The Economist on the Inflation Tax

Greg Mankiw has a problem with one aspect of something in this discussion:

Investors who bought Treasury bonds in 1946, when yields were around current levels, did not suffer a formal default. But over the following 35 years they lost money in real terms at a rate of 2% a year. The cumulative real loss was 91%. By that standard, Greek creditors, who recently suffered a 50% loss via default, were lucky.

Greg’s comment is simply this:

Answer: The second number is inconsistent with the first. Note that .98^35=.49, so we get only a 51 percent cumulative loss. In fact, the price level from 1946 to 1981 rose by a factor of about 5, so holding currency with a zero nominal return led to a real loss of only about 80 percent.

Interest rates on Treasury bonds reflect the expected inflation rate at the time a person purchases the bond plus the real interest rate at the time. Treasury bonds in 1946 were generally around 2.5% so if actual inflation over the period that the person held the bond exceeded expected inflation, then ex post real rates would be lower that the real rate expected when the person purchased the bond. But eventually the bond matures and the person is free to renegotiate based on market conditions and the expected inflation rate when purchases new bonds. So was The Economist referring to 10-year Treasuries or 30-year Treasuries? Simply put – it is not inflation but unexpected inflation that leads to the type of losses described in this discussion. To fair, the discussion later admits:

The answer to that conundrum may be that default happens suddenly, whereas inflation and depreciation are slower, giving investors more time to adjust by demanding higher interest rates to compensate for their losses. This is particularly true in the case of short-term debt, such as Treasury bills; inflation is unlikely to do serious damage to a portfolio in the course of a few months.

Alas, the discussion goes off track in my view with:

But by buying bonds in the name of “quantitative easing”, central banks are influencing interest rates of all maturities these days. By holding down bond yields, the authorities are employing a policy some have dubbed “financial repression”, in which real returns on government debt are reduced. The idea is to make investors buy riskier assets, such as equities and corporate bonds. In effect, the bond vigilantes have been neutered.

Doesn’t financial repression suggest that interest rates are low because the Federal Reserve has suppressed market forces creating a difference between the market demand for government debt and its supply? One would think the real story is the incredibly weak state of the overall economy has been the driving factor in keeping real interest rates so low.

Accelerating Inflation?

Today (October 27, 2013), the New York Times has an excellent page 1 story by Binyamin Applebaum indicating that more and more economists favor the encouragement of inflation as a way to fight the persistent stagnation that the U.S. economy has been suffering from since the Big Financial Flop of 2008 and the resulting Great Recession.  As Paul Krugman notes in his blog, this policy is what he's been advocating for awhile. This pro-inflation company includes even Kenneth Rogoff, the Chicken Little of government debt.

One argument against this view is that of economists who "warn that the Fed could lose control of price as the economy recovers." The idea is that inflation will accelerate (speed up) in a way that gets us back to the conditions that the U.S. last saw during the 1970s.The problem with this "Back to the 1970s" perspective is a key fact that was left out of the news story.

What's left out is the fact that the official (U3) unemployment rate is currently at 7.2%, which is significantly higher than almost all estimates of the inflation-barrier unemployment rate, also known as the NAIRU. (The initials stand for the Non-Accelerating Inflation Rate of Unemployment. This rate is known to ignorami as the "natural" rate of unemployment.) Worse, the ratio of paid employment to the potentially working population has stayed distressingly low since the Great Recession (even when corrected for the population's changing age profile). It's true that the official unemployment rate has edged downward, but this is largely an illusion: as unemployed people stop looking for jobs (discouraged by the bad job situation), the statisticians count them as having dropped out of the labor force and therefore as no longer unemployed. If all of those workers who left the labor force were counted as "unemployed," the unemployment rate would be much higher. Heidi Shierholz of the Economic Policy Institute has shown this by looking at real-world data.

Anyway, the point is that the NAIRU concept cuts both ways. In happier times, conservative economists could point to this minimum and use it to argue against people who want full employment. They'd say that "we can't go there because there be monsters," where of course the monsters are worsening inflation rates. If the Fed encourages inflation, people will begin to expect inflation and will act to protect the real purchasing power of their incomes (or to buy now, before prices go up). This means that inflation becomes built into the economy's normal behavior. If the unemployment rate stays below the NAIRU, the inflation gets worse and worse.

But nowadays, the U.S. economy has unemployment significantly above this threshold. In the current situation, the inflation rate should be falling and it is doing that, as Appelbaum's graph shows. Except for the usual barriers against cutting wages and prices (some of which were mentioned in the article), it could easily become negative, so that we would see deflation (as actually seen in Japan). People would expect falling prices, which would then lead to behavior that causes prices to fall further. In this case, we would see a vicious cycle that encourages depression.

That is, the "Back to the 1970s" scenario might have applied in 2006, when the job situation was significantly better, but it cannot apply now. Any inflationary surge that the Federal Reserve and the federal government engineer would be canceling out the current deflationary tendency. It wouldn't actually cause rising inflation.

Putting it a different way, those who are always shouting "inflation!"  are assuming that the economy is operating at the NAIRU, or what used to be called the "inflation barrier" or full employment.

