The inflation expectations fairy

There are confidence fairies and there is the inflation expectations fairy. It's a 4% fairy apparently. I'll explain. So Krugman correctly points out always that the more fundamentalist neoclassical economists (the Talibans that love price flexibility and instantaneous adjustment to full employment, not the moderates that also believe in a natural rate, but think it takes a while to get to it like Krugman himself) believe that the economy would recover if only a proper environment for investment was created. Hence, if confidence returned we would have a recovery.

They obviously invert causality between confidence and recovery. As noted by Marriner Eccles long ago: "confidence itself is not a cause. It is the effect of things already in motion. (...) What passed as a 'lack of confidence' crisis was really nothing more than an investor's recognition of the fact that new plant facilities were not needed at the time." Investment is the result of a growing economy, in which firms tend to adjust their capacity to demand. No demand for your goods no need to invest to create capacity to produce more. Plain and simple.

Now a dispute on what is the appropriate policy for the Fed, and what has been Bernanke's role has developed between Krugman and Bernanke (see here and here) [Ball has a more academic paper saying basically the same as Krugman here]. They argue that Bernanke has been correct in pursuing quantitative easing -- the buying of long term Treasury bonds to keep not just short, but also long term interest low -- and saving banks, but he has been reluctant to increase the inflation target to 4%. Blanchard has said pretty much the same about the need for a higher inflation target (this was hailed as new thinking in macroeconomics; with that criteria when Greenspan disregarded the 6% natural rate of unemployment level, believing it was somewhat lower, he was a radical innovator!). [I’ll leave for another post the question of why are we even talking about an inflation target in the US if the Fed supposedly doesn’t have one].

Krugman notes that Greg Mankiw actually has sent a veiled (or not so veiled threat, as he is the advisor to Romney, which may or may not have something to do with Bernanke’s reappointment in the future), saying that “if Chairman Bernanke ever suggested increasing inflation to, say, 4 percent, he would quickly return to being Professor Bernanke” (originally published here, yep Mankiw also writes regularly for the NYTimes).

So what is the mechanism according to Krugman (and the ‘progressives’ like the IMF chief economist Blanchard) by which a higher inflation target would lead to a recovery. In Krugman’s own words:

"If the Fed were to raise its target for inflation — and if investors believed in the new target — expected inflation over the medium term, say the next 10 years, would be higher. … [and] higher expected inflation would aid an economy up against the zero lower bound, because it would help persuade investors and businesses alike that sitting on cash is a bad idea. "

So if the Fed says it’s willing to accept a higher level of inflation – without doing anything concrete and objective like intervening and forcing banks to refinance the mortgages of people in foreclosure – then if investors are persuaded they may be confident enough to spend more. And that’s not a fairy?! The problem with any theory, including the New Keynesian, that believes [or says it does in order to get published] that there is a tendency to full employment, is that it must end on some sort of confidence for spending story, since under normal conditions the system would actually do it anyways. The confidence fairy is dead; long live the inflation expectations fairy!

Jamie Galbraith on the jobs plan

Jamie's take on the plan. Here is the link.

On China and Jobs

It is true that whenever the economy grows trade deficits tend to become larger, and the United States, which has had persistent deficits since the early 1980s, is particularly prone to those. Dean Baker has been the most vocal defender of a weak dollar (mostly as measure to boost local manufacturing jobs, since a depreciated currency protects local production; here for example a recent piece). Krugman too has recently argued for a more depreciated dollar and also for trade restrictions against China (see here for a recent one).

In all fairness, I have a few concerns with these line of thought, and not because I am (or ever was) a "free trader", like Krugman (by the way Free Trade is a terrible misnomer and there are serious problems with the conventional arguments for it; theme for another post, I guess).

First, in the case of China, the exchange rate has appreciated a lot since the crisis as can be seen in the graph below (Data from the Economist Intelligence Unit).

Further, when measured by changes in wages (labor costs) the real appreciation since 2007 has been of around 27%, 10% more than when measured by prices, since real wages grow relatively fast in China. Further, China has grown since 2007 at an average of 10.5% per year. In other words, China is growing and revaluing its currency; not sure what more can be expected on that front. Blaming China for lack of fiscal stimulus in the US seems, not just futile, but wrongheaded.

