Beat the Press

Beat the press por Dean Baker

Beat the Press is Dean Baker's commentary on economic reporting. He is a Senior Economist at the Center for Economic and Policy Research (CEPR). To never miss a post, subscribe to a weekly email roundup of Beat the Press. Please also consider supporting the blog on Patreon.

There are legitimate debates over what tax rates should be, even if many of us consider the current tax rates on the rich and super-rich far too low. However, there really is not a legitimate debate on whether the rich should have to pay the taxes they owe.

Unfortunately, our politics is such that it is now a partisan matter as to whether rich people should have to pay the taxes they owe. This comes up in many contexts, but perhaps most strikingly with the estate tax.

Just to be clear, the only people who owe any money at all under the estate tax are very rich. The current tax has a $12.06 million dollar exemption, per person. That means a couple can pass along $24.12 million to their kids without paying a dime in estate tax.

This is not a tax paid by small business owners or successful lawyers. It is a tax paid by the very rich: full stop. A successful small business owner would be extremely lucky to have accumulated $5 to $10 million in their business over their lifetime, less than half the cutoff for a couple to owe any estate tax at all.

It’s also important to remember that, like the income tax, the estate tax is a marginal tax where it is only paid on the increment above the cutoff. So, let’s suppose our “small” business owning couple has accumulated $24.2 million over their lifetime, $80,000 over the cutoff.

This means they will have to pay the 40 percent estate tax rate on the $80,000 over the cutoff, not the full $24,200,000. Their tax, in this case, would be $32,000 or 0.13 percent of the value of their estate. Can we find the world’s smallest violin?

Let’s not waste time with foolishness, the estate tax is a tax paid by a tiny number of rich people. That is who we are talking about.

Why Do Only the Non-Rich Have to Pay the Taxes They Owe?

The vast majority of people get the vast majority of their income through their wages. We don’t have much choice in paying our taxes, they are deducted directly from our paychecks. It is only the rich and the very rich that find ways to avoid or evade taxes.[1]

As noted earlier, we can debate how much different groups should be paying in taxes. The rich have been winning this debate big time over the last sixty years. The top marginal tax rate was lowered from 90 percent in the early 1960s to just under 40.0 percent in 2022.[2]

There is a similar story with the estate tax. In 1980, estates larger than $500,000 (in 2022 dollars) were subject to the tax. There were a set of marginal estate tax rates, but the top rate paid by the largest estates was 70 percent. This meant that a person with a $1 billion estate would pay close to $700 million in taxes to the government.

In the years since 1980, the cutoff for estate tax liability was both hugely raised, and the rate was cut almost in half to 40 percent. The current $24.12 million cutoff means that even the very rich avoid paying taxes on a sizable portion of their estate. A couple with an estate of $50 million would be able to have almost half of their estate completely avoid taxes, even without playing any games.

Unfortunately, the very rich are still not satisfied with this situation. They would prefer not to pay any taxes (so would we all), and they can hire the tax lawyers and accountants to make their tax aversion a reality. The law allows rich people to create trusts for a variety of purposes. These trusts can be used to transfer wealth to descendants, without anyone ever paying estate tax on the money.

Although the rules on trusts generally have limits on the amount of wealth that can be placed in them without being subject to tax, the rich have found ways to get around these limits.[3] These tricks have allowed some of the richest people in the country, for example Sam Walton, the founder of Walmart, to pass their fortune onto heirs, while paying minimal amounts of estate tax.

It makes no sense to allow these abuses to continue. Creating trusts or other vehicles, exclusively to avoid paying taxes is a total waste from an economic perspective. Not only are we allowing the richest people in the country to avoid paying the taxes they owe, but we are tying up resources, which could go to productive purposes, in this process. Many highly trained, and likely highly accomplished, lawyers, accountants, and their staff, spend millions of hours in this gaming.

As that great proponent of progressive taxation [sarcasm], Ronald Reagan, said when he launched his push for the 1986 tax bill, the tax code at the time “causes some to invest their money, not to make a better mousetrap but simply to avoid a tax trap.” After we have had the political battles over tax rates, there is not a political question as to whether the agreed upon tax rates should be paid. This is simply an issue of the rich wanting to steal from the rest of us.

Congress should crack down hard on the games being used by the very rich to avoid paying the estate tax. Senator Bernie Sanders has proposed legislation that would eliminate the most obvious tricks now being used. This is not just an effort by the progressive wing of the Democratic Party, people closer to the center, like Maryland Senator Chris Van Hollen, have also expressed support for curbing abuses, as has the Biden Treasury Department.

To my mind, the estate tax should be far higher. Rates of 60 or 70 percent would still allow the Elon Musks and Bill Gates’s of the country to pass on vast fortunes to their kids that will allow them to live in total luxury without working a day in their life. I also would not be troubled if the rich, say couples with $5 million in their estate, had to pay some tax, and not just the super-rich. (Remember, it is a marginal tax.)

That is a topic for future political battles. But once Congress has set the rate, there really is not an argument about whether it should actually be collected. This is simply a question of law enforcement and the super-rich stand on the other side. We need some good old-fashioned “law and order,” the super-rich have to be forced to pay the money they owe on the estate tax.

[1] The difference between tax avoidance and tax evasion is that avoidance is a legal method for reducing a person’s tax liability. Evasion is an illegal method. Some schemes are borderline, since their legality is not clear.

[2] This includes the 2.95 percent Medicare tax that high income households must pay.

[3] Some of the ways in which these trusts are abused are discussed here, here, and here.

There are legitimate debates over what tax rates should be, even if many of us consider the current tax rates on the rich and super-rich far too low. However, there really is not a legitimate debate on whether the rich should have to pay the taxes they owe.

Unfortunately, our politics is such that it is now a partisan matter as to whether rich people should have to pay the taxes they owe. This comes up in many contexts, but perhaps most strikingly with the estate tax.

Just to be clear, the only people who owe any money at all under the estate tax are very rich. The current tax has a $12.06 million dollar exemption, per person. That means a couple can pass along $24.12 million to their kids without paying a dime in estate tax.

This is not a tax paid by small business owners or successful lawyers. It is a tax paid by the very rich: full stop. A successful small business owner would be extremely lucky to have accumulated $5 to $10 million in their business over their lifetime, less than half the cutoff for a couple to owe any estate tax at all.