The 64 thousand ruble question -- also not addressed by Appelbaum -- is how the Fed and the federal government are ever going to cause an inflationary surge. The Fed's stimulus as mostly created a lot of excess reserves in the banks' coffers rather than stimulating the economy and the inflation rate. The federal government has been going in the opposite direction, joining most of the state and local governments to encourage deflation.  -- Jim Devine

A Fuzzchart on Federal Spending Courtesy of John Taylor

Mark Thoma used to crack me up when he would refer to those Jerry Bowyer National Review graphs as Fuzz Charts since Bowyer usually tried to deceive his readers. Now if you miss those good old days – John Taylor has kindly decided to take over when Jerry left off with his latest:

A starting point is to lay out in simple big picture terms what the House and Senate budget resolutions passed earlier this year look like. The chart below tries to do this. It was put together from those resolutions passed last March. It provides the year-by-year totals (not ten years sums) needed to compare the two budgets. This kind of chart is more useful for comparing budgets than the ten-year multi-trillion dollar totals which few people can understand. The chart shows the recent history of federal outlays along with the path of outlays as a percentage of GDP under the Senate proposal and under the House proposal. There is a big difference in these two paths. Spending gradually comes down to pre-crisis levels as a share of GDP under the House plan and remains high under the Senate plan. I have been arguing since 2009 that undoing the recent spending binge is a reasonable goal, and prefer the House version on that count.

My problem with his chart is its historical starting point is 2000 when Federal spending as a share of GDP was only 18.5%. Note the Ryan plan would bring us back to this level whereas the Senate plan would leave this share closer to 22%. A naïve reader might think the historical norm was the 18.5% observed in 2000, but my graph takes us back to 1961. And it turns out that Federal spending as a share of GDP was not always as low it was at the end of the Clinton years. The peace dividend years are over and future health care spending isn’t going to what it was in 2000 – but John Taylor wants us to think there is something magical and normal about the Ryan budget.

Harrisonburger Predicts Victory in VA AG Race by Harrisonburger Republican

I am the Harrisonburger making the prediction that fellow Harrisonburger, Mark Obenshain, whom I have known for decades, will be elected Attorney General of Virginia in the nationally watched election coming up in VA shortly.  OTOH, I expect that the Dems, McAuliffe and Northam, will win the races for Governer and Lieutenant Governor, although neither of those is a sure thing, particularly the second.

Of course, the most important race is that for Governor, and if the current polls showing Terry McAuliffe ahead of Ken ("the Cooch") Cuccinelli prove to be correct in the end, this will be the first time since 1973 when Republican Mills Godwin (a former Byrd Machine Dem) was elected Governor while someone from the same party sat in the White House, Republican Richard Nixon.  The state has had a rebellious contrary streak since to always go for someone of the opposite party to the person in the WH.  But, moderate Republicans are angry at how Cuccinelli grabbed the nomination in a stacked conventino rather than having a primary over Lt. Gov. Bolling, GOP business leaders in NoVa have been unhappy at the Cooch's opposition to the transportation plan put forward by GOP Gov. McDonnell (whose scandal problems have not helped and in which the Cooch is also somewhat involved), although now the Cooch says that he will not undo the plan, on top of which there are the impacts of the government shutdown, massively unpopular across the board here in VA, which the Cooch has said he might have voted for, on top of which Libertarian candidate Robert Sarvis is scoring 10% in the polls reportedly drawing more from otherwise likely GOP voters than from likely Dem voters.  The two have their final debate tonight, but unless one of them makes some massively idiotic statement, I doubt it will affect things much.

However, I suspect the outcome will be much closer than most polls show.  I see three reasons: 1) Cuccinelli has intense support from his base, which will turn out, and WaPo today reported that in the final stretch he is leaning to the base, not playing ads in NoVA and trying to get it out; 2)  Some of those Sarvis voters will probably "go home" to whomever they initially supported on "don't waste your vote" argument, with that probably adding a few points for the Cooch, and 3)  Two weeks is the limit of short-term memory, and while now only one week after the end of the shutdown many are very angry and motivated against Cuccinelli, by election day a lot of those softer supporters, minorities and younger voters will have gotten past that immediate annoyance and may lose their anger and motivation.  The Cooch can still pull this off, particularly if McAuliffe stumbles and says something stupid.

BTW, my own personal opposition to him has many grounds, but probably at the top of the list is the lawsuit he brought against the University of Virginia as AG demanding all the emails and other records of climatologist, Michael Mann, from when he was at UVa.  Mann has been at Penn State for some time, so this was a dredge through ancient history to try to find some nonexistent smoking gun disproving global warming, which did get rejected by the courts.  But, quite aside from the specifics of the global warming issue, this assault on academic freedom is simply beyond the pale for me.

