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Article Artículo

Pension Panic: Round XXII

There has been a flurry of recent articles touting recent work by Stanford Business School Professor Joshua Rauh, arguing that state and local pension fund liabilities are far larger than generally reported. Rauh puts the unfunded liabilities of state and local pension funds at $3.4 trillion, more than three times the figures that the pensions themselves calculate. He predicts looming crises with many local governments driven into bankruptcy.

The reason for the difference between Rauh’s $3.4 trillion number and the shortfall of roughly $1 trillion using the pension fund’s methodology is the rate of discount used to evaluate pensions’ liability. Pension funds calculate their liability using their expected rate of return as the rate of discount. This currently averages just over 7.0 percent on their assets. In contrast, Rauh uses the risk-free rate of interest for discounting, using the current 2.5 percent yield on 30-year Treasury bonds. The lower interest rate puts a much higher value on projected funding shortfalls 20-30 years in the future.

While many would like the public to be scared by Rauh’s calculations, there are a few points worth keeping in mind. First, the return numbers that pension funds use are not pulled out of the air. They reflect projections of investment returns based on actual experience and a range of standard economic projections. They will of course not be exactly right, but they are also unlikely to be hugely wrong.

As a recent report from Pew Research Center points out, the main reason that some pension funds are in serious trouble is not that they were overly optimistic about investment returns, the pensions that are into serious trouble were the ones that failed to make their required contributions. In states like New Jersey and Illinois, not making pension contributions became almost a sport among politicians. The same was true for the city of Chicago under Mayor Richard M. Daley. If governments don’t contribute to their pensions, they will be underfunded regardless of what returns are assumed.

Dean Baker / April 13, 2016

Article Artículo

Olivier Blanchard Is Worried About Inflation In Japan

Olivier Blanchard is one of the world’s leading macroeconomists. In addition to a long and distinguished academic career, in his tenure as the chief economist at the I.M.F. he turned its research department into a major producer of cutting edge research. In particular, the research department was instrumental in producing work that undermined the case for austerity that was being widely pushed across the globe. Unfortunately, politics was able to overcome the research, and austerity won.

But that is the past. In an interview with the Telegraph, Blanchard warned that Japan will soon switch from combating deflation to a struggle to contain inflation. The core problem is its debt burden, which now stands at almost 250 percent of GDP.

This concern seems more than a bit bizarre, especially coming from an economist as knowledgeable as Blanchard. The first point is that, in spite of the high ratio of debt to GDP, Japan actually has a low interest burden. According to the OECD, Japan’s net interest payments on its debt were 1.0 percent of GDP in 2015. By contrast, U.S. payments were well over 3.0 percent of GDP in the 1990s.

This matters, not only because the interest payments represent the actual drain on resources, but also because the value of the debt is largely arbitrary. If that sounds strange, it’s worth thinking about what happens to the value of debt when interest rates rise. The current interest rate on a 10-year Japanese government bond is -0.09 percent. On a 30-year bond it’s 0.41 percent. Suppose that the interest rate on a 10-year bond rose to a still historically low 4.0 percent and the 30-year bond to 5.0 percent.

According to my bond calculator, the market price of a newly issued 10-year bond would drop by almost one-third and the price of a newly issued 30-year bond would fall by more than 75 percent. Of course not all Japanese debt is long-term, nor is it all newly issued, but the point is that the market value of its outstanding debt would drop sharply if interest rates rose to even modest levels. If the 30-year rate got as high as 7.0 percent (lower than the U.S. rate in much of the 1990s), then the market price of the newly issued 30-year bond would drop by more than 85 percent from its current level.

The way governments typically keep their books, this plunge in the market price would not affect Japan’s debt to GDP ratio. But if the markets were actually troubled by the high ratio of debt to GDP, Japan could simply issue new debt to buy up old debt at a fraction of its face value. This would quickly send its debt to GDP ratio plunging. (This is why the Reinhart-Rogoff 90 percent cliff story never should have passed the laugh test even before the exposure of the famous Excel spreadsheet error.)

Dean Baker / April 13, 2016

Article Artículo

United States

Vacancies and Rents: A Causal Relationship
buffie vacancies 2016 04 11 fig1

The figure above compares the average 2015 rental vacancy rate with the percent increase in owner’s equivalent rent for 30 metropolitan areas. Although the relationship is imperfect, there is a clear trend to the data: higher vacancy rates are associated with lower inflation. The concept here is relatively simple: when a large number of rentals are vacant, rentiers must set prices relatively low in order to compete for potential renters.