It’s also important to remember that, like the income tax, the estate tax is a marginal tax where it is only paid on the increment above the cutoff. So, let’s suppose our “small” business owning couple has accumulated $24.2 million over their lifetime, $80,000 over the cutoff.

This means they will have to pay the 40 percent estate tax rate on the $80,000 over the cutoff, not the full $24,200,000. Their tax, in this case, would be $32,000 or 0.13 percent of the value of their estate. Can we find the world’s smallest violin?

Let’s not waste time with foolishness, the estate tax is a tax paid by a tiny number of rich people. That is who we are talking about.

Why Do Only the Non-Rich Have to Pay the Taxes They Owe?

The vast majority of people get the vast majority of their income through their wages. We don’t have much choice in paying our taxes, they are deducted directly from our paychecks. It is only the rich and the very rich that find ways to avoid or evade taxes.[1]

As noted earlier, we can debate how much different groups should be paying in taxes. The rich have been winning this debate big time over the last sixty years. The top marginal tax rate was lowered from 90 percent in the early 1960s to just under 40.0 percent in 2022.[2]

There is a similar story with the estate tax. In 1980, estates larger than $500,000 (in 2022 dollars) were subject to the tax. There were a set of marginal estate tax rates, but the top rate paid by the largest estates was 70 percent. This meant that a person with a $1 billion estate would pay close to $700 million in taxes to the government.

In the years since 1980, the cutoff for estate tax liability was both hugely raised, and the rate was cut almost in half to 40 percent. The current $24.12 million cutoff means that even the very rich avoid paying taxes on a sizable portion of their estate. A couple with an estate of $50 million would be able to have almost half of their estate completely avoid taxes, even without playing any games.

Unfortunately, the very rich are still not satisfied with this situation. They would prefer not to pay any taxes (so would we all), and they can hire the tax lawyers and accountants to make their tax aversion a reality. The law allows rich people to create trusts for a variety of purposes. These trusts can be used to transfer wealth to descendants, without anyone ever paying estate tax on the money.

Although the rules on trusts generally have limits on the amount of wealth that can be placed in them without being subject to tax, the rich have found ways to get around these limits.[3] These tricks have allowed some of the richest people in the country, for example Sam Walton, the founder of Walmart, to pass their fortune onto heirs, while paying minimal amounts of estate tax.

It makes no sense to allow these abuses to continue. Creating trusts or other vehicles, exclusively to avoid paying taxes is a total waste from an economic perspective. Not only are we allowing the richest people in the country to avoid paying the taxes they owe, but we are tying up resources, which could go to productive purposes, in this process. Many highly trained, and likely highly accomplished, lawyers, accountants, and their staff, spend millions of hours in this gaming.

As that great proponent of progressive taxation [sarcasm], Ronald Reagan, said when he launched his push for the 1986 tax bill, the tax code at the time “causes some to invest their money, not to make a better mousetrap but simply to avoid a tax trap.” After we have had the political battles over tax rates, there is not a political question as to whether the agreed upon tax rates should be paid. This is simply an issue of the rich wanting to steal from the rest of us.

Congress should crack down hard on the games being used by the very rich to avoid paying the estate tax. Senator Bernie Sanders has proposed legislation that would eliminate the most obvious tricks now being used. This is not just an effort by the progressive wing of the Democratic Party, people closer to the center, like Maryland Senator Chris Van Hollen, have also expressed support for curbing abuses, as has the Biden Treasury Department.

To my mind, the estate tax should be far higher. Rates of 60 or 70 percent would still allow the Elon Musks and Bill Gates’s of the country to pass on vast fortunes to their kids that will allow them to live in total luxury without working a day in their life. I also would not be troubled if the rich, say couples with $5 million in their estate, had to pay some tax, and not just the super-rich. (Remember, it is a marginal tax.)

That is a topic for future political battles. But once Congress has set the rate, there really is not an argument about whether it should actually be collected. This is simply a question of law enforcement and the super-rich stand on the other side. We need some good old-fashioned “law and order,” the super-rich have to be forced to pay the money they owe on the estate tax.

[1] The difference between tax avoidance and tax evasion is that avoidance is a legal method for reducing a person’s tax liability. Evasion is an illegal method. Some schemes are borderline, since their legality is not clear.

[2] This includes the 2.95 percent Medicare tax that high income households must pay.

[3] Some of the ways in which these trusts are abused are discussed here, here, and here.

Politico has decided to make a big deal out of Treasury Secretary Janet Yellen’s supposedly embarrassing admission that:

“There have been unanticipated and large shocks to the economy that have boosted energy and food prices and supply bottlenecks that have affected our economy badly that I didn’t — at the time — didn’t fully understand, but we recognize that now.”

While Politico’s implication from this “admission” is that the $1.9 trillion American Recovery Plan Biden was a mistake, this is not what Yellen said. She said that she did not anticipate large shocks to the economy. Obviously, she is referring to the delta and omicron rounds of the pandemic, as well as the war in Ukraine.

These subsequent rounds of the pandemic both disrupted production in the United States and elsewhere, and prevented a more rapid return to normal consumption patterns. The ongoing disruption of production, due to the pandemic, prevented supply chains from returning to normal through the fall and winter, and even now, as China’s exports continue to face disruptions.  

The subsequent waves of COVID-19 also prevented people from returning to normal consumption patterns. This meant that consumers continued to spend less than normal amounts on services involving exposure to other people (restaurants, movies, gyms) and larger than normal amounts of money on things (televisions, cars, clothes). This continued shift to goods consumption aggravated supply chain problems.   

The war in Ukraine has sent the world price of oil and natural gas soaring. This has pushed gas prices to near record levels in real terms. The war has also raised the price of wheat and other agricultural commodities, as both Russia and Ukraine are major grain exporters.

It’s good that Yellen admitted her failure to see these shocks, although it’s not clear what different policy the administration should have pursued if she had seen them coming. The world price of oil, and therefore the price of gas, would be just as high today if the Biden administration had not passed its recovery plan.

There is a point here on which the Biden administration certainly can be criticized, although not one mentioned by Politico. If the Biden administration had made vaccinating the world a top priority, it is likely that we would not have seen the development of the omicron variant and quite possibly also have prevented the delta variant.

The number of mutations of a virus will depends on the extent of its spread. If we had worked aggressively with other countries to produce and distribute as many doses of the vaccine as quickly as possible, overriding patent monopolies and other protections, we could have prevented hundreds of millions of cases, along with the resulting sicknesses and death.

