• Economic Crisis and RecoveryCrisis económica y recuperación
Many people were struck by the 1.4 percent drop in GDP in the first quarter, with some reports suggesting this was the beginning of a recession. This is not the real story of the first quarter GDP, instead it looks like growth is continuing at a healthy rate. To understand this point, it is important to recognize how imports are counted in GDP, since the increase in imports subtracted 2.53 percentage points from GDP growth in the quarter.[1]
Imagine that the sum of consumption spending, investment, and government spending increased at 2.7 percent annual rate in the quarter (which they did). Now suppose that we offloaded $60 billion of goods from boats sitting offshore, increasing our imports by this amount. On an annual basis, this additional $60 billion in imports would be $240 billion, or roughly 1.0 percent of GDP. This would reduce GDP by this amount, even though our purchases for consumption, investment, and the government had not changed.
Okay, that story is not exactly right. The goods that we offloaded from the ships are now sitting in warehouses at the ports or on their way to the retail outlets where they will eventually be sold. This increase in inventories would raise GDP by an amount equal to the growth in imports, offsetting the drag that imports otherwise would have been on growth. However, inventories were actually a drag on growth in the quarter, subtracting 0.84 percentage points from GDP.
These two facts can be reconciled by looking at the actual amount that inventories increased in the first quarter. The report showed that inventories increased at a $158.7 billion annual rate. (Non-farm inventories rose at an even more rapid $185.3 billion annual rate. Farm inventories shrank at a $35.8 billion rate, continuing a pattern that has been going on for sixteen years, but that is another story.)
This is an extremely fast pace of inventory accumulation. By comparison, in the years of 2016-2018, three normal years of economic growth, inventory accumulation averaged $45 billion. The reason inventories were a negative factor in growth in the first quarter, in spite of this extraordinary rate of accumulation, is that inventories grew at an even more rapid $193.2 billion annual rate in the fourth quarter of 2021. That rise added 5.32 percentage points to the fourth quarter’s growth.
So how do we think about first quarter growth? It probably makes the most sense to focus on the measure of final demand to domestic purchasers, which rose at a very healthy 2.6 percent annual rate. This is measuring the growth in consumption, fixed investment, and government expenditures. If we want the fullest picture, we can combine the fourth quarter’s 6.9 percent growth rate with the first quarter’s 1.4 percent decline to get a 2.8 percent average growth rate for the last two quarters.
In addition to recognizing that the economy is still growing at very healthy pace, inventories have been largely rebuilt, in spite of supply chain problems. Real non-farm inventories at the end of the first quarter were just 0.1 percent below their pre-pandemic levels. (Farm inventories are now at just 53.0 percent of their level of 16 years ago.) This is a very positive sign, in that it should be mean that the prices of many items that rose sharply in the last year will be leveling off, and quite likely coming down.
In short, rather than being a bad report with a drop in GDP, this report is overwhelming good news. It shows that the main components of final demand, consumption, investment, and government expenditures, are growing at a healthy pace. And, it shows that inventories have been largely rebuilt, meaning that supply chain problems are being alleviated. Inflation is of course a problem, but this rise in inventories is exactly what we want to see if inflation is to be slowed.
[1] A drop in exports subtracted another 0.68 percentage points. This is likely also due to supply chain issues, as exporters can’t arrange for shipping containers.
Many people were struck by the 1.4 percent drop in GDP in the first quarter, with some reports suggesting this was the beginning of a recession. This is not the real story of the first quarter GDP, instead it looks like growth is continuing at a healthy rate. To understand this point, it is important to recognize how imports are counted in GDP, since the increase in imports subtracted 2.53 percentage points from GDP growth in the quarter.[1]
Imagine that the sum of consumption spending, investment, and government spending increased at 2.7 percent annual rate in the quarter (which they did). Now suppose that we offloaded $60 billion of goods from boats sitting offshore, increasing our imports by this amount. On an annual basis, this additional $60 billion in imports would be $240 billion, or roughly 1.0 percent of GDP. This would reduce GDP by this amount, even though our purchases for consumption, investment, and the government had not changed.
Okay, that story is not exactly right. The goods that we offloaded from the ships are now sitting in warehouses at the ports or on their way to the retail outlets where they will eventually be sold. This increase in inventories would raise GDP by an amount equal to the growth in imports, offsetting the drag that imports otherwise would have been on growth. However, inventories were actually a drag on growth in the quarter, subtracting 0.84 percentage points from GDP.
These two facts can be reconciled by looking at the actual amount that inventories increased in the first quarter. The report showed that inventories increased at a $158.7 billion annual rate. (Non-farm inventories rose at an even more rapid $185.3 billion annual rate. Farm inventories shrank at a $35.8 billion rate, continuing a pattern that has been going on for sixteen years, but that is another story.)
This is an extremely fast pace of inventory accumulation. By comparison, in the years of 2016-2018, three normal years of economic growth, inventory accumulation averaged $45 billion. The reason inventories were a negative factor in growth in the first quarter, in spite of this extraordinary rate of accumulation, is that inventories grew at an even more rapid $193.2 billion annual rate in the fourth quarter of 2021. That rise added 5.32 percentage points to the fourth quarter’s growth.
So how do we think about first quarter growth? It probably makes the most sense to focus on the measure of final demand to domestic purchasers, which rose at a very healthy 2.6 percent annual rate. This is measuring the growth in consumption, fixed investment, and government expenditures. If we want the fullest picture, we can combine the fourth quarter’s 6.9 percent growth rate with the first quarter’s 1.4 percent decline to get a 2.8 percent average growth rate for the last two quarters.
In addition to recognizing that the economy is still growing at very healthy pace, inventories have been largely rebuilt, in spite of supply chain problems. Real non-farm inventories at the end of the first quarter were just 0.1 percent below their pre-pandemic levels. (Farm inventories are now at just 53.0 percent of their level of 16 years ago.) This is a very positive sign, in that it should be mean that the prices of many items that rose sharply in the last year will be leveling off, and quite likely coming down.
In short, rather than being a bad report with a drop in GDP, this report is overwhelming good news. It shows that the main components of final demand, consumption, investment, and government expenditures, are growing at a healthy pace. And, it shows that inventories have been largely rebuilt, meaning that supply chain problems are being alleviated. Inflation is of course a problem, but this rise in inventories is exactly what we want to see if inflation is to be slowed.
[1] A drop in exports subtracted another 0.68 percentage points. This is likely also due to supply chain issues, as exporters can’t arrange for shipping containers.
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• Economic Crisis and RecoveryCrisis económica y recuperaciónGlobalization and TradeGlobalización y comercio
It is amazing how frequently policy types talk about “free trade” as though it is actually a policy anyone is interested in promoting. The reality is that what passes for free trade is a policy of removing barriers to allow low cost manufactured goods to enter the United States without restrictions. This puts downward pressure on the pay of manufacturing workers. Since manufacturing had historically been a source of high paying jobs for workers without college degrees (it is no longer), the loss of these jobs out downward pressure on the pay of non-college educated workers more generally.
A policy of genuine free trade would mean eliminating barriers that limit trade in physicians’ services as well as the services of highly paid professionals more generally. It would also mean weakening or eliminating patent and copyright monopolies, which can raise the price of protected items by many thousand percent above the free market price.
There is no political constituency for removing these protectionist barriers, as can be clearly seen by the fact that no major political figure is advocating this path. Instead, there is a strong political constituency, which includes many self-described liberals, for a trade policy designed to reduce the pay of non-college educated workers.
It is politically more salable to describe this policy as “free trade,” but it is a lie. Reporters should not describe it that way if they are trying to be objective.
It is amazing how frequently policy types talk about “free trade” as though it is actually a policy anyone is interested in promoting. The reality is that what passes for free trade is a policy of removing barriers to allow low cost manufactured goods to enter the United States without restrictions. This puts downward pressure on the pay of manufacturing workers. Since manufacturing had historically been a source of high paying jobs for workers without college degrees (it is no longer), the loss of these jobs out downward pressure on the pay of non-college educated workers more generally.
A policy of genuine free trade would mean eliminating barriers that limit trade in physicians’ services as well as the services of highly paid professionals more generally. It would also mean weakening or eliminating patent and copyright monopolies, which can raise the price of protected items by many thousand percent above the free market price.
There is no political constituency for removing these protectionist barriers, as can be clearly seen by the fact that no major political figure is advocating this path. Instead, there is a strong political constituency, which includes many self-described liberals, for a trade policy designed to reduce the pay of non-college educated workers.
It is politically more salable to describe this policy as “free trade,” but it is a lie. Reporters should not describe it that way if they are trying to be objective.
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It has become popular among the “Let’s Go Brandon” crowd, and major news outlets, to blame President Biden for the high price of gas. While this might excite the right, it literally has no foundation in reality.
The basic story is that gas is expensive because the world price of oil is high. There are small differences in oil prices across countries due to transportation costs, but if the world price of oil goes up sharply, as it has, then we will pay more for gas in the United States.
The U.S. can at best have a very limited impact on the world price of oil. When the U.S. economy grows rapidly, as it did in 2021, it increases world demand for oil. However, the impact of U.S. growth, by itself, is very limited. If the U.S. economy grew 2.0 percent in 2021, instead of its actual 5.5 percent rate, then perhaps the price of a barrel of oil would be $1 to $2 a barrel lower. That would save U.S. consumers 2.5 to 5.0 cents a gallon.