This becomes clear when you look at specific metropolitan areas. The three areas with the highest vacancy rates also happened to have the three lowest inflation rates. Two areas in Ohio — Akron and Cincinnati — had 12.1 and 10.2 percent vacancy rates, respectively. Increases in rents were just 1.5 and 1.1 percent in those two areas, compared to the sample median of 3.4 percent. St. Louis, Missouri had a 9.7 percent vacancy rate — 3 percentage points above the median vacancy rate of 6.7 percent — and saw just a 2.0 percent increase in rental prices.

CEPR and Nicolas Buffie / April 12, 2016

Article Artículo

Bernie Sanders: Enemy of the World’s Poor?

A popular theme in the media in recent days is that the world’s poor would face disaster if Bernie Sanders ended up in the White House.[1] The story is that Sanders would try to protect jobs for manufacturing workers in the United States. The loss of these jobs has been a major source of downward pressure on the wages and living standards of a large portion of the working class over the last four decades.

While saving manufacturing jobs here may be good for U.S. workers, the media line is that by trying to block imports from the developing world, Sanders would be denying hundreds of millions of people their route out of poverty. This story may be comforting for elites in the U.S. and Senator Sanders’ political opponents, but it defies basic economics and common sense.

To see the problem in the logic, note that the essence of the Sanders as an enemy of the world’s poor story is that manufacturing workers in the developing world need people in the United States to buy their stuff. If people in the United States didn’t buy their stuff, these workers would be out on the street and growth in the developing world would grind to a halt.

In this story, the problem is that we don’t have enough people in the world to buy stuff — there is a shortage of demand. But is it really true that no one else in the world would buy the stuff produced by people in the developing world if they couldn’t sell it to consumers in the United States? Suppose people in the developing world bought the stuff they produced, you know, raising their living standards by raising their consumption.

That is actually the way the economics is supposed to work. In the standard theory, general shortages of demand are not a problem. Economists have traditionally assumed that economies tended toward full employment. The economic constraint was a lack of supply. The problem was that we couldn’t produce enough goods and services, not that we were producing too much and couldn’t find anyone to buy them.

Dean Baker / April 12, 2016

Article Artículo

The Growth of Finance, In Graphs

Over the past three decades, the top 1 percent’s share of national income has more than doubled. In 1978, the richest 1 percent of income earners made less than 9 percent of total income; by 2014, their share was over 21 percent.

The growth of the financial sector has been one of the primary drivers of this increase. During the 1940s to 1970s, finance typically accounted for about 3 to 4 percent of GDP; by 2005 and 2006, just before the financial crisis, finance claimed 7.6 percent of GDP. While the industry’s share of national income fell during the recession, it is back above 7 percent today.

CEPR and Nicolas Buffie / April 11, 2016

Article Artículo

United States

An Accountable Federal Reserve Board: Professor Levin's Proposal

Professor Andrew Levin (Dartmouth College), the former special advisor to Fed Chair Ben Bernanke and then-Vice Chair Janet Yellen, released a proposal for reform of the Federal Reserve Board’s governing structure in a press call sponsored by the Fed Up Campaign. The proposal has a number of important features, but the main point to make the Fed more accountable to democratically elected officials and to reduce the power of the banking industry in monetary policy.

Under its current structure, the banks largely control the twelve Federal Reserve district banks. This matters because the presidents of these banks are part of the Federal Reserve Board’s Open Market Committee (FOMC) which determines monetary policy. At any point in time five of twelve district bank presidents will be voting members of the FOMC, but all twelve take part in the discussion. The voting presidents will typically be outnumbered by the seven Federal Reserve Board governors, who appointed by the president and approved by the Senate, although there have been just five sitting governors for the last two years, as the Senate has refused to consider President Obama’s nominees.

There is no obvious reason that the banking industry should have special input into the country’s monetary policy. This would be comparable to reserving seats on the Federal Communications Commission’s board for the cable television industry. While there is no way to prevent an industry group from trying to influence a government regulatory body, in all other cases they at least must do so from the outside. It is only the Fed where we allow the most directly affected industry group to actually have a direct voice in the policies determined by its regulatory agency.

Dean Baker / April 11, 2016