The Biden administration ostensibly supported a limited waiver of patent protection for vaccines, but this support was at best half-hearted. It really should have been the top priority of the Biden administration, from day one, to spread the vaccines, as well as tests and treatments, as widely as possible as quickly as possible. Clearly this was not the case, and for that it deserves considerable blame. (Of course, it would have been even better if we embarked on this path back in March of 2020, but we know Donald Trump doesn’t care about stopping deadly pandemics.)

Anyhow, there was a very serious mistake, for which the Biden administration deserves to be taken to task big time. Unfortunately, it is not a mistake that Politico is interested in talking about.

Politico has decided to make a big deal out of Treasury Secretary Janet Yellen’s supposedly embarrassing admission that:

“There have been unanticipated and large shocks to the economy that have boosted energy and food prices and supply bottlenecks that have affected our economy badly that I didn’t — at the time — didn’t fully understand, but we recognize that now.”

While Politico’s implication from this “admission” is that the $1.9 trillion American Recovery Plan Biden was a mistake, this is not what Yellen said. She said that she did not anticipate large shocks to the economy. Obviously, she is referring to the delta and omicron rounds of the pandemic, as well as the war in Ukraine.

These subsequent rounds of the pandemic both disrupted production in the United States and elsewhere, and prevented a more rapid return to normal consumption patterns. The ongoing disruption of production, due to the pandemic, prevented supply chains from returning to normal through the fall and winter, and even now, as China’s exports continue to face disruptions.  

The subsequent waves of COVID-19 also prevented people from returning to normal consumption patterns. This meant that consumers continued to spend less than normal amounts on services involving exposure to other people (restaurants, movies, gyms) and larger than normal amounts of money on things (televisions, cars, clothes). This continued shift to goods consumption aggravated supply chain problems.   

The war in Ukraine has sent the world price of oil and natural gas soaring. This has pushed gas prices to near record levels in real terms. The war has also raised the price of wheat and other agricultural commodities, as both Russia and Ukraine are major grain exporters.

It’s good that Yellen admitted her failure to see these shocks, although it’s not clear what different policy the administration should have pursued if she had seen them coming. The world price of oil, and therefore the price of gas, would be just as high today if the Biden administration had not passed its recovery plan.

There is a point here on which the Biden administration certainly can be criticized, although not one mentioned by Politico. If the Biden administration had made vaccinating the world a top priority, it is likely that we would not have seen the development of the omicron variant and quite possibly also have prevented the delta variant.

The number of mutations of a virus will depends on the extent of its spread. If we had worked aggressively with other countries to produce and distribute as many doses of the vaccine as quickly as possible, overriding patent monopolies and other protections, we could have prevented hundreds of millions of cases, along with the resulting sicknesses and death.

The Biden administration ostensibly supported a limited waiver of patent protection for vaccines, but this support was at best half-hearted. It really should have been the top priority of the Biden administration, from day one, to spread the vaccines, as well as tests and treatments, as widely as possible as quickly as possible. Clearly this was not the case, and for that it deserves considerable blame. (Of course, it would have been even better if we embarked on this path back in March of 2020, but we know Donald Trump doesn’t care about stopping deadly pandemics.)

Anyhow, there was a very serious mistake, for which the Biden administration deserves to be taken to task big time. Unfortunately, it is not a mistake that Politico is interested in talking about.

We have been hearing endless screaming from the media about out of control inflation. It certainly is the case that inflation is higher than anyone feels comfortable with, and prices of gas and food are especially troublesome, since they are necessities for most families.

But the key question when we get a monthly job report is whether the situation is getting better or worse. Anyone looking at the May jobs report with clear eyes should have concluded the picture is getting better.

The issue with jobs and inflation is the concern that we will see a wage-price spiral like what we saw in the 1970s. The story there is that workers saw rising prices, to which they responded by demanding higher wages. This meant higher costs for businesses, leading to still higher inflation, and an even larger round of pay hikes.

The 1970s story of spiraling inflation is one where the rate of wage growth is increasing. The May data shows that the pace of wage growth is actually falling. The average hourly wage, the key measure of wage growth in the report, increased by 6.5 percent over the last year. That is a pace that is clearly inconsistent with a rate of inflation that most people would consider acceptable.

However, we get a much better picture if we focus on the more recent period. The annualized rate of wage growth comparing the last three months (March, April, and May) with the prior three months (December, January, and February) was 4.3 percent. This is only moderately higher than the peak 3.6 percent year over year rate of wage growth hit in February 2019. In 2019, inflation was well under control, with few seeing it as a serious problem.

Wage data are erratic (that is the reason for taking three-month averages), but it is clear that the direction of change based on the data we have is downward. This is the opposite of the wage-price spiral story, wage growth is moderating.

This is not the only item in the May jobs report that should help to calm the inflation hawks. One way that businesses responded to the difficulty in hiring workers earlier in the recovery was to increase the length of the workweek. The average workweek was 34.4 hours in 2019, before the pandemic. It peaked at 35.0 hours in January of 2021. That would be equivalent to hiring roughly 2.6 million workers at 34.4 hours a week.

The length of the average workweek has now shortened to 34.6 hours over the last three months. This suggests that employers no longer feel a need to lengthen hours to compensate for not being able to hire workers. Again, this is evidence that the labor market is stabilizing.

The third item that should calm inflation hawks is the drop in the share of unemployment due to people voluntarily quitting their jobs. This is an important measure, since workers will only quit their jobs before having a new one lined up, if they are confident they will be able to get another job.

The share of unemployment due to voluntary quits edged down to 12.8 percent in May. It had peaked at 15.1 percent in February, and since trended downward. The share of unemployment due to quits also reached levels above 15.0 percent just before the pandemic and in 2000. In short, this is not a labor market in which workers feel totally comfortable quitting their jobs.

In short, this is a jobs report that should have made inflation hawks very happy. It shows a strong, but stable, labor market with moderating wage growth. This is definitely not a wage-price spiral story.

Of course, this report does nothing to reduce the price of gas. If you’re concerned about the price of gas, then you need to pay attention to the war in Ukraine, not the US labor market. The world price of oil determines the price of gas here, not our employment levels.   

We have been hearing endless screaming from the media about out of control inflation. It certainly is the case that inflation is higher than anyone feels comfortable with, and prices of gas and food are especially troublesome, since they are necessities for most families.

