Pethokoukis

James Pethokoukis: Covering the nexus of Washington and Wall Street

Pethokoukis, Economics, Taxes and Spending

How S&P just killed off a ‘grand bargain,’ Bowles-Simpson, and the push for more US austerity

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061113deficit

The US faces serious long-term debt problems due to its unfunded social insurance programs. But the federal debt upgrade by credit rater S&P helps ensure a solution will come later rather than sooner. Erskine Bowles, Alan Simpson, and rest of the Washington debt hawks can go take a sabbatical. A “grand bargain” on spending, taxes, and debt isn’t happening anytime soon. As analyst Chris Krueger of the Washington Research Groups explains in a research note:

As if Washington needed another reason not to enact a “grand bargain” on long-term deficit reduction, credit rating agency S&P moved the U.S. credit rating outlook from negative to stable yesterday, citing an improving economy and recent budget deals.

With a credit rater downgrade threat now off the table in the near term, there is little to compel policymakers to compromise on a broad deficit reduction plan composed of revenue raisers, entitlement reform, and spending cuts before the midterm elections in November 2014. It appears that growth is the new austerity in Washington.

By revising its debt outlook to stable from negative, S&P effectively said there is a less than one-third chance of a downgrade in the next two years. And the move isn’t so surprising given the steep drop in the US budget deficit thanks to this year’s tax hikes and spending cuts. The Congressional Budget Office recently said the annual fiscal shortfall will shrink this year to $642 billion, the smallest gap since 2008 and down some $200 billion from its forecast earlier in the year.

S&P’s update and CBO’s revision are only the latest nails in the austerity coffin. Academic pushback against the famous Reinhart-Rogoff study — the one claiming high debt levels slow GDP growth — has hurt the economic case for further immediate fiscal retrenchment. And slowing health care cost growth suggests a possible lower trajectory for future government health care spending. In addition, voters seem to have a different priority, as Washington has surely noticed. A recent CBS News-New York Times poll found 34% of Americans say the weak job market is the biggest problem facing the nation. Just 6% cited the national debt. Perhaps the public has noticed interest rates are superlow, while unemployment is historically high.

America has concluded that for right now, at least, it faces a jobs crisis, not a debt crisis. So there is probably not much political gain to be had by claiming a debt crisis is right around the corner. Of course, the debt problem has not been solved. Not only is a deluge of entitlement debt still looming, it’s unlikely the spending sequestration will stick in its current form.

But if debt hawks and Tea Party Republicans are waiting for a debt crisis and interest rate spike to finally force Washington’s hand, they may be waiting for some time. As economist Brad DeLong recently theorized, the Great Recession and Financial Crisis may have made global investors severely risk averse for decades, creating high, long-term demand for AAA assets — US, UK, German, and Japanese debt. DeLong:

In this scenario, we may well find ourselves in a situation in which the U.S; government can simply borrow and borrow and never have to pay it back because the economy grows faster than interest accrues. In which case the U.S. government looks much more like the Renaissance Medici Bank–an organization you are happy to pay to keep your money safe, rather than a debtor from whom you demand a healthy return. The treasury becomes a profit center for the government rather than a cost. We will know if this scenario is true when the labor market normalizes: do we then find the interest rates environment we have had in the past five years persisting, a new normal for the long term?

If so, there will be a New Normal political and policy reality in Washington, as well.

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Pethokoukis, Economics, U.S. Economy

Higher taxes, not the sequester, is what’s killing US economic growth — San Francisco Fed

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061013sffed

A new study from the San Francisco Fed estimates US budget policy will knock as much as one percentage point a year from GDP growth over the next three years. And 90% of the fiscal drag comes from higher taxes. The SF Fed:

Surprisingly, despite all the attention federal spending cuts and sequestration have received, our calculations suggest they are not the main contributors to this projected drag. The excess fiscal drag on the horizon comes almost entirely from rising taxes. Specifically, we calculate that nine-tenths of that projected 1 percentage point excess fiscal drag comes from tax revenue rising faster than normal as a share of the economy. … The CBO points to several factors underlying this “super-cyclical” rise, including higher income tax rates for high-income households, the recent expiration of temporary Social Security payroll tax cuts, and new taxes associated with the Obama Administration’s health-care legislation.

