Beat the Press is Dean Baker's commentary on economic reporting. Dean Baker is co-director of the Center for Economic and Policy Research (CEPR).

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The Washington Post had a piece on the latest efforts by centrist Democrats to counter the rise of the progressive wing of the party. It tells readers:

"Many of them pushed in the 1990s, under President Bill Clinton, to expand global trade and deregulate the financial sector. They now concede those efforts did not go according to script, particularly for middle-class workers, but they are not calling for a full rewrite in response."

Actually, increasing inequality was an entirely predictable outcome of expanded trade with developing countries with large amounts of low-paid labor. Reduced wages for manufacturing workers and less-educated workers is exactly what the Stolper-Samuelson theory, one of the bedrocks of trade theory, predicts. 

In fact, since the trade agreements of the last quarter century left in place or increased protections for highly paid professionals and also increased patent and copyright protections, it is difficult to believe anyone would not have expected the upward redistribution that occurred. It certainly was entirely predictable at the time.

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The Washington Post ran a major piece pointing out some of the difficulties involved in shifting over to a universal Medicare system as advocated by Senator Bernie Sanders. While the piece notes many of the problems, it never mentions that the United States pays hugely more per person for its health care with little obvious benefit in terms of outcomes. As a result, there would be enormous potential savings from switching to a universal Medicare-type system.

For example, according to the OECD, the UK spends less than half as much per person as the United States. This means that if the United States could get its costs down to UK levels, it would save more than $20 trillion (@ $60,000 per person) over the next decade. While accomplishing a transition to a more efficient system would be difficult, as the piece notes, but the potential gains are enormous.

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Actually that is not quite what Pearlstein said. The billionaire-owned Post, which has largely turned itself in recent weeks into a Bernie Sanders attack organ, apparently wanted yet another hit piece. Pearlstein in fact told readers that if the country elected Senator Sanders, and he was able to implement his policies to make the United States more like Scandinavia, then we would have to get used to a higher unemployment rate (twice). 

While the unemployment rates in these countries are somewhat higher than in the United States, the employment rates are also higher. According to the OECD, the percentage of people between the ages of 15 and 64 who are working is 75.5 percent in Sweden, 74.4 percent in Norway, and 73.2 percent in Denmark compared to 68.9 percent in the United States. If the United States had the same share of its population working as Denmark employed, 10 million more people would have jobs. If we had the same employment rates as Sweden, 15 million more people would be working.

The reason that these countries can have both a higher employment rate and unemployment rate is that more people in these countries are in the labor market. This is in part because they have more family friendly policies, such as long periods of paid parental leave and good publicly supported child care. (The employment gap is much larger for women than men.) It is also because they have better education systems that ensure even people at the bottom have decent educations. And, they don't incarcerate almost one percent of their population like the United States.

Pearlstein also cites a paper by Daron Acemoglu, Thierry Verdier, and James Robinson which argues that countries with strong welfare states like the Scandanavian countries don't produce the same sort of innovation as countries like the United States. This paper relies far more on hand-waving than data to make its case. These countries have high rates of new business formation and innovation by most measures.

Pearlstein also cites an analysis by the Tax Policy Center which argues that a financial transactions tax can only raise $50 billion a year rather than the $75 billion a year assumed by Sanders campaign. (He proposes this tax to pay for free college for all.) It is worth noting that this difference is due to the fact that the Tax Policy Center assumes that trading of stocks and other assets is highly responsive to the tax. Under the Tax Policy Center's assumptions, the decline in trading expenses would actually be larger than the revenue raised through the tax. This means that the entire burden of the tax would be borne from Wall Street in the form of less revenue from trading. (This assumes that less trading — falling back to 1990s levels — does not reduce the ability of firms to raise capital.)

It would be very impressive if a tax could raise $50 billion a year by eliminating wasteful trading on Wall Street. It would have been useful if Pearlstein had pointed out this implication of the Tax Policy Center's analysis.

Anyhow, it is clear that the billionaire owned Post is prepared to do its part to undermine a candidate who wants to reduce the wealth and power of billionaires. It is also not surprising that it very much objects to a candidate who thinks billionaires should pay taxes.

 

Addendum:

For a fuller set of comparisons between the United States and the larger group of Nordic countries, see CEPR's chartbook.

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Paul Krugman has agreed to use his blog this week as a jumping off point for great CEPR papers of the past (yes, I'm kidding), but he gives us a great segue into an old paper on unionization rates in Canada with his latest blogpost. In his post Krugman makes the simple point that if inevitable forces like globalization and technology were responsible for the decline in unionization rates in the United States then we should expect to see a comparable decline in Canada. After all, Canada's economy is even more exposed to trade than the United States and the country has all the same technologies that we enjoy south of the border.