But the key question when we get a monthly job report is whether the situation is getting better or worse. Anyone looking at the May jobs report with clear eyes should have concluded the picture is getting better.

The issue with jobs and inflation is the concern that we will see a wage-price spiral like what we saw in the 1970s. The story there is that workers saw rising prices, to which they responded by demanding higher wages. This meant higher costs for businesses, leading to still higher inflation, and an even larger round of pay hikes.

The 1970s story of spiraling inflation is one where the rate of wage growth is increasing. The May data shows that the pace of wage growth is actually falling. The average hourly wage, the key measure of wage growth in the report, increased by 6.5 percent over the last year. That is a pace that is clearly inconsistent with a rate of inflation that most people would consider acceptable.

However, we get a much better picture if we focus on the more recent period. The annualized rate of wage growth comparing the last three months (March, April, and May) with the prior three months (December, January, and February) was 4.3 percent. This is only moderately higher than the peak 3.6 percent year over year rate of wage growth hit in February 2019. In 2019, inflation was well under control, with few seeing it as a serious problem.

Wage data are erratic (that is the reason for taking three-month averages), but it is clear that the direction of change based on the data we have is downward. This is the opposite of the wage-price spiral story, wage growth is moderating.

This is not the only item in the May jobs report that should help to calm the inflation hawks. One way that businesses responded to the difficulty in hiring workers earlier in the recovery was to increase the length of the workweek. The average workweek was 34.4 hours in 2019, before the pandemic. It peaked at 35.0 hours in January of 2021. That would be equivalent to hiring roughly 2.6 million workers at 34.4 hours a week.

The length of the average workweek has now shortened to 34.6 hours over the last three months. This suggests that employers no longer feel a need to lengthen hours to compensate for not being able to hire workers. Again, this is evidence that the labor market is stabilizing.

The third item that should calm inflation hawks is the drop in the share of unemployment due to people voluntarily quitting their jobs. This is an important measure, since workers will only quit their jobs before having a new one lined up, if they are confident they will be able to get another job.

The share of unemployment due to voluntary quits edged down to 12.8 percent in May. It had peaked at 15.1 percent in February, and since trended downward. The share of unemployment due to quits also reached levels above 15.0 percent just before the pandemic and in 2000. In short, this is not a labor market in which workers feel totally comfortable quitting their jobs.

In short, this is a jobs report that should have made inflation hawks very happy. It shows a strong, but stable, labor market with moderating wage growth. This is definitely not a wage-price spiral story.

Of course, this report does nothing to reduce the price of gas. If you’re concerned about the price of gas, then you need to pay attention to the war in Ukraine, not the US labor market. The world price of oil determines the price of gas here, not our employment levels.   

The April data on consumption expenditures left many people, including economics reporters, confused about consumer behavior. The basis of the confusion was a reported decline in the saving rate in April to 4.4 percent. It had been running over 8.0 percent in 2021.

However, this reported decline in the saving rate is deceptive. The saving rate is measure as the share of disposable income that is not spent. Disposable income, in turn, is defined as personal income (wages, government transfer payments, interest, dividends etc.) minus taxes.

The saving rate can fall either because consumption rises rapidly or disposable income falls. It turns out that the story we currently have of a declining saving rate is the latter, disposable income has been rising very slowly.

But the trick here is that the slow growth in disposable income is not due to slow growth in personal income. Rather, the slow growth in disposable income is the result of a big increase in taxes. In April, people paid taxes at an annual rate of $3,089 billion.[1] This is up by more than 40.0 percent from the $2,205 billion paid in taxes back in 2019, before the pandemic.

There has been no big increase in tax rates in the last three years, so that would not explain this huge jump in tax collections. The more likely explanation is that people have made large gains in the stock market over this period. They are cashing out some of these gains and paying capital gains taxes on them.

Capital gains income does not count as income in the national accounts. This means that when people sell stock at a gain, and then pay income tax on it, we would see this as a decline in disposable income. If consumption is unchanged, the GDP accounts would be showing a drop in the saving rate.

There is a simple way to adjust for this problem. We can just look at saving, plus taxes, as a percent of personal income. If we look at this figure for April of 2022, it comes to 19.2 percent. That is down from the 19.5 percent rate for the four years prior to the pandemic, but I’m not sure that drop would warrant a big story about people spending down their savings.  

[1] This refers to income and payroll taxes, it does not count taxes like sales taxes or excise taxes on items like alcohol and cigarettes.

 

Note: This piece has been edited to more accurately explain the calculation showing that the saving rate has not really declined to any substantial extent.

The April data on consumption expenditures left many people, including economics reporters, confused about consumer behavior. The basis of the confusion was a reported decline in the saving rate in April to 4.4 percent. It had been running over 8.0 percent in 2021.

However, this reported decline in the saving rate is deceptive. The saving rate is measure as the share of disposable income that is not spent. Disposable income, in turn, is defined as personal income (wages, government transfer payments, interest, dividends etc.) minus taxes.

The saving rate can fall either because consumption rises rapidly or disposable income falls. It turns out that the story we currently have of a declining saving rate is the latter, disposable income has been rising very slowly.

But the trick here is that the slow growth in disposable income is not due to slow growth in personal income. Rather, the slow growth in disposable income is the result of a big increase in taxes. In April, people paid taxes at an annual rate of $3,089 billion.[1] This is up by more than 40.0 percent from the $2,205 billion paid in taxes back in 2019, before the pandemic.

There has been no big increase in tax rates in the last three years, so that would not explain this huge jump in tax collections. The more likely explanation is that people have made large gains in the stock market over this period. They are cashing out some of these gains and paying capital gains taxes on them.

Capital gains income does not count as income in the national accounts. This means that when people sell stock at a gain, and then pay income tax on it, we would see this as a decline in disposable income. If consumption is unchanged, the GDP accounts would be showing a drop in the saving rate.

There is a simple way to adjust for this problem. We can just look at saving, plus taxes, as a percent of personal income. If we look at this figure for April of 2022, it comes to 19.2 percent. That is down from the 19.5 percent rate for the four years prior to the pandemic, but I’m not sure that drop would warrant a big story about people spending down their savings.  

[1] This refers to income and payroll taxes, it does not count taxes like sales taxes or excise taxes on items like alcohol and cigarettes.

 

Note: This piece has been edited to more accurately explain the calculation showing that the saving rate has not really declined to any substantial extent.

