Arthur Burns Can’t Get the Blame for the 1970s Inflation

March 13, 2016

13 Marzo 2016

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

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

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

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

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

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

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

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

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

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

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

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

Is Donald Trump’s Protectionism New?

By Dean BakerDean Baker

March 11, 2016

11 Marzo 2016

That is what Binyamin Appelbaum argued in a Upshot column with the headline, “on trade, Donald Trump breaks with 200 years of economic orthodoxy.” The piece points to Trump’s rhetoric in which he claims that other countries are taking advantage of the United States because they are running large trade surpluses with us. It then turns to an old speech from Milton Friedman saying the opposite is true: “'Economists have spoken with almost one voice for some 200 years,’ the economist Milton Friedman said in a 1978 speech. ‘The gain from foreign trade is what we import. What we export is the cost of getting those imports. And the proper objective for a nation, as Adam Smith put it, is to arrange things so we get as large a volume of imports as possible for as small a volume of exports as possible.’” This is in fact the classic economics argument for the merits of trade, but there is an important assumption in the argument which is not mentioned. The assumption is that the trade deficit has no effect on the level of aggregate demand and output in the United States. In the standard economic view, if our annual trade deficit increases by $200 billion we will simply make up this demand elsewhere in the economy. A combination of higher consumption, investment, and government spending will fully offset the $200 billion reduction in demand resulting from the rise in the trade deficit. This means that total demand in the economy will not change, nor will total employment. There could be some shift in employment, from the import competing industries to the industries that meet the new demand, but in the standard economics story of trade, overall unemployment is not a problem. This view of trade is less tenable in an economy that faces a chronic shortfall of demand, as is the case in the United States. Most economists now recognize that advanced economies like those in the United States, Japan, and the European Union can have prolonged periods of inadequate demand (a.k.a. “secular stagnation”) leading to unemployment and underemployment.

Educating the Washington Post on the Way Washington Works

By Dean BakerDean Baker

March 11, 2016

11 Marzo 2016

In recent weeks the Washington Post has virtually transformed itself into a Bernie Sanders attack platform, filling both its news and opinion pages with critical pieces. For this reason it was not surprising to see its lead editorial today criticizing Senator Sanders for not supporting an auto bailout because it was attached to funding for the Wall Street bailout. First, it worth once again correcting its misstatements about the Wall Street bailout. The piece tells readers: "In September 2008, Ms. Clinton and Mr. Sanders were both U.S. senators deciding whether to vote for a $700 billion fund to prop up the rapidly collapsing U.S. financial system. Ms. Clinton voted yes, on the sound view that the likely alternative to this admittedly undeserved rescue of Wall Street would have been global calamity. Mr. Sanders voted no, demanding that Wall Street pay for its own bailout. As it happens, the bailout fund, known as the Troubled Asset Relief Program (TARP), ended up costing far less than the initial headline figure suggested, and even made taxpayers some money; but, as was foreseeable at the time, that hasn’t stopped the country’s political purists, left and right, from second-guessing and making political hay." As I and others have pointed out, the "second Great Depression" story pushed by bailout supporters assumes that Washington does nothing even as the unemployment rate soars into the double digits. There is no historical support for anything like this. Even President George W. Bush supported a stimulus package when the unemployment rate was just 4.9 percent. Furthermore, the fact the bailout "made taxpayers some money" really has nothing to do with the time of day. The government lent billions of dollars (trillions of dollars counting the loans from the Fed) to some of the richest people in the country at rates that were far below what they would have been forced to pay in the market. This was an enormous transfer of wealth from the rest of us to Wall Street.

Tell Morning Edition: It's Not "Free Trade" Folks

By Dean BakerDean Baker

March 10, 2016

10 Marzo 2016

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

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

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

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

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

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

Bankers’ Bailout: Quick Thoughts on the Tarp

By Dean BakerDean Baker

March 10, 2016

10 Marzo 2016

Since the TARP has come up repeatedly in the debates between Secretary Hillary Clinton and Senator Bernie Sanders, it is worth briefly correcting a couple of major misconceptions. The first one is that we would have had a second Great Depression without the bailout. This assertion requires rejecting everything we know about the first Great Depression. The first Great Depression was caused by a series of bank collapses as runs spread from bank to bank. The country was much better positioned to prevent the same sort of destruction of wealth and liquidity most importantly because of the existence of deposit insurance backed up by the Federal Deposit Insurance Corporation. More importantly, the downturn from the collapse persisted for over a decade because of the lack of an adequate fiscal response. In other words, if we had spent lots of money, we could have quickly ended the depression as we eventually did with the spending associated with World War II in 1941. There is no reason in principle that we could not have had this spending for peaceful purposes in 1931, which would have quickly brought the depression to an end. The claim that we risked a second Great Depression in 2008 (defined as a decade of double-digit unemployment) is not only a claim that we faced a Great Depression sized financial collapse but also that we would be too stupid to spend the money needed to get us out of the downturn for a decade. None of the second Great Depression myth promulgators has yet made that case.

Raising Wages: What’s Wrong With Ending Protection for Those on Top?

