Monday, July 28, 2014
Economics, Pethokoukis, U.S. Economy

Yellen’s big mistake

Is “substantially stretched” the new “irrational exuberance”? Anyway, MKM Partners economist Mike Darda thinks Fed boss Yellen made a big mistake yesterday:

Fed Chair Yellen threw a bone to the financial stability hawks yesterday by specifically mentioning “stretched” valuations in small cap and biotech stocks, social media concerns and the high yield/levered loan market. Although a gathering chorus of hawks on Wall Street and Washington believe this was simply stating the obvious (and, if anything, long overdue), the implications for monetary policy could be problematic. Historically, the Fed does not have a track record of being able to micro manage specific asset valuations without doing more harm than good: the Fed’s attempt to lower commodity prices after WWI and to lower equity prices in 1928-1929 both ended in deflationary depression. In any event, it is far from clear that valuations in the areas highlighted by Fed Chair Yellen yesterday are materially outside where they should be considering low risk free and corporate bond rates, low inflation, a recovering business cycle with low near-term recession risk and a burst of innovation in certain areas of technology. Although we remain in the camp that this will be a longer-than-average business cycle (perhaps 7-10 years), we will watch this issue very closely as the Fed as an institution has a history of fighting last wars.

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.

Economics, Pethokoukis, U.S. Economy

Why Amity Shlaes is dead wrong about inflation


Are conservatives forever and always doomed to be obsessed by fear that inflation is perpetually just around the corner? Perhaps, since it was the Great Inflation of the 1970s that helped give rise to Reagan and Thatcher and the conservative revival. Even worse, this inflation obsession spawns conspiracy theories that government is manipulating the data to hide skyrocketing prices.

To be sure, the prices of some things have gone up a lot and continue to rise, such as college tuition. But overall inflation has been quiescent. The Consumer Price Index, including food and energy, has risen by an annual average of just 1.6% since 2008, including 1.5% last year. Is Washington phonying up the numbers? Well, MIT’s Billion Price Project, which “uses prices collected from hundreds of online retailers around the world on a daily basis”  puts US inflation at just over 2% the past year. In other words, the CPI is roughly correct, though your personal mileage will vary a bit. Looking forward, a Cleveland Fed model based on both economic surveys and financial derivatives reports that its “latest estimate of 10-year expected inflation is 1.83%. In other words, the public currently expects the inflation rate to be less than 2 percent on average over the next decade.” Not surprisingly, then, I strongly disagree with the inflation fretting of Amity Shlaes in her new NRO piece, “Inflation Vacation: Things are more expensive than government statistics say they should be.” Here is Shlaes;

All the official numbers, especially the Consumer Price Index, say that inflation is reasonable. Economists you respect tell you the wages are low because of “misallocation of resources.” Janet Yellen, the new Fed chairman, says she’s not worried. Maybe she will have a good vacation.

But other numbers suggest that inflation is higher than what the official data suggest. One set, from which some of the price bites above were taken, is here. For a more thorough review of why official numbers err, have a look at the work of John Williams, a consultant who has tracked data over the years.

Boiled down, Williams’s contention is that several alterations in the way we measure inflation have caused distortion. The Consumer Price Index used to be simple: The government measured the same basket of goods every year. If the price went up, the index captured that. Decades ago, authorities pointed out that people substitute a cheaper item when what they originally bought was too expensive. They altered the index to capture substitution. If steak is expensive, you buy chicken. The result of their fiddle is that inflation looks lower than it would otherwise. That’s disappointing. No vacation is a true vacation without a really good tenderloin.

Conservatives like Shlaes — she is hardly the only one — should really stop using John Williams and his ShadowStats site as source for their inflation arguments. Many economists, not to mention the BLS itself, have given reason to think his approach methodologically unsound. According to one Williams’s calculation, annual inflation has never been below 5% since the mid-1980s and is nearly 10% today.

Think for a moment what that means for real GDP growth the past three decades. Nominal GDP averaged about 5% from 1986 through 2013. Of that 5%, 2% was inflation and 3% was real GDP growth. If inflation was really 5% — and often, according to Williams, it was much, much higher — then there has been no real economic growth in America all that time. Actually, we have probably been in a long depression from the Reagan years forward.

Is that what folks on the right really want to argue? Conservatives should not be so desperate to make the “Obama is Carter” argument or push for a return to the gold standard or to “end the Fed” that they will use any source to back their inflation claims, including sources about which even a quick Google search would raise numerous red flags. Such sloppiness render arguments unpersuasive to anyone but true believers. It also feeds a conspiratorial mindset unhelpful for anything other that creating customers for the numerous gold hawkers on talk radio.

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.