There is good reason for believing that the prices of many items that drove inflation higher in the last year have stopped rising and are may even be going in the opposite direction. Used cars are the best example. The CPI index for used vehicles rose 40.5 percent from January 2021 to January 2022. In the three months from January to April, the CPI index has fallen by 4.5 percent.

More generally, the supply shortages that drove prices higher in 2021 seem to be replaced by gluts, with major retailers like Amazon and Target complaining about stockpiles of unsold goods. With the stimulus measures from the pandemic fading into the past, and people no longer fearing to travel or go to restaurants, it is likely that we will be seeing serious downward pressure on the prices of many goods.

While inflation may be easing on the goods side, there are questions about prices in the service sector, most importantly rent. Rent accounts for more than 31.0 percent of the overall CPI, and almost 40 percent of the core index.

Rental inflation had been running at close to a 3.5 percent annual rate before the pandemic. It slowed in 2021, but is now running at almost a 5.0 percent annual rate. There are reasons for believing that it could go still higher. Home sales price growth has been in the double digits the last two years. Many indexes of market rents (units that change hands) have also shown double-digit growth. This raises the possibility that the CPI measure of rental inflation (which covers all units, not just those that change hands) will increase even more rapidly in the rest of 2022 and 2023.

Given its importance in the indexes, and people’s spending, it will be hard to contain inflation if rents are rising at a 5.0 percent, or higher, annual rate. Fortunately, there are some reasons for believing that we may be seeing downward pressure on rental inflation also.

First, the Fed’s interest rate hikes have had a huge impact on home sales. The interest rate for 30-year mortgages has risen by more than 2.0 percentage points, causing home sales to plummet. In recent weeks, purchase mortgage applications have been down by double-digit amounts from year ago levels. Other data, like pending home sales, also show a sharp drop off.

While the relationship between the ownership market and rental market is somewhat indirect, fewer homes being sold is likely to somewhat increase the supply available to renters. To see this point, consider three possibilities.

In the first, would be homebuyers deterred by higher interest rates were looking to move from either a rental or ownership unit of roughly the same size. In this case, the fact that they don’t buy a home has no impact on the overall demand for housing. They just would have occupied a different unit, leaving their current home vacant.

In a second case, imagine that the would be homebuyers were planning to occupy more space. Perhaps they would have moved from a one-bedroom apartment to a three-bedroom house. Alternatively, maybe they were sharing an apartment or house and would have instead have their own, if they bought. In this case, their decision not to buy frees up space that they otherwise would have occupied. That means, other things equal, downward pressure on rents.

It is important in this story to recognize both, that houses can be, and often are divided so that they are shared by multiple individuals or families. This can happen either because the owner formally divides a house explicitly into multiple units, or multiple individuals choose to share a house. Also, houses can be rented if they are not sold. Roughly 30 percent of rental units are single family homes.

The third case is where a would be homebuyer is looking to buy a second home. If higher interest rates make this impractical, then another unit is freed up for somewhat else to occupy.

While a large share, perhaps the majority, of would be homebuyers fall into the first category, people buying homes with comparable space to their current apartment or house, clearly a large number fall into the second and third categories. Therefore, it is reasonable to expect that higher mortgage rates will also help to lower rents.

It is worth mentioning that higher rates are likely to discourage construction and thereby have a negative effect on supply. This is true, but with the sharp run-up in prices over the last two years, homebuilders would have far more incentive to build even with higher interest rates, than they did at the start of the pandemic.

There is also reason to think that the supply of housing will be increasing simply due to the easing of supply chain problems.  During the pandemic, it became difficult for builders to get many items needed to finish a home. As a result, while housing starts rose to an annual pace of almost 1.8 million, completions rose little from their pre-pandemic pace of 1.3 million. With supply problems gradually being addressed, we should expect completions to rise to near the rate of housing starts. This will mean a substantial increase in the supply of housing over the next six months or year.

Finally, I should also add a somewhat morbid, but important point, to the rental picture. In an ordinary year there are close to 1 million evictions. We had around half this number in 2020 and 2021, due to eviction moratoriums. Thankfully, we have not seen the flood of evictions many predicted when these moratoriums ended, but we should expect to see evictions get back to their normal pace. This will also free up some units, putting downward pressure on rents.

Converting Office Space to Residential

As the pandemic has dragged on longer than most of us expected, the remote work arrangements that many companies adopted look to become permanent. Dates for returning to the office were continually pushed off, and now many companies are planning to live with a situation where a substantial share of their workers are expected to show up at the office either infrequently, or not at all.

As a result, many office buildings are now largely empty. The number of workers going into offices nationwide is still less than 40 percent of its pre-pandemic level. This huge amount of vacant office space offers the quickest route for increasing the supply of housing.

While it is true that many new office buildings cannot be easily converted to residential units, that is really beside the point. What we would expect is that as a glut of office space pushes down rents. Landlords in buildings that can be more easily converted will turn their space into apartments or condominiums. This would push tenants that had been using these buildings for offices into the buildings that are not easily converted to residential usage.

This is a straightforward market process, but it can be helped along by government. Unnecessary zoning barriers that make such conversions difficult can be relaxed. Governments can also inventory best practices, sharing examples of buildings that have been successfully converted. Low interest loans, to subsidize conversions, as well as the moves of tenants who need new space, can also be helpful.

There are undoubtedly many other policies that can hasten this process without large expenditures or bureaucracies, but governments have to agree that this is the route they want to follow. As it is, many politicians, most notably New York Governor Kathy Hochul and New York City Mayor Eric Adams, have been leaning on companies to bring their workers back to the office.

Hochul and Adams are responding to the thousands of businesses that are dependent on the throngs of commuters that used to come into Manhattan every day. With this figure slashed by more than 60 percent, many of these businesses cannot survive.

Their concern over these businesses is understandable, but we are seeing a permanent change in the economy, and New York and other cities will simply have to adapt. Most of the millions of workers newly given the opportunity to work remotely value this freedom. They can save thousands of dollars a year on commuting and other work-related expenses. In addition, they save the time needed for commuting, which can easily be ten hours a week in a major city like New York.

For these reasons, it is understandable that many workers do not want to return to the office. Employers that do not allow their employees to work remotely are likely to find themselves at a serious disadvantage in their efforts to attract and retain workers. In short, remote work is now a fact of life, we cannot turn back the clock.[1]

While this is bad news for the businesses that depended on a commuting workforce, it does not have to be bad news for cities. If the office space is converted to residential space, it will increase the number of people living in cities. The new residents will also require services from businesses, even though these may be different than the needs of the commuting population.