Yet, Canada has seen only a modest decline in its unionization rate over the last three decades. It is still close to 28 percent, compared to just 11 percent in the United States.

The CEPR paper, by former research associate Kris Warner, explains that the difference is the result of differing institutional structures around the unionization process. In most Canadian provinces (labor law is set at provincial level in Canada, as opposed to the national level in the United States), workers can organize through a process of majority sign-up. This means that if a majority of workers in a bargaining unit sign cards indicating their desire to join a union, then the employer must recognize the union.

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Paul Krugman had a blogpost this morning that included a simple chart showing that Mexico's per capita GDP has actually diverged from U.S. per capita GDP in the years since NAFTA. This is not supposed to happen, our econ textbooks tell us that poor countries are supposed to grow more rapidly than rich countries and this should have been especially true with Mexico post-NAFTA.

There should not be anything particularly controversial about Krugman's post, after all it comes directly from World Bank data, but it is worth noting that the World Bank tried to tell an opposite story. Back in 2004, on the tenth anniversary of NAFTA, the World Bank published a study that purported to show a convergence of per capita GDP between Mexico and the United States in the years since NAFTA was passed.

We tried to set them straight, since we knew the data did not support this claim. The World Bank refused to acknowledge the obvious error (it seems their study used exchange rate measures instead of purchasing power parity measures of GDP) and presumably continues to this day to treat their study as being valid. Perhaps Krugman's simple chart will force them to acknowledge the truth.

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E.J. Dionne used his column to argue that it is not just the establishment Republicans who are facing a crisis because of the rise of Donald Trump. He argues that the establishment Democrats also face a crisis:

“Its ideology was rooted in a belief that capitalism would deliver the economic goods and could be balanced by a ‘competent public sector, providing services of quality to the citizen and social protection for those who are vulnerable.’”

This is far too generous an account. The Clinton Democrats were actively steering the economy in a direction to redistribute income upward. This was clear in a number of areas.

First, their trade policy was quite explicitly designed to put U.S. manufacturing workers in direct competition with low paid workers in the developing world, but maintaining or increasing protections for highly paid professionals like doctors and lawyers. The predicted and actual outcome of this policy is a redistribution from ordinary workers to those at the top. This effect of this policy was aggravated by the massive trade deficit that was the predictable result of the high dollar policy promoted by Robert Rubin.

They also pushed for longer and stronger patent and copyright protection both domestically and internationally in trade pacts. This meant more money for the pharmaceutical, software, and entertainment industry at the expense of the rest of society.

They pushed deregulation in the financial industry, which allowed for an explosion in the share of national income that went to the financial sector. Again, this upward redistribution came at the expense of the rest of society.

And, they effectively supported the explosion of CEO pay. Clinton pushed a transparently absurd measure to cap CEO pay. (He pushed a measure that removed the tax deductibility for non-performance related pay in excess of $1 million a year. This green-lighted huge option based packages.)

Clinton also promoted the outsourcing of government services (a.k.a. re-inventing government). This typically meant replacing relatively well-paid union workers with much lower paid contract workers. At the same time it often meant big profits for well-connected contractors, which meant that taxpayers received no benefit from the deal. The fact a Democratic president pushed this process at the national level encouraged many state and local governments to follow the same path.

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A Washington Post piece on the Fed and the presidential elections told readers:

“A strong economy tends to boost the party currently in power, which is why President Nixon installed confidante Arthur Burns as head of the Fed in 1970, urging him to keep interest rates low to stoke the job market. The result was a decade of runaway inflation that was tamed only by a painful recession.”

This is a very strong and implausible claim. The inflation in the 1970s was fueled in large part by two huge rises in the price of oil. The first was associated with an OPEC oil embargo directed against the United States, which led to a quadrupling in the price of oil between 1973 and 1974. The second was associated with the Iranian revolution, which essentially stopped Iran’s oil exports. At the time, Iran was the world’s second largest oil exporter. There was also a sharp surge in food prices associated with massive sales of wheat to the Soviet Union in 1973.

In addition, there was a sharp slowdown in productivity growth beginning in 1973, which persisted until 1995. This slowdown was completely unexpected and to this day there still is no agreed upon explanation among economists. With workers expecting wage growth in line with the prior rate of productivity growth (2.5–3.0 percent annually), it is not surprising that slower productivity growth would be lead to higher inflation.

Furthermore, there was an error in the official measure of inflation, the consumer price index (CPI), which added approximately 6 percentage points to its measure of inflation over the course of the decade compared to the way the CPI is calculated today. This overstatement of inflation in the CPI likely lead to higher actual inflation since many contracts, most importantly wage contracts, were explicitly tied to the CPI. This means that if mis-measurement caused the CPI to show a higher rate of inflation it would lead to higher wages and prices in many sectors of the economy.