Economics, Pethokoukis, U.S. Economy

CBO makes clear what Obamacrats don’t: Tax hikes won’t come close to solving US debt problem


The New York Times is happy that a new Congressional Budget Office report is forecasting slower Medicare spending growth — even if the reason is puzzling. From reporter Margot Sanger-Katz:

The last few years have seen a puzzling and welcome new trend in health care spending: Instead of going up and up, increases have slowed way down. Since health care costs are growing more slowly than they have in decades, they’re making budget forecasts look better and better.

Here’s your trouble: while it is good news that Medicare is now expected to make up 4.6% of GDP in 25 years vs. 4.9% in last year’s estimate, the US budget is still a snowball headed for hell. The above chart shows the 2013 and 2014 long-term CBO estimates under the extended baseline scenario (current spending and tax provisions continue or expire according to law) and alternative fiscal scenario (what is likely to happen to current spending and tax laws).

What more, the CBO report clearly states we cannot just  tax our way out of this problem. As summarized by the Committee for a Responsible Federal Budget:

CBO projects that revenues will also grow as a share of GDP, but from a lower starting point and not as quickly. Specifically, revenues will rise from 17.6 percent of GDP this year to 18.4 percent by 2025, 19.5 percent by 2040, 21.3 percent by 2060 and 23.6 percent by 2085. By comparison, revenue has averaged about 17.4 percent of GDP over the past 40 years.

Over time, CBO projects spending will grow significantly, from more than 20 percent of GDP in 2014 to nearly 23 percent by 2025, 26 percent by 2040, nearly 30 percent by 2060, and nearly 36 percent by 2085. By comparison, spending has averaged about 20.5 percent of GDP over the past 40 years. 

So even though revenue will rise 6 percentage points over historical levels, spending will rise by 16 points over historical levels. Record tax revenue, but also record spending. As I said, there’s your trouble.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.

Pethokoukis, Economics, U.S. Economy

How to save US workers from the robots: A Q&A with entrepreneur Ashwin Parameswaran

Image Credit: Shutterstock

Image Credit: Shutterstock

An important question and a vexing one: Why is the US recovery still so weak? Five years after the official end of the Great Recession, growth remains maddeningly subpar. Folks on the right like to talk about “uncertainty” stemming from President Obama’s economic policies, from Obamacare to environmental regulation to Dodd Frank. Folks on the left have latched onto a theory called “secular stagnation,” cooked up by former Obama White House economist Larry Summers, which see chronic inadequate demand  – partially driven by income inequality — as the big problem.

Blogger, ex-banker, and current entrepreneur Ashwin Parameswaran has an intriguing thesis of his own — much of it concerning automation –outlined in his marvelous essay “Technological Unemployment Amidst Stagnation.” This alternate explanation also attempts to explain why “the “benefits of the current economic recovery have flown disproportionately towards corporate profits with wages and employment lagging far behind.” In this episode of the Ricochet Money and Politics Podcast, I chat with Parameswaran about his ideas. Here are some edited highlights from our chat:


Let’s start by laying out your theory. and then I’m going to try to push back a bit on it.

There are more than two ways of looking at what’s wrong with the economy right now, and there are a lot of contradictory positions. One of the contradictions that a lot of people don’t seem to focus on is the fact that we seem to be worried about technological unemployment and that robots are going to make human beings obsolete. And at the same time, we seem to have this idea that we are in the midst of this great stagnation [as seen in] Tyler Cowen’s great book on this topic.

This essay in particular and a lot of my other work is trying to argue that these two are not opposing phenomena. They both can happen at the same time. The primary argument is really that we are getting a lot of process innovation which means that we are making things that we consume today in a more efficient and cheaper manner which means less manpower. That leads to a lot of technological unemployment. But we are not getting enough product innovation. We are not getting enough disruptive innovation, which means we are not making new products that people consume.

The combination of these two things means that we can have long-run stagnation, but at the same time we get technological unemployment. It’s easy to argue why we have process innovation and technological unemployment because of it. But the larger question is why we don’t have enough disruptive innovation.

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Economics, Monetary Policy, Pethokoukis

Economists overwhelmingly reject GOP’s Fed reform plan. But should that end the argument?

Image Credit: Shutterstock

Image Credit: Shutterstock

The GOP has a big idea on how to reform monetary policy: Get Congress more involved. Economists — and this is not surprising — think that idea is not so good:

Chicago Booth, IGM Forum

Chicago Booth, IGM Forum

As you can see, 90% of the economists surveyed — when ranked by confidence level — disagree with the GOP plan. So, yeah. Kind of overwhelming. And the reason this result is not surprising is that intuition, historical example, and research suggest that without independence, central banks will submit to their political overlords and run the printing presses.

