactions–and the election is coming up as well. So come summer/fall I may be hanging around here more than just a bit.

Today, he revisits the Mariel boat lift:

On Mariel: A couple of readers of early drafts of We Wanted Workers made some comments last spring that planted an idea in my head: perhaps it was time to revisit Mariel and see what we could learn from that supply shock with the hindsight of 25-years worth of additional research. ...

I then spent the entire summer working time-and-a-half on my Mariel paper. The paper went through several rounds. I got a lot of feedback from many friends who read early drafts. And I even did something that I had never done before: I hired someone to replicate the entire exercise from scratch just to make sure it was right!

The paper came out as an NBER working paper in September 2015. At least in my corner of the universe, it created a disturbance in the force reminiscent of the destruction of Alderaan, leading to a debate in the past few weeks (here’s the Peri-Yasenov criticism) and to my writing a follow-up paper showing that the critics are wrong. ... And here is a popular piece I published in National Review that summarizes my take on what is going on.

The critics harp on the fact that my sample of prime-age, non-Hispanic working men is small (which it is, as I explicitly noted in my original paper). But they ignore that I report many statistical tests showing the post-1980 wage drop in Miami to be statistically significant, despite the small samples.

Even worse, the only way to make sure your lying eyes see the “right” wage trend is to enlarge the sample in ways that are, at best, questionable and, most likely, just plain wrong. ...

After everything is said and done, it surely seems as if something happened to the low-skill labor market in Miami after 1980, and that something depressed low-skill wages for several years. This fact has a really interesting implication. Suppose that the Mariel natural experiment is giving us the correct estimate of the wage depression. We may then be severely understating the economic gains from immigration.

'The Volcanic Core Fueling the 2016 Election'

Robert Reich:

The Volcanic Core Fueling the 2016 Election: ...as I talked with ... people, I kept hearing the same refrains. They wanted to end “crony capitalism.” They detested “corporate welfare,” such as the Wall Street bailout.

They wanted to prevent the big banks from extorting us ever again. Close tax loopholes for hedge-fund partners. Stop the drug companies and health insurers from ripping off American consumers. End trade treaties that sell out American workers. Get big money out of politics.

Somewhere in all this I came to see the volcanic core of what’s fueling this election.

If you’re one of the tens of millions of Americans who are working harder than ever but getting nowhere, and who understand that the political-economic system is rigged against you and in favor of the rich and powerful, what are you going to do?

Either you’re going to be attracted to an authoritarian son-of-a-bitch who promises to make America great again by keeping out people different from you and creating “great” jobs in America, who sounds like he won’t let anything or anybody stand in his way, and who’s so rich he can’t be bought off.

Or you’ll go for a political activist who tells it like it is, who has lived by his convictions for fifty years, who won’t take a dime of money from big corporations or Wall Street or the very rich, and who is leading a grass-roots “political revolution” to regain control over our democracy and economy.

In other words, either a dictator who promises to wrest power back to the people, or a movement leader who asks us to join together to wrest power back to the people.

You don’t care about the details of proposed policies and programs.

You just want a system that works for you.

Paul Krugman: Michigan’s Great Stink

The "poisonous interaction between ideology and race":

Michigan’s Great Stink, by Paul Krugman, Commentary, NY Times: ...Modern politicians, no matter how conservative, understand that public health is an essential government role. Right? No, wrong — as illustrated by the disaster in Flint, Mich.

What we know so far is that in 2014 the city’s emergency manager — appointed by Rick Snyder, the state’s Republican governor — decided to switch to an unsafe water source, with lead contamination and more, in order to save money. And it’s becoming increasingly clear that state officials knew that they were damaging public health...

This story ... would be a horrifying outrage even if it were an accident or an isolated instance of bad policy. But it isn’t. ...

In the modern world, much government spending goes to social insurance programs — things like Social Security, Medicare and so on, that are supposed to protect citizens from the misfortunes of life. Such spending is the subject of fierce political debate, and understandably so. ...

There should, however, be much less debate about spending on ... public goods — things that benefit everyone and can’t be provided by the private sector. ...

Yet ... hard-line conservatives have ... sought to cut social insurance spending on the poor. ... But what we also see is extreme penny pinching on public goods. ...

Nor are we talking only about a handful of cases. Public construction spending as a share of national income has fallen sharply... And this includes sharp cuts in spending on water supply.

So are we just talking about the effects of ideology? Didn’t Flint find itself in the cross hairs of austerity because it’s a poor, mostly African-American city? Yes, that’s definitely part of what happened — it would be hard to imagine something similar happening to Grosse Pointe.

But these really aren’t separate stories. What we see in Flint is an all too typically American situation of (literally) poisonous interaction between ideology and race, in which small-government extremists are empowered by the sense of too many voters that good government is simply a giveaway to Those People.

Now what? Mr. Snyder has finally expressed some contrition, although he’s still withholding much of the information we need to fully understand what happened. And meanwhile we are, inevitably, being told that we shouldn’t make the poisoning of Flint a partisan issue.

But you can’t understand what happened in Flint, and what will happen in many other places if current trends continue, without understanding the ideology that made the disaster possible.