Finally, inflation rose sharply in the 1970s not only in the United States, but almost everywhere in the world. Arthur Burns’ policies could not in any obvious way lead to greater inflation in Europe, Canada, and elsewhere.

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In recent weeks the Washington Post has virtually transformed itself into a Bernie Sanders attack platform, filling both its news and opinion pages with critical pieces. For this reason it was not surprising to see its lead editorial today criticizing Senator Sanders for not supporting an auto bailout because it was attached to funding for the Wall Street bailout. 

First, it worth once again correcting its misstatements about the Wall Street bailout. The piece tells readers:

"In September 2008, Ms. Clinton and Mr. Sanders were both U.S. senators deciding whether to vote for a $700 billion fund to prop up the rapidly collapsing U.S. financial system. Ms. Clinton voted yes, on the sound view that the likely alternative to this admittedly undeserved rescue of Wall Street would have been global calamity. Mr. Sanders voted no, demanding that Wall Street pay for its own bailout. As it happens, the bailout fund, known as the Troubled Asset Relief Program (TARP), ended up costing far less than the initial headline figure suggested, and even made taxpayers some money; but, as was foreseeable at the time, that hasn’t stopped the country’s political purists, left and right, from second-guessing and making political hay."

As I and others have pointed out, the "second Great Depression" story pushed by bailout supporters assumes that Washington does nothing even as the unemployment rate soars into the double digits. There is no historical support for anything like this. Even President George W. Bush supported a stimulus package when the unemployment rate was just 4.9 percent. Furthermore, the fact the bailout "made taxpayers some money" really has nothing to do with the time of day. The government lent billions of dollars (trillions of dollars counting the loans from the Fed) to some of the richest people in the country at rates that were far below what they would have been forced to pay in the market. This was an enormous transfer of wealth from the rest of us to Wall Street.

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That is what Binyamin Appelbaum argued in a Upshot column with the headline, “on trade, Donald Trump breaks with 200 years of economic orthodoxy.” The piece points to Trump’s rhetoric in which he claims that other countries are taking advantage of the United States because they are running large trade surpluses with us.

It then turns to an old speech from Milton Friedman saying the opposite is true:

“'Economists have spoken with almost one voice for some 200 years,’ the economist Milton Friedman said in a 1978 speech. ‘The gain from foreign trade is what we import. What we export is the cost of getting those imports. And the proper objective for a nation, as Adam Smith put it, is to arrange things so we get as large a volume of imports as possible for as small a volume of exports as possible.’”

This is in fact the classic economics argument for the merits of trade, but there is an important assumption in the argument which is not mentioned. The assumption is that the trade deficit has no effect on the level of aggregate demand and output in the United States. In the standard economic view, if our annual trade deficit increases by $200 billion we will simply make up this demand elsewhere in the economy.

A combination of higher consumption, investment, and government spending will fully offset the $200 billion reduction in demand resulting from the rise in the trade deficit. This means that total demand in the economy will not change, nor will total employment. There could be some shift in employment, from the import competing industries to the industries that meet the new demand, but in the standard economics story of trade, overall unemployment is not a problem.

This view of trade is less tenable in an economy that faces a chronic shortfall of demand, as is the case in the United States. Most economists now recognize that advanced economies like those in the United States, Japan, and the European Union can have prolonged periods of inadequate demand (a.k.a. “secular stagnation”) leading to unemployment and underemployment.

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Since the TARP has come up repeatedly in the debates between Secretary Hillary Clinton and Senator Bernie Sanders, it is worth briefly correcting a couple of major misconceptions. The first one is that we would have had a second Great Depression without the bailout. This assertion requires rejecting everything we know about the first Great Depression.

The first Great Depression was caused by a series of bank collapses as runs spread from bank to bank. The country was much better positioned to prevent the same sort of destruction of wealth and liquidity most importantly because of the existence of deposit insurance backed up by the Federal Deposit Insurance Corporation.

More importantly, the downturn from the collapse persisted for over a decade because of the lack of an adequate fiscal response. In other words, if we had spent lots of money, we could have quickly ended the depression as we eventually did with the spending associated with World War II in 1941. There is no reason in principle that we could not have had this spending for peaceful purposes in 1931, which would have quickly brought the depression to an end.

The claim that we risked a second Great Depression in 2008 (defined as a decade of double-digit unemployment) is not only a claim that we faced a Great Depression sized financial collapse but also that we would be too stupid to spend the money needed to get us out of the downturn for a decade. None of the second Great Depression myth promulgators has yet made that case.

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Hey, can an experienced doctor from Germany show up and start practicing in New York next week? Since the answer is no, we can say that we don't have free trade. It's not an immigration issue, if the doctor wants to work in a restaurant kitchen, she would probably get away with it. We have protectionist measures that limit the number of foreign doctors in order to keep their pay high. These protectionist measures have actually been strengthened in the last two decades.