The Lieutenant Governor race is more important than one might think because the state Senate is evenly split between the parties.  Who is LG determines who controls the Senate, and currently that is relatively moderate but still GOP Bill Bolling.  If Northam beats Jackson, as polls suggest, the Dems will gain control.  I note that Jackson is further to the right to the point of complete insanity, claiming that modern libearlism is worse for African-Americans than was slavery or the KKK.  I note that he is an African-American minister and got the nomination out of 7 candiates at the convention that was heavily dominated by Tea Partiers impressed by whomever could be farther and crazily to the right than the others.  That proved to be Jackson, who is so far out that the other two GOP candidates have clearly avoided being seen with him.  But, the lack of a Libertarian distraction and as a spinoff if turnout strongly favors the right wing base, Jackson couild win, and very likely will if Cuccinelli does.  This is not out of the question.

Which brings us to my fellow resident of Harrisonburg, the GOP AG candidate.  Mark has long been asociated wtih the conservative wing of the VA GOP, with his late father having been one of the main leaders of that wing in the past.  His cred with the Tea Partiers is solid, and there is little distance between his and Cuccinelli's views.  Indeed they are personally close, having shared a desk apparently in the state Senate, where Mark is still our local Senator, while the Cooch was there prior to getting elected AG four years ago.  Nevertheless, Mark looks like the rational moderate compared to the other two and also does not have a Libertarian distracter.  The polls show his Dem opponent Herring slightly in the lead, but that race is clearly much closer than the other two.  I suspect in the end the enthusiasm factor of the TP base, plus some more moderate types willing to vote for him as he has assiduously avoided saying obviously crazy things, will put him over the top. 

Nevertheless, he really is a social and otherwise conservative along Cooch lines, and when he was on the Board of Visitors that oversees James Madison University (JMU) where I teach economics, he made his biggest splash making the student health center not be able to hand out contraceptives.  If  elected, he will not be undoing the moves that Cuccinelli made to close down abortion clinics and other such policies.

Barkley Rosser

Update:  One more serious problem with Cuccinelli is that unlike the previous 6 VA AGs who ran for higher office over several decades, he has not resigned his position prior to running.  As it comes down, there are major legal issues arising over this election, most noticeably the purge of 57,000 voters from the lists, supposedly illegal, although it is increasingly clear that a substantial minority of them are properly and legally registered, although there is no way to adjudicate all this prior to the election, and, guess who?, is responsible ultimately for overseeing this?  Well, Ken Cuccinelli, candidate for Governor and sitting Attorney General.  This scum must not become Governor.  Period.

The Greenspan FED and the Housing Bubble – Two Critiques

Steve Pearlstein and John Taylor are both blaming certain aspects of Federal Reserve policy during the latter years of the Greenspan era but their critiques are quite different. Taylor references something by Alexandra Wolfe:

He said he is baffled by all the blame that has been piled on him. Since the recession, critics have said the increased money supply and low interest rates during his tenure at the Fed from 1987 to 2006 led to bubble investments. Mr. Greenspan first heard that theory, he says, in 2007, when John Taylor, a professor of economics at Stanford University who has advised Republicans, made the connection between easy money and the housing bubble. "It had absolutely nothing to do with the housing bubble," he says. "That's ridiculous."

While Taylor continues to argue for his thesis that the FED kept interest rates too low for too long, I sort of agree with Greenspan. Doesn’t John Taylor recall that the employment to population ratio remained at or below 62.5% until the spring of 2005? In fact, it did not reach 63% until 2006. I’m sure he remembers the dismal state of the labor market back then as the economic advisors for President Bush (of which he was one) was excusing serial doses of fiscal stimulus (two tax cuts, a large increase in defense spending, and an unpaid for new prescription drug benefit) on arguments that a depressed economy needed aggregate demand stimulus. And many economists note – monetary stimulus may be preferred to fiscal stimulus if that means lower interest rates and increased business investment. In fact, the FED started raising interest rates in 2004 in part because of the extent of Bush’s fiscal stimulus. Not exactly a pro-growth policy mix. But you say there was a housing bubble, which later burst leading to our current mess. Pearlstein’s critique is more on point:

His latest book, oddly named “The Map and the Territory,” is meant to be an account of his intellectual journey to discover why, as the nation’s top bank regulator and its most famous economic prognosticator, he failed to see it all coming. Why had the markets, which for centuries had been so adept at self-correction, failed this time? Why had bank executives, with every incentive to protect their fortunes and reputations, knowingly gambled it all away? What we find, however, is that Greenspan’s journey of discovery brings him right back to where he began — to an unshakable faith in free markets, an antipathy toward market regulation, and a conviction that progressive taxes and social spending are to blame for slow growth, stagnant wages and exploding deficits. Those who have followed his career know that it was Greenspan who gave the green light to bank consolidation, Greenspan who pushed financial deregulation, Greenspan who advocated new global rules that would have reduced bank capital reserves and Greenspan who blocked efforts to crack down on abusive subprime lending. But if you are looking for him to accept any responsibility for the crisis that ensued, you will be sorely disappointed.

But I guess an economic advisor to Romney-Ryan isn’t going to criticize deregulation given it is the position of many leading Republicans that we should not re-regulate. This matters more than a historical exercise of where the Greenspan FED failed as these issues will face the Yellen FED. Taylor is already arguing that the FED should get back to his magical rule as soon as possible. Count me as hoping the Yellen ignores Taylor’s advice on monetary policy as she seeks to have our policymakers reverse some of the Greenspan deregulations.