Links for 01-25-16

• German exports and the Eurozone - mainly macro
• US slowdown is now a headache for the Fed - Gavyn Davies
• Goodfriend and King misreport stance of the minority - Lars Svensson
• Graphing the English-speaking university curriculum - Understanding Society
• How Strong is the Evidence for Hysteresis? - Robert Waldmann
• Book Review: "Economics Rules" - Noahpinion
• The German minotaur - longandvariable
• Against Krugman - Economic Principals
• Rethinking College Admissions - The New York Times
• Labour supply responses of lottery winners - VoxEU

Banks' Influence on Congressional ''Reform'' of the Fed

Narayana Kocherlakota:

Banks' Influence on Congressional “Reforms” of the Fed: Senator Sanders’ December 23 NYT op-ed expressed concern about what he perceived to be an undue influence of the financial sector on the Federal Reserve. In my last post, I explained how the Fed could allay these concerns through greater transparency about the role of the Board of Governors. In this post, I elaborate on what I see as a much bigger problem: the financial sector’s influence on Congress as it seeks to “reform” the Fed.

Here’s an example of what I mean. Last year, Congress amended Section 10.1 of the Federal Reserve Act. That section now requires a person who is experienced with community banks to be on the Board of Governors. There is no other explicit sectoral requirement of this kind in the Act.

How should one interpret this new statutory requirement? The issue is not whether it is often beneficial to have a Board member who has prior experience with community banks. I fully agree that it is. But that’s true of many other sectors in the US economy. So why is Congress picking this particular sector as being one that needs to be represented on the Board?

Unfortunately, the answer is clear to me (as I suspect that it will be to anyone who fills this new slot): Congress wants the Fed to tilt supervision, regulation, and monetary policy to be more favorable to community banks. This interpretation is consistent with the fact that the passage of this statutory change came after six years of lobbying from the Independent Community Bankers of America.

This statutory preference for community banks is disturbing. It’s true that community banks are often located on Main Street. But the interests of community banks are absolutely not the same as the interests of Main Street.

In terms of supervision and regulation: lax supervision and regulation increases the probability of bank failure. Bank failures impose a cost on the FDIC which is, ultimately, backstopped by the taxpayer. Community banks operating in the interests of their shareholders should not - and don’t - fully internalize these taxpayer costs. Accordingly, community banks systematically favor less supervision and regulation than would be in the public interest.

In terms of monetary policy, the profits that banks derive from many of their products are positively correlated with the overall level of interest rates in the economy. For this reason, community bankers typically favor higher interest rates than is in the general public interest. (Of course, this preference is shared by larger financial institutions for similar reasons.)

In writing the above, I’m not intending to be critical of community banks. They’re private businesses. No one should expect the interests of a given private business to coincide with the general public interest.

The problem is with Congress. Congress is supposed to act in the interest of the public. But this law is not in the public interest. Instead, it is a rather clear attempt to influence the Fed so that it acts more in the interest of (part of) the financial sector.

In his op-ed, Senator Sanders says that he wants to reform the Fed so that “the foxes would no longer guard the henhouse”. The first step in this agenda should be to repeal the recent amendment to section 10.1 of the Federal Reserve Act. This step will not be easy to accomplish. The amendment passed with overwhelming support from both parties in both Houses of Congress.

Links for 01-24-16

• Wonks and Minions - Paul Krugman
• The Great Lead Water Pipe Disaster - Alex Tabarrok
• How To Make Donald Trump President - Payl Krugman
• he Need for More Transparency at the Fed - Narayana - Kocherlakota
• Levels, Rates, and Sweden - Paul Krugman
• Against laws & "facts" - Stumbling and Mumbling

'Can Lower Oil Prices Cause a Recession?'

Jim Hamilton:

Can lower oil prices cause a recession?: ...A drop in oil prices means less money in the hands of oil producers but more money in the hands of oil consumers. Currently the U.S. is importing about 5.1 million barrels a day more than we’re exporting of crude oil and petroleum products. At $100 a barrel, that had been a net drain on the U.S. economy of $190 billion each year. That drain that will now be cut by more than half by falling oil prices.

We usually see consumers spend their extra income right away, whereas it takes more time for producers to alter their spending plans. As a result, even if the U.S. was not a net importer of oil, we might still expect to see a short-run positive stimulus from dropping oil prices. ... The conclusion I draw ... is that each consumer spent more than they would have if oil prices had not fallen, but that there were other macro headwinds at the same time that were offsetting some of the positive stimulus of falling oil prices.

In any case, we’ve now had plenty of time for cuts in spending by U.S. oil producers to start to have an economic effect of their own. If there’s an increase in spending by consumers of $1 and a decrease in spending by producers of $1, it’s not really a net wash for the economy. The reason is that the consumers are spending their money in different places and on different items than the producers are cutting. There is a lot of specialized labor and capital that’s involved in oil extraction that can’t move costlessly to some other sector when the oil patch goes sour. ...

And of course we’re talking here not just about the people who work in the oil industry itself but all the other industries and services that sell to the oil sector and more in turn who sell to these suppliers. ...

There are thus some reasons why a decrease in oil prices would be a boost to the U.S. economy and other reasons why it could even be a drag. A number of studies have looked at the effects of oil price decreases and concluded that these have little or no net positive effect on U.S. real GDP growth...

