More on Trans-Pacific Partnership Models: Response to Petri and Plummer

March 09, 2016

09 Marzo 2016

I see that Peter Petri and Michael Plummer (PP) have responded to my blog post on their models projections for the TPP. In essence, they minimize the concern that the TPP or even trade deficits more generally can lead to a prolonged period of high unemployment or secular stagnation to use the currently fashionable term.Dealing with the second issue first, they argue: “While trade agreements include many provisions on exports and imports, they typically contain no provisions to affect savings behavior. Thus, net national savings, and hence trade balances, will remain at levels determined by other variables, and real exchange rates will adjust instead. “A similar argument applies to overall employment. The TPP could affect employment in the short run — a possibility that we examine below — but those effects will fade because of market and policy adjustments. Since there is nothing in TPP provisions to affect long-term employment trends, employment too will converge to these levels, as long as adjustments are completed in the model’s 10 to 15 year time horizon.” In short, PP explicitly argues that trade agreements neither affect the trade balance nor employment as a definitional matter. They argue that the trade balance is determined by net national savings. They explicitly disavow the contention in my prior note that we cannot assume an adjustment process that will restore the economy to full employment: “In fact, critics of microeconomic analysis often challenge the credibility of market adjustment even in the long term. Dean Baker (2016) argues, for example, that mechanisms that may have once enabled the US economy to return to equilibrium are no longer working in the aftermath of the financial crisis. But the data tell a different, less pessimistic story (figure 1). Since 2010, the US economy has added 13 million jobs, a substantial gain compared to job growth episodes in recent decades, and the US civilian unemployment rate has declined from nearly 10 percent to under 5 percent. The broadest measure of unemployment (U6), which also includes part-time and discouraged workers, has declined almost as sharply, from 17 to 10 percent, and is now nearly back to average levels in precrisis, nonrecession years.” As I noted in my original blog post, the PP analysis is entirely consistent with standard trade and macroeconomic approaches, however these approaches do not seem credible in the wake of the Great Recession. The standard view was that the economy would quickly bounce back to its pre-recession trend levels of output and employment. This view provides the basis for the projections made by the Congressional Budget Office (CBO) in its 2010 Budget and Economic Outlook (CBO, 2010). These projections are useful both because they were made with a full knowledge of the depth of the downturn (the recovery had begun in June of 2009) and also because CBO explicitly tries to make projections that are in line with the mainstream of the economics profession.

Krugman on China, Trump, and Romney

By Dean BakerDean Baker

March 08, 2016

08 Marzo 2016

I see Paul Krugman was taking cheap shots at my heroes while I was on vacation. Krugman argues that Trump is wrong to claim that China is acting to keep down the value of its currency against the dollar. He points to recent efforts to prop up the value of the yuan by selling foreign exchange as evidence that China is actually doing the opposite of what Trump claims. Krugman should know better. This is a story of stocks and flows. It’s true that China’s central bank is now selling reserves rather than buying them, but it still holds more than $3 trillion in reserves. The conventional rule of thumb is that reserves should be equal to six months of imports, which would be around $1 trillion in China’s case. This means that China’s stock of reserves is more than $2 trillion above what would be expected if it were just managing its reserves for standard purposes. We should expect the stock of reserves to put upward pressure on the value of the dollar in international currency markets. This is the same story as with the Fed’s holding of $3 trillion in assets. It is widely argued (including by Paul Krugman) that the Fed’s holding of a large stock of assets reduces interest rates, even if it is not currently adding to that stock. The point is that if the private investors were to hold these assets instead of the Fed, they would carry a lower price and interest rates would be higher. To take the stock and flow China analogy to the Fed, when the Fed raised the federal funds rate in December, it was trying to put some upward pressure on interest rates. But if we snapped our fingers and imagined that the federal funds rate was still zero, but the Fed’s asset holding were at more normal levels, do we think interest rates would be higher or lower?

Can We Stop with the Fear of Deflation Stuff Already?

By Dean BakerDean Baker

March 01, 2016

01 Marzo 2016

Paul Krugman, who certainly knows better, referred to the “risk of deflation” receding in the euro zone in his blog today. The point is that it doesn’t matter if the inflation rate crosses zero and turns negative, the problem is that the inflation rate is too low. It’s more too low if we have -0.5 percent inflation rather than 0.5 percent inflation, but this is no worse than having the inflation rate fall from 1.5 percent to 0.5 percent.

As I pointed in my prior post: “The inflation rate is an aggregate of millions of different price changes (quality adjusted). If it is near zero then a very large number of the changes will already be negative. When it falls below zero it simply means that the negative share is somewhat higher. How can that be a qualitatively different economic universe?”