Reform Translated Means Dooh Nibor Economics

With debt default temporarily averted and the Federal government back open for a few months, we are already hearing certain members of both parties talking about “reform”. But tax “reform” typically refers to having the middle class lose a few tax deductions so that we can cut tax rates on the rich even more – and any Republican version of this would mean even less tax revenues. But don’t fret boys and girls as they will reduce spending via entitlement “reform”, which means again that the middle class and the poor would have even less income so the rich can pay less in taxes. What did Paul Krugman call this?

That agenda is to impose Dooh Nibor economics -- Robin Hood in reverse. The end result of current policies will be a large-scale transfer of income from the middle class to the very affluent, in which about 80 percent of the population will lose and the bulk of the gains will go to people with incomes of more than $200,000 per year.

So why don’t the center right Democrats who want to assist the Republicans in this agenda just drop the word reform and speak clearly? Is it because if they did speak in plain English, the public would turn against them? One small glimmer of hope is that the repeal of the medical device excise tax – which would be a giveaway to the medical device fat cats – was not part of yesterday’s deal in part because the dreaded Tea Partiers actually turned against this repeal. A small bit of light finally appears?

Please, Mr. President, Just Bite The Bullet And Declare The Debt Ceiling Unconstitutional!

Which it is, btw, the 14th Amendment and all that, although some fools think that Treasury can prioritize and just pay interest on the debt while not paying all sorts of other legally mandated bills.  As it is, it is against the law not to pay legally mandated bills, although those who want to blow past the debt ceiling say that all that would be involved would be delaying paying the bills.  But the effect would be very bad for the US and world economy, as leaders from all over the world are telling us about as loudly as they can, not that those who are pushing for a default are paying the slightest shred of attention to them.

Quite aside from the fact that the debt ceiling is unconstitutional, even if, Mr. President, you are reported to accept the argument of Laurence Tribe that it is constitutional, you yourself have analyzed how given the current polarization, it just sets you and your successors up for repeated blackmail.  You already caved in 2011 and are now trying to put the genie back into the bottle.  It looks like it is not going, with Vix soaring and Congress just apparently unable to cut any sort of deal.  Maybe, just maybe, Boehner will simply pass some six weeks extension at the last minute, but that simply puts the day of reckoning off six weeks.  It is time to end this once and for all, even though you will probably be impeached by the loonies in the House. Rest assured that you will not be convicted by the Senate, and the world and history will be grateful, even if SCOTUS later stupidly disagrees with the judgment and reinstates the damned thing.  Hopefully they will not, and the US and world economies and future presidents will be freed from this noxious law that never should have been passed and is the only one of its kind ever passed in any nation on the planet.

Let us recognize that in fact we really do not know what will happen if there is a default.  It may well be the case that those saying consequences will not be all that bad may prove to be right.  Interest rates will go up in the US with a slowdown in US growth, but adjustments will be made and the world will not come to an end.  OTOH, there is a really serious downside tail risk here, one that those who are more closely connected with the financial markets seem to take very seriously. One of the worst possible scenarios would be a complete freezeup of the repo bond market.  The reason would be that what gets traded there are essentially short term Treasury securities, whose interest rates are currently soaring.  This is the main market the Fed uses for its open market operations, and it is arguably at the very foundation of the entire global financial system.  Causing it to freeze up completely by defaulting on the main security being traded in it might well lead to the Fed to being totally crippled in dealing with this crisis and essentially freezing up nearly every financial market in the world in a scenario that not only would make 2008 look like a picnic on Sesame Street, but could rival even 1931 as well.  Yes, this is a less than 50% probability outcome, but, Mr. President, do you really want to risk this?  Please act to forestall such an utterly disastrous possibility.

Barkley Rosser

Fair and Balnced in Sweden

One guy gets a Nobel for  showing that asset markets are  efficient. Another gets  one for showing  that they are nothing of the sort! Go figure.

Greg Mankiw’s Misguided Example of the Lack of Political Comity

Greg Mankiw pens an admirable call for both parties to work together. Alas his example strikes me as one that completely ignores the history of the health care debate:

the vote on President Obama’s 2010 health care reform was entirely one-sided, so it is no surprise that the law is still the source of much rancor

As long as this op-ed was, could Mankiw have noted that Obama decided not to go for the progressive’s preferred approach – universal health care? Obama instead put forth a plan that John Gruber designed, which was the same plan that Governor Romney adopted in Massachuetts. In other words, he reached out to the other side and adopted what used to be the Republican alternative to universal health care. He also was willing to work with Republicans but these same Republicans acted just like the Eagles and the Rattlers in his summer camp parable. While calls for comity are admirable, we need to start the process with at least a shred of honesty.