Links for 01-23-16

• How Stories Drive the Stock Market - Robert Shiller
• A note on the ethics of nudges - Vox EU
• Shadow Banking is Key to Financial Reform - Mike Konczal
• The geography of the foreign exchange market - VoxEU
• Discounting climate change investments - Vox EU
• Firm reorganization and firm productivity - VoxEU
• Low Oil Prices Lead To Low, Stock Prices? - EconoSpeak
• Sincerity - the subjective rationality of markets - Tim Johnson
• Philanthropy, American Style - Tim Taylor
• Dean Baker’s Libertarian Socialism - askblog
• When Will the Candidates Talk About the Economy? - NYTimes
• What happened to UK corporate debt? - Bank Underground
• How school children respond to exam pressure - VoxEU

'A Progressive Way to End Corporate Taxes'

Curious what you think of this proposal from Dean Baker:

A Progressive Way to End Corporate Taxes, by Dean Baker, NY Times: Just about every American chief executive has the same dream: to get out from under the corporate income tax. ...

Suppose that, instead of taxing corporate profits, we required companies to turn over an amount of stock, in the form of nonvoting shares, to the government. ...

The shares would be nontransferable, except in the case of mergers or buyouts, but they otherwise would be treated just like any other shares. If the company paid a dividend to its other stockholders, then it would pay the same per share dividend to the government. If it bought back 10 percent of its shares, then it would buy back 10 percent of the government’s shares at the same price. In the event of a takeover, the buyer would have to pay the same per-share price to the government as it did to the holders of other shares.

This way, there is no way for a corporation to escape its liability. A portion of whatever profit it makes will automatically go to the government. It also eliminates the enormous cost and waste associated with complying with or avoiding the corporate income tax... And federal revenues will go up, because companies will have incentive to do what is most profitable, not what minimizes their tax liability. ...

Ideally, replacing the income tax with stock issuance would be mandatory. But it could be done on an optional basis. ...

The switch from a corporate income tax to ownership of shares wouldn’t be good news for the tax avoidance industry, or for leading tax-avoiding corporations. But it would be a huge gain for just about everyone else.

FRBSF FedViews: The Current Economy and the Outlook

The view of the economy from the SF Fed:

FRBSF FedViews: The Current Economy and the Outlook: Mark Spiegel, vice president at the Federal Reserve Bank of San Francisco, stated his views on the current economy and the outlook as of January 14, 2016.

• Real GDP has grown at an average annual rate of 2.2% over the first three quarters of 2015. However, a number of recent indicators suggest weaker growth in the fourth quarter, including declines in construction and existing home sales, as well as weaker manufacturing data and a sharp decline in inventory buildup.
• Despite the fourth quarter weakness, we expect real GDP to rebound in the first quarter of 2016, due to inventory payback and continued consumption strengths, and grow at an average annual rate of around 2¼% over the year as a whole.

• The labor market continues to surprise on the upside. The December payroll report was very strong, as the U.S. economy added 292,000 jobs and figures for October and November were revised upwards sharply. The six-month moving average remains well above 200,000 jobs per month, portending continued labor market tightening.

• The unemployment rate held steady in December at 5.0%, as increased labor force participation accompanied the growth in payroll employment. This suggests that some workers who were classified as out of the labor force have resumed searching for jobs, presumably due to improved expectations about chances for finding employment. As a result of the strong pace of job creation, we expect the unemployment rate to decline later this year to levels below the long-run natural rate of about 5%.

• Inflation remains substantially below the Federal Open Market Committee’s stated 2% target. Oil prices have decreased dramatically, with West Texas Intermediate oil falling below $30 a barrel. Other commodity prices have fallen sharply as well. In addition, the broad trade-weighted value of the dollar has continued to rise, also putting downward pressure on import prices and inflation.
• We project that headline inflation in 2016 will come in between 1% and 1¼% and rise gradually towards the 2% target as the effects of transitory shocks to energy prices and the exchange rate dissipate and as improving labor market conditions strengthen wage growth.

• The FOMC “lifted off” after its December 2015 meeting, raising the federal funds rate target range from 0–25 to 25–50 basis points. This policy change was accompanied by only mild financial market volatility, with muted movements in market yields before and after the announcement date. This suggests that the Federal Reserve successfully prepared financial markets for the liftoff announcement through its prior statements and communications.

• Yields on emerging market securities, as measured by the Emerging Market Bond Index (EMBI), also demonstrated little volatility immediately after the FOMC announcement.
• More recently, U.S. financial market volatility as measured by the VIX rate has turned up, largely because of concerns about financial volatility overseas, particularly in China. Chinese equity markets enjoyed a strong rally between the fall of 2014 and the summer of 2015, with values more than doubling. However, after a sharp selloff in the latter half of 2015, the Chinese government intervened in a variety of forms to stabilize equity prices. These efforts appeared to be temporarily successful, but prices resumed their downturn near the end of 2015 in response to additional weak news about Chinese economic fundamentals, particularly in its manufacturing sector. Technical factors, such as the on-off use of “circuit breakers” to limit sharp price changes, also appear to have exacerbated equity market volatility. Since the beginning of 2016, China’s stock market is down around 15%, more than erasing the overall gains in 2015.

• Another source of concern for Chinese investors has been the value of the renminbi. In August 2015, Chinese policymakers surprised markets with a devaluation of the renminbi against the dollar of approximately 4% and allowed greater flexibility in the exchange rate. The currency subsequently stabilized, but renewed depreciation of the renminbi occurred with the December 11 announcement that China would begin pegging its currency to a broad basket of currencies.