The reason why this matters is that we can get a false complacency over the fact that prices are not falling, just rising very slowly. We should want a higher rate of inflation. And we should not be congratulating the central bankers just because the aggregate measure of inflation is greater than zero.

Paul Krugman, who certainly knows better, referred to the “risk of deflation” receding in the euro zone in his blog today. The point is that it doesn’t matter if the inflation rate crosses zero and turns negative, the problem is that the inflation rate is too low. It’s more too low if we have -0.5 percent inflation rather than 0.5 percent inflation, but this is no worse than having the inflation rate fall from 1.5 percent to 0.5 percent.

As I pointed in my prior post: “The inflation rate is an aggregate of millions of different price changes (quality adjusted). If it is near zero then a very large number of the changes will already be negative. When it falls below zero it simply means that the negative share is somewhat higher. How can that be a qualitatively different economic universe?”

The reason why this matters is that we can get a false complacency over the fact that prices are not falling, just rising very slowly. We should want a higher rate of inflation. And we should not be congratulating the central bankers just because the aggregate measure of inflation is greater than zero.

I Am Out of Here!

By Dean BakerDean Baker

March 01, 2016

01 Marzo 2016

Folks,

I’m off on vacation, so I won’t be beating the press for the next week. I’ll be back Wednesday, March 9th. Just remember, in the meantime, don’t believe anything you read in the paper.

Folks,

I’m off on vacation, so I won’t be beating the press for the next week. I’ll be back Wednesday, March 9th. Just remember, in the meantime, don’t believe anything you read in the paper.

The Fact Checker’s Judgment on Clinton’s Claim That Republicans Want to Turn Social Security Over to Wall Street

By Dean BakerDean Baker

February 29, 2016

29 Febrero 2016

Glenn Kessler, the Washington Post’s Fact Checker, gave former Secretary of State Hillary Clinton three Pinocchios for saying that the Republicans wanted to turn Social Security money over to Wall Street. I am afraid that I see this one a bit differently. First, as a small point, the piece comments: “We have explained before that “privatization” is one of those pejorative political labels used by opponents of the Bush plan…” That’s not how I remember the story. In the 1990s many conservatives openly talked about their plans to “privatize” Social Security. At some point, they apparently ran focus groups and discovered that the term “privatization” did not poll well. At that point, they switched directions and starting talking about “personal accounts,” rather than privatizing Social Security. While the advocates of a policy certainly have the right to assign whatever name they like to the policy, it seems a bit extreme to criticize its opponents for using the term that advocates themselves had used in the recent past. The piece then notes that President Clinton had openly advocated investing Social Security money in a stock index fund, therefore: “One could certainly say that the first president who wanted to ‘give the Social Security trust fund to Wall Street’ was Bill Clinton.” It is worth making an important distinction between the possible meanings of turning Social Security over to Wall Street. On the one hand, there is the possibility of directly investing some of the trust fund in the stock market. On the other hand, there are proposals to turn over the administration of individuals' Social Security to private financial firms. These routes have very different meanings and implications.

The Fed’s Bubble Promotion Strategy and Current Fed Policy

By Dean BakerDean Baker

February 28, 2016

28 Febrero 2016

Neil Irwin had an interesting piece on the Federal Reserve Board’s interest rate policy and its relationship to the stock market. The piece essentially argues that if the Fed were to make its interest rate decision based on economic data that it would hike rates at its next meeting. By contrast if it bases its decision on the stock market, it will leave rates where they are. It also argues that the Fed had acted to prop up the stock market in the 1997 following the East Asian financial crisis. This is interesting analysis but there are some additional pieces that needed to be added to this puzzle. First, it is far from clear that the stock market was the main concern when Greenspan cut rates in 1997. There was a massive outflow of capital from developing countries following the East Asian financial crisis in the summer of that year. At that time, many countries in the developing world had fixed their exchange rate to the dollar, as did Russia. This outflow of capital made it difficult for them to maintain the value of their currency. A reduction in interest rates by the Fed helped to alleviate some of the pressure on these currencies. (It didn’t work; most of them eventually devalued their currency against the dollar.) Greenspan was also concerned about a stock bubble since the summer of 1996. (We know this from Fed minutes.) He decided not to act against the bubble, deciding it would be best to just let the bubble run its course. The recession that resulted from its eventual collapse in 2000–2002 gave us the longest period without net job growth since the Great Depression, at least until the 2008 recession. Anyhow, while it is clear that Greenspan didn’t act against a stock bubble, it is a bit stronger claim to assert that he deliberately propped it up. It is also worth noting both that the price to trend earnings ratios were far higher in the 1990s (peaking at over 30 to 1) than what we are seeing at present. Furthermore, this was in a much higher interest rate environment, with interest rates on Treasury bonds in the 5.0–6.0 percent range, as opposed to 2.0 percent today. In other words, there was a clear case for a bubble in the late 1990s, which is not true today.