Paul Ryan Echoes Niall Ferguson

Paul Ryan to the rescue in terms of the government shut down?! I’ll leave it to others to make the political point – he is throwing the anti-Obamacare Tea Party agenda under the bus in favor of the good old fashion Romney more tax cuts for the rich. After all, the first two paragraphs of his latest rant is wasted on blaming the President for not negotiating. But should we not have seen this coming given the latest nonsense from Niall Ferguson? Consider Ryan’s dire warning:

The Federal Reserve won't keep interest rates low forever. The demographic crunch will only get worse. So once interest rates rise, borrowing costs will spike. If we miss this moment, the debt will spiral out of control.

OK – Ryan did not get into the numbers over whether interest expenses are 8% of GDP or 8% of tax revenues. But Ryan and Ferguson are on the same page as to how to lower future deficits:

the discretionary spending levels in the Budget Control Act are a major concern. And the truth is, there's a better way to cut spending. We could provide relief from the discretionary spending levels in the Budget Control Act in exchange for structural reforms to entitlement programs. These reforms are vital. Over the next 10 years, the Congressional Budget Office predicts discretionary spending—that is, everything except entitlement programs and debt payments—will grow by $202 billion, or roughly 17%. Meanwhile, mandatory spending—which mostly consists of funding for Medicare, Medicaid and Social Security—will grow by $1.6 trillion, or roughly 79%. The 2011 Budget Control Act largely ignored entitlement spending. But that is the nation's biggest challenge.

Gee whiz – Social Security cuts and scaling back Federal spending on health care, which was the fiscal part of the Romney-Ryan 2012 campaign. How well did that campaign work out? And why do we need to cut entitlements? Ryan repeats his desire for even lower tax rates than we got by making the Bush tax cuts permanent. Finally, Ryan like Ferguson must have missed what the latest from the CBO said why their forecast of the future debt path deteriorated:

Federal revenues under the extended baseline are now expected to be substantially lower in coming decades than CBO projected in 2012 (see the top panel of Figure A-2). By 2023, revenues are projected to be 2.8 percent of GDP lower than projected in the 2012 analysis: 18.5 percent of GDP rather than 21.3 percent ... Noninterest spending under the extended baseline is now expected to be lower in coming decades than CBO projected in 2012 (see the middle panel of Figure A-2). Specifically, noninterest spending in 2038 is projected to be 1.4 percent of GDP lower than in the 2012 analysis.

Even though Romney-Ryan lost the election in 2012, they have won in terms of getting spending cuts to pay for making the Bush tax cuts permanent. But they want even more spending and tax cuts and are mad that President Obama is not capitulating again.

Thank You Mr. President And All The Best To Janet Yellen

President Obama has finally seen the light and agreed to nominate Janet L. Yellen as Fed Chair.  Sen. Corker of TN is against her, but otherwise it looks like she has overwhelming support in the Senate and will be confirmed quite easily.  Futures on stock markets are up despite falling sharply today as it increasingly looks like not only might the shutdown get fail to get solved soon, but there might actually be a default by the US government. Although Obama is reportedly saying that this decision had nothing to do with the current budget crisis, word of it has sent futures on the stock market upwards, although that will probably get quickly reversed if there continues to be no resolution.  In any case, it takes one element of uncertainty off the table in a period of sharply rising uncertainty, with the VIX having risen over 50% since Sept. 20.

As it is, that old Chinese curse holds, "May you live in interesting times."  It may well be that if there is a failure to raise the debt ceiling or otherwise get around it with a major financial crisis ensuing, it will hit while Bernanke is still  officially in charge.  But clearly Yellen will be faced with having to deal with the cleanup of the mess that will ensue.  While one can poke at this or that aspect of her views, there is no doubt that she is as qualified and capable as any potential Fed Chair to handle these potential upcoming "interesting times" as anybody else out there, with her excellent track record of forecasting as documented by the Wall Street Journal encouraging in this respect. In any case, whatever anybody thinks of her, we all should wish her the very best in dealing with these "interesting times," which threaten to get just all too interesting in the near future.

BTW, I cannot resist reminding one and all for the record that I was the first person on the planet to publicly call for her to be appointed as Fed Chair, and I did it all the way back in July, 2009 right here on Econospeak. So I am pleased to pat myself on the back publicly in seeing my long ago request finally being fulfilled.  Of course, I must applaud it, :-).

Barkley Rosser

A Small Addendum to Mike Konczal’s Take Down on Conservative “Experts” on the Debt Ceiling

Mike notes this political spin:

Right now, many House Tea Party members believe that a default is impossible because we can prioritize interest payments to go first.

He provides some very good discussions on the likely impact of default but also notes that the Usual Suspects – Dan Mitchell of Cato, the Heritage Foundation, and the American Enterprise Institute – were happy to parrot this political spin. But seriously – does anyone take these guys seriously? Which I am obligated to provide this from Greg Mankiw:

My Harvard colleague Martin Feldstein writes me in an email: The WSJ and FT continue to write about the risk of default, quoting the Treasury, Boehner and others. There really is no need for a default on the debt even if the debt ceiling is not raised later this month. The US government collects enough in taxes each month to finance the interest on the debt, etc. The government may not be able to separate all accounts into "pay" and "no pay" groups but it can certainly identify the interest payments. An inability to borrow would have serious economic consequences if it lasted for any sustained period but it would not have to threaten our credit standing.