• The continued appreciation of the dollar against the renminbi and other currencies poses a downside risk to the U.S. inflation outlook.

The views expressed are those of the author, with input from the forecasting staff of the Federal Reserve Bank of San Francisco. They are not intended to represent the views of others within the Bank or within the Federal Reserve System.

'Paul Krugman: How Change Happens'

Does transformational rhetoric lead to revolutionary change?:

How Change Happens, by Paul Krugman, Commentary, NY Times: There are still quite a few pundits determined to pretend that America’s two great parties are symmetric — equally unwilling to face reality, equally pushed into extreme positions by special interests and rabid partisans. It’s nonsense, of course. ...

Still, there are some currents in our political life that do run through both parties. And one of them is the persistent delusion that a hidden majority of American voters either supports or can be persuaded to support radical policies, if only the right person were to make the case with sufficient fervor.

You see this on the right among hard-line conservatives, who insist that only the cowardice of Republican leaders has prevented the rollback of every progressive program instituted in the past couple of generations. ...

Meanwhile, on the left there is always a contingent of idealistic voters eager to believe that a sufficiently high-minded leader can conjure up the better angels of America’s nature and persuade the broad public to support a radical overhaul of our institutions. In 2008 that contingent rallied behind Mr. Obama; now they’re backing Mr. Sanders...

But as Mr. Obama himself found out as soon as he took office, transformational rhetoric isn’t how change happens..., his achievements have depended ... on accepting half loaves as being better than none: health reform that leaves the system largely private, financial reform that seriously restricts Wall Street’s abuses without fully breaking its power, higher taxes on the rich but no full-scale assault on inequality. ...

And the question Sanders supporters should ask is, When has their theory of change ever worked? Even F.D.R., who rode the depths of the Great Depression to a huge majority, had to be politically pragmatic, working not just with special interest groups but also with Southern racists.

Remember, too, that the institutions F.D.R. created were add-ons, not replacements: Social Security didn’t replace private pensions, unlike the Sanders proposal to replace private health insurance with single-payer. Oh, and Social Security originally covered only half the work force, and ... largely excluded African-Americans. ...

The point is that while idealism is fine and essential — you have to dream of a better world — it’s not a virtue unless it goes along with hardheaded realism about the means that might achieve your ends. ...

Sorry, but there’s nothing noble about seeing your values defeated because you preferred happy dreams to hard thinking about means and ends. Don’t let idealism veer into destructive self-indulgence.

Links for 01-22-16

• Fudging hell: Are results in top journals to be trusted? - The Economist
• Global Economy Can’t Withstand Four 2016 Fed Hikes - Larry Summers
• It’s Time to Make a Hard U-Turn- Narayana Kocherlakota
• Two serious mistakes in the Goodfriend and King review - Lars Svensson
• Updating Paul Krugman, "Evolution Groupie" - Evonomics
• The dead hand of austerity; left and right - mainly macro
• The Dead Hand of Austerity; Left and Right - Brad DeLong
• Workplace surveillance - Stumbling and Mumbling
• Expecting less inflation - Tyler Cowen
• Immigrants and homeownership - Vox EU
• Flooded cities - VoxEU

'New Experiments Challenge Economic Game Assumptions'

"We found that many of the so-called conditional cooperators are confused and do not seem to understand the public-goods game":

New experiments challenge economic game assumptions, EurekAlert: Too much confidence is placed in economic games, according to research by academics at Oxford University.

While traditional economic and evolutionary theory predicts that people will typically seek to maximize their own success, the results of economic games have shown people to be much more altruistic than expected.

But a series of experiments carried out by evolutionary biologists at Oxford found that people are just as generous towards computers, which cannot benefit materially from cooperation, and that simply misunderstanding the game may lead to altruism in many cases. ...

The Oxford research involved setting up public-goods games of varying complexity with humans and computers, and solely humans.

Dr Burton-Chellew said: 'We found that many of the so-called conditional cooperators are confused and do not seem to understand the public-goods game, appearing to think that being generous towards others will make them money. We primarily demonstrated this by having them play with computers, which cannot benefit from this cooperation, and showing that people behaved the same way regardless.

'The upshot of this is that these games are not reliably measuring motivations and therefore may not be informative of real-world behavior. This has obvious policy implications, as well as implications for our understanding of the evolution of social behavior. Furthermore, it casts doubt on the idea that there are fundamentally different social-types of people. I think it is more useful to focus on when and where people cooperate, rather than identifying who does and does not cooperate, especially in the artificial world of the lab.

'In short, I would argue that there is too much confidence placed in the results of these economic games; too much confidence in their ability to measure social preferences.'

When Robots Rule the Working World

I haven't had the courage to read the comments:

What happens if robots take all the jobs?, by Mark Thoma: The theme of this year's World Economic Forum (WEF) meeting in Davos, Switzerland, can be summarized as the impact of the fourth industrial revolution on jobs, inequality and the quality of life.

How will digital revolution change our lives? Will robots take most of the good jobs? Are we headed for a future where a few people -- those who are fortunate enough to own the robots and other technology needed to produce goods and services -- receive most of the income, and those who don't struggle to find work that pays enough to feed their families? ...