The Old Which Way Is Up Problem in Economics

By Dean BakerDean Baker

February 27, 2016

27 Febrero 2016

Many people have contempt for economists. It is remarkable they don’t have more. Economists can’t even agree on answers to the most basic questions, like is an economy suffering from too little demand or too much demand. If that sounds confusing, this is like a weatherperson telling us that we don’t know whether to expect severe drought or record floods.

Today’s example is Japan. The NYT had a front page story about its declining population. Unlike many pieces on falling populations, this one at least pointed out the positives aspects, such as less crowded cities and less strain on infrastructure. But after making this point, the piece tells readers:

“The real problem, experts say, is less the size of the familiar ‘population pyramid’ but its shape — in Japan’s case, it has changed. Because the low birthrate means each generation is smaller than the last, it has flipped on its head, with a bulging cohort of older Japanese at the top supported by a narrow base of young people.

“One-quarter of Japanese are now over 65, and that percentage is expected to reach 40 percent by 2060. Pension and health care costs are growing even as the workers needed to pay for them become scarcer.”

Okay, this is a story of inadequate supply. The argument is that Japan’s large number of retirees will be making demands on its economy that its dwindling group of workers will be unable to meet.

That’s an interesting story, but anyone who has followed the debates on economic policy in Japan for the last three years knows that the government has been desperately struggling to increase demand. Prime Minister Abe has been pushing both monetary and fiscal stimulus with the hope of getting more spending to spur growth. In other words, Abe is concerned that Japan doesn’t have enough old people with pensions and health care demands to keep the economy fully employed.

Now this is pretty goddamn incredible. It is possible for an economy to face problem of too little demand. That was the story in the depression and I would argue facing most of the world today.

It is also possible for an economy to face a problem of excess demand, as is being described in this article. This is a situation where it lacks the resources needed to meet the demand it is generating. That typically manifests itself in high and rising inflation (clearly not the story in Japan today.)

It is not possible for a country to have both too much aggregate demand and too little aggregate demand at the same time. Maybe the NYT editors should sit down with those covering Japan and figure out which story fits the country’s economy. Until they can decide, maybe they should refrain from reporting on a country’s economy that they obviously do not understand.

Many people have contempt for economists. It is remarkable they don’t have more. Economists can’t even agree on answers to the most basic questions, like is an economy suffering from too little demand or too much demand. If that sounds confusing, this is like a weatherperson telling us that we don’t know whether to expect severe drought or record floods.

Today’s example is Japan. The NYT had a front page story about its declining population. Unlike many pieces on falling populations, this one at least pointed out the positives aspects, such as less crowded cities and less strain on infrastructure. But after making this point, the piece tells readers:

“The real problem, experts say, is less the size of the familiar ‘population pyramid’ but its shape — in Japan’s case, it has changed. Because the low birthrate means each generation is smaller than the last, it has flipped on its head, with a bulging cohort of older Japanese at the top supported by a narrow base of young people.

“One-quarter of Japanese are now over 65, and that percentage is expected to reach 40 percent by 2060. Pension and health care costs are growing even as the workers needed to pay for them become scarcer.”

Okay, this is a story of inadequate supply. The argument is that Japan’s large number of retirees will be making demands on its economy that its dwindling group of workers will be unable to meet.

That’s an interesting story, but anyone who has followed the debates on economic policy in Japan for the last three years knows that the government has been desperately struggling to increase demand. Prime Minister Abe has been pushing both monetary and fiscal stimulus with the hope of getting more spending to spur growth. In other words, Abe is concerned that Japan doesn’t have enough old people with pensions and health care demands to keep the economy fully employed.

Now this is pretty goddamn incredible. It is possible for an economy to face problem of too little demand. That was the story in the depression and I would argue facing most of the world today.

It is also possible for an economy to face a problem of excess demand, as is being described in this article. This is a situation where it lacks the resources needed to meet the demand it is generating. That typically manifests itself in high and rising inflation (clearly not the story in Japan today.)

It is not possible for a country to have both too much aggregate demand and too little aggregate demand at the same time. Maybe the NYT editors should sit down with those covering Japan and figure out which story fits the country’s economy. Until they can decide, maybe they should refrain from reporting on a country’s economy that they obviously do not understand.