Also, additional residential space will put downward pressure on rents more generally. This is bad news for landlords, but it will mean more money for renters, who will now have more money to spend on things other than rent.

Even without large-scale conversion of office space, we have seen a sharp slowing of rental inflation in some of the highest cost cities. The CPI measure of rent has increased by close to 1.0 percent over the last year in New York, San Francisco, and Washington, DC. This likely reflects many people taking advantage of increased opportunities for remote work to move to lower cost parts of the country.

The flip side of this story is that rents in lower cost cities, like Detroit, Atlanta, and Phoenix, have far out-paced the national rate of rental inflation over the last year. This is fine for the renters who are moving from much higher cost cities. The resulting rise in house sale prices is also good news for homeowners in these places. However, it is bad news for those who were already renting in these lower cost cities, although the impact might be largely offset by increased job opportunities resulting from an influx of relatively affluent workers. In any case, this migration is almost certainly a net positive, even if there are likely to be some losers.

The Prospect of Lower Inflation Going Forward

Most of the new data that we have seen in the last few months supports the view that inflation is coming down, rather than spiraling upward. The Congressional Budget Office threw its lot in with this view in its latest budget and economic outlook. In many areas, the price declines will come about through the normal working of the market, however in the case of rent, the government can help to counter inflation by encouraging the conversion of vacant office space to residential units.

[1] Remote work is also great for the environment, since it means less carbon emissions from commuting.

There is good reason for believing that the prices of many items that drove inflation higher in the last year have stopped rising and are may even be going in the opposite direction. Used cars are the best example. The CPI index for used vehicles rose 40.5 percent from January 2021 to January 2022. In the three months from January to April, the CPI index has fallen by 4.5 percent.

More generally, the supply shortages that drove prices higher in 2021 seem to be replaced by gluts, with major retailers like Amazon and Target complaining about stockpiles of unsold goods. With the stimulus measures from the pandemic fading into the past, and people no longer fearing to travel or go to restaurants, it is likely that we will be seeing serious downward pressure on the prices of many goods.

While inflation may be easing on the goods side, there are questions about prices in the service sector, most importantly rent. Rent accounts for more than 31.0 percent of the overall CPI, and almost 40 percent of the core index.

Rental inflation had been running at close to a 3.5 percent annual rate before the pandemic. It slowed in 2021, but is now running at almost a 5.0 percent annual rate. There are reasons for believing that it could go still higher. Home sales price growth has been in the double digits the last two years. Many indexes of market rents (units that change hands) have also shown double-digit growth. This raises the possibility that the CPI measure of rental inflation (which covers all units, not just those that change hands) will increase even more rapidly in the rest of 2022 and 2023.

Given its importance in the indexes, and people’s spending, it will be hard to contain inflation if rents are rising at a 5.0 percent, or higher, annual rate. Fortunately, there are some reasons for believing that we may be seeing downward pressure on rental inflation also.

First, the Fed’s interest rate hikes have had a huge impact on home sales. The interest rate for 30-year mortgages has risen by more than 2.0 percentage points, causing home sales to plummet. In recent weeks, purchase mortgage applications have been down by double-digit amounts from year ago levels. Other data, like pending home sales, also show a sharp drop off.

While the relationship between the ownership market and rental market is somewhat indirect, fewer homes being sold is likely to somewhat increase the supply available to renters. To see this point, consider three possibilities.

In the first, would be homebuyers deterred by higher interest rates were looking to move from either a rental or ownership unit of roughly the same size. In this case, the fact that they don’t buy a home has no impact on the overall demand for housing. They just would have occupied a different unit, leaving their current home vacant.

In a second case, imagine that the would be homebuyers were planning to occupy more space. Perhaps they would have moved from a one-bedroom apartment to a three-bedroom house. Alternatively, maybe they were sharing an apartment or house and would have instead have their own, if they bought. In this case, their decision not to buy frees up space that they otherwise would have occupied. That means, other things equal, downward pressure on rents.

It is important in this story to recognize both, that houses can be, and often are divided so that they are shared by multiple individuals or families. This can happen either because the owner formally divides a house explicitly into multiple units, or multiple individuals choose to share a house. Also, houses can be rented if they are not sold. Roughly 30 percent of rental units are single family homes.

The third case is where a would be homebuyer is looking to buy a second home. If higher interest rates make this impractical, then another unit is freed up for somewhat else to occupy.

While a large share, perhaps the majority, of would be homebuyers fall into the first category, people buying homes with comparable space to their current apartment or house, clearly a large number fall into the second and third categories. Therefore, it is reasonable to expect that higher mortgage rates will also help to lower rents.

It is worth mentioning that higher rates are likely to discourage construction and thereby have a negative effect on supply. This is true, but with the sharp run-up in prices over the last two years, homebuilders would have far more incentive to build even with higher interest rates, than they did at the start of the pandemic.

There is also reason to think that the supply of housing will be increasing simply due to the easing of supply chain problems.  During the pandemic, it became difficult for builders to get many items needed to finish a home. As a result, while housing starts rose to an annual pace of almost 1.8 million, completions rose little from their pre-pandemic pace of 1.3 million. With supply problems gradually being addressed, we should expect completions to rise to near the rate of housing starts. This will mean a substantial increase in the supply of housing over the next six months or year.

Finally, I should also add a somewhat morbid, but important point, to the rental picture. In an ordinary year there are close to 1 million evictions. We had around half this number in 2020 and 2021, due to eviction moratoriums. Thankfully, we have not seen the flood of evictions many predicted when these moratoriums ended, but we should expect to see evictions get back to their normal pace. This will also free up some units, putting downward pressure on rents.

Converting Office Space to Residential

As the pandemic has dragged on longer than most of us expected, the remote work arrangements that many companies adopted look to become permanent. Dates for returning to the office were continually pushed off, and now many companies are planning to live with a situation where a substantial share of their workers are expected to show up at the office either infrequently, or not at all.

As a result, many office buildings are now largely empty. The number of workers going into offices nationwide is still less than 40 percent of its pre-pandemic level. This huge amount of vacant office space offers the quickest route for increasing the supply of housing.