That might be helpful to people, but would not qualitatively change the story of high gas prices. So, if the unemployment rate was 1-2 percentage points higher (meaning another 1.5-3.0 million unemployed), and GDP was 3.5 percent smaller, car owners might be saving 5 cents on a gallon of gas.
There is even less of a story on the supply side. Biden has been pushing for measures that would promote the development and use of clean energy. To date these have had at best a very limited effect in moving us away from dependence on fossil fuels. But, insofar as they have had any impact, these measures would lower gas prices, not raise them.
He has proposed limiting drilling on government land, but he has opened up huge tracts for leasing to oil and gas developers. Furthermore, the oil and gas industries already have access to far more land than they are currently using. In short, there is no case that Biden’s efforts to reduce greenhouse gas emissions have had any noticeable effect on U.S. production of oil and gas.
Some right-wingers have highlighted Biden’s decision to nix the Keystone pipeline, which would bring oil from Canada to the United States. This pipeline was nowhere close to completion in any case. Furthermore, this oil is already making it to the world markets, meaning that any redirection due to the Keystone pipeline would have a trivial impact on world prices.
There is an important way in which Biden’s actions have lowered world oil prices. He is drawing down the U.S. strategic oil reserves by 1 million barrels a day. This has the same impact on world oil prices as if we increased U.S. production by 1 million barrels a day. An increase of this size would get production roughly back to the pre-pandemic level. The actual impact on world prices is even somewhat larger, since Biden also arranged for several of our allies to release oil from their reserves.
If there is a president to blame for high oil prices it would be Donald Trump. He actually boasted about arranging for OPEC to reduce its production of oil during the pandemic. OPEC still has not returned to its pre-pandemic levels of oil production. Apart from concerns over the Ukraine war leading to a reduction in world oil supplies, the reduction in oil production arranged by Donald Trump is by far the most important reason that gas prices are above their pre-pandemic level.
That reality may not fit the “let’s go Brandon” story, but as the Republicans always say, “reality has no place in politics.”
It has become popular among the “Let’s Go Brandon” crowd, and major news outlets, to blame President Biden for the high price of gas. While this might excite the right, it literally has no foundation in reality.
The basic story is that gas is expensive because the world price of oil is high. There are small differences in oil prices across countries due to transportation costs, but if the world price of oil goes up sharply, as it has, then we will pay more for gas in the United States.
The U.S. can at best have a very limited impact on the world price of oil. When the U.S. economy grows rapidly, as it did in 2021, it increases world demand for oil. However, the impact of U.S. growth, by itself, is very limited. If the U.S. economy grew 2.0 percent in 2021, instead of its actual 5.5 percent rate, then perhaps the price of a barrel of oil would be $1 to $2 a barrel lower. That would save U.S. consumers 2.5 to 5.0 cents a gallon.
That might be helpful to people, but would not qualitatively change the story of high gas prices. So, if the unemployment rate was 1-2 percentage points higher (meaning another 1.5-3.0 million unemployed), and GDP was 3.5 percent smaller, car owners might be saving 5 cents on a gallon of gas.
There is even less of a story on the supply side. Biden has been pushing for measures that would promote the development and use of clean energy. To date these have had at best a very limited effect in moving us away from dependence on fossil fuels. But, insofar as they have had any impact, these measures would lower gas prices, not raise them.
He has proposed limiting drilling on government land, but he has opened up huge tracts for leasing to oil and gas developers. Furthermore, the oil and gas industries already have access to far more land than they are currently using. In short, there is no case that Biden’s efforts to reduce greenhouse gas emissions have had any noticeable effect on U.S. production of oil and gas.
Some right-wingers have highlighted Biden’s decision to nix the Keystone pipeline, which would bring oil from Canada to the United States. This pipeline was nowhere close to completion in any case. Furthermore, this oil is already making it to the world markets, meaning that any redirection due to the Keystone pipeline would have a trivial impact on world prices.
There is an important way in which Biden’s actions have lowered world oil prices. He is drawing down the U.S. strategic oil reserves by 1 million barrels a day. This has the same impact on world oil prices as if we increased U.S. production by 1 million barrels a day. An increase of this size would get production roughly back to the pre-pandemic level. The actual impact on world prices is even somewhat larger, since Biden also arranged for several of our allies to release oil from their reserves.
If there is a president to blame for high oil prices it would be Donald Trump. He actually boasted about arranging for OPEC to reduce its production of oil during the pandemic. OPEC still has not returned to its pre-pandemic levels of oil production. Apart from concerns over the Ukraine war leading to a reduction in world oil supplies, the reduction in oil production arranged by Donald Trump is by far the most important reason that gas prices are above their pre-pandemic level.
That reality may not fit the “let’s go Brandon” story, but as the Republicans always say, “reality has no place in politics.”
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Inflation has stayed higher longer than I expected. I got that one wrong. I am happy to acknowledge my mistake, but I also want to know the reason why. This is not a question of finding excuses, I want to know why the economy is acting differently than I thought it would.
The most obvious reason is the supply chain disruptions that led to the original jump in prices have lasted longer and been more far-reaching than I expected. Part of this is due to the persistence of the pandemic, with the delta and omicron strains disrupting economies around the world.
The other major source of disruption is Russia’s invasion of Ukraine. This has blocked the supply of many items manufactured in Ukraine, but more importantly, the war reduces its ability to grow and sell wheat and other crops on world markets. There is also the risk of losing Russia’s oil and gas, which propelled oil prices to levels not seen in more than a decade.[1]
The idea that inflation would spike under such circumstances should not be surprising. As has been widely noted, the jump in inflation was worldwide, not just in the United States. The increase in the inflation rate was comparable in the European Union and the United Kingdom, so it obviously was not just a story of excessive stimulus in the United States. The break-even inflation rate on German 10-year government bonds are now essentially the same as in the United States, indicating that investors expect inflation in the two countries to be roughly the same over this period.
The logic here should not be hard to understand. The normal delivery of goods and services was disrupted by the pandemic. Since overall demand did not drop to anywhere near the same extent (due to various stimulus measures), we had shortages of many items, leading to sharp increases in prices.
While there were jumps in demand at various points during the pandemic, associated with the timing of stimulus payments, overall growth has not been extraordinary. Real consumption expenditures for February of 2022 (the most recent month for which we have data) were 4.6 percent higher than they were two years ago, a 2.3 percent annual rate of growth.
The problem has been, and still is, a huge shift from consumption of services to consumption of goods, due to the pandemic. While service consumption was still slightly below its pre-pandemic level in February of 2022, consumption of nondurable goods was up 11.8 percent, a 5.9 percent annual rate of growth. Consumption of durable goods grew even more rapidly, rising 22.6 percent, a 10.7 percent rate of growth.
This jump in demand would have been difficult for the economy to meet even without pandemic-related, and now war-related, supply issues, but definitely overstretched capacity given where the economy is at present. If the pandemic continues to wane, it should mean that consumption will continue to switch back towards services. It should also mean a reduction in pandemic-related supply disruptions, although disruptions associated with the war may continue and could grow worse.
The Optimistic Route to Lower Inflation
It is important to recount the route to the surge in inflation, since it matters for our prospects for reducing inflation. Recounting our historical track record in bringing inflation down after surges that came from fundamentally different sources is not necessarily useful in describing our prospects for bringing down the current inflation spike.
The optimistic path for lowering inflation would be for an end to the supply chain issues that pushed inflation higher. This means an end to the backlogs at ports, an end to the shortage of truckers, and an end to COVID-19-related shutdowns in China and other manufacturing locations. Also, the shift back to services will reduce the extent to which demand for goods is exceeding the economy’s ability to supply them.[2]
The story would be that when these disruptions are ended, or at least ameliorated, the prices of many items would stop rising and even come back down. This should not sound far-fetched. Televisions provide a great example. The price of televisions had been falling gradually for decades. It suddenly surged 8.7 percent in the five months from March of 2021 until August. The index then turned around and fell sharply, so that it’s now lower than it had been in March of last year.
We may also be seeing this story now with used cars and trucks. Used vehicles prices rose 41.2 percent from February 2021 to February 2022, adding 1.1 percentage points to the overall inflation rate. (New vehicle prices rose 12.4 percent over this period, adding 0.5 percentage points to the inflation rate over the year.) Used vehicle prices fell 3.8 percent in March, after dropping 0.2 percent in February. A private index shows an even sharper drop in used vehicle prices, dropping 6.3 percent since its peak in January.
If we don’t see another resurgence of the pandemic, and the war in Ukraine doesn’t escalate further, these sorts of price reversals may be the norm. A wide range of goods that saw sharp increases in price during the pandemic may experience rapid price declines as the economy normalizes further and supply chain problems are overcome.
Apart from the small number of cases where prices are now falling, there is a more general reason why we might expect these price reversals to be common. Prices have hugely outpaced costs during the pandemic. This has led to a large shift from wages to profits, with the profit share of corporate income rising by more than two percentage points since the pandemic began.
If we think that the conditions of competition have not changed in most sectors since the start of the pandemic, it is reasonable to think that the labor and capital shares will return to their pre-pandemic level. Of course, this is not a given. Inertia is a powerful economic force, so it may be the case that even if we return to roughly pre-pandemic conditions, the profit share will remain elevated. But it is still plausible that we would return to pre-pandemic shares. That would increase the likelihood of price reversals like what we have already seen with televisions and may be now seeing with used vehicles.