Real Median Household Income in the US

Links for 01-21-16

• Lessons From Vermont - Paul Krugman
• A quick look at recent wage growth - Jared Bernstein
• 2015 Was the Hottest Year on Record - Scientific American
• The Declining Marginal Product of Capital - Growth Economics
• Graph For the Day: Is QE4 Far Away? - Roger Farmer
• Has Macroeconomic Policy Been Overly Tight? - David Beckworth
• Immigrants and homeownership - Vox EU
• To the Fed and the Treasury: Can we Play Cooperatively? - Roger Farmer
• The Federal Reserve and awareness of racial inequality - Nick Bunker
• Snapshots and Visualizations of the Global Economy - Tim Taylor
• Money in a modern economy with no banks - Bank Underground
• Why America Stopped Being a Startup Nation - Noah Smith
• The trade consequences of the oil price - VoxEU
• Flooded cities - VoxEU

'A Different Kind of Ash-Hole Problem: Does the Distribution of Costs Matter to Economists?'

Tim Haab:

A different kind of ash-hole problem: Does the distribution of costs matter to economists?. Environmental Economics: ... Coal-ash is a by-product of coals fired electricity production. The ash from burning coal is stored in big lagoon-like ponds called ash-impoundments, or as I like to call them, ash-holes. ...

Beyond the obvious yuck factor and potential standard externality problems associated with leakage and breeches of the lagoons, location of these ash-holes near low-income populations creates concerns over environmental justice.

A federal civil rights commission is holding a hearing this week about whether coal ash disproportionately affects low-income and minority populations.

Lenore Ostrowsky, a lawyer for the U.S. Commission on Civil Rights, said federal data already show that some of those populations bear the highest burden...

Ohio's coal-ash containment areas are mainly in rural, low-income areas, and most are along the Ohio River...

Economists are often bad at considering the distributional impacts of policies: To the point that we often ignore issues of equity in favor of the more objective measure of efficiency. If two policies were to result in the same net benefits to society, but different distribution of those benefits within society, the efficiency-oriented economist would have trouble distinguishing between the policies.

But what if one distribution of benefits (or costs) is socially preferred to another. Or put a different way, what if society were willing to forego resources (willing to pay?) to ensure a different distribution of benefits (or costs)? In that case, the distribution of resources might fit within the realm of the efficiency paradigm as now society can be viewed as better or worse off depending on the distribution of resources.

Of course this raises all kinds of questions about morals, ethics, social welfare, interdependent utility...but it is at least a recognition that the distribution of resources has real and tangible benefits and costs and might be considered within the neoclassical economic framework.

Just a thought.

'The Impact of Consumer Financial Regulation: Evidence from the CARD Act'

This is from Microeconomic Insights, a new "home for accessible summaries of high quality microeconomic research which informs the public about microeconomic issues that are, or should be, in the public’s eye." ( I edited four of the articles, but this is not one of them, Twitter: http://www.twitter.com/micro_econ, RSS: http://microeconomicinsights.org/feed/):

The impact of consumer financial regulation: evidence from the CARD Act: In the wake of the financial crisis, there has been a surge of interest in regulating consumer financial products (e.g., Campbell et al., 2011). In the United States, the 2010 Dodd-Frank “Wall Street Reform and Consumer Protection Act” established a Consumer Financial Protection Bureau to monitor and regulate mortgages, credit cards, and other similar products. In July 2013, the European Commission proposed new legislation to simplify disclosures and tighten guidance requirements for financial products.

Does such regulation benefit consumers? Critics have expressed skepticism about the effectiveness of regulation, while warning of unintended consequences. Proponents argue that it is necessary, as consumer financial markets have become increasingly unfair, with firms taking advantage of consumers’ behavioral biases—such as inattention and present bias—to earn large profits.

In Agarwal et al. (2015), we aim to advance this debate by examining the consequences of one such regulation. We study two aspects of the 2009 Credit Card Accountability Responsibility and Disclosure (CARD) Act in the United States:

• Restrictions on certain types of credit card fees and
• The introduction of a repayment “nudge.”

We find, first, that consumer fees declined after the regulation. But we find no evidence of an offsetting increase in interest rates or the reduced access to credit that critics had warned of (American Bankers Association, 2013).  Second, we find that the repayment nudge had a small but significant effect on consumer behavior.

These findings come from a panel dataset of 160 million credit card accounts held by the eight largest banks in the US. The data include account-level information on contract terms, utilization, and payments at the monthly level from January 2008 to December 2012. They also include consumers with different levels of credit worthiness: about 30% of consumers in our data have a FICO score of “fair or lower” (below 660) and about 17% have a score of “bad” (below 620). ...

Links for 01-20-16

• Weakened at Bernie's - Paul Krugman
• The US Phillips Curve: Back to the 60s? - Olivier Blanchard
• Write Congress! (If You Want Higher Rates) - Narayana Kocherlakota
• Human Capital Contracts Would Discriminate - Mike Konczal
• A Small Silent Minority - Paul Krugman
• Digital Dividends and Development - Tim Taylor
• Against anti-economics - Stumbling and Mumbling
• Quantitative easing: A new VoxEU eBook - VoxEU
• The ECB and the Fed: A comparative narrative - Vox EU

'Who Lost the White Working Class?'