Whatever! OK – on a more serious note, Menzie Chinn takes a look at what happened to the S&P 500 index “when we last came close to a breach, but the Government didn't actually default”.

CBO’s Projections of Spending Did Not Rise as Suggested by Niall Ferguson

Niall Ferguson writes in the Wall Street Journal:

An entitlement-driven disaster looms for America ... True, the federal deficit has fallen to about 4% of GDP this year from its 10% peak in 2009. The bad news is that, even as discretionary expenditure has been slashed, spending on entitlements has continued to rise—and will rise inexorably in the coming years, driving the deficit back up above 6% by 2038. A very striking feature of the latest CBO report is how much worse it is than last year's. A year ago, the CBO's extended baseline series for the federal debt in public hands projected a figure of 52% of GDP by 2038. That figure has very nearly doubled to 100%. A year ago the debt was supposed to glide down to zero by the 2070s. This year's long-run projection for 2076 is above 200%.

The reader is likely left with the impression that this change in the projected debt path was driven by an increase in expected future spending. Brad DeLong:

A year ago, the CBO was required by law to calculate its extended baseline by assuming that all of the tax cuts originally put in place in 2001 and 2003 would expire at the end of 2012, and never be reinstated.

In other words, much of the blame for the worsening projection had to do with the decision to make the Bush tax cuts permanent. But could it be the case that some of the blame is due to a rise in the expected path of Federal spending? If anyone actually bothered to read the CBO report that Mr. Ferguson referenced, the answer would clearly be no. Figure A.2 of The 2013 Long-term Budget Outlook is entitled “Comparison of CBO’s 2012 and 2013 Budget Projections Under the Extended Baseline”. Check the graphs out for yourself or simply read what the CBO says:

Federal revenues under the extended baseline are now expected to be substantially lower in coming decades than CBO projected in 2012 (see the top panel of Figure A-2). By 2023, revenues are projected to be 2.8 percent of GDP lower than projected in the 2012 analysis: 18.5 percent of GDP rather than 21.3 percent ... Noninterest spending under the extended baseline is now expected to be lower in coming decades than CBO projected in 2012 (see the middle panel of Figure A-2). Specifically, noninterest spending in 2038 is projected to be 1.4 percent of GDP lower than in the 2012 analysis.

In other words, the document that Mr. Ferguson references says precisely the opposite about spending from what he is trying to claim in his Wall Street Journal oped. Did he really read the entire thing? If so – he could not have missed this central point.

Reification

Chris Dillow writes:

"In the day job, I point out that the "Mr Market" metaphor can be be misleading. If markets are complex emergent processes, as Alan Kirman shows, prices and quantities cannot be seen as the result simply of an individual's behaviour writ large, and markets are unpredictable.

Such a conception is consistent with Marxian concepts of alienation and reification. In capitalism, said Marx, "the productive forces appear as a world for themselves, quite independent of and divorced from the individuals." Or as Lukacs put it:

A relation between people takes on the character of a thing and thus acquires a ‘phantom objectivity’, an autonomy that seems so strictly rational and all-embracing as to conceal every trace of its fundamental nature: the relation between people." "

He goes on to argue that we shouldn't worry about alienation/reification because a) workers may well enjoy alienated labor and b) there's nothing the government can do about it short of  replacing the market with central planning, which doesn't work.

My take on alienation is somewhat different. I think that something like reification appears in the context of coordination games. Here's a simple one. We each decide  separately and independently whether or not to walk downtown at night. Suppose it's the case that when enough people walk the street, downtown is safe; otherwise it's dangerous . So we get 2 equilibria: We all walk, the streets are safe, so we all walk; or no one walks, the streets are dangerous, so no one walks. Let's say we're in the latter equilibrium:  we have reification if each of us thinks that the reason he/she doesn't walk is that the streets are dangerous. In fact, the reverse is true: collectively, the streets are dangerous because we don't use them. This seems to capture the idea that  without explicit coordination,  we fail to see our own authorship of  social reality. Notice too that the problem still exists in the better equilibrium. Here we get the efficient equilibrium, but to the extent that we see the safety of the streets as a fact to which we respond by walking out at night, we have reification.

Here's another example: Each employer decides not to hire because there is insufficient demand, while in fact there is insufficient demand because collectively employers are not hiring. Or: we run the bank because we believe it will fail when in fact the bank will fail becuse we are running it.

Is reification in this sense a problem?  Well with explicit coordination, we would avoid the bad equilibrium. And the situation could be fixed without coercion and without any sort of Hayekian knowledge problem to contend with. Suppose though that we are in the better equilibrium and yet we have reification in this sense: I think Marx would say it is a problem:  people are confused about their own agency and thus in some sense unfree. I

This might be one rational(or irrational) reconstruction too much, I realize!