There is one other point that has been largely neglected in the comparisons with the 1970s inflation. In the 1970s, there was a sharp slowdown in productivity growth. Productivity had been growing at close to 2.5 percent annually in the quarter century from 1947 to 1972. This allowed for rapid wage growth, with wages rising roughly in step with productivity for most workers. This changed in the seventies, with productivity growth falling to just over 1.0 percent annually from 1972 to 1980.
By contrast, we have seen a rise in productivity growth in the last three years, with the rate of growth increasing from just over 0.7 percent annually, between the fourth quarter of 2010 and the fourth quarter of 2018, to a 2.3 percent pace in the years from the fourth quarter of 2018 to the fourth quarter of 2021. This acceleration in productivity growth should allow for healthy real wage growth without inflation.
Trends in productivity growth are notoriously unpredictable, with few economists having expected the major breaks in trend in the post-war era. But it is encouraging that we have seen strong productivity growth through the pandemic, with businesses finding ways to innovate around unpredictable disruptions to supply chains, as well as their workforce. In this respect, it is worth noting that real output is now higher in restaurants than before the pandemic, even though aggregate hours worked in the sector is 7.2 percent lower than before the pandemic.
Rent and House Prices
While we may be getting some good news on price trends with a wide range of goods, in recent months we have been seeing an acceleration in the rate of rent increases. This could be a big factor increasing inflation since the rental components accounts for more than 31 percent of the overall CPI and almost 40 percent of the core CPI.
The underlying issue in higher rents and house sales prices (house prices have been rising at more than double-digit rates since the start of the pandemic), is a dozen years of extraordinarily weak construction following the collapse of the housing bubble in 2006 to 2009. The economy recovered very slowly from the collapse of the bubble, but when the labor market began to look more normal in the five years prior to the pandemic, rent began to outpace the overall rate of inflation. The rise in rents and sales prices did lead to an increase in housing construction, but the pace of construction was likely still below the growth of demand.
The pandemic aggravated the imbalance in the housing market through several different channels. First, and most obviously, the plunge in mortgage interest rates made it far cheaper for people to buy homes. With the mortgage rate bottoming out at under 3.0 percent, prospective home buyers could afford to pay far more for a house.
Another factor pushing house prices higher was the increase of remote work. Tens of millions of people began to work from home during the pandemic. This meant that they needed more space in their house to accommodate a home office. They also had additional money to pay for rent or a mortgage, since they were saving a large amount of money on commuting costs. It’s not clear how enduring the increase in remote work will be, but it is virtually certain that millions of additional workers will be working remotely, at least part-time, even after the pandemic.
A third factor that boosted housing demand was the eviction moratorium that went in place in April of 2020 and lasted until September, 2021. In an ordinary year, there are close to 1 million evictions. This number fell by more than half during the moratorium. While there were warnings of an explosion in evictions when the moratorium ended, there was no huge surge, even as the rate of evictions moved closer to normal.
It is not good to see people evicted from their home, but keeping tenants in their home does reduce the number of units that are coming on the market. The moratorium helped increase the demand for housing over the last two years.
In the four years from the fourth quarter of 2017 to the fourth quarter of 2021, the number of occupied units increased by more than 7.2 million. By contrast, in the prior four years the number of occupied units increased by only 5.2 million units. This is likely a big part of the story of the run-up in both sales prices and rents, as vacancy rates fell to near record low levels.
However, we may be reaching a turning point in the housing market as well. The Fed’s moves on interest rates have the most direct impact on the housing market. Even though the federal funds rate has risen by just 0.25 percent, the interest rate on 30-year mortgages has already gone up by more than 2.0 percentage points from its pandemic low.
It is still early to get good data on the impact of this rise mortgage rates, but there is evidence that it has already substantially slowed the housing market. Applications for purchase mortgages are down by double-digit amounts from their year ago level. There is also considerable anecdotal evidence of realtors reporting a qualitative shift in the market, with many sellers now making cutting prices from their original listing price.
Another factor that can put downward pressure on sales prices and rents would be an increase in the rate of housing completions. The rate of housing construction rose sharply in the pandemic, rising from less than 1.3 million in 2019, to close to 1.8 million in recent months. However, there has been no comparable increase in the rate of housing completions, which is still running at just over 1.3 million annual rate.
The gap is another aspect of the supply chain crisis. Builders are finding it difficult to get the materials they need to complete a home. There are shortages of everything from lumber to garage doors. If we can resolve supply chain issues, the gap between starts and completions should close quickly. It will take several years to make up the shortfall in supply resulting from more than a decade of severe under building, but increasing completions by 500,000 to 600,000 a year should help to alleviate the severe shortages being seen in many areas.
In short, there are important factors on both the demand and the supply side that should alleviate the upward pressure on rents and house sale prices. There is always a considerably amount of inertia in the housing market, but we may not see as a high rate of rental inflation as many analysts are now expecting.
In sum, there is a plausible story whereby inflation begins to come down in the not distant future. In this scenario, instead of seeing a wage-price spiral, we see inflation gradually fall back to levels that most of us would feel comfortable with.
The Bad Inflation Story
We can hope for the good inflation story, but there is also the bad one that needs to be taken seriously. In this view, we are already seeing a wage-price spiral. High inflation is changing people’s expectations, with workers now looking to get higher wage increases to compensate for the high inflation of the prior year. A round of wage increases that compensate for last year’s inflation will put more upward pressure on prices. This sequence continues, with inflation rates getting to ever more unacceptable levels.
The seventies inflation was eventually broken by the Fed pushing its overnight interest rate to more than 20.0 percent. This led to a steep recession in 1981-1982, with the unemployment rate peaking at just under 11.0 percent.
The recession brought down inflation by forcing workers to take pay cuts. With double-digit unemployment, few workers had the bargaining power to secure wage gains that kept pace with inflation. This reduced cost pressure and led to a rapid drop in the inflation rate to a more moderate pace.
It is important to recognize that this is a process involving enormous pain for tens of millions of people. The media have been full of reports of people who have trouble paying for gas and food with the recent rise in prices. In fact, most workers have had pay increases that have roughly kept pace with inflation since the pandemic, with pay for most workers at the bottom end of the wage distribution actually outpacing inflation.
However, if the Fed brings on a serious recession to combat inflation, many of the people in these news stories, who are now struggling to pay for food and gas, will be unemployed, or at least will have endured a stretch of unemployment. (Most spells of unemployment are relatively short.) Those who have jobs will likely not be getting pay increases that keep pace with whatever rate of inflation the economy is seeing at the time. Their ability to demand higher pay from their employer, or to seek a new job, will be severely limited by high unemployment. In other words, the process whereby inflation is brought down, will not be good news for them.
This point is important to keep in mind. There is not a simple and painless way to bring down the inflation rate through interest rate hikes by the Fed. It is not just a matter of turning down the thermostat a few notches. The rate hike put in place in March, coupled with a commitment to further hikes over the course of the year, has cooled down the housing market in a way that was necessary. It will also have a modest impact in slowing inflation in other sectors.
But the sort of rate hikes put in place by the Volcker Fed at the start of the 1980s would, at least in the short-term, make life far worse for the bulk of the population, even if there may be longer term benefits in the form of a lower and stable inflation rate. Everyone should be very clear on this point.
The Pandemic and the War Created Inflation and There Is No Simple Way to Bring it Down
The main points here are that the rise in the inflation rate as the economy reopened from the pandemic was overwhelmingly the result of inherent problems with reopening, and now disruptions created by the war in Ukraine. We can see this by virtue of the fact that most of Europe is now seeing comparable inflation rates. The stimulus provided by the Biden administration undoubtedly increased the inflation rate somewhat, but we would still be seeing uncomfortably high rates of inflation, along with higher unemployment, even without this stimulus.
There are reasons for thinking that the inflation rate will slow sharply as supply chain problems get resolved. We have already seen this sort of price reversal with some items, most notably televisions, where a sharp price last summer has been completely reversed in the last seven months. While the Biden administration can try to help in working through supply chain bottlenecks, there is no simple way to resolve this problem.
There is also no happy alternative path to lowering inflation. The route pursued by the Fed under Volcker subjected tens of millions of workers to unemployment. The mechanism was to undermine workers’ bargaining power, so that they would be forced to take real wage cuts. If people are struggling now to pay for gas and milk, their situation will not be improved if they lose their jobs and/or get lower real wages when they are working.
[1] FWIW, it seems unlikely that much Russian oil would be removed from world markets. Even if European countries join the United States in boycotting Russian oil, it would most likely be sold to other countries, most importantly India and China. The net effect on world supplies is likely to be limited.
[2] It is worth noting that demand for cars and other big-ticket items is to some extent self-limiting. People who bought a car or refrigerator in 2020 or 2021 are unlikely to buy another one in 2022.
Inflation has stayed higher longer than I expected. I got that one wrong. I am happy to acknowledge my mistake, but I also want to know the reason why. This is not a question of finding excuses, I want to know why the economy is acting differently than I thought it would.
The most obvious reason is the supply chain disruptions that led to the original jump in prices have lasted longer and been more far-reaching than I expected. Part of this is due to the persistence of the pandemic, with the delta and omicron strains disrupting economies around the world.