That point of view is reflected in some of the comments from the economists, such as this one from the University of Chicago’s Nancy Stokey: “A central bank should be independent. Look at Argentina as an example of where political oversight leads.” Berkeley’s Carl Shapiro offers the “If it ain’t broke, don’t fix it” defense of the status quo: “The Fed has served Americans very well over many decades; meddling by politicians would worsen the performance of the Fed and the economy.”

But what has been the American experience? And what lessons can be drawn? While conservatives often point to the Great Inflation of the 1970s as an example of the Fed gone wild, both the Great Depression and Great Recession are examples of the Fed crashing the economy by being too tight. Taken together, do they really suggest a Fed that has “served Americans very well over many decades”? Highly debatable, at least.

Perhaps what those examples suggest is that discretionary monetary policy really is problematic. There should not just be a rule, but the correct rule that is clear on what the goal is. As Stanford’s Robert Hall, who disagrees with the GOP idea, states: “Monetary policy should be based on a target for inflation and unemployment (such as difference between the two) not on an instrument rule.”

My preference is for nominal GDP level targeting. Here is Scott Sumner:

My suggestion is that we end the independence of central banks, but replace it with something else–an explicit, legal, central bank target.  Let’s suppose the Congress instructed the Fed to target 2% inflation.  Now assume Congress wants more growth because we are in a recession, but because inflation is currently 2% the Fed doesn’t want to ease.  The fiscal authorities could instruct the central bank to aim for 2% inflation in the long run, but allow a bit more inflation during the current recession, at the expense of a bit less that 2% inflation during the subsequent years.  In other words the Fed would still have some discretion, even though their long-run mandate would be 2% inflation.  They would have the legal authority to tell the fiscal authorities “OK, we’ll provide a bit more inflation right now, as long as you understand that it is being “borrowed” from future inflation.  We intend to run below 2% inflation during the next boom.”  This would allow for some fruitful policy coordination, while still protecting the central bank from pressure to alter its long run inflation target.

You might be thinking; “Lower than average inflation during booms and higher than average inflation during recessions.  What a great idea for macroeconomic stabilization.  How can we formulate that into a simple and easy to understand nominal target?”

Seriously, Congress needs to decide on some sort of explicit policy goal for aggregate demand.  Whether it be inflation, the price level, or NGDP, the point is to have clearly spelled out goals so that they and the Fed are pulling in the same direction.  Indeed if the goals are spelled out, there is no reason why Congress should ever have to do any pulling.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.


Pethokoukis, Economics, U.S. Economy

Surprise? Not really: Nations with more generous welfare states are hurt by higher immigration

Image Credit: Shutterstock

Image Credit: Shutterstock

The Economist highlights the key takeaways from a new study of the economic impact of immigration on 20 nations, “Immigration, Search, and Redistribution: A Quantitative Assessment of Native Welfare” by “Michele Battisti, Gabriel Felbermayr, Giovanni Peri, and Panu Poutvaara.”

First, simply shutting the doors would make the native population worse off in 19 of 20 countries. Second, most countries should allow more immigration. As for the US, “a one-percentage point increase in the proportion of immigrants in the population made the native-born 0.05% better off.” (As a side note, some advanced economies have a far greater share of the population that is foreign born, including Canada, Australia, and Switzerland.) Now the third takeaway is the perhaps the most significant:

Life can be tough for immigrants in America … And if you can’t find work, don’t expect the taxpayer to bail you out. Unlike in some European countries, it is extremely hard for an able-bodied immigrant to live off the state. A law passed in 1996 explicitly bars most immigrants, even those with legal status, from receiving almost any federal benefits. That is one reason why America absorbs immigrants better than many other rich countries. … The opposite was true in some countries with generous or ill-designed welfare states, however. A one-point rise in immigration made the native-born slightly worse off in Austria, Belgium, Germany, Luxembourg, the Netherlands, Sweden and Switzerland. In Belgium, immigrants who lose jobs can receive almost two-thirds of their most recent wage in state benefits, which must make the hunt for a new job less urgent.

This would seem to be an important finding! And it is very much in the spirit of what Milton Friedman once said about immigration and welfare state:

Why is it that free immigration was a good thing before 1914 and free immigration is a bad thing today? Well, there is a sense in which that answer is right. There’s a sense in which free immigration, in the same sense as we had it before 1914 is not possible today. Why not?

Because it is one thing to have free immigration to jobs. It is another thing to have free immigration to welfare. And you cannot have both. If you have a welfare state, if you have a state in which every resident is promises a certain minimal level of income, or a minimum level of subsistence, regardless of whether he works or not, produces it or not. Then it really is an impossible thing.

Well, not impossible. But a stingier welfare state does, apparently, help the absorption process, according to this study. Also: the tiny gains from immigration would also suggest more attention needs to paid to composition.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.