While it is true that many new office buildings cannot be easily converted to residential units, that is really beside the point. What we would expect is that as a glut of office space pushes down rents. Landlords in buildings that can be more easily converted will turn their space into apartments or condominiums. This would push tenants that had been using these buildings for offices into the buildings that are not easily converted to residential usage.

This is a straightforward market process, but it can be helped along by government. Unnecessary zoning barriers that make such conversions difficult can be relaxed. Governments can also inventory best practices, sharing examples of buildings that have been successfully converted. Low interest loans, to subsidize conversions, as well as the moves of tenants who need new space, can also be helpful.

There are undoubtedly many other policies that can hasten this process without large expenditures or bureaucracies, but governments have to agree that this is the route they want to follow. As it is, many politicians, most notably New York Governor Kathy Hochul and New York City Mayor Eric Adams, have been leaning on companies to bring their workers back to the office.

Hochul and Adams are responding to the thousands of businesses that are dependent on the throngs of commuters that used to come into Manhattan every day. With this figure slashed by more than 60 percent, many of these businesses cannot survive.

Their concern over these businesses is understandable, but we are seeing a permanent change in the economy, and New York and other cities will simply have to adapt. Most of the millions of workers newly given the opportunity to work remotely value this freedom. They can save thousands of dollars a year on commuting and other work-related expenses. In addition, they save the time needed for commuting, which can easily be ten hours a week in a major city like New York.

For these reasons, it is understandable that many workers do not want to return to the office. Employers that do not allow their employees to work remotely are likely to find themselves at a serious disadvantage in their efforts to attract and retain workers. In short, remote work is now a fact of life, we cannot turn back the clock.[1]

While this is bad news for the businesses that depended on a commuting workforce, it does not have to be bad news for cities. If the office space is converted to residential space, it will increase the number of people living in cities. The new residents will also require services from businesses, even though these may be different than the needs of the commuting population.

Also, additional residential space will put downward pressure on rents more generally. This is bad news for landlords, but it will mean more money for renters, who will now have more money to spend on things other than rent.

Even without large-scale conversion of office space, we have seen a sharp slowing of rental inflation in some of the highest cost cities. The CPI measure of rent has increased by close to 1.0 percent over the last year in New York, San Francisco, and Washington, DC. This likely reflects many people taking advantage of increased opportunities for remote work to move to lower cost parts of the country.

The flip side of this story is that rents in lower cost cities, like Detroit, Atlanta, and Phoenix, have far out-paced the national rate of rental inflation over the last year. This is fine for the renters who are moving from much higher cost cities. The resulting rise in house sale prices is also good news for homeowners in these places. However, it is bad news for those who were already renting in these lower cost cities, although the impact might be largely offset by increased job opportunities resulting from an influx of relatively affluent workers. In any case, this migration is almost certainly a net positive, even if there are likely to be some losers.

The Prospect of Lower Inflation Going Forward

Most of the new data that we have seen in the last few months supports the view that inflation is coming down, rather than spiraling upward. The Congressional Budget Office threw its lot in with this view in its latest budget and economic outlook. In many areas, the price declines will come about through the normal working of the market, however in the case of rent, the government can help to counter inflation by encouraging the conversion of vacant office space to residential units.

[1] Remote work is also great for the environment, since it means less carbon emissions from commuting.

Inflation is persisting at rates far higher than most of us consider acceptable. The future path continues to be the focus of the debate on economic prospects. On one side, many of us continue to believe inflation is a temporary phenomenon caused by the reopening from the pandemic and the war in Ukraine. On the other side are those who see inflation spiraling upward to more dangerous levels, with a severe recession the only factor that can stop it.

In its latest report on the budget and the economy, the Congressional Budget Office (CBO) sided clearly with those arguing the case for inflation being temporary. The report projected that inflation, as measured by the Consumer Price Index, would fall to 2.7 percent next year and 2.3 percent in 2024. That is somewhat higher than in the pre-pandemic period, but certainly not spiraling inflation.

This drop in the inflation rate is not accomplished by a surge in unemployment. It projects that unemployment in the fourth quarter of this year will be 3.7 percent this year. It will be 3.6 percent in the fourth quarter of next year, and 3.8 percent in 2024. If this projection proves to be true, this would be the lowest three-year stretch for unemployment in the post-World War II era.

CBO also projects that the profit share of national income will fall back to its pre-pandemic level. This will allow wage growth to outpace productivity growth for this three-year period.

These projections show an outstanding picture of the economy for this period. CBO can be wrong, but these are serious projections from a non-partisan source. If they prove true, we will have much to celebrate.   

Inflation is persisting at rates far higher than most of us consider acceptable. The future path continues to be the focus of the debate on economic prospects. On one side, many of us continue to believe inflation is a temporary phenomenon caused by the reopening from the pandemic and the war in Ukraine. On the other side are those who see inflation spiraling upward to more dangerous levels, with a severe recession the only factor that can stop it.

In its latest report on the budget and the economy, the Congressional Budget Office (CBO) sided clearly with those arguing the case for inflation being temporary. The report projected that inflation, as measured by the Consumer Price Index, would fall to 2.7 percent next year and 2.3 percent in 2024. That is somewhat higher than in the pre-pandemic period, but certainly not spiraling inflation.

This drop in the inflation rate is not accomplished by a surge in unemployment. It projects that unemployment in the fourth quarter of this year will be 3.7 percent this year. It will be 3.6 percent in the fourth quarter of next year, and 3.8 percent in 2024. If this projection proves to be true, this would be the lowest three-year stretch for unemployment in the post-World War II era.

CBO also projects that the profit share of national income will fall back to its pre-pandemic level. This will allow wage growth to outpace productivity growth for this three-year period.

These projections show an outstanding picture of the economy for this period. CBO can be wrong, but these are serious projections from a non-partisan source. If they prove true, we will have much to celebrate.   

The New York Times ran a piece discussing why innovations in cloud computing and artificial technology have not led to more rapid increases in productivity. It raises a number of possibilities, but leaves out an obvious one, increasing waste associated with rent-seeking. We clearly see an increase in waste associated with rent-seeking, the only question is whether it is large enough to have a notable effect on productivity growth.

The piece actually touches on, without commenting on it, one of the major sources of waste. It discusses the practices of a major health insurer.

Health insurance does not directly contribute to GDP. Health care (actually health) is what we care about. Health insurers determines who has access to health care. In principle we want as few people employed in the health insurance industry as possible, we want people to be able to get health care, not to have insurers block their path.