NBER Recessions vs. Actual Recessions? (part 2 of 2)

(continued from part 1)

Employment Recessions. The end of the discussion of part 1 of this blog post suggests another way that the econopundits and people differ. Our commentators usually only care about the flow of money through the market economy (corrected for the impact of inflation, of course). In terms of the analogy, they care about the health of the "tiger." That’s what’s measured by GDP: nonmarket goods and service and nonmarket costs are not counted as part of GDP (with one minor exception). One reason why the econopundits have this focus is that they care a lot about stock prices (perhaps because they own stock), while the stock market’s speculative ups and downs are encouraged by GDP fluctuations. They are also more likely to be served well by the market than are people who are living from paycheck to paycheck.

But for most people, there’s a more important issue than GDP: to quote an old labor leader, for most people what’s counts is “jobs, jobs, jobs.” That is, though money flowing through the economy helps create jobs, what’s crucial is the general availability of job vacancies. We must ask: is the flow of money fast enough to lower the unemployment rate, to make the labor-market situation better for the vast majority? Or with a recession, is the flow of money so slow that the availability of jobs sags and unemployment soars? (That is, what about the health of the people who are clinging to the tiger's back?)

It’s this conflict of perspectives that’s behind the seemingly oxymoronic phrase “jobless recovery.” In this situation, the “economy” is recovering in the sense that real GDP is rising (with more money flowing) but jobs aren’t being created quickly enough to provide employment to new job-seekers and those who have lost their jobs. Thus, despite rising GDP, unemployment rates rise!

This contradiction – and the possibility of a jobless recovery – arises because of what economists call “Okun’s Law,” named after the late economist Arthur Okun. It’s really just a rule of thumb based on studying the real world, not a law. A law is a regularity which always works the same way, such the law of gravity in physics. There are no laws like that in economics. Thus, Okun's rule of thumb says that the slow growth of the U.S. economy since the 2009 should imply rising official unemployment rates (U3), but exactly the opposite has happened.

However despite this seeming contradiction, Okun's law captures the nature of a real problem. This idea goes beyond the common-sense idea that producing more real GDP means that more jobs are available, so that unemployment rates fall. It says that in order to prevent unemployment rates from rising the year-to-year growth rate of real GDP must exceed approximately 3 percent per year.

Why is it that real GDP must grow faster than 3 percent per year to get unemployment rates to fall? Partly it’s because new workers keep entering (or reentering) the labor force, seeking jobs and adding to the potential pool of unemployed workers. In addition, the normal growth of workers’ productivity – their ability to produce output during an hour of paid work – means that if the demand for products doesn’t rise fast enough, bosses may find some or even all of their existing employees to be “redundant” and so lay them off.

That is, if the economy – as measured by flows of money through markets – is growing at 4 or 5% per year (or even 3.5% per year), unemployment rates fall significantly and in a sustained way. This kind of true recovery is exactly what the doctor ordered for the current U.S. economy, since unemployment rates are so high. (It’s true that inflation may result from a true recovery, but that doesn’t make it any less of a recovery. Rather, it tells us that the tiger can eat too much.)

On the other hand (if Harry Truman hasn’t sawed off the economist’s other arm yet), if the economy is growing at only 1 or 2% per year, unemployment rates rise. That situation might be a jobless recovery. But there’s a second possibility: it might be a case of that mysterious creature called a growth recession. In this case, real GDP slows its growth without actually falling (a negative growth rate), so that unemployment rates rise.

There’s a third situation where we see rising unemployment despite growing real GDP. This occurs before an NBER recession occurs: if real GDP growth slows (causing rising unemployment as collateral damage), it can lead businesses to start retrenching and cut their new fixed investment spending. This in turn can lead to an NBER recession (an actual sustained fall of real GDP) to follow. This might be called a prelude employment recession (though it would be helpful if someone could suggest a better name).

Major causes of prelude recessions include a private-sector slowdown (as in classic stories of business cycle) and efforts by the Federal Reserve or other policymakers to attain a “soft landing.” (This refers to an effort to engineer a gradual reduction of real GDP growth and slow the fall of unemployment rates (or even raised them) in order to keep inflation from getting worse.)

A prelude recession might also happen due to the government’s budget sequester and the current partisan-driven “shutdown.” Both reduce government spending and hiring, which can reverberate through the economy causing the real GDP growth to slow. This process might snowball as both consumers and businesses cut spending, again reducing the availability of jobs and income. Thus an NBER recession can result. It's also possible that all we're going to have is a growth recession, but that's not what the doctor ordered when we still haven't recovered from the Great Recession.

The Measures. With these three kinds of non-NBER recessions in mind, I measured a “recession” as involving two or more back-to-back quarters of rising unemployment rates. These may be called “employment recessions” since employment recedes as unemployment rises. I use the unemployment rate, since talking about thousands or millions of unemployed workers misses the fact that the labor force (those both willing and able to work for pay) steadily increases over time. I use quarters (rather than months or years) in order to parallel the journalist’s version of the NBER definition of a recession. Just as with an NBER downturn or a Household Income Recession, I omit the period of stagnation that occurs in the aftermath of a recession. However, note that Household Income Recessions typically last longer than Employment Recessions.