The other major source of disruption is Russia’s invasion of Ukraine. This has blocked the supply of many items manufactured in Ukraine, but more importantly, the war reduces its ability to grow and sell wheat and other crops on world markets. There is also the risk of losing Russia’s oil and gas, which propelled oil prices to levels not seen in more than a decade.[1]
The idea that inflation would spike under such circumstances should not be surprising. As has been widely noted, the jump in inflation was worldwide, not just in the United States. The increase in the inflation rate was comparable in the European Union and the United Kingdom, so it obviously was not just a story of excessive stimulus in the United States. The break-even inflation rate on German 10-year government bonds are now essentially the same as in the United States, indicating that investors expect inflation in the two countries to be roughly the same over this period.
The logic here should not be hard to understand. The normal delivery of goods and services was disrupted by the pandemic. Since overall demand did not drop to anywhere near the same extent (due to various stimulus measures), we had shortages of many items, leading to sharp increases in prices.
While there were jumps in demand at various points during the pandemic, associated with the timing of stimulus payments, overall growth has not been extraordinary. Real consumption expenditures for February of 2022 (the most recent month for which we have data) were 4.6 percent higher than they were two years ago, a 2.3 percent annual rate of growth.
The problem has been, and still is, a huge shift from consumption of services to consumption of goods, due to the pandemic. While service consumption was still slightly below its pre-pandemic level in February of 2022, consumption of nondurable goods was up 11.8 percent, a 5.9 percent annual rate of growth. Consumption of durable goods grew even more rapidly, rising 22.6 percent, a 10.7 percent rate of growth.
This jump in demand would have been difficult for the economy to meet even without pandemic-related, and now war-related, supply issues, but definitely overstretched capacity given where the economy is at present. If the pandemic continues to wane, it should mean that consumption will continue to switch back towards services. It should also mean a reduction in pandemic-related supply disruptions, although disruptions associated with the war may continue and could grow worse.
The Optimistic Route to Lower Inflation
It is important to recount the route to the surge in inflation, since it matters for our prospects for reducing inflation. Recounting our historical track record in bringing inflation down after surges that came from fundamentally different sources is not necessarily useful in describing our prospects for bringing down the current inflation spike.
The optimistic path for lowering inflation would be for an end to the supply chain issues that pushed inflation higher. This means an end to the backlogs at ports, an end to the shortage of truckers, and an end to COVID-19-related shutdowns in China and other manufacturing locations. Also, the shift back to services will reduce the extent to which demand for goods is exceeding the economy’s ability to supply them.[2]
The story would be that when these disruptions are ended, or at least ameliorated, the prices of many items would stop rising and even come back down. This should not sound far-fetched. Televisions provide a great example. The price of televisions had been falling gradually for decades. It suddenly surged 8.7 percent in the five months from March of 2021 until August. The index then turned around and fell sharply, so that it’s now lower than it had been in March of last year.
We may also be seeing this story now with used cars and trucks. Used vehicles prices rose 41.2 percent from February 2021 to February 2022, adding 1.1 percentage points to the overall inflation rate. (New vehicle prices rose 12.4 percent over this period, adding 0.5 percentage points to the inflation rate over the year.) Used vehicle prices fell 3.8 percent in March, after dropping 0.2 percent in February. A private index shows an even sharper drop in used vehicle prices, dropping 6.3 percent since its peak in January.
If we don’t see another resurgence of the pandemic, and the war in Ukraine doesn’t escalate further, these sorts of price reversals may be the norm. A wide range of goods that saw sharp increases in price during the pandemic may experience rapid price declines as the economy normalizes further and supply chain problems are overcome.
Apart from the small number of cases where prices are now falling, there is a more general reason why we might expect these price reversals to be common. Prices have hugely outpaced costs during the pandemic. This has led to a large shift from wages to profits, with the profit share of corporate income rising by more than two percentage points since the pandemic began.
If we think that the conditions of competition have not changed in most sectors since the start of the pandemic, it is reasonable to think that the labor and capital shares will return to their pre-pandemic level. Of course, this is not a given. Inertia is a powerful economic force, so it may be the case that even if we return to roughly pre-pandemic conditions, the profit share will remain elevated. But it is still plausible that we would return to pre-pandemic shares. That would increase the likelihood of price reversals like what we have already seen with televisions and may be now seeing with used vehicles.
There is one other point that has been largely neglected in the comparisons with the 1970s inflation. In the 1970s, there was a sharp slowdown in productivity growth. Productivity had been growing at close to 2.5 percent annually in the quarter century from 1947 to 1972. This allowed for rapid wage growth, with wages rising roughly in step with productivity for most workers. This changed in the seventies, with productivity growth falling to just over 1.0 percent annually from 1972 to 1980.
By contrast, we have seen a rise in productivity growth in the last three years, with the rate of growth increasing from just over 0.7 percent annually, between the fourth quarter of 2010 and the fourth quarter of 2018, to a 2.3 percent pace in the years from the fourth quarter of 2018 to the fourth quarter of 2021. This acceleration in productivity growth should allow for healthy real wage growth without inflation.
Trends in productivity growth are notoriously unpredictable, with few economists having expected the major breaks in trend in the post-war era. But it is encouraging that we have seen strong productivity growth through the pandemic, with businesses finding ways to innovate around unpredictable disruptions to supply chains, as well as their workforce. In this respect, it is worth noting that real output is now higher in restaurants than before the pandemic, even though aggregate hours worked in the sector is 7.2 percent lower than before the pandemic.
Rent and House Prices
While we may be getting some good news on price trends with a wide range of goods, in recent months we have been seeing an acceleration in the rate of rent increases. This could be a big factor increasing inflation since the rental components accounts for more than 31 percent of the overall CPI and almost 40 percent of the core CPI.
The underlying issue in higher rents and house sales prices (house prices have been rising at more than double-digit rates since the start of the pandemic), is a dozen years of extraordinarily weak construction following the collapse of the housing bubble in 2006 to 2009. The economy recovered very slowly from the collapse of the bubble, but when the labor market began to look more normal in the five years prior to the pandemic, rent began to outpace the overall rate of inflation. The rise in rents and sales prices did lead to an increase in housing construction, but the pace of construction was likely still below the growth of demand.
The pandemic aggravated the imbalance in the housing market through several different channels. First, and most obviously, the plunge in mortgage interest rates made it far cheaper for people to buy homes. With the mortgage rate bottoming out at under 3.0 percent, prospective home buyers could afford to pay far more for a house.
Another factor pushing house prices higher was the increase of remote work. Tens of millions of people began to work from home during the pandemic. This meant that they needed more space in their house to accommodate a home office. They also had additional money to pay for rent or a mortgage, since they were saving a large amount of money on commuting costs. It’s not clear how enduring the increase in remote work will be, but it is virtually certain that millions of additional workers will be working remotely, at least part-time, even after the pandemic.
A third factor that boosted housing demand was the eviction moratorium that went in place in April of 2020 and lasted until September, 2021. In an ordinary year, there are close to 1 million evictions. This number fell by more than half during the moratorium. While there were warnings of an explosion in evictions when the moratorium ended, there was no huge surge, even as the rate of evictions moved closer to normal.
It is not good to see people evicted from their home, but keeping tenants in their home does reduce the number of units that are coming on the market. The moratorium helped increase the demand for housing over the last two years.
In the four years from the fourth quarter of 2017 to the fourth quarter of 2021, the number of occupied units increased by more than 7.2 million. By contrast, in the prior four years the number of occupied units increased by only 5.2 million units. This is likely a big part of the story of the run-up in both sales prices and rents, as vacancy rates fell to near record low levels.
However, we may be reaching a turning point in the housing market as well. The Fed’s moves on interest rates have the most direct impact on the housing market. Even though the federal funds rate has risen by just 0.25 percent, the interest rate on 30-year mortgages has already gone up by more than 2.0 percentage points from its pandemic low.
It is still early to get good data on the impact of this rise mortgage rates, but there is evidence that it has already substantially slowed the housing market. Applications for purchase mortgages are down by double-digit amounts from their year ago level. There is also considerable anecdotal evidence of realtors reporting a qualitative shift in the market, with many sellers now making cutting prices from their original listing price.
Another factor that can put downward pressure on sales prices and rents would be an increase in the rate of housing completions. The rate of housing construction rose sharply in the pandemic, rising from less than 1.3 million in 2019, to close to 1.8 million in recent months. However, there has been no comparable increase in the rate of housing completions, which is still running at just over 1.3 million annual rate.
The gap is another aspect of the supply chain crisis. Builders are finding it difficult to get the materials they need to complete a home. There are shortages of everything from lumber to garage doors. If we can resolve supply chain issues, the gap between starts and completions should close quickly. It will take several years to make up the shortfall in supply resulting from more than a decade of severe under building, but increasing completions by 500,000 to 600,000 a year should help to alleviate the severe shortages being seen in many areas.
In short, there are important factors on both the demand and the supply side that should alleviate the upward pressure on rents and house sale prices. There is always a considerably amount of inertia in the housing market, but we may not see as a high rate of rental inflation as many analysts are now expecting.
In sum, there is a plausible story whereby inflation begins to come down in the not distant future. In this scenario, instead of seeing a wage-price spiral, we see inflation gradually fall back to levels that most of us would feel comfortable with.