Robert Reich:

Who Lost the White Working Class: Why did the white working class abandon the Democrats? The conventional answer is that Republicans skillfully played the race card. In the wake of the Civil Rights Act, segregationists like Alabama Governor George C. Wallace led southern whites out of the Democratic Party. Later, Republicans charged Democrats with coddling black “welfare queens” (Ronald Reagan popularized the term), being soft on black crime (George W. Bush’s “Willie Horton” ads in 1988), and trying to give jobs to less-qualified blacks over more-qualified whites (the battle over affirmative action).

The bigotry now spewing forth from Donald Trump and several of his Republican rivals is an extension of this old race card, now applied to Mexicans and Muslims – with much the same effect on the white working class voters, who don’t trust Democrats to be as “tough.”  

But this doesn’t tell the whole story. Democrats also abandoned the white working class. ...

In part, it was because Democrats bought the snake oil of the “suburban swing voter” – so-called “soccer moms” in the 1990s and affluent politically-independent professionals in the 2000s – who supposedly determined electoral outcomes.

Meanwhile, as early as the 1980s they began drinking from the same campaign funding trough as the Republicans – big corporations, Wall Street, and the very wealthy. ...

Nothing in politics is ever final. Democrats could still win back the white working class – putting together a coalition of the working class and poor, of whites, blacks, and Latinos.

This would give them the political clout to restructure the economy – rather than merely enact palliative programs papering over the increasing concentration of wealth and power in America.  

But to do this they’d have to stop obsessing over upper-income suburban swing voters, and end their financial dependence on big corporations, Wall Street, and the wealthy. Will they? If not, a third party might emerge that does it instead.

'The Political Right’s Dangerous Support for Economic Quackery'

"Why oh why can't we have a better press corps?" This is Simon Wren-Lewis:

The political right’s dangerous support for economic quackery: You may remember Niall Ferguson’s disastrous attempt to claim that George Osborne’s imagined success proved Keynesians and Keynes were wrong. That kind of nonsense makes it into a serious paper like the Financial Times because it is written by a famous history professor, or maybe on other occasions by a senior policy maker. But for those who only read this serious press, it is in fact one example of many. There is a little cottage industry out there of so called journalists and think tanks who peddle economic quackery to support right wing policies.

Take, for example, this recent piece by James Bartholomew in the Spectator. Deficit spending by the government never works, he claims. Presumably the opposite also holds, which is that fiscal consolidation (aka austerity) never hurt anyone. Mainstream economics has it all wrong. One of the skills writers like this have is to make very little evidence seem like a lot. ...

To his credit Bartholomew does admit that logically Keynesian policies should work. But there is an awful lot he does not tell you. ... There is no way that his article is a measured piece of journalism. It is designed to discredit the economics that is taught to every student the world over.

There is plenty of this on the left too: people who want to tell you mainstream economics is all wrong. Yet until very recently at least, the influence of this group on politicians on the mainstream left had been minimal, and this group has a far smaller public presence than their equivalent on the right. On the right they are ubiquitous. ...

This is dangerous for two reasons. The first is that it can lead to major macroeconomic policy errors: in the UK think money supply targets, entering the ERM at an overvalued rate, and 2010 fiscal consolidation, in the Eurozone think of the Stability and Growth Pact and the 2011-13 recession. The second is that it encourages a lazy anti-science attitude, all too evident in climate change denial. If the political right in the UK and Europe want to see where this could lead, look across the Atlantic. With the left in disarray and flirting with non-mainstream economics, the right has an excellent opportunity (when a new Chancellor takes over in the UK, for example) to re-engage with mainstream economics, and cast off the quackery of the Ferguson and Bartholomew ilk.

Links for 01-19-16

• Causes of the Great Recession and the Prospects for Recovery - Brad DeLong
• Wealth Inequality Rising Fast, Oxfam Says, Faulting Tax Havens - NYTimes
• Should cable television channels be offered à la carte? - Microeconomic Insights
• Improving health through socialised medicine: Evidence from Turkey - Vox EU
• Competition and ideological diversity - Microeconomic Insights
• Please: Lets Agree to Speak the Same Language - Roger Farmer
• MLK Day Reflections on the FOMC - Narayana Kocherlakota
• Monetary Policy and Inequality - Stephen Williamson
• Some Economics for Martin Luther King Jr. Day - Tim Taylor
• Neo-Fisherian Equilibrium with upper and lower bounds - Nick Rowe
• ‘Metrics Monday: The Tobit Temptation - Marc Bellemare
• Interview with Sir Charles Bean - Cecchetti & Schoenholtz
• Health Reform Is Hard - Paul Krugman

Revolution

This song is stuck in my head today. Can't imagine why:

You say you want a revolution
Well, you know
We all want to change the world

You tell me that it's evolution
Well, you know
We all want to change the world ...

You say you got a real solution
Well, you know
We'd all love to see the plan...

But if you go carrying pictures of chairman Mao
You ain't going to make it with anyone anyhow...

Don't you know know it's gonna be alright
Alright, alright...

'Paul Krugman, Bernie Sanders, and Medicare for All'

Dean Baker (this was posted at Econospeak instead of CEPR due to website troubles -- assuming CPER's Creative Commons license still applies):

Paul Krugman, Bernie Sanders, and Medicare for All: Paul Krugman weighs in this morning on the debate between Bernie Sanders and Hillary Clinton as to whether we should be trying to get universal Medicare or whether the best route forward is to try to extend and improve the Affordable Care Act. Krugman comes down clearly on the side of Hillary Clinton, arguing that it is implausible that we could get the sort of political force necessary to implement a universal Medicare system.