Another important point often missed in these discussions of the exchange rate is that a depreciated currency, everything else constant (economists do like a ceteris paribus condition) implies lower real wages, since imported goods tend to be part of the workers' consumption basket. Hence, if you favor a depreciated dollar, but tend to be for workers (which are getting to bear the brunt of this crisis, as is always the case), then compensating measures are needed to increase real wages without reducing competitiveness (other costs must be reduced, or profit margins would have to be squeezed; that's just the algebra).

Finally, my perennial question, raised before here, so if US deficits are larger, but we give the Chinese dollars, and they hold dollar denominated assets, what's the downside again?

PS: Concerned about the dollar? Go here.

Robert Barro vs. Jamie Galbraith

Jamie Galbraith goes head to head with Robert Barro, in the enemy's territory (Bloomberg). Several important points raised by Jamie. Beware of the delirium about the post-1980s being the start of two decades of prosperity. In fact, medium income stagnated after that, and growth has been based on a series of unsustainable bubbles.

Robert Barro does not believe in evolution

Okay, in all fairness he does not believe in expansionary fiscal expansions. But it is the same. All the evidence supports the functioning of the simple Keynesian multiplier. One might disagree about its size, but not its existence. Barro says that we are in:

"the third year of a grand experiment by the Obama administration to revive the economy through enormous borrowing and spending by the government."

You would expect that at least when referring to the data he would be accurate, but evidence has nothing to do with how he understands the economy (remember this is the guy of Ricardian Equivalence, i.e. if the government increases spending, people raise their savings proportionally to pay the future anticipated taxes with no effect on output).

The graph below shows percent changes in total government spending and revenues since 2006.

As it can be seen, spending (in red) increased in 2008, as a result of the recession, but has been falling ever since. The deficits are caused, not by an experiment in Big Government as he suggests, but because revenues fell.  And yes the recovery, even a mild one, led to a significant increase in revenue last year. In 2010 revenues increased by 7% from previous year, while spending did it by only 0.7%. That's why in the first year of Obama's own budget, in 2010 (2009 he inherited from Bush), the size of the deficit actually fell (a bad thing, by the way, in the middle of a recession). So to avoid a double dip recession we need to do the opposite of what Barro says.

PS: Krugman also criticizes Barro here.

Paul Davidson on Obama's job speech

Here is a link to an interview with Paul Davidson. He makes it clear why a payroll tax cut and other incentives to hiring will not be enough to create new jobs. Lower costs will not lead to hiring if there is no demand. It's not just basic economics, it's simple logic.

Lipstick on a Pig

While I understand the title may be culturally specific, almost surely the metaphor isn't.

The American Jobs Act, unveiled fairly vigorously by President Obama last night to a joint session of the Congress, is an attempt to dress up the employment disaster the US and other advanced economies are needlessly enduring.

The metaphor presumes that you share in the general notion that pigs lack pulchritude. The current lack-of-jobs status is about as ugly as it gets. And the address last night leaves it barely improved at best. This is the biggest economic crisis of the last four generations, and we get....lipstick?

It is conceivable that, if the program manages to survive the worst Congress in my memory, it could help. The various early modeling returns have it adding between 500K and 3 million jobs over three years. So Mark Thoma and Paul Krugman say it positively surprised them. How low have our expectations sunk? These normally very good economists know how to do much much better than this. C'mon guys, this practically stinks.

This is at least a 15,000,000 jobs BIG pig, and getting bigger every day.

Mr. President, this economy must have at least 400K net new jobs per MONTH to fulfill both the economic potential and the moral imperative to reduce the totally needless suffering of the unemployed. C'mon Mr. President. 400K net new jobs per MONTH, hell or high water.

Put away the lipstick. We need jobs. Lots of them, private and public.

Update: via Jared Bernstein, Mark Zandi's model speaks and we strain to listen: AJA => 1.9 million net new jobs. While better than no jobs, folks, this is a crisis, and requires crisis-worthy action. I realize the political challenges, but as soon as we have whatever crumbs can be pried from agreements with the 'pubs, it will be time to put maximum political pressure on them to do the right thing -- 400K jobs a month. C'mon Mr. President, less lipstick, more jobs.