Pethokoukis, Economics, U.S. Economy

Remember, 2014 was supposed to be, finally (!), the Year of Acceleration


An historically bad winter may have frozen the economy last winter, but why was there no equally significant spring thaw? Real GDP decreased at an annual rate of 2.9% — the deepest mid-expansion decline in 70 years — but hopes for a strong second-quarter rebound are fading. The other day I noted that the Atlanta Fed’s real-time GDP forecasting model, GDPNow, was predicting 2.6% RGDP growth in 2Q. And here is how JPMorgan factors in the new retail sales numbers:

Retail sales increased 0.2% in June, which was below expectations, nonetheless the important details used to track real consumer spending were actually better than anticipated. …  Real consumer spending in Q2, which was previously tracking 1.5% annual growth, is now coming in around 1.8%. We continue to project real Q2 GDP growth at 2.5%; prior to today’s number we were tracking about a tenth light, and we are now tracking about a tenth firm. Even with today’s number, consumer spending can’t be described as roaring back from Q1 weakness, but at least it looks like it is returning to a moderate pace of expansion.

Along the same lines, this is what the CEO of discount retailer Family Dollar had to say in his recent earnings call with analysts:

Our observations are it’s still pretty tough out there. The low-end consumer has not benefited in this recovery at all, in fact, I think have slipped further back. Unemployment trends remain high. The government cutbacks continue. There’s quite a bit of health care uncertainty. Coming from this unbelievably cold winter, heating prices, heating oil and gas prices are moving upward. So there is — it’s a tough playing field out there.”

Of course, maybe the rebound will be more apparent in the second half. Certainly some economists argue that. But getting back to JPM note from economist Michael Feroli, “a moderate pace of expansion” would be OK if we were not still trying to close the “growth gap” caused by the Great Recession and Not-So-Great Recovery. As economist David Beckworth notes in a recent WaPo piece: ” … the CBO estimates that GDP is 5 percent below potential, and, even worse, 10 percent below its pre-crisis trend. We’ve only recently made up for the 8 million jobs we lost during the crisis, but we’re still far short of how many we need to keep up with all the population growth the past five years.”

Beckworth goes to discount the current left-wing Unified Theory of Everything, secular stagnation: “A better story is that the economy got hit by a once-in-three-generations crisis that’s taken awhile—too long, really—to overcome. But in the long run, the slump will be dead.” To that explanation, though, I would add a worrisome supply-side story that predates the Great Recession, which could be damaging US growth potential.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.

Economics, Pethokoukis

Is Obama’s focus on income inequality coming back to bite Democrats?


National Journal reporter Alex Roarty concludes that it’s not the economy, stupid — at least when it comes to the 2014 midterms. Roarty:

Even if job gains do spike—and there’s plenty of reluctance to predict an accelerating recovery after years of stop-and-start growth—it’s unlikely voters will feel demonstrably better about the economy in time for November. Ultimately, how voters feel about the economy and their own financial situation is what matters when they step in the polling booth—not abstract economic data.

But there’s another, more surprising reason a late-developing recovery wouldn’t help Democrats. A plethora of political-science research suggests the economy, except in extreme circumstances, doesn’t matter much in midterm elections anyway. A boost in growth certainly wouldn’t hurt, but its effect on candidacies would be indirect and minor.

In other words, a second-half acceleration won’t be the thing that keeps the Senate in Dem hands. But Roarty may have buried the lede. Deeper in the piece, a Democratic pollster offers a different explanation why a better economy won’t help incumbents:

“It’s unlikely that even if you have sustained job growth that you’re going to see a big difference in the perception of the economy,” said Jeff Liszt, a pollster who, among other races, is working with Sen. Kay Hagan’s reelection campaign in North Carolina. “And people may believe it’s getting better, but not in any way that’s helping them. Or even to extent it’s helping them, they may feel like they’re getting crumbs and others are getting the main benefit.”

That quote immediately brought to mind the “keeping up with the Joneses” effect found in the economic literature where individual happiness, at least for the middle-class, depends on relative rather than absolute wealth. Therefore rising income inequality would keep the 99% miserable even with rising take-home pay. Now who has been banging the drum about inequality and how rich are gobbling up all the income gains? Democrats, mostly.

So aren’t the the inequality alarmists on the left actually undercutting themselves by reinforcing perceptions that the Obama recovery is either (a) only helping a favored few or (b) not helping the broad middle class as much as if gains from growth were more evenly distributed. So even if the economy picks up steam and incomes rise, voters may not get much happier since they will think things would be even better if not for income inequality — a natural conclusion based on what the Obamacrats have been saying. They will think their relative position hasn’t improved much since they are not keeping up with the 1% Joneses. And are voters likely to blame Republicans for this state of affairs, given that this is Year Six of the Obama presidency and the GOP only holds the House?

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.

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