See, when an economy goes into a recession, fiscal policy automatically becomes expansionary. Income taxes fall, while unemployment insurance and Medicaid rise. Deficits increase. During upturns, the process reverses. Spending on safety net programs declines, and tax revenues rise. Deficits decrease.

During the Great Recession, fiscal policy was more expansionary than typical because of the stimulus, but since mid-2010, fiscal policy has reversed. Since then, federal fiscal policy has been much more contractionary than normal. Spending has fallen sharply, and tax revenue has grown faster than usual given the weak recovery.

Now time for some math:

1. The SF analysis assumes each increase in spending or decline in taxes has a corresponding impact on economic growth.

2. The Congressional Budget Office projects that the federal deficit as a share of GDP will drop 1.4 percentage points per year over the next three years. In other words, GDP will be 1.4 points lower each year because deficits will be smaller due to spending declines and tax increases. (That’s a full percentage point more than than the typical deficit decline of 0.4 points per year.)

3. That amount would fall slightly to 1.2 percentage points per year if sequestration spending cuts were reversed. So the rest of the drag comes from higher taxes.

Federal fiscal policy has been a modest headwind to economic growth so far during the recovery. This is typical for recovery periods and in line with the historical relationship between the business cycle and fiscal policy. However, CBO projections and our estimate based on the countercyclical history of fiscal policy suggest that federal budget trends will weigh on growth much more severely over the next three years. The federal deficit is projected to decline faster than normal over the next three years, largely because tax revenue is projected to rise faster than usual. Given reasonable assumptions regarding the economic multiplier on government spending and taxes, the rapid decline in the federal deficit implies a drag on real GDP growth about 1 percentage point per year larger than the normal drag from fiscal policy during recoveries.

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Economics, Monetary Policy, Pethokoukis

The Fed, QE, and the eurozone counterfactual

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061013growth

From my National Review column today:

So we have an intriguing natural economic experiment. Two large, advanced economies are both undergoing fiscal austerity from spending cuts and tax increases. But one is recovering, though glacially, from a previous downturn; the other is deteriorating.

The likely difference: monetary policy. Not only did the Federal Reserve slash short-term interest rates to nearly zero way back in 2008, but it has also embarked upon a massive bond-buying program known as quantitative easing. The European Central Bank, however, only last month cut its key interest rate to 0.5 percent, still higher than the Fed-funds rate. And the ECB’s “unconventional” monetary policy has been far more modest, with bond purchases less than a tenth the size of the Fed’s. Its goals have also been more limited: stabilizing southern Europe’s debt markets and avoiding a financial crisis. At a recent speech in Frankfurt, Germany, St. Louis Fed president James Bullard said that unless Europe adopts an aggressive bond-buying program, it risks an extended period of low growth and deflation like what Japan has experienced since the 1980s.

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Economics, Monetary Policy, Pethokoukis

Desperately seeking a housing bubble, and failing

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061013housingbubble

One of the supposed terrible effects of the Fed’s recent round of bond buying is a reinflation of the housing bubble. Hard to see it in the above chart from The Economist, which concludes:

For houses, The Economist each quarter compares the ratio of prices to household income and rents against their long-run average in 20 countries. We have now done the same for the 20 metropolitan areas in the Case-Shiller index. The verdict: in most markets houses are at or near their long-run values, but none looks bubbly. … Many things could trip up the housing recovery, from stalling job growth to higher mortgage rates. But at the moment a bursting bubble is not one of them.

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Pethokoukis, Economics, U.S. Economy

Study: What happened to US job growth in the 2000s? China happened

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060613jobsmanufac

Even before the Great Recession, there was a problem with the US jobs machine. Between 1991 and 2000, the share of the adult population working rose by nearly two percentage points to a high of 64.7%. The jobs growth rate averaged 1.4% a year.

Then something bad happened.