More on the employment news

Just to add to Steve's discussion of the terrible jobs situation, the graph below shows that the stimulus was enough to reverse the downward trend in non-farm employment (to download go here), but not enough to maintain a healthy recovery.

By mid-2010, when the stimulus package started to wind down, employment creation basically stalled. There is some additional employment growth after the late 2010 fiscal package, but that is gone now.  Only in May 2010 more than 400K jobs were created. I'm all for the government hiring workers if the private sector doesn't, as in Steve's proposal, but I'm sorry to say that I don't think Obama, let alone Congressional Republicans, will move in that direction.

PS: Some of the employment creation in 2010 was the result of direct government hiring for the Census, by the way.

Stunningly disastrous news on employment

Net ZERO new jobs in August (BLS report here). As in nada, nothing, nadir... pick your favorite disaster-evoking word. The only possible silver lining is if things are now "bad enough" that the momentum for doing what non-"regular" economists (a slam on Barro's most recent lunacy; subscription required), that is economists who understand and fundamentally believe Keynesian macro models, know how to do.



This is the worst job performance since 1945, I just heard, but haven't verified.

President Obama needs to lead. Meaning capture the essence of fixing the problem and communicate it in a compelling way.



My proposal for that is simple: 400,000 new jobs per month, private and public, we desperately need them all. Hell or high water. At this point arguing over the details means absolutely nothing -- we must commit to creating any kind of job that moves us toward 400K.



Given this truly abysmal news, maybe it should be hell AND high water. C'mon Mr. President!

Plosser thinks there is no jobs problem

So while we wait for the jobs plan that the president will announce later this week, the Fed published the minutes of the Federal Open Market Committee's (FOMC) meeting.  Three members, including Real Business Cycle (RBC) guru Charles Plosser, voted against maintaing interest rates close to zero until 2013. The three that voted against are afraid about core inflation, and signaling that rates will not increase if inflation accelerates.   Also, somebody believes that a slight increase in core inflation with the slightly lower unemployment (even though the lower unemployment is related to participation rates) implies that potential output is lower.  Not kidding.  Precise words in the minutes are:

"A couple of others, however, suggested that the juxtaposition of higher core inflation and somewhat lower unemployment could imply that the level of potential output was lower than had been thought."

The economy grew 0.7% in the first six months of the year, and we are still below the previous peak, but we're close to potential output?! My guess is that "the couple of others" includes Plosser.  In other words, this guy thinks that around 9 percent unemployment is close to the natural rate.  Nothing like believing that anything is full employment to convince yourself that markets actually produce optimal outcomes.

Alan Krueger to lead the CEA

The NYTimes reports that Alan Krueger will be the next chairman of the Council of Economic Advisors. A well respected, serious professor from Princeton, that almost everybody from Mankiw to Krugman will approve of. He is a labor economist, and yes that is a problem. My concern with labor economists, is that they tend to think in microeconomic terms when it comes to employment creation, and that is definitely not a solution for the current situation.



For example, the Times tells us that:

"Dr. Krueger was also one of the administration’s chief spokesmen for a payroll tax cut designed to encourage employers to hire, a policy that was in effect under the HIRE Act during 2010. The tax incentive, which was designed by Senators Chuck Schumer and Orrin Hatch after a raft of competing proposals floated through Washington, was criticized by some economists as being too small and ill-targeted to make much of a difference in hiring."

Don't get me wrong a reduction of payroll taxes, a regressive tax that burdens low income groups more heavily, is a good idea. But the reason is that it would stimulate consumption, not that it would reduce costs and lead to additional hiring. Why would a firm hire workers, because costs are lower, if they don't have demand for their products? Employment creation is NOT about incentives to the supply side, but about creating more demand!

Warren Buffett on job creators

According to the GOP, and their economists, you cannot tax the rich (sorry job creators), because that would have a negative impact on employment.  Warren Buffett (a very job creating guy) thinks differently.  He says:

"Back in the 1980s and 1990s, tax rates for the rich were far higher, and my percentage rate was in the middle of the pack. According to a theory I sometimes hear, I should have thrown a fit and refused to invest because of the elevated tax rates on capital gains and dividends.