The Bureau of Labor Statistics produces several other measures of “labor market slack,” but here I’m going to use what econopundits think of as the “official” unemployment rate (U3). This is partly due to the fact that the BLS didn’t start reporting other measures until relatively recently. It’s also the number that receives the most attention in the press even though it leaves out problems such as involuntary part-time workers, people who are driven out of job-seeking by bad prospects, and long-term unemployment. I doubt that using other measures will change my results, but we shall see. (Being fundamentally lazy, I’ll let someone else do this work.)

In any event, I doubt that there is a “correct” gauge of the starts and stops of recessions. If anything, I’d prefer the Household Income Recession measure of my previous blog. But it’s time to get to the results. But the point is not to present a total alternative to the NBER’s recession as much as to look at the economy from a different perspective.

I used quarterly data from 1948 to the present as provided by the BLS and massaged by the Federal Reserve Bank of St. Louis, to get quarterly numbers. I also got the NBER dates from the St. Louis Fed. First, we see three recessions that the NBER missed completely. They are growth recessions, since unemployment rose due to slowing real GDP growth without a full-scale GDP downturn happening. They occurred in 1951, 1959, and 1976. By sheer coincidence each of these occurred in the third and fourth quarters of the year (and yes the number were seasonally adjusted). Only the middle one (1959) really deserves serious attention, however, since the increases in the unemployment rate during the other two growth recessions were minor (i.e., one tenth of a percentage point). Of course, these growth-rate dips are “minor” only from an economist’s perspective. For those people in involved, the situation could easily been dire, since so many of us have a hard time doing well unless the economy is truly booming.

Next, we see the infamous jobless recoveries. They appear in the table below, using both my dates and those of the NBER, where “q” refers to the quarter of a year. Ignoring the growth recessions, all of the recessions I found except the second Volcker recession (1981q4-1982q4) ended after the trough quarter of the corresponding NBER recession. For Volcker #2, it’s cold comfort that unemployment stopped rising, since that one attained the highest unemployment rate the U.S. had seen since the Great Depression of the 1930s. Anyway, here’s my list, with the ways in which the two measures differ highlighted in boldface. The list includes the second Volcker recession as #8.

            dates of cyclical peaks and following troughs

                 NBER Recession  ||  Employment Recession

1. 1949q1–1949q3  ||  1949q1–1949q4
2. 1953q3–1954q2  ||  1953q3–1954q3
3. 1957q4–1958q1  ||  1957q2–1958q2 
4. 1960q2–1961q1  ||  1960q2–1961q2
5. 1970q1–1970q4  ||  1970q1–1971q1
6. 1974q1–1975q1  ||  1974q1–1975q2
7. 1980q1–1980q2  ||  1979q3–1980q3
8. 1981q4–1982q4  ||  1981q4–1982q4
9. 1990q3–1991q1  ||  1990q3–1992q2
10. 2001q2–2001q4  ||  2001q1–2002q2
11. 2008q1–2009q2  ||  2007q3–2009q4

(I have to figure out how to format this to make this table look decent.)

On the other hand, all of the employment recessions ended a quarter or more after the NBER recession ended. That is, the jobs situation (as measured by the official unemployment rate) continued to get worse even though the speed of the money flow through markets started rising. This joblessness was significantly worse during the 1990q3-1992q2 recession (#9), which ended fully five quarters after the NBER declared the recession over. It was this event which gave birth to the phrase “jobless recovery” while also helping to push President Bush #1 out of office (to be replaced by Clinton #1).

The lack of job creation after the NBER recovery began got worse, with recessions #10 and #11. The allegedly “mild” recession of 2001 (which I date as continuing all the way to 2002q2) ended two quarters after the NBER date. The same applies to the 2007q3-2009q4 “Great” one. Jobless recoveries seem to becoming the rule rather than the exception.

What about those prelude recessions? The first Volcker recession (#7) started two quarters earlier than in the NBER’s log. That is, the recession was much worse for working people than would be indicated by only looking at fluctuations of real GDP or NBER dates. The 2001 employment recession (#10) started one quarter “early” (compared to the NBER measure). I don’t know why this happened. Suffice it to say that the “Clinton boom” wasn’t as good as advertised.

Finally, the Great Recession (#11), which I date as being from 2007Q3 to the end of 2009, began one quarter earlier than the NBER measure. The fading job market was actually noted by the NBER committee that determines dates for business-cycle peaks and troughs, so that they stressed employment numbers much more than the usual real GDP measure in their dating. (They also dated the peak before the storm as during late 2007, but that’s lost when you use quarterly data.)

Conclusion. It's hard to draw a simple conclusion from these data. But two general conclusions are obvious. First, we shouldn't take NBER recessions as somehow reflecting the "gospel truth." The popular view that the "recession isn't over" actually says more than the NBER studies. Second, how we measure a peak month or quarter that begins a "recession" and the trough month or quarter that ends it depends on what our purposes are.  The use of an unemployment measure, for example, illuminates the phenomenon of a "growth recession" (and similar) and the conflict between what's good for the market economy (measured by GDP) and what's good for working people (measured by employment rates).

– Jim Devine