However, we have over 900,000 people employed in health and life insurance companies. Much of what they do is made profitable by the fact that patent monopolies make many drugs and medical equipment expensive. In the absence of these monopolies, no insurer would look to block patients from getting the drugs or medical care recommended by their physician.

There are similar stories in many other sectors. The financial industry employs hundreds of thousands of people shuffling assets in ways that contribute nothing to GDP. The same is true with the lawyers and accountants devoting their efforts to help rich people and corporations avoid paying taxes.

Eliminating, or at least reducing, this waste would be a great way to increase productivity. Unfortunately, the people get rich and richer off this waste prevent it from being addressed politically, or even discussed in the New York Times.

The New York Times ran a piece discussing why innovations in cloud computing and artificial technology have not led to more rapid increases in productivity. It raises a number of possibilities, but leaves out an obvious one, increasing waste associated with rent-seeking. We clearly see an increase in waste associated with rent-seeking, the only question is whether it is large enough to have a notable effect on productivity growth.

The piece actually touches on, without commenting on it, one of the major sources of waste. It discusses the practices of a major health insurer.

Health insurance does not directly contribute to GDP. Health care (actually health) is what we care about. Health insurers determines who has access to health care. In principle we want as few people employed in the health insurance industry as possible, we want people to be able to get health care, not to have insurers block their path.

However, we have over 900,000 people employed in health and life insurance companies. Much of what they do is made profitable by the fact that patent monopolies make many drugs and medical equipment expensive. In the absence of these monopolies, no insurer would look to block patients from getting the drugs or medical care recommended by their physician.

There are similar stories in many other sectors. The financial industry employs hundreds of thousands of people shuffling assets in ways that contribute nothing to GDP. The same is true with the lawyers and accountants devoting their efforts to help rich people and corporations avoid paying taxes.

Eliminating, or at least reducing, this waste would be a great way to increase productivity. Unfortunately, the people get rich and richer off this waste prevent it from being addressed politically, or even discussed in the New York Times.

Sorry folks, I’m back!!!! Anyhow, I was following the news the last few weeks and was struck by a couple of items that seem to have gotten little attention.

First, on inflation, we have seen a sharp fall in the break-even inflation rate for inflation-indexed 10-year Treasury bonds compared with conventional Treasury bonds. This break-even rate had been rising through the fall and winter, peaking at just over 3.0 percent on April 21.

Anyhow, it has since fallen sharply, and stood at 2.6 percent on Monday. This is still somewhat higher than the Fed’s 2.0 percent inflation target, but not by much, since everyone expects higher inflation in 2022 and there is around a 0.3 percentage point gap between the CPI, which is the basis of the index and the PCE deflator than the Fed targets.

The drop in this break-even rate deserves more attention than it’s getting. As someone who warned of both the stock bubble in the 1990s and the housing bubble in the ‘00s, I am well aware that markets can be wrong, but it is still worth paying attention to what they are telling us.

Rather than seeing a story of spiraling inflation, actors in financial markets seem to be expecting that the inflation rate will quickly fall back to more moderate levels. That is worth noting.

The other issue is the plunge in the stock market that has upset many people, including some self-identified liberals. There all sorts of factors, both rational and irrational, that can explain stock market movements, but in principle, the stock market is supposed to represent the discounted value of future corporate profits.

Many of us have noted that the pandemic inflation has been associated with a sharp shift from wage income to profit income, with the latter rising by roughly 2 percentage points of corporate income. The immediate trigger for the latest plunge was reports from Target and Amazon that they are seeing increasing pricing pressure, and therefore lower profit margins, on a wide range of goods.

Let’s suppose that this is the beginning of a reversal in profit shares, with the possibility that they will return to their pre-pandemic level. This is what many of us had been hoping for.

But what would be the predicted effect on stock prices of a drop in profit shares of roughly 2 percentage points, or 10 percent of current profits? That’s right, we would expect a plunge in stock prices. The good news for workers here (lower prices mean high real wages) is bad news for the stock market.

Too early to say if this is in fact the story, but if it is, progressives should be happy.

Sorry folks, I’m back!!!! Anyhow, I was following the news the last few weeks and was struck by a couple of items that seem to have gotten little attention.

First, on inflation, we have seen a sharp fall in the break-even inflation rate for inflation-indexed 10-year Treasury bonds compared with conventional Treasury bonds. This break-even rate had been rising through the fall and winter, peaking at just over 3.0 percent on April 21.

Anyhow, it has since fallen sharply, and stood at 2.6 percent on Monday. This is still somewhat higher than the Fed’s 2.0 percent inflation target, but not by much, since everyone expects higher inflation in 2022 and there is around a 0.3 percentage point gap between the CPI, which is the basis of the index and the PCE deflator than the Fed targets.

The drop in this break-even rate deserves more attention than it’s getting. As someone who warned of both the stock bubble in the 1990s and the housing bubble in the ‘00s, I am well aware that markets can be wrong, but it is still worth paying attention to what they are telling us.

Rather than seeing a story of spiraling inflation, actors in financial markets seem to be expecting that the inflation rate will quickly fall back to more moderate levels. That is worth noting.

The other issue is the plunge in the stock market that has upset many people, including some self-identified liberals. There all sorts of factors, both rational and irrational, that can explain stock market movements, but in principle, the stock market is supposed to represent the discounted value of future corporate profits.

Many of us have noted that the pandemic inflation has been associated with a sharp shift from wage income to profit income, with the latter rising by roughly 2 percentage points of corporate income. The immediate trigger for the latest plunge was reports from Target and Amazon that they are seeing increasing pricing pressure, and therefore lower profit margins, on a wide range of goods.

Let’s suppose that this is the beginning of a reversal in profit shares, with the possibility that they will return to their pre-pandemic level. This is what many of us had been hoping for.

But what would be the predicted effect on stock prices of a drop in profit shares of roughly 2 percentage points, or 10 percent of current profits? That’s right, we would expect a plunge in stock prices. The good news for workers here (lower prices mean high real wages) is bad news for the stock market.

Too early to say if this is in fact the story, but if it is, progressives should be happy.

Taking May Off

I will be vacationing for the month, so it is unlikely that I will post anything until the end of the month. See you then.

I will be vacationing for the month, so it is unlikely that I will post anything until the end of the month. See you then.

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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