Accelerating Inflation: The Attack of the Job Killers

By Dean BakerDean Baker

February 27, 2016

27 Febrero 2016

The job killers (proponents of Fed rate hikes) seized on some modest upticks in the January inflation data to argue that the economy is near capacity and the Fed should be pushing up interest rates. After all, the core (excluding food and energy) consumer price index (CPI) rose by 2.2 percent over the last year, somewhat over the Fed’s 2.0 percent target. That’s pretty scary stuff.

I’ll make a few quick points here. First, the Fed officially targets the core personal consumption expenditure deflator. That index has risen by just 1.7 percent over the last twelve months, still below the Fed’s target.

Second, the Fed’s target is explicitly an average rate of inflation, not a ceiling. Many of us think that the 2.0 percent target is arbitrary and unreasonably low, but even if we accept this level, the inflation rate has a long way to go upward before the Fed will have even hit this target. We could have 4 years of 3.0 percent inflation and still be pretty much on target over the prior decade.

The third point is that the modest uptick in the inflation rate shown in the CPI is largely coming from rising rents. Here is the index the Bureau of Labor Statistics constructs for a core index that excludes shelter (mostly rent).

Non-Shelter Inflation, Last 12 Months

Source: Bureau of Labor Statistics.

There is a very small uptick in this index also, but only to 1.5 percent inflation over the last year. (There was a much larger uptick at the start of 2011.) We are still well below the Fed’s 2.0 percent inflation target if we pull out rent.

This matters, because if higher inflation is being driven by rising rents, it is not clear that higher interest rates are the right tool to bring prices down. Every Econ 101 textbook tells us about supply and demand. The main factor pushing up rents is more demand for the limited supply of housing. The best way to address this situation is to construct more housing.

But housing is perhaps the most interest sensitive component of demand. If we raise interest rates, then builders are likely to put up fewer new units. This will create more pressure on the housing stock and push rents up further.

Yes, the fuller picture is more complicated. Zoning restrictions often prevent housing from being built and there are many issues about what type of housing gets built. But as a general rule, more housing means lower rents, and if the Fed’s interest rate hikes lead to less construction, they will likely lead to a higher rate of rental inflation, the opposite of its stated intention.

The moral of the story is that the Fed should keep its fingers off the trigger. There is no reason for concern about inflation in the economy in general and in the one major sector where it is somewhat of a problem, higher interest rates will make the situation worse.

The job killers (proponents of Fed rate hikes) seized on some modest upticks in the January inflation data to argue that the economy is near capacity and the Fed should be pushing up interest rates. After all, the core (excluding food and energy) consumer price index (CPI) rose by 2.2 percent over the last year, somewhat over the Fed’s 2.0 percent target. That’s pretty scary stuff.

I’ll make a few quick points here. First, the Fed officially targets the core personal consumption expenditure deflator. That index has risen by just 1.7 percent over the last twelve months, still below the Fed’s target.

Second, the Fed’s target is explicitly an average rate of inflation, not a ceiling. Many of us think that the 2.0 percent target is arbitrary and unreasonably low, but even if we accept this level, the inflation rate has a long way to go upward before the Fed will have even hit this target. We could have 4 years of 3.0 percent inflation and still be pretty much on target over the prior decade.

The third point is that the modest uptick in the inflation rate shown in the CPI is largely coming from rising rents. Here is the index the Bureau of Labor Statistics constructs for a core index that excludes shelter (mostly rent).

Non-Shelter Inflation, Last 12 Months

Source: Bureau of Labor Statistics.

There is a very small uptick in this index also, but only to 1.5 percent inflation over the last year. (There was a much larger uptick at the start of 2011.) We are still well below the Fed’s 2.0 percent inflation target if we pull out rent.

This matters, because if higher inflation is being driven by rising rents, it is not clear that higher interest rates are the right tool to bring prices down. Every Econ 101 textbook tells us about supply and demand. The main factor pushing up rents is more demand for the limited supply of housing. The best way to address this situation is to construct more housing.

But housing is perhaps the most interest sensitive component of demand. If we raise interest rates, then builders are likely to put up fewer new units. This will create more pressure on the housing stock and push rents up further.

Yes, the fuller picture is more complicated. Zoning restrictions often prevent housing from being built and there are many issues about what type of housing gets built. But as a general rule, more housing means lower rents, and if the Fed’s interest rate hikes lead to less construction, they will likely lead to a higher rate of rental inflation, the opposite of its stated intention.

The moral of the story is that the Fed should keep its fingers off the trigger. There is no reason for concern about inflation in the economy in general and in the one major sector where it is somewhat of a problem, higher interest rates will make the situation worse.