The Bad Inflation Story
We can hope for the good inflation story, but there is also the bad one that needs to be taken seriously. In this view, we are already seeing a wage-price spiral. High inflation is changing people’s expectations, with workers now looking to get higher wage increases to compensate for the high inflation of the prior year. A round of wage increases that compensate for last year’s inflation will put more upward pressure on prices. This sequence continues, with inflation rates getting to ever more unacceptable levels.
The seventies inflation was eventually broken by the Fed pushing its overnight interest rate to more than 20.0 percent. This led to a steep recession in 1981-1982, with the unemployment rate peaking at just under 11.0 percent.
The recession brought down inflation by forcing workers to take pay cuts. With double-digit unemployment, few workers had the bargaining power to secure wage gains that kept pace with inflation. This reduced cost pressure and led to a rapid drop in the inflation rate to a more moderate pace.
It is important to recognize that this is a process involving enormous pain for tens of millions of people. The media have been full of reports of people who have trouble paying for gas and food with the recent rise in prices. In fact, most workers have had pay increases that have roughly kept pace with inflation since the pandemic, with pay for most workers at the bottom end of the wage distribution actually outpacing inflation.
However, if the Fed brings on a serious recession to combat inflation, many of the people in these news stories, who are now struggling to pay for food and gas, will be unemployed, or at least will have endured a stretch of unemployment. (Most spells of unemployment are relatively short.) Those who have jobs will likely not be getting pay increases that keep pace with whatever rate of inflation the economy is seeing at the time. Their ability to demand higher pay from their employer, or to seek a new job, will be severely limited by high unemployment. In other words, the process whereby inflation is brought down, will not be good news for them.
This point is important to keep in mind. There is not a simple and painless way to bring down the inflation rate through interest rate hikes by the Fed. It is not just a matter of turning down the thermostat a few notches. The rate hike put in place in March, coupled with a commitment to further hikes over the course of the year, has cooled down the housing market in a way that was necessary. It will also have a modest impact in slowing inflation in other sectors.
But the sort of rate hikes put in place by the Volcker Fed at the start of the 1980s would, at least in the short-term, make life far worse for the bulk of the population, even if there may be longer term benefits in the form of a lower and stable inflation rate. Everyone should be very clear on this point.
The Pandemic and the War Created Inflation and There Is No Simple Way to Bring it Down
The main points here are that the rise in the inflation rate as the economy reopened from the pandemic was overwhelmingly the result of inherent problems with reopening, and now disruptions created by the war in Ukraine. We can see this by virtue of the fact that most of Europe is now seeing comparable inflation rates. The stimulus provided by the Biden administration undoubtedly increased the inflation rate somewhat, but we would still be seeing uncomfortably high rates of inflation, along with higher unemployment, even without this stimulus.
There are reasons for thinking that the inflation rate will slow sharply as supply chain problems get resolved. We have already seen this sort of price reversal with some items, most notably televisions, where a sharp price last summer has been completely reversed in the last seven months. While the Biden administration can try to help in working through supply chain bottlenecks, there is no simple way to resolve this problem.
There is also no happy alternative path to lowering inflation. The route pursued by the Fed under Volcker subjected tens of millions of workers to unemployment. The mechanism was to undermine workers’ bargaining power, so that they would be forced to take real wage cuts. If people are struggling now to pay for gas and milk, their situation will not be improved if they lose their jobs and/or get lower real wages when they are working.
[1] FWIW, it seems unlikely that much Russian oil would be removed from world markets. Even if European countries join the United States in boycotting Russian oil, it would most likely be sold to other countries, most importantly India and China. The net effect on world supplies is likely to be limited.
[2] It is worth noting that demand for cars and other big-ticket items is to some extent self-limiting. People who bought a car or refrigerator in 2020 or 2021 are unlikely to buy another one in 2022.
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The New York Times had an editorial about the corruption of the patent system in recent decades. It noted that the patent office is clearly not following the legal standards for issuing a patent, including that the item being patented is a genuine innovation and that it works. Among other things, it pointed out that Theranos had been issued dozens of patents for a technique that clearly did not work.
As the editorial notes, the worst patent abuses occur with prescription drugs. Drug companies routinely garner dozens of dubious patents for their leading sellers, making it extremely expensive for potential generic competitors to enter the market. The piece points out that the twelve drugs that get the most money from Medicare have an average of more than fifty patents each.
The piece suggests some useful reforms, but it misses the fundamental problem. When patents can be worth enormous sums of money, companies will find ways to abuse the system.
We need to understand the basic principle here. Patents are a government intervention in the free market, they impose a monopoly in a particular market.
We should think of patents like price controls under the Soviet system of central planning. This system routinely led to shortages in many areas. As a result, there was a huge black market. Well-positioned individuals pulled items like blue jeans or milk, or other consumer products out of the official system and sold them for a huge premium on the black market.
The Soviet Union responded by getting more police and imposing harsher penalties for black market trades, but the standard economist solution was to take the money away. By that we mean stop regulating prices, let the market determine the price. When that happens, there is no room for a black market.
We should think about patents in the same way. While patents can be a useful tool for promoting innovation, when huge sums are available by claiming a patent, we should expect there will be corruption, in spite of our best efforts to constrain it. This means that we should limit their use and try to ensure that we only rely on them where patent monopolies are clearly the best mechanism to promote innovation.
I have argued that we should rely on publicly funded research, rather than patent monopolies when it comes to prescription drugs and medical equipment. In addition to promoting corruption, these monopolies create the absurd situation where many lifesaving drugs that would sell in a free market for twenty or thirty dollars, instead sell for thousands or even tens of thousands of dollars. (Solvaldi, a breakthrough drug for treating Hepatitis C, sold here for $84,000 for a three-month course of treatment. A high-quality generic version was available in India for $300.)
The situation is made even worse by the fact that we typically have third party payers. This means that patients needing treatment have to persuade a government bureaucracy or private insurer to pay for an expensive drug that would cost just a few dollars in a free market.
The abuses are less severe in other areas, but we should be looking to reduce the value of patents (and copyrights) everywhere, and rely on alternative mechanisms for supporting innovation. I discuss alternatives in chapter 5 of Rigged (it’s free).
It’s great to see the New York Times recognize the abuses of the patent system. It would be even better if it opened its pages to discussion of alternative mechanisms for financing innovation.
The New York Times had an editorial about the corruption of the patent system in recent decades. It noted that the patent office is clearly not following the legal standards for issuing a patent, including that the item being patented is a genuine innovation and that it works. Among other things, it pointed out that Theranos had been issued dozens of patents for a technique that clearly did not work.
As the editorial notes, the worst patent abuses occur with prescription drugs. Drug companies routinely garner dozens of dubious patents for their leading sellers, making it extremely expensive for potential generic competitors to enter the market. The piece points out that the twelve drugs that get the most money from Medicare have an average of more than fifty patents each.
The piece suggests some useful reforms, but it misses the fundamental problem. When patents can be worth enormous sums of money, companies will find ways to abuse the system.
We need to understand the basic principle here. Patents are a government intervention in the free market, they impose a monopoly in a particular market.
We should think of patents like price controls under the Soviet system of central planning. This system routinely led to shortages in many areas. As a result, there was a huge black market. Well-positioned individuals pulled items like blue jeans or milk, or other consumer products out of the official system and sold them for a huge premium on the black market.
The Soviet Union responded by getting more police and imposing harsher penalties for black market trades, but the standard economist solution was to take the money away. By that we mean stop regulating prices, let the market determine the price. When that happens, there is no room for a black market.
We should think about patents in the same way. While patents can be a useful tool for promoting innovation, when huge sums are available by claiming a patent, we should expect there will be corruption, in spite of our best efforts to constrain it. This means that we should limit their use and try to ensure that we only rely on them where patent monopolies are clearly the best mechanism to promote innovation.
I have argued that we should rely on publicly funded research, rather than patent monopolies when it comes to prescription drugs and medical equipment. In addition to promoting corruption, these monopolies create the absurd situation where many lifesaving drugs that would sell in a free market for twenty or thirty dollars, instead sell for thousands or even tens of thousands of dollars. (Solvaldi, a breakthrough drug for treating Hepatitis C, sold here for $84,000 for a three-month course of treatment. A high-quality generic version was available in India for $300.)
The situation is made even worse by the fact that we typically have third party payers. This means that patients needing treatment have to persuade a government bureaucracy or private insurer to pay for an expensive drug that would cost just a few dollars in a free market.
The abuses are less severe in other areas, but we should be looking to reduce the value of patents (and copyrights) everywhere, and rely on alternative mechanisms for supporting innovation. I discuss alternatives in chapter 5 of Rigged (it’s free).
It’s great to see the New York Times recognize the abuses of the patent system. It would be even better if it opened its pages to discussion of alternative mechanisms for financing innovation.
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Peter Coy used his column to discuss the prospects of Section 230 of the Communications Decency Act, the provision that protects Internet sites from being sued for defamation for third party content. Many right-wingers have bizarrely targeted Section 230, arguing that it allows companies like Twitter and Facebook to do things like remove postings from Donald Trump and his supporters. As Coy points out, these companies might actually be quicker to remove this content without Section 230, since they could be held liable for their defamatory claims.
In reviewing the arguments for Section 230 repeal, Coy left out what I considered the most important, the downsizing of Facebook and Twitter. In their current mode of operation, these companies depend on not being held responsible for defamatory items in third party content. If they were subject to the same sort of liability as their competitors in print and broadcast media, they would have to spend far more money in viewing and moderating posts and ads.