Between 2001 and 2007, the employment-population ratio gave back all those gains. And while the growth rate of the US working age population was virtually identical during the 1990s and the 2000s, averaging 1.1 to 1.2% in both decades, the growth rate of employment averaged only 0.9% between 2000 and 2007.

Was it just mean reversion, a cooling off after a too-hot decade? Maybe. But perhaps there was something else at play. From “Import Competition and the Great US Employment Sag of the 2000s”  (via Marginal Revolution) by Daron Acemoglu, David Autor, David Dorn, Gordon Hanson, and Brendan Price explains why the US lost 4 million factory jobs in less than a decade:

Our results suggest that rising import competition from China has contributed significantly to the decline in U.S. manufacturing employment since 1991, with most of the adverse employment effects occurring between 1999 and 2007. The employment decline in trade-exposed industries stems both from a reduction in the number of firms and a reduction in employees per firm, and consists of declines in both production and non-production employment.

Taking into account input-output linkages between sectors, our estimates suggest that import competition in manufacturing has also contributed to a slowdown of employment growth in non-manufacturing industries that supply services to trade-exposed manufacturing firms.

The implied quantitative magnitudes are large. Our baseline estimates imply that of the substantial decline in US manufacturing employment between 1999 and 2007, 16% is due to the direct effect of Chinese import competition. Our preliminary estimates incorporating input-output linkages further indicate that over half of this 1999-2007 manufacturing employment decline could be due to Chinese import competition.

Importantly, however, this computation ignores any employment gains that would occur through other general equilibrium channels, such as further expansion in employment in manufacturing or service industries experiencing an increase in relative price (because the prices of industries competing with Chinese imports are declining). With this strong caveat, our results nevertheless suggest that the direct and indirect effects of Chinese import competition could be a key factor in the US employment sag of the last decade.

Kinda wow, particularly the negative spillover. Now, how exactly this sorts out with automation impacts, which clearly had a major impact on manufacturing, I’m not sure. The paper is preliminary and lacks policy recommendations, which I would be eager to see.

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Pethokoukis

The sequester isn’t biting, is it?

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060713jobs

I think this headline on a IHS Global Insight report says it all: “Better-Than-Expected Jobs Report Suggests That the Private Sector Is (Still) Not Spooked by the Sequester.”

And from the report itself:

Despite the major headwind of fiscal tightening, the US economy has been able to sustain decent jobs growth in the past six months. Because of the sequester, the increase in payroll jobs will slow a little in the coming months, but should hold up at around 150,000—at least. By the end of the year and in 2014, IHS expects the pace of jobs growth to pick up.

Does this mean sequestration is having no effect on the private labor market? I wouldn’t go that far. But, hey, the Fed counts, too! And the central bank’s bond-buying is likely helping offset continued fiscal austerity, including tax hikes. MKM’s Mike Darda:

During 2013, NFP growth has averaged 189K compared with a 183K average in 2012; private sector job growth has averaged 194K in 2013 compared with 189K in 2012. In other words, despite massive hand-wringing about the effects of the sequester, average job gains this year are actually slightly stronger than the average of 2012, meaning the Fed, unlike the ECB, has likely offset the impact of austerity on NGDP.

 

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Pethokoukis, Economics, U.S. Economy

Waiter and waitress nation: The May payrolls report shows the US creating jobs, just not many good ones

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060713food

The headline numbers for the May jobs report are about what you would expect for a New Normal economy stuck in 2% growth mode: 175,000 net new jobs last month, the unemployment rate ticking up to 7.6%. No broad signs of acceleration; just the opposite, in fact. As Barclays bank points out, the three-month average increase in nonfarm payrolls through May is now 155,000 vs. a first-quarter average of 207,000. (And at May’s pace of job creation, it would take another 58 months to get back to 5% unemployment.)

In addition, hours worked grew at a 1.9% annualized rate in April and May versus the 3.6% growth seen in the first three months of the year. This downshift reflects a slowing in GDP growth. The bank’s tracking estimate for real GDP growth in the second quarter stands at 1.2%, down from 2.4% in the first quarter.