By Dean BakerDean Baker

March 09, 2016

09 Marzo 2016

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

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

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

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

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

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

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

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

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

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

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

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

More on Trans-Pacific Partnership Models: Response to Petri and Plummer

By Dean BakerDean Baker

March 09, 2016

09 Marzo 2016

I see that Peter Petri and Michael Plummer (PP) have responded to my blog post on their models projections for the TPP. In essence, they minimize the concern that the TPP or even trade deficits more generally can lead to a prolonged period of high unemployment or secular stagnation to use the currently fashionable term.Dealing with the second issue first, they argue: “While trade agreements include many provisions on exports and imports, they typically contain no provisions to affect savings behavior. Thus, net national savings, and hence trade balances, will remain at levels determined by other variables, and real exchange rates will adjust instead. “A similar argument applies to overall employment. The TPP could affect employment in the short run — a possibility that we examine below — but those effects will fade because of market and policy adjustments. Since there is nothing in TPP provisions to affect long-term employment trends, employment too will converge to these levels, as long as adjustments are completed in the model’s 10 to 15 year time horizon.” In short, PP explicitly argues that trade agreements neither affect the trade balance nor employment as a definitional matter. They argue that the trade balance is determined by net national savings. They explicitly disavow the contention in my prior note that we cannot assume an adjustment process that will restore the economy to full employment: “In fact, critics of microeconomic analysis often challenge the credibility of market adjustment even in the long term. Dean Baker (2016) argues, for example, that mechanisms that may have once enabled the US economy to return to equilibrium are no longer working in the aftermath of the financial crisis. But the data tell a different, less pessimistic story (figure 1). Since 2010, the US economy has added 13 million jobs, a substantial gain compared to job growth episodes in recent decades, and the US civilian unemployment rate has declined from nearly 10 percent to under 5 percent. The broadest measure of unemployment (U6), which also includes part-time and discouraged workers, has declined almost as sharply, from 17 to 10 percent, and is now nearly back to average levels in precrisis, nonrecession years.” As I noted in my original blog post, the PP analysis is entirely consistent with standard trade and macroeconomic approaches, however these approaches do not seem credible in the wake of the Great Recession. The standard view was that the economy would quickly bounce back to its pre-recession trend levels of output and employment. This view provides the basis for the projections made by the Congressional Budget Office (CBO) in its 2010 Budget and Economic Outlook (CBO, 2010). These projections are useful both because they were made with a full knowledge of the depth of the downturn (the recovery had begun in June of 2009) and also because CBO explicitly tries to make projections that are in line with the mainstream of the economics profession.

Krugman on China, Trump, and Romney

By Dean BakerDean Baker

March 08, 2016

08 Marzo 2016

I see Paul Krugman was taking cheap shots at my heroes while I was on vacation. Krugman argues that Trump is wrong to claim that China is acting to keep down the value of its currency against the dollar. He points to recent efforts to prop up the value of the yuan by selling foreign exchange as evidence that China is actually doing the opposite of what Trump claims. Krugman should know better. This is a story of stocks and flows. It’s true that China’s central bank is now selling reserves rather than buying them, but it still holds more than $3 trillion in reserves. The conventional rule of thumb is that reserves should be equal to six months of imports, which would be around $1 trillion in China’s case. This means that China’s stock of reserves is more than $2 trillion above what would be expected if it were just managing its reserves for standard purposes. We should expect the stock of reserves to put upward pressure on the value of the dollar in international currency markets. This is the same story as with the Fed’s holding of $3 trillion in assets. It is widely argued (including by Paul Krugman) that the Fed’s holding of a large stock of assets reduces interest rates, even if it is not currently adding to that stock. The point is that if the private investors were to hold these assets instead of the Fed, they would carry a lower price and interest rates would be higher. To take the stock and flow China analogy to the Fed, when the Fed raised the federal funds rate in December, it was trying to put some upward pressure on interest rates. But if we snapped our fingers and imagined that the federal funds rate was still zero, but the Fed’s asset holding were at more normal levels, do we think interest rates would be higher or lower?

Can We Stop with the Fear of Deflation Stuff Already?

By Dean BakerDean Baker

March 01, 2016

01 Marzo 2016

Paul Krugman, who certainly knows better, referred to the “risk of deflation” receding in the euro zone in his blog today. The point is that it doesn’t matter if the inflation rate crosses zero and turns negative, the problem is that the inflation rate is too low. It’s more too low if we have -0.5 percent inflation rather than 0.5 percent inflation, but this is no worse than having the inflation rate fall from 1.5 percent to 0.5 percent.

As I pointed in my prior post: “The inflation rate is an aggregate of millions of different price changes (quality adjusted). If it is near zero then a very large number of the changes will already be negative. When it falls below zero it simply means that the negative share is somewhat higher. How can that be a qualitatively different economic universe?”

The reason why this matters is that we can get a false complacency over the fact that prices are not falling, just rising very slowly. We should want a higher rate of inflation. And we should not be congratulating the central bankers just because the aggregate measure of inflation is greater than zero.

Paul Krugman, who certainly knows better, referred to the “risk of deflation” receding in the euro zone in his blog today. The point is that it doesn’t matter if the inflation rate crosses zero and turns negative, the problem is that the inflation rate is too low. It’s more too low if we have -0.5 percent inflation rather than 0.5 percent inflation, but this is no worse than having the inflation rate fall from 1.5 percent to 0.5 percent.

As I pointed in my prior post: “The inflation rate is an aggregate of millions of different price changes (quality adjusted). If it is near zero then a very large number of the changes will already be negative. When it falls below zero it simply means that the negative share is somewhat higher. How can that be a qualitatively different economic universe?”

The reason why this matters is that we can get a false complacency over the fact that prices are not falling, just rising very slowly. We should want a higher rate of inflation. And we should not be congratulating the central bankers just because the aggregate measure of inflation is greater than zero.

I Am Out of Here!

By Dean BakerDean Baker

March 01, 2016

01 Marzo 2016

Folks,

I’m off on vacation, so I won’t be beating the press for the next week. I’ll be back Wednesday, March 9th. Just remember, in the meantime, don’t believe anything you read in the paper.

Folks,

I’m off on vacation, so I won’t be beating the press for the next week. I’ll be back Wednesday, March 9th. Just remember, in the meantime, don’t believe anything you read in the paper.