Getting universal Medicare would require overcoming opposition not only from insurers and drug companies, but doctors and hospital administrators, both of whom are paid at levels two to three times higher than their counterparts in other wealthy countries. There would also be opposition from a massive web of health-related industries, including everything from manufacturers of medical equipment and diagnostic tools to pharmacy benefit managers who survive by intermediating between insurers and drug companies.  

Krugman is largely right, but I would make two major qualifications to his argument. The first is that it is necessary to keep reminding the public that we are getting ripped off by the health care industry in order to make any progress at all. The lobbyists for the industry are always there. Money is at stake if they can get higher prices for their drugs, larger compensation packages for doctors or hospitals, or weaker regulation on insurers.

The public doesn’t have lobbyists to work the other side. The best we can hope is that groups that have a general interest in lower health care costs, like AARP, labor unions, and various consumer groups can put some pressure on politicians to counter the industry groups. In this context, Bernie Sanders’ push for universal Medicare can play an important role in energizing the public and keeping the pressure on.

Those who think this sounds like stardust and fairy tales should read the column by Krugman’s fellow NYT columnist, health economist Austin Frakt. Frakt reports on a new study that finds evidence that public debate on drug prices and measures to constrain the industry had the effect of slowing the growth of drug prices. In short getting out the pitchforks has a real impact on the industry’s behavior.

The implication is that we need people like Senator Sanders to constantly push the envelope. Even if this may not get us to universal Medicare in one big leap, it will create a political environment in which we can move forward rather than backward.

The other point has to do with an issue that Krugman raises in his blogpost on the topic. He argues that part of the story of lower health care costs in Canada and other countries involves saying “no,” by which he means refusing to pay for various drugs and treatments that are considered too expensive for the benefit they provide.

While there is some truth to this story, it is important to step back for a moment. In the vast majority of cases, the drugs in question are not actually expensive to manufacture. The way the drug industry justifies high prices is that they must recover their research costs. While the industry does in fact spend a considerable amount of money on research (although they likely exaggerate this figure), at the point the drug is being administered this is a sunk cost. In other words, the resources devoted to this research have already been used; the economy doesn’t somehow get back the researchers’ time and the capital expended if fewer people take a drug that is developed from their work.

Ordinarily economists treat it as an absolute article of faith that we want all goods and services to sell at their marginal cost without interference from the government, like a trade tariff or quota. However in the case of prescription drugs, economists seem content to ignore the patent monopolies granted to the industry, which allow it to charge prices that are often ten or even a hundred times the free market price. (The hepatitis C drug Sovaldi has a list price in the United States of $84,000. High quality generic versions are available in India for a few hundred dollars per treatment.) In this case, we are effectively looking at a tariff that is not the 10-20 percent that we might see in trade policy, but rather 1,000 percent or even 10,000 percent.

This sort of gap between price and marginal cost leads to exactly the sort of distortions that economists predict when the government intervenes in a market with trade tariffs, except the distortions are hugely larger with drugs. Companies have incentive to engage in massive marketing efforts, they push their drugs for conditions for which they may not be appropriate, and they conceal evidence suggesting their drugs may be less effective than advertised, or possibly even harmful. They also lobby politicians for ever longer and stronger patent protection, and they use the legal system to harass potential competitors, both generic and brand. Even research is distorted by this incentive structure, with large portions of the industry’s budget being devoted to developing copycat drugs to gain a share of a competitor’s patent rents.

Perhaps the worst part of this story is that the patent monopolies put us in a situation where we might have to say no. The industry’s monopoly allows it to say that it will not turn over a life-saving drug for less than $100,000, $200,000, or whatever price tag it chooses. However, if there was no patent monopoly, we would be looking at buying this drug at its cost of production. That will rarely be more than $1,000 and generally much less. At those prices, it will rarely make sense to say no. (The same issue arises with most medical equipment – once we have the technology, producing an MRI is relatively cheap, as would be the cost of an individual screening.)

We do have to pay for the research, but the way we are now doing it is incredibly backward. It is like paying the firefighters when they show up at the burning house with our family inside. Of course we would pay them millions to save our family (if we had the money), but it is nutty to design a system that puts us in this situation.

We should be looking for a system that pays for the research upfront. There are various mechanisms to accomplish this goal. (Here’s my plan for a system of publicly funded clinical trials.) Obviously overhauling our system for financing drug research is not something that is done overnight, but it is an issue that needs attention. The current system is incredibly wasteful and it needlessly puts in a situation where we have to say no in contexts where the costs to society of administering treatment are actually very low.

This doesn’t mean that we would pay for everything for everybody. There are some procedures that actually are very expensive, for example surgeries requiring many hours of the time of highly skilled surgeons. But we should be trying to design a system that minimizes these sorts of situations, rather than making them an everyday occurrence.

Paul Krugman: Health Reform Realities

Would it be worth it to try to enact single-payer health care system?:

Health Reform Realities, by Paul Krugman, Commentary, NY Times: ... Obamacare is ... a somewhat awkward, clumsy device with lots of moving parts. This makes it more expensive than it should be, and will probably always cause a significant number of people to fall through the cracks.