I didn’t refuse, nor did others. I have worked with investors for 60 years and I have yet to see anyone — not even when capital gains rates were 39.9 percent in 1976-77 — shy away from a sensible investment because of the tax rate on the potential gain. People invest to make money, and potential taxes have never scared them off. And to those who argue that higher rates hurt job creation, I would note that a net of nearly 40 million jobs were added between 1980 and 2000. You know what’s happened since then: lower tax rates and far lower job creation."

Of course this involves actual evidence, which is irrelevant for the discussion about economic policy with Republicans these days.  In their view, Warren Buffett is a job creation denier.

I know, I know, I should be grading (or working on my diss), but c'mon Mr. President, 400K jobs a month!

A 1932 Low cartoon via Luke Ashworth via Worthwhile Canadian Initiative.




I promise I am grading, but Ken Rogoff was just sounding like a total idiot (sorry, nothing pejorative intended for those who truly deserve our support) arguing (need I even add badly?) with Paul Krugman on Fareed Zakaria's GPS. So I can't help myself.




We do need to do whatever possible to shake this President out of his torpor. Here is the beginning of a campaign I just posted on Economist's View, and will be posting wherever there are smart readers. Quoting




"C'mon Mr. President!!! 400,000 jobs a month. Private, public, we need them all. If Plouffe and Daley disagree, tell them to get with the program.

Listen to your economists, present and former. Romer in particular is showing the right brand of spunk ... watch her Bill Maher appearance... and has the economics right. Sperling has both the politics and the economics right. 400,000 pragmatic jobs a month. Hell or high water. You're the President. C'mon.

Here's just one of many links to Romer (this one from HuffPo):

Send the kids out of the room."

I am actually beginning to like Christy Romer in spite of past peccadilloes.


Ok, back to grading, but not before I pose a related question: How is that austerity thing going after the riots this week Mr. Prime Minister Cameron?

The Colombia FTA: Only Corporations Win

Trade has been a contentious issue in U.S. politics for a very long while. In recent times, free trade agreements have been promoted as essential by the cheerleaders of globalization, and as a threat to good jobs with decent wages and benefits by those who are skeptical about the advantages of the global economy. President Obama, a man of broad views, seems to represent both opinions. On February 12, 2008, candidate Obama made the following argument on this issue:

“It’s a game where trade deals like NAFTA ship jobs overseas and force parents to compete with their teenagers to work for minimum wage at Wal-Mart. That’s what happens when the American worker doesn’t have a voice at the negotiating table, when leaders change their positions on trade with the politics of the moment, and that’s why we need a President who will listen to Main Street—not just Wall Street; a President who will stand with workers not just when it’s easy, but when it’s hard.”

The previous year, Senator Obama had opposed trade deals with Colombia, Panama, and South Korea, while favoring one with Peru. Facing several critics, even before he won the nomination, Obama clarified that he did not intend to unilaterally revise NAFTA, but would be favorable to having a dialogue about the costs of free trade agreements (FTAs). Once in office, however, Obama seems to have made a 180-degree turn.



Read the rest here.

We've Become a Nation of Takers, Not Makers

More Americans work for the government than in manufacturing, farming, fishing, forestry, mining and utilities combined.

Census Worker AFP File image

Stephen Moore
Wall Street Journal

If you want to understand better why so many states—from New York to Wisconsin to California—are teetering on the brink of bankruptcy, consider this depressing statistic: Today in America there are nearly twice as many people working for the government (22.5 million) than in all of manufacturing (11.5 million). This is an almost exact reversal of the situation in 1960, when there were 15 million workers in manufacturing and 8.7 million collecting a paycheck from the government.

It gets worse. More Americans work for the government than work in construction, farming, fishing, forestry, manufacturing, mining and utilities combined. We have moved decisively from a nation of makers to a nation of takers. Nearly half of the $2.2 trillion cost of state and local governments is the $1 trillion-a-year tab for pay and benefits of state and local employees. Is it any wonder that so many states and cities cannot pay their bills?

Every state in America today except for two—Indiana and Wisconsin—has more government workers on the payroll than people manufacturing industrial goods. Consider California, which has the highest budget deficit in the history of the states. The not-so Golden State now has an incredible 2.4 million government employees—twice as many as people at work in manufacturing. New Jersey has just under two-and-a-half as many government employees as manufacturers. Florida's ratio is more than 3 to 1. So is New York's.

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