And what kind of jobs are being created? As economist Dean Baker of the Center for Economic and Policy Research points out, job growth was again narrowly concentrated, with the restaurant sector (38,100 jobs), retail trade (27,700) and temporary employment (25,600) accounting for more than half of the job growth in May. Baker: “These are all low-paying sectors. It is worth noting that the job growth reported in these sectors is more an indication of the weakness of the labor market than the type of jobs being generated by the economy. The economy always creates bad jobs, but in a strong labor market workers don’t take them.”

Indeed, restaurant jobs make up just under a tenth of total US nonfarm jobs, but they accounted for more than a fifth of the jobs created last month.

Another sign of internal labor market weakness: the underemployment rate of 13.8% — which includes part-timers who would prefer full-time work — remains more than six percentage points above the “real’ unemployment rate. Before the Great Recession, that gap was typically less than four points. Indeed, 5.7% of US nonfarm workers are now “part-time for economic reasons” — either their hours were cut back or they can only find part-time gigs — vs. 3.2% precession.

No wonder we’re getting anemic wage growth. JPMorgan: “Wage gains remain pathetic, as average hourly earnings were unchanged last month. … After ramping up late last year and early this year, the trend in labor income is cooling off a bit, as total private wages are increasing at a modest 2.9% annual rate in the three months ending in May.”

Possible suspects include Obamacare, automation, and weak labor demand. Several other observations:

1. The labor force participation rate ticked up to 63.4%. If that rate were back to where it was in January 2008, the unemployment rate would be 11.4%. Even assuming for demographics like the aging of the population, a normalized unemployment rate would be over 9%.

2. The share of the adult population that’s employed remained stuck at 58.6%. While the unemployment rate has fallen over the past 3½ years to 7.6% from a high of 10%, the employment-to-population ratio has risen only from a low of 58.2% in 2011 vs. 63.4% pre-recession.

3. As the below chart shows, the official unemployment rate remains far above what Team Obama predicted back in 2009 if Congress passed his $800 billion stimulus plan:

romerbernsteinbasemay

 

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Economics, Monetary Policy, Pethokoukis

The solution to the weak economy is… a tighter Fed? Not so sure about that one

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060613gdp

Ed Lazear, former head of President George W. Bush’s Council of Economic Advisers, points out (via the WSJ) that despite the drop in the unemployment rate, the employment-population ratio — the share of the adult population with jobs — is “stuck in the mud.”

While the unemployment rate has fallen over the past 3½ years to 7.5% from a high of 10%, the employment-to-population ratio has risen only to 58.6% from a low of 58.2% in 2011 (vs. 63.4% pre-recession).

Dead cat bounce, in other words. We’re still some 2 million private-sector jobs below pre-recession levels, and, as Lazear points out, at the present meager pace of job growth, it will require more than a decade to return to full employment.

So what should the Bernanke Fed make of all this? Lazear:

The Fed may draw two inferences from the experience of the past few years. The first is that it may be a very long time before the labor market strengthens enough to declare that the slump is over. The lackluster job creation and hiring that is reflected in the low employment-to-population ratio has persisted for three years and shows no clear signs of improving.

The second is that the various programs of quantitative easing (and other fiscal and monetary policies) have not been particularly effective at stimulating job growth. Consequently, the Fed may want to reconsider its decision to maintain a loose-money policy until the unemployment rate dips to 6.5%.

But what really is the counterfactual here? Better to mimic the inflation-obsessed ECB and get a terrible double-dip recession and 12% unemployment? The US has almost certainly experienced better economic growth than otherwise due to the Fed’s — admittedly imperfect — bond-buying programs.

Look at it this way: the US economy is managing OK nominal GDP growth of around 4% despite a big helping of fiscal austerity: 1) the annual federal budget deficit has plunged from 10% of GDP in 2009 to a projected 4% this year; 2) federal spending has fallen from 25.2% of GDP in 2009 to a projected 21.5%; c) we’ve just jacked up marginal tax rates on labor and capital income. Why would we want to combine fiscal austerity with monetary tightening? I don’t get it. As CNBC’s Larry Kudlow tweeted earlier today:

060613kudlow

Even tighter monetary policy is hardly the answer.

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