It would be impractical for Facebook and Twitter to moderate the billions of daily posts as they went up, but they could face takedown rules, similar to what is required with copyrighted material under the Digital Millennial Copyright Act. This would mean that they could be subject to defamation suits, if they did not remove potentially defamatory material in a timely manner, after they were notified.
To ensure that this change benefitted competitors at the expense of Facebook and Twitter, Section 230 type protection can be left in place for sites that did not rely on selling advertising or personal information. This means that sites that had a fundamentally different mode of operation, relying on either subscriptions or donations, would be able to continue to operate as they do now. (I discuss this idea in somewhat more detail here.)
Insofar as there is a legitimate issue with Facebook and Twitter’s moderation decisions, it stems from their size. While people may be unhappy with the editorial decisions on content made by the New York Times or CBS News, no one thinks that they raise any fundamental free speech issues. The same would be the case with a seriously downsized Facebook and Twitter.
To my view, this is the best argument for altering Section 230. There is no good reason that Internet intermediaries should be exempt from the same sort of liability for spreading defamatory statements as print or broadcast media.[1] Treating them in a symmetric manner would be a big step forward.
[1] Under Section 230, if some racist starts posting claims on Facebook or Twitter, that he and his family got food poisoning from various Black or Asian owned restaurants, these restaurants would have no course of action against these companies. They could sue the racist, but if he either has no assets, or has them hidden, they would not be able to collect any damages from the companies that had allowed these false claims to be widely spread. In contrast, if a local newspaper had published these false claims, they absolutely could be held liable, which is why they would likely never allow them to be printed in the first place.
Peter Coy used his column to discuss the prospects of Section 230 of the Communications Decency Act, the provision that protects Internet sites from being sued for defamation for third party content. Many right-wingers have bizarrely targeted Section 230, arguing that it allows companies like Twitter and Facebook to do things like remove postings from Donald Trump and his supporters. As Coy points out, these companies might actually be quicker to remove this content without Section 230, since they could be held liable for their defamatory claims.
In reviewing the arguments for Section 230 repeal, Coy left out what I considered the most important, the downsizing of Facebook and Twitter. In their current mode of operation, these companies depend on not being held responsible for defamatory items in third party content. If they were subject to the same sort of liability as their competitors in print and broadcast media, they would have to spend far more money in viewing and moderating posts and ads.
It would be impractical for Facebook and Twitter to moderate the billions of daily posts as they went up, but they could face takedown rules, similar to what is required with copyrighted material under the Digital Millennial Copyright Act. This would mean that they could be subject to defamation suits, if they did not remove potentially defamatory material in a timely manner, after they were notified.
To ensure that this change benefitted competitors at the expense of Facebook and Twitter, Section 230 type protection can be left in place for sites that did not rely on selling advertising or personal information. This means that sites that had a fundamentally different mode of operation, relying on either subscriptions or donations, would be able to continue to operate as they do now. (I discuss this idea in somewhat more detail here.)
Insofar as there is a legitimate issue with Facebook and Twitter’s moderation decisions, it stems from their size. While people may be unhappy with the editorial decisions on content made by the New York Times or CBS News, no one thinks that they raise any fundamental free speech issues. The same would be the case with a seriously downsized Facebook and Twitter.
To my view, this is the best argument for altering Section 230. There is no good reason that Internet intermediaries should be exempt from the same sort of liability for spreading defamatory statements as print or broadcast media.[1] Treating them in a symmetric manner would be a big step forward.
[1] Under Section 230, if some racist starts posting claims on Facebook or Twitter, that he and his family got food poisoning from various Black or Asian owned restaurants, these restaurants would have no course of action against these companies. They could sue the racist, but if he either has no assets, or has them hidden, they would not be able to collect any damages from the companies that had allowed these false claims to be widely spread. In contrast, if a local newspaper had published these false claims, they absolutely could be held liable, which is why they would likely never allow them to be printed in the first place.
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• Economic Crisis and RecoveryCrisis económica y recuperación
That’s what readers can conclude from a piece headlined “several million U.S. workers seen staying out of the labor force indefinitely.” The problem with the piece is that, according to data from the Bureau of Labor Statistics, the overwhelming majority of workers who left the labor market during the pandemic have returned.
Here’s the picture with prime age workers (ages 25 to 54).
As can be seen, the labor force participation rate (LFPR) has risen back to levels seen in the first half of 2019 just 0.6 percentage points below the pre-pandemic peak. Perhaps the problem is that young people have left the labor market.
This one doesn’t fit the story either. The LFPR for workers ages 16 to 24 is higher than the average for 2019, although it is 1.1 percentage points below a one month peak hit in February of 2020, just before the pandemic hit.
Well, if prime age workers aren’t leaving the labor market and young workers are working in pretty much the same numbers as before the pandemic, maybe the issue is older workers taking early retirement. That one doesn’t fit with either, the LFPR for this group is the same as just before the pandemic and above the 2019 average.
So, where does the Wall Street Journal see its millions of missing workers? According to the Bureau of Labor Statistics there were still 800,000 workers who were not in the labor force in March because of concerns about getting COVID-19, being sick with COVID-19, or caring for a family member who had COVID-19. This figure pretty much fully explains the remaining shortfall in workers compared to the pandemic level. Presumably most of these people will go back to work, if the pandemic continues to fade.
There is one explanation for fewer workers than the Journal’s trend growth path. Under the Trump administration we sharply reduced the number of immigrants entering the country. The reduction in immigration undoubtedly slowed the rate of labor force growth, since the vast majority of people looking to immigrate are younger people who want to work in the United States. Incredibly, the piece does not once mention immigration.
That’s what readers can conclude from a piece headlined “several million U.S. workers seen staying out of the labor force indefinitely.” The problem with the piece is that, according to data from the Bureau of Labor Statistics, the overwhelming majority of workers who left the labor market during the pandemic have returned.
Here’s the picture with prime age workers (ages 25 to 54).
As can be seen, the labor force participation rate (LFPR) has risen back to levels seen in the first half of 2019 just 0.6 percentage points below the pre-pandemic peak. Perhaps the problem is that young people have left the labor market.
This one doesn’t fit the story either. The LFPR for workers ages 16 to 24 is higher than the average for 2019, although it is 1.1 percentage points below a one month peak hit in February of 2020, just before the pandemic hit.
Well, if prime age workers aren’t leaving the labor market and young workers are working in pretty much the same numbers as before the pandemic, maybe the issue is older workers taking early retirement. That one doesn’t fit with either, the LFPR for this group is the same as just before the pandemic and above the 2019 average.
So, where does the Wall Street Journal see its millions of missing workers? According to the Bureau of Labor Statistics there were still 800,000 workers who were not in the labor force in March because of concerns about getting COVID-19, being sick with COVID-19, or caring for a family member who had COVID-19. This figure pretty much fully explains the remaining shortfall in workers compared to the pandemic level. Presumably most of these people will go back to work, if the pandemic continues to fade.
There is one explanation for fewer workers than the Journal’s trend growth path. Under the Trump administration we sharply reduced the number of immigrants entering the country. The reduction in immigration undoubtedly slowed the rate of labor force growth, since the vast majority of people looking to immigrate are younger people who want to work in the United States. Incredibly, the piece does not once mention immigration.
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• Economic Crisis and RecoveryCrisis económica y recuperaciónIntellectual PropertyPropiedad Intelectual
With the high rate of inflation reported for March, the chorus for strong measures from the Federal Reserve Board is growing louder. The idea is that the Fed needs to substantially accelerate its pace of rate increases. This will slow economic growth, increase unemployment and then put downward pressure on wages.
A slower pace of wage growth should help to slow inflation, since wages are a major cost of production. In this respect, it is worth noting that wages have not been driving inflation, unlike in the 1970s wage-price spiral. Wage growth has been lagging price growth, as there has been a shift from wages to profits since the pandemic.
It is also worth noting that the Fed rate hikes will disproportionately hit workers who are most disadvantaged in the labor market. The people who will lose their jobs will be disproportionately, Black, Hispanic, people with disabilities, and people with criminal records.
One of the ironies of much reporting on inflation is that it has claimed that lower income people have been hit hardest by inflation. In fact, wage growth has been most rapid in the lowest paying industries, such as restaurants and convenience stores. It will be interesting to see if news stories tell us if these low-paid workers are doing better when the rate of inflation has slowed, but they’ve lost their jobs.
The Origins of the Current Inflation
It is fashionable among Republican politicians, and political reporters, to blame the upsurge in inflation on President Biden’s policies. This is hard to reconcile with a simple fact, inflation has risen pretty much everywhere. Our year over year inflation rate was 8.5 percent as of March, the year over year inflation rate in Europe over this period has been 7.5 percent.
Needless to say, no one here would be celebrating if our inflation rate was 7.5 percent. There are reasons why our economies, as well as our measures of inflation, differ, but the point is that most of the jump in the inflation rate over the last year had little to do with anything the Biden administration did or did not do. The rise in the inflation rate was the result of difficulties associated with reopening from a worldwide pandemic, as well as Russia’s invasion of Ukraine.
Blaming Biden for high inflation, without noting the pandemic and the war, would be like blaming Louisiana’s governor for the housing shortage in 2006, without mentioning that the most populated part of the state had been devastated by Hurricane Katrina. Unfortunately, this level of seriousness is pretty much the norm in current policy discussions.