The question for progressives — a question that is now central to the Democratic primary — is whether these failings mean that they should re-litigate their own biggest political success in almost half a century, and try for something better.

My answer ... is that they shouldn’t, that they should seek incremental change on health care (Bring back the public option!) and focus their main efforts on other issues...

If we could start from scratch, many, perhaps most, health economists would recommend single-payer, a Medicare-type program covering everyone. But single-payer wasn’t a politically feasible goal in America, for three big reasons...

First, like it or not, incumbent players have a lot of power. ...

Second, single-payer would require a lot of additional tax revenue — and we would be talking about taxes on the middle class...

Finally, and I suspect most important, switching to single-payer would impose a lot of disruption on tens of millions of families who currently have good coverage through their employers. ...

What this means, as the health policy expert Harold Pollack points out, is that a simple, straightforward single-payer system just isn’t going to happen. ...

Which brings me to the Affordable Care Act, which was designed to bypass these obstacles. ... Even so, achieving this reform was a close-run thing: Democrats barely got it through during the brief period when they controlled Congress. Is there any realistic prospect that a drastic overhaul could be enacted any time soon — say, in the next eight years? No.

You might say that it’s still worth trying. But politics, like life, involves trade-offs.

There are many items on the progressive agenda, ranging from an effective climate change policy, to making college affordable for all, to restoring some of the lost bargaining power of workers. Making progress on any of these items is going to be a hard slog, even if Democrats hold the White House and, less likely, retake the Senate. ...

So progressives must set some priorities. And it’s really hard to see, given this picture, why it makes any sense to spend political capital on a quixotic attempt at a do-over, not of a political failure, but of health reform — their biggest victory in many years.

Links for 01-18-16

• World oil supply and demand - Econbrowser
• Economics Rules by Dani Rodrik - mainly macro
• Growth and Employment Tell Different Stories - NYTimes
• The Hive Becomes More Populous - Economic Principals
• The Bundy Brigade’s Economic Delusions - James Surowiecki
• What The Big Short Gets Right (and  Politico Gets Wrong) - Mike Konczal
• WaPo Does Another OMG!  on Social Security and Medicare - Dean Baker
• What parts of the social world admit of explanation? - Understanding Society
• China devaluation – a necessary evil? - Gavyn Davies
• Bank Failures by Year - Calculated Risk

'The Price of Oil, China, and Stock Market Herding'

Olivier Blanchard:

The Price of Oil, China, and Stock Market Herding: The stock market movements of the last two weeks are puzzling.

Take the China explanation. A collapse of growth in China would indeed be a world changing event. But there is just no evidence of such a collapse. ...

Take the oil price explanation. It is even more puzzling. Traditionally, it was taken for granted that a decrease in the price of oil was good news for oil importing countries such as the United States. ... We learned in the last year that, in the short run, the adverse effect on investment on energy producing firms could come quickly and temporarily slow down the effect, but this surely does not undo the general conclusion. Yet the headlines are now about low oil prices leading to low stock prices. ...

Maybe we should not believe the market commentaries. Maybe it was neither oil nor China. Maybe what we are seeing is a delayed reaction to the slowdown in the world economy... Maybe…

I think the explanation is largely elsewhere. I believe that to a large extent, herding is at play. If other investors sell, it must be because they know something you do not know. Thus, you should sell, and you do, and so down go stock prices. Why now? Perhaps because we have entered a period of higher uncertainty. ...

So how much should we worry? This is where economics ... gives the dreaded two-handed answer. If it becomes clear within a few days or a few weeks that fundamentals are in fact not so bad, stock prices will recover... If, however, the stock market slump lasts longer or gets worse, it can become self-fulfilling. Low stock prices lasting for long lead to lower consumption, lower demand, and, potentially, to a recession. The ability of the Fed, fresh out of the zero lower bound, to counteract a slowdown in demand remains limited. One has to hope for the first scenario, but worry about the second.

Links for 01-17-16

• TINA and the ACA - Paul Krugman
• Why creating single-payer health care in America is so hard - Harold Pollock
• The Grand Strategy of Rising Superpower Management - Brad DeLong
• A ranking of financial economists by centrality - Vox EU
• Why Does "Pi" Appear in the Normal Density - Dave Giles
• Replicability and Publication - Leisure of the Theory Class
• What Davos should be talking about - CBS News
• What #ResistCapitalism Gets Wrong - Noah Smith
• Deliberation, rationality, and reasoning - Understanding Society
• The stabilising role of dollar borrowing - Vox EU

'Oil Goes Nonlinear'

Paul Krugman:

Oil Goes Nonlinear: When oil prices began their big plunge, it was widely assumed that the economic effects would be positive. Some of us were a bit skeptical. But maybe not skeptical enough: taking a global view, there’s a pretty good case that the oil plunge is having a distinctly negative impact. Why? ...

I believe ... there’s an important nonlinearity in the effects of oil fluctuations. A 10 or 20 percent decline in the price might work in the conventional way. But a 70 percent decline has really drastic effects on producers; they become more, not less, likely to be liquidity-constrained than consumers. Saudi Arabia is forced into drastic austerity policies; highly indebted fracking companies find themselves facing balance-sheet crises.

Or to put it differently: small oil price declines may be expansionary through usual channels, but really big declines set in motion a process of forced deleveraging among producers that can be a significant drag on the world economy, especially with the whole advanced world still in or near a liquidity trap.