Cheap Oil Is Good News for Japan: Lesson on Inflation #52,467

By Dean BakerDean Baker

February 26, 2016

26 Febrero 2016

The confusion on inflation continues. The NYT ran a Reuters piece on the latest inflation data from Japan. The piece began by telling readers:

“Japan’s core consumer prices were unchanged in January from a year earlier, suggesting that persistent falls in energy costs will keep inflation well below the central bank’s 2 percent target.

“While falling fuel costs may be a boon for corporate profits, low energy prices suppress inflation which in turn may discourage companies from raising wages or the prices of their goods.”

Okay, let’s step back a second. The reason that folks care about having higher inflation is to give firms more incentive to invest. If the goods and services they are selling rise in price by 2.0 percent a year, as opposed to staying flat, then they have more incentive to invest at the same nominal interest rate. We’ll call this 2.0 percent inflation case “Scenario I.”

Now let’s imagine Scenario II. Suppose that the prices of the goods and services firms in Japan produce rise by 2.0 percent a year, as in Scenario I, but the prices of oil and other items that Japan imports fall rapidly. The result is that the overall inflation rate is zero.

Your brainteaser for tonight is: do Japanese firms have any less incentive to invest in the Scenario II than Scenario I?

Addendum

I should mention that cheap oil is horrible for the environment since it encourages people to use more of the stuff and makes it more difficult to promote clean energy. This may be obvious, but is worth repeating.

The confusion on inflation continues. The NYT ran a Reuters piece on the latest inflation data from Japan. The piece began by telling readers:

“Japan’s core consumer prices were unchanged in January from a year earlier, suggesting that persistent falls in energy costs will keep inflation well below the central bank’s 2 percent target.

“While falling fuel costs may be a boon for corporate profits, low energy prices suppress inflation which in turn may discourage companies from raising wages or the prices of their goods.”

Okay, let’s step back a second. The reason that folks care about having higher inflation is to give firms more incentive to invest. If the goods and services they are selling rise in price by 2.0 percent a year, as opposed to staying flat, then they have more incentive to invest at the same nominal interest rate. We’ll call this 2.0 percent inflation case “Scenario I.”

Now let’s imagine Scenario II. Suppose that the prices of the goods and services firms in Japan produce rise by 2.0 percent a year, as in Scenario I, but the prices of oil and other items that Japan imports fall rapidly. The result is that the overall inflation rate is zero.

Your brainteaser for tonight is: do Japanese firms have any less incentive to invest in the Scenario II than Scenario I?

Addendum

I should mention that cheap oil is horrible for the environment since it encourages people to use more of the stuff and makes it more difficult to promote clean energy. This may be obvious, but is worth repeating.

Misplaced Celebration on Durable Goods Orders

By Dean BakerDean Baker

February 26, 2016

26 Febrero 2016

The Washington Post headlined a Reuters’ piece on the Commerce Department’s release of January data on durable goods orders “new orders for durable goods increased in January.” The first sentence told readers:”New orders for long-lasting U.S. manufactured goods in January rose by the most in 10 months as demand picked up broadly, offering a ray of hope for the downtrodden manufacturing sector.”This is more than a bit misleading. The 4.9 percent jump in January looks much less impressive when considered with a 4.6 percent decline in December and a 0.5 percent decline in November. The monthly data in this series are highly erratic.

The large drop reported for December was almost certainly a measurment error and did not reflect an actual decline in orders. This means that the January jump was primarily attributable to the series again more accurately reflecting the true level of orders in the economy. Looking over a longer period, nominal orders are up by less than 1.0 percent over the last year. While this is not a horrible story of collapsing manufacturing, it is wrong to imply there is any evidence of a bounce back in this sector.

The Washington Post headlined a Reuters’ piece on the Commerce Department’s release of January data on durable goods orders “new orders for durable goods increased in January.” The first sentence told readers:”New orders for long-lasting U.S. manufactured goods in January rose by the most in 10 months as demand picked up broadly, offering a ray of hope for the downtrodden manufacturing sector.”This is more than a bit misleading. The 4.9 percent jump in January looks much less impressive when considered with a 4.6 percent decline in December and a 0.5 percent decline in November. The monthly data in this series are highly erratic.

The large drop reported for December was almost certainly a measurment error and did not reflect an actual decline in orders. This means that the January jump was primarily attributable to the series again more accurately reflecting the true level of orders in the economy. Looking over a longer period, nominal orders are up by less than 1.0 percent over the last year. While this is not a horrible story of collapsing manufacturing, it is wrong to imply there is any evidence of a bounce back in this sector.