Stemming Inflation at the Top
The Fed’s high interest rate approach to stemming inflation is about reducing the bargaining power of workers, and especially workers at the lower end of the wage ladder. (To be clear, some increase in interest rates does make sense, given the current strength of the labor market. The Fed had pushed its overnight interest rate to zero with the idea the economy needed stimulus in the pandemic recession. With 3.6 percent unemployment, this is no longer true.) Instead of having a policy focused on reducing the bargaining power of workers at the middle and bottom, we can attack inflation by reducing the bargaining power for those at the top.
Prescription Drugs and Medical Equipment
My favorite place to start is with prescription drugs. We will pay over $500 billion this year for drugs that would almost certainly sell for less than $100 billion in a free market, without government-granted patent monopolies and related protections.[1] The $400 billion difference would come to almost $3,300 per family a year.
The federal government has some tools it could use to directly bring about most of these savings. Section 1498 of the US Commercial Code gives the government broad power to override patents. It does have to compensate the patent holder, but it could immediately act to suspend drug patents and then allow the drug companies to fight out in court how much they should be compensated.
The Bayh-Dole Act, which allows drug companies to take advantage of government research in their patented products, has a provision which allows the government to demand a lower price. Many, if not most, drugs rely on research financed through the National Institutes of Health, or other government agencies. These “march in” rights can be used to force lower prices on a wide array of prescription drugs.
There is a similar story with medical equipment and devices. In almost all cases, the high prices charged for scanning machines, dialysis machines, and other cutting-edge medical equipment is due to patent monopolies and related protections. The same tools can be used to push down these prices, potentially saving another $100 billion a year.
The industry will scream bloody murder if the government were to take these paths to lowering prices for drugs and medical equipment. They would say that they would not have the money or incentive to develop new drugs and medical equipment.
The obvious answer is to simply increase public funding to make up for the lost patent supported funding. As should be apparent, these are substitutes. The industry spends roughly $100 billion a year developing drugs. This compares to more than $50 billion than the government spends through the National Institutes of Health and other government agencies. Even if the federal government had to replace the industry’s funding in full, we would still be far ahead.
The impact of these measures on inflation will be both direct and indirect. The direct impact will be lower drug prices. The weight of prescription drugs is just over 1.0 percent in the Consumer Price Index. This means that if drug prices fall by 50 percent (a good target), it would knock 0.5 percentage points off the annual rate of inflation.
The indirect impact would be that we would be reducing the money going to top executives, highly paid researchers, and shareholders in the drug companies. This would likely curtail their consumption. These people would be less likely to own second or third homes, and the ones they do own would likely be smaller. They would also be spending less money on a wide range of goods and services, from cars and hotel rooms to restaurants and gyms. The reduction in demand should help to put downward pressure on prices in many sectors of the economy.
Eliminating Waste in Finance
Our bloated financial sector is an enormous source of waste in the economy. It also has created many of the country’s biggest fortunes. That should make it a prime target for inflation fighters, but we all know about US politics.
Anyhow, as is the case with the pharmaceutical industry, there is both a direct effect on inflation and an indirect one. The direct one is interesting because it is not actually picked up in the Consumer Price Index (CPI) or other measures of inflation.
The most direct way to eliminate waste in the financial sector is with a financial transactions tax, effectively a sales tax on shares of stock and other financial assets, similar to the sales tax that we pay on clothes, cars, and most other things we buy. The rates usually proposed for such taxes are in the range of 0.1 to 0.2 percent on stock sales, with equivalent rates on trades of bonds, options, futures, and other derivatives.
While the financial industry hates the tax, most countries around the world, including the United States, either currently have such a tax or had one in the not distant past. The United Kingdom has had a tax of 0.5 percent on stock trades for more than three centuries.
The direct effect of such a modest financial transactions tax in the United States would be to eliminate a huge amount of wasteful trading. Many people have retirements accounts, which shuffle stock back and forth, without any gains to them. Most trades in fact end up losing money because people don’t cover the commissions and other trading costs. If we cut trading volume in half (saving us over $100 billion a year in commissions and fees), returns on 401(k)s and other retirement accounts would not be harmed.
The same story applies to pension funds and other pools of wealth. Of course, this one is difficult politically because most people do not want to believe that they are throwing their money in the toilet by trading. Also, for pension fund managers it is very embarrassing to admit that they were handing workers’ money to rich people in the financial industry for nothing.
But here are Beat the Press, we don’t have to worry about the politics. If we imposed a modest financial transactions tax it, it would leave most investors unharmed. It could raise around $100 billion a year for the government by eliminating waste in the financial industry. However, the reduction in spending on trades would not lower the CPI because the trades themselves are counted as being valuable, even if they do not benefit the investor.
The same applies to my other favorite reform of the financial industry: universal bank accounts at the Federal Reserve Board. People could save tens of billions of dollars annually on bank fees and penalties if the Fed created a system of accounts for every individual and corporation. These accounts could be used to make costless transfers. This means that workers could have their paycheck automatically deposited in their account, have their mortgage or rent paid from the account, and pretty much do any sort of financial transaction they like.
This would save low- and moderate-income households tens of billions of dollars that they now pay banks and other financial institutions to make these payments, as well as penalties that they frequently incur due to overdrafts. Needless to say, these savings are money out of the pockets of the financial industry. These savings also don’t show up as a reduction in the CPI, rather they would be counted as a reduction in services provided by the financial industry.
These changes would also have the same indirect effect as the changing our policy on patent monopolies. There would be many rich people in the financial sector who would be considerably less rich. That would mean fewer second and third homes and other forms of luxury consumption. That would free up more resources for the rest of the country.
Other Routes to Reducing Inflation
There are other areas where we can look to reduce inflation pressures by hitting those at or near the top of the income distribution. We can subject doctors and dentists to more competition, both nationally and from increasing access to qualified foreign professionals. Bringing their pay more in line with their counterparts in other wealthy countries could save us more than $150 billion a year on our tab for their services.
We can also change the rules of corporate governance to get CEO pay in line with their actual contribution to their companies. If the ratio of CEO pay to the pay of an ordinary workers was 20 or 30, like it was back in the 1960s and 1970s, CEOs would get $2 million to $3 million a year, instead of $20 million or more. This would have a huge impact on pay structures at the top throughout the economy, pulling tens of billions a year out of the pockets of some of the richest people in the country.
These and other policies could dampen inflation by directly lowering the price of many goods and services and reducing the purchasing power of the rich and very rich. I discuss these policies in more detail in Rigged (it’s free).
The point is that if we want to reduce inflationary pressures, there are a whole set of policies that we can look to implement that would lower the incomes of people at the top of the income ladder. Unfortunately, we are not likely to go this route, because rich people have enormous political power and will likely beat back any effort to reduce their income.
In short, when it comes to fighting inflation, it is too politically difficult to go high. Instead, policy types look to go low and have the Fed reduce the purchasing power of those workers at bottom of the income distribution.
[1] Data on spending on prescription drugs can be found in the Bureau of Economic Analysis, National Income and Product Accounts, Table 2.4.5U, Line 121. Calculations for the gap between patent protected prices and free market prices can be found here.
With the high rate of inflation reported for March, the chorus for strong measures from the Federal Reserve Board is growing louder. The idea is that the Fed needs to substantially accelerate its pace of rate increases. This will slow economic growth, increase unemployment and then put downward pressure on wages.
A slower pace of wage growth should help to slow inflation, since wages are a major cost of production. In this respect, it is worth noting that wages have not been driving inflation, unlike in the 1970s wage-price spiral. Wage growth has been lagging price growth, as there has been a shift from wages to profits since the pandemic.
It is also worth noting that the Fed rate hikes will disproportionately hit workers who are most disadvantaged in the labor market. The people who will lose their jobs will be disproportionately, Black, Hispanic, people with disabilities, and people with criminal records.
One of the ironies of much reporting on inflation is that it has claimed that lower income people have been hit hardest by inflation. In fact, wage growth has been most rapid in the lowest paying industries, such as restaurants and convenience stores. It will be interesting to see if news stories tell us if these low-paid workers are doing better when the rate of inflation has slowed, but they’ve lost their jobs.
The Origins of the Current Inflation
It is fashionable among Republican politicians, and political reporters, to blame the upsurge in inflation on President Biden’s policies. This is hard to reconcile with a simple fact, inflation has risen pretty much everywhere. Our year over year inflation rate was 8.5 percent as of March, the year over year inflation rate in Europe over this period has been 7.5 percent.
Needless to say, no one here would be celebrating if our inflation rate was 7.5 percent. There are reasons why our economies, as well as our measures of inflation, differ, but the point is that most of the jump in the inflation rate over the last year had little to do with anything the Biden administration did or did not do. The rise in the inflation rate was the result of difficulties associated with reopening from a worldwide pandemic, as well as Russia’s invasion of Ukraine.
Blaming Biden for high inflation, without noting the pandemic and the war, would be like blaming Louisiana’s governor for the housing shortage in 2006, without mentioning that the most populated part of the state had been devastated by Hurricane Katrina. Unfortunately, this level of seriousness is pretty much the norm in current policy discussions.