We also have strengthened patent and copyright protections, making drugs and other affected items far more expensive. These protections are also forms of protectionism.

This is why Morning Edition seriously misled its listeners in an interview with ice cream barons Ben Cohen and Jerry Greenfield over their support of Senator Bernie Sanders. The interviewer repeatedly referred to "free trade" agreements and Sanders' opposition to them. While these deals are all called "free trade" deals to make them sound more palatable ("selective protectionism to redistribute income upward" doesn't sound very appealing), that doesn't mean they are actually about free trade. Morning Edition should not have used the term employed by promoters to push their trade agenda.

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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.

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Eduardo Porter noted the rise in income inequality over the last three decades. He then suggests a few policies that could raise incomes for those at the middle and bottom, such as the wage insurance policy recently proposed by President Obama and the Earned Income Tax Credit. While these are reasonable proposals, it is also reasonable to suggest ending the protections that act to raise incomes for those at the top.

For example, we can use trade policy to provide more competition for doctors, dentists, lawyers and other highly paid professionals who occupy the top 1–2 percent of the wage distribution. There are plenty of very bright people in the developing world (and even West Europe) who would be happy to train to U.S. standards and work in the United States at a fraction of the wages of the people who currently hold these positions.

This would directly reduce inequality by eliminating the walls that now sustain the living standards of these highly educated workers. It would also raise the real wages of less-educated workers by reducing the cost of health care and the other services they provide.

We can also use trade policy to reduce the length and strength of patent and copyright protection. This would reduce the cost of drugs and software, further raising the wages of ordinary workers. This would also reduce the income of those at the top, like Bill Gates and the executives in the pharmaceutical industry.

We can also stop using the Federal Reserve Board as a tool to keep down the wages of ordinary workers, which thereby boosts the wages of those at the top. This means not raising interest rates at the first hint of any real wage growth by those at the middle and bottom of the wage ladder.

There are many other policies that could be introduced that would raise the wages of ordinary workers by reducing the income of those at the top. It is remarkable that such policies rarely seem to appear on the national agenda. It is not surprising that this leaves many working class voters resentful.

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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?

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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.

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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.

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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.

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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.

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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
non shelter inflation

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.

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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.

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Are rivers flowing upstream? Has anyone seen four horsemen? Anyhow, it seems that the Washington Post editorial board is now acknowledging that a financial transactions tax [FTT] could be a serious policy. It ran an editorial which included a few derisive comments directed towards Senator Bernie Sanders, who has advocated a financial transactions tax in his presidential campaign, but favorably cited the Tax Policy Center’s analysis and said:

“They [FTTs] represent a ‘tempting’ option that might help the United States raise revenue while curbing speculative excess.”

There are a few points worth adding to the Post’s comments. The Post told readers:

“However, a tax would undoubtedly dampen some productive trading and not necessarily raise that much revenue, the report found — about $50 billion a year, in contrast to the $75 billion figure Mr. Sanders floats.”

As far as the concern for productive trading, the way the tax would reduce this is by raising the cost of trades. However, the cost of trading has fallen sharply over the last four decades. This means that the tax would, depending on the exact rate, only raise the cost of trading part of the way back to where it was four decades ago.

If the tax were set at a 0.1 percent rate on stock, with lower rates for other assets, then it would be raising the cost of trading to the levels of 10–20 years ago. So unless we see much more productive trading in the markets today than we did in the 1990s, we wouldn’t have much to worry about in this respect.

As far as the amount of money that would be raised, this depends hugely on the sensitivity of trading volume to the size of the tax. The Tax Policy Center assumed an elasticity of 1.5, meaning that the percentage drop in trading volume would be 1.5 times the percentage increase in trading costs associated with the tax. This elasticity assumption is certainly at the high end of the estimates in the literature. An elasticity assumption closer to 1.0, which is more in the center of the estimates in the research, implies the tax would raise roughly twice as much revenue.

It is also is worth noting that the 1.5 elasticity assumption used by the Tax Policy Center implies that trading volume decreases by a larger percentage than the increase in costs due to the tax. It would mean, for example, that if the tax raised trading costs by 40 percent, then trading volume would decline by close to 60 percent.

This means investors would reduce their trading by a larger amount than their costs per trade increased. As a result, investors would on average spend less money on trading, even including the tax, than they did before the tax was put in place. In that scenario, the entire burden of the tax is borne by the financial industry in the form of lost trading revenue.

Arguably the 1.5 elasticity assumption by the Tax Policy Center is too high, but if it is correct, it does mean the tax will raise less revenue, but it also means a much larger hit to the financial industry. Insofar as a purpose of the tax is to reduce the amount of resources being wasted by shuffling stock and derivatives back and forth all day, an FTT would have a huge effect in this case.

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