Stemming Inflation at the Top
The Fed’s high interest rate approach to stemming inflation is about reducing the bargaining power of workers, and especially workers at the lower end of the wage ladder. (To be clear, some increase in interest rates does make sense, given the current strength of the labor market. The Fed had pushed its overnight interest rate to zero with the idea the economy needed stimulus in the pandemic recession. With 3.6 percent unemployment, this is no longer true.) Instead of having a policy focused on reducing the bargaining power of workers at the middle and bottom, we can attack inflation by reducing the bargaining power for those at the top.
Prescription Drugs and Medical Equipment
My favorite place to start is with prescription drugs. We will pay over $500 billion this year for drugs that would almost certainly sell for less than $100 billion in a free market, without government-granted patent monopolies and related protections.[1] The $400 billion difference would come to almost $3,300 per family a year.
The federal government has some tools it could use to directly bring about most of these savings. Section 1498 of the US Commercial Code gives the government broad power to override patents. It does have to compensate the patent holder, but it could immediately act to suspend drug patents and then allow the drug companies to fight out in court how much they should be compensated.
The Bayh-Dole Act, which allows drug companies to take advantage of government research in their patented products, has a provision which allows the government to demand a lower price. Many, if not most, drugs rely on research financed through the National Institutes of Health, or other government agencies. These “march in” rights can be used to force lower prices on a wide array of prescription drugs.
There is a similar story with medical equipment and devices. In almost all cases, the high prices charged for scanning machines, dialysis machines, and other cutting-edge medical equipment is due to patent monopolies and related protections. The same tools can be used to push down these prices, potentially saving another $100 billion a year.
The industry will scream bloody murder if the government were to take these paths to lowering prices for drugs and medical equipment. They would say that they would not have the money or incentive to develop new drugs and medical equipment.
The obvious answer is to simply increase public funding to make up for the lost patent supported funding. As should be apparent, these are substitutes. The industry spends roughly $100 billion a year developing drugs. This compares to more than $50 billion than the government spends through the National Institutes of Health and other government agencies. Even if the federal government had to replace the industry’s funding in full, we would still be far ahead.
The impact of these measures on inflation will be both direct and indirect. The direct impact will be lower drug prices. The weight of prescription drugs is just over 1.0 percent in the Consumer Price Index. This means that if drug prices fall by 50 percent (a good target), it would knock 0.5 percentage points off the annual rate of inflation.
The indirect impact would be that we would be reducing the money going to top executives, highly paid researchers, and shareholders in the drug companies. This would likely curtail their consumption. These people would be less likely to own second or third homes, and the ones they do own would likely be smaller. They would also be spending less money on a wide range of goods and services, from cars and hotel rooms to restaurants and gyms. The reduction in demand should help to put downward pressure on prices in many sectors of the economy.
Eliminating Waste in Finance
Our bloated financial sector is an enormous source of waste in the economy. It also has created many of the country’s biggest fortunes. That should make it a prime target for inflation fighters, but we all know about US politics.
Anyhow, as is the case with the pharmaceutical industry, there is both a direct effect on inflation and an indirect one. The direct one is interesting because it is not actually picked up in the Consumer Price Index (CPI) or other measures of inflation.
The most direct way to eliminate waste in the financial sector is with a financial transactions tax, effectively a sales tax on shares of stock and other financial assets, similar to the sales tax that we pay on clothes, cars, and most other things we buy. The rates usually proposed for such taxes are in the range of 0.1 to 0.2 percent on stock sales, with equivalent rates on trades of bonds, options, futures, and other derivatives.
While the financial industry hates the tax, most countries around the world, including the United States, either currently have such a tax or had one in the not distant past. The United Kingdom has had a tax of 0.5 percent on stock trades for more than three centuries.
The direct effect of such a modest financial transactions tax in the United States would be to eliminate a huge amount of wasteful trading. Many people have retirements accounts, which shuffle stock back and forth, without any gains to them. Most trades in fact end up losing money because people don’t cover the commissions and other trading costs. If we cut trading volume in half (saving us over $100 billion a year in commissions and fees), returns on 401(k)s and other retirement accounts would not be harmed.
The same story applies to pension funds and other pools of wealth. Of course, this one is difficult politically because most people do not want to believe that they are throwing their money in the toilet by trading. Also, for pension fund managers it is very embarrassing to admit that they were handing workers’ money to rich people in the financial industry for nothing.
But here are Beat the Press, we don’t have to worry about the politics. If we imposed a modest financial transactions tax it, it would leave most investors unharmed. It could raise around $100 billion a year for the government by eliminating waste in the financial industry. However, the reduction in spending on trades would not lower the CPI because the trades themselves are counted as being valuable, even if they do not benefit the investor.
The same applies to my other favorite reform of the financial industry: universal bank accounts at the Federal Reserve Board. People could save tens of billions of dollars annually on bank fees and penalties if the Fed created a system of accounts for every individual and corporation. These accounts could be used to make costless transfers. This means that workers could have their paycheck automatically deposited in their account, have their mortgage or rent paid from the account, and pretty much do any sort of financial transaction they like.
This would save low- and moderate-income households tens of billions of dollars that they now pay banks and other financial institutions to make these payments, as well as penalties that they frequently incur due to overdrafts. Needless to say, these savings are money out of the pockets of the financial industry. These savings also don’t show up as a reduction in the CPI, rather they would be counted as a reduction in services provided by the financial industry.
These changes would also have the same indirect effect as the changing our policy on patent monopolies. There would be many rich people in the financial sector who would be considerably less rich. That would mean fewer second and third homes and other forms of luxury consumption. That would free up more resources for the rest of the country.
Other Routes to Reducing Inflation
There are other areas where we can look to reduce inflation pressures by hitting those at or near the top of the income distribution. We can subject doctors and dentists to more competition, both nationally and from increasing access to qualified foreign professionals. Bringing their pay more in line with their counterparts in other wealthy countries could save us more than $150 billion a year on our tab for their services.
We can also change the rules of corporate governance to get CEO pay in line with their actual contribution to their companies. If the ratio of CEO pay to the pay of an ordinary workers was 20 or 30, like it was back in the 1960s and 1970s, CEOs would get $2 million to $3 million a year, instead of $20 million or more. This would have a huge impact on pay structures at the top throughout the economy, pulling tens of billions a year out of the pockets of some of the richest people in the country.
These and other policies could dampen inflation by directly lowering the price of many goods and services and reducing the purchasing power of the rich and very rich. I discuss these policies in more detail in Rigged (it’s free).
The point is that if we want to reduce inflationary pressures, there are a whole set of policies that we can look to implement that would lower the incomes of people at the top of the income ladder. Unfortunately, we are not likely to go this route, because rich people have enormous political power and will likely beat back any effort to reduce their income.
In short, when it comes to fighting inflation, it is too politically difficult to go high. Instead, policy types look to go low and have the Fed reduce the purchasing power of those workers at bottom of the income distribution.
[1] Data on spending on prescription drugs can be found in the Bureau of Economic Analysis, National Income and Product Accounts, Table 2.4.5U, Line 121. Calculations for the gap between patent protected prices and free market prices can be found here.
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• Economic Crisis and RecoveryCrisis económica y recuperación
The New York Times headlined a piece on March retail sales “retail sales grew in March as inflation soared.” This might lead readers to believe that we had strong retail sales in March, in spite of high inflation.
In fact, if we pull out sales of gas, retail sales actually fell 0.3 percent. This drop is before adjusting for higher prices. The core consumer price index for goods (excluding food and gas) rose 0.3 percent in March, with food prices rise 1.0 percent. If we assume that the average price rise for the non-gas index was 0.4 percent, then real retail sales fell 0.7 percent in March.
Monthly data on retail sales are erratic and subject to large revisions, but contrary to the picture presented by the headline, the data released by the Commerce Department today suggest a rapidly slowing economy.
The New York Times headlined a piece on March retail sales “retail sales grew in March as inflation soared.” This might lead readers to believe that we had strong retail sales in March, in spite of high inflation.
In fact, if we pull out sales of gas, retail sales actually fell 0.3 percent. This drop is before adjusting for higher prices. The core consumer price index for goods (excluding food and gas) rose 0.3 percent in March, with food prices rise 1.0 percent. If we assume that the average price rise for the non-gas index was 0.4 percent, then real retail sales fell 0.7 percent in March.
Monthly data on retail sales are erratic and subject to large revisions, but contrary to the picture presented by the headline, the data released by the Commerce Department today suggest a rapidly slowing economy.
Read More Leer más Join the discussion Participa en la discusión
• Economic Crisis and RecoveryCrisis económica y recuperación
Trump demanded that Saudi Arabia cut back production back in 2020. According to Trump, he worked out a deal where OPEC producers would all agree to reduce their output. The reason we now have high oil prices is that they have not returned their production to pre-pandemic levels. Hey, by the media’s standards of what makes a politician responsible for an event in the world, this is practically airtight.
It’s more than a bit bizarre that Donald Trump literally boasted about getting oil producers to cut production, but somehow President Biden is held responsible for high gas prices.
Trump demanded that Saudi Arabia cut back production back in 2020. According to Trump, he worked out a deal where OPEC producers would all agree to reduce their output. The reason we now have high oil prices is that they have not returned their production to pre-pandemic levels. Hey, by the media’s standards of what makes a politician responsible for an event in the world, this is practically airtight.
It’s more than a bit bizarre that Donald Trump literally boasted about getting oil producers to cut production, but somehow President Biden is held responsible for high gas prices.
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