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Many people have contempt for economists. It is remarkable they don’t have more. Economists can’t even agree on answers to the most basic questions, like is an economy suffering from too little demand or too much demand. If that sounds confusing, this is like a weatherperson telling us that we don’t know whether to expect severe drought or record floods.
Today’s example is Japan. The NYT had a front page story about its declining population. Unlike many pieces on falling populations, this one at least pointed out the positives aspects, such as less crowded cities and less strain on infrastructure. But after making this point, the piece tells readers:
“The real problem, experts say, is less the size of the familiar ‘population pyramid’ but its shape — in Japan’s case, it has changed. Because the low birthrate means each generation is smaller than the last, it has flipped on its head, with a bulging cohort of older Japanese at the top supported by a narrow base of young people.
“One-quarter of Japanese are now over 65, and that percentage is expected to reach 40 percent by 2060. Pension and health care costs are growing even as the workers needed to pay for them become scarcer.”
Okay, this is a story of inadequate supply. The argument is that Japan’s large number of retirees will be making demands on its economy that its dwindling group of workers will be unable to meet.
That’s an interesting story, but anyone who has followed the debates on economic policy in Japan for the last three years knows that the government has been desperately struggling to increase demand. Prime Minister Abe has been pushing both monetary and fiscal stimulus with the hope of getting more spending to spur growth. In other words, Abe is concerned that Japan doesn’t have enough old people with pensions and health care demands to keep the economy fully employed.
Now this is pretty goddamn incredible. It is possible for an economy to face problem of too little demand. That was the story in the depression and I would argue facing most of the world today.
It is also possible for an economy to face a problem of excess demand, as is being described in this article. This is a situation where it lacks the resources needed to meet the demand it is generating. That typically manifests itself in high and rising inflation (clearly not the story in Japan today.)
It is not possible for a country to have both too much aggregate demand and too little aggregate demand at the same time. Maybe the NYT editors should sit down with those covering Japan and figure out which story fits the country’s economy. Until they can decide, maybe they should refrain from reporting on a country’s economy that they obviously do not understand.
Many people have contempt for economists. It is remarkable they don’t have more. Economists can’t even agree on answers to the most basic questions, like is an economy suffering from too little demand or too much demand. If that sounds confusing, this is like a weatherperson telling us that we don’t know whether to expect severe drought or record floods.
Today’s example is Japan. The NYT had a front page story about its declining population. Unlike many pieces on falling populations, this one at least pointed out the positives aspects, such as less crowded cities and less strain on infrastructure. But after making this point, the piece tells readers:
“The real problem, experts say, is less the size of the familiar ‘population pyramid’ but its shape — in Japan’s case, it has changed. Because the low birthrate means each generation is smaller than the last, it has flipped on its head, with a bulging cohort of older Japanese at the top supported by a narrow base of young people.
“One-quarter of Japanese are now over 65, and that percentage is expected to reach 40 percent by 2060. Pension and health care costs are growing even as the workers needed to pay for them become scarcer.”
Okay, this is a story of inadequate supply. The argument is that Japan’s large number of retirees will be making demands on its economy that its dwindling group of workers will be unable to meet.
That’s an interesting story, but anyone who has followed the debates on economic policy in Japan for the last three years knows that the government has been desperately struggling to increase demand. Prime Minister Abe has been pushing both monetary and fiscal stimulus with the hope of getting more spending to spur growth. In other words, Abe is concerned that Japan doesn’t have enough old people with pensions and health care demands to keep the economy fully employed.
Now this is pretty goddamn incredible. It is possible for an economy to face problem of too little demand. That was the story in the depression and I would argue facing most of the world today.
It is also possible for an economy to face a problem of excess demand, as is being described in this article. This is a situation where it lacks the resources needed to meet the demand it is generating. That typically manifests itself in high and rising inflation (clearly not the story in Japan today.)
It is not possible for a country to have both too much aggregate demand and too little aggregate demand at the same time. Maybe the NYT editors should sit down with those covering Japan and figure out which story fits the country’s economy. Until they can decide, maybe they should refrain from reporting on a country’s economy that they obviously do not understand.
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The job killers (proponents of Fed rate hikes) seized on some modest upticks in the January inflation data to argue that the economy is near capacity and the Fed should be pushing up interest rates. After all, the core (excluding food and energy) consumer price index (CPI) rose by 2.2 percent over the last year, somewhat over the Fed’s 2.0 percent target. That’s pretty scary stuff.
I’ll make a few quick points here. First, the Fed officially targets the core personal consumption expenditure deflator. That index has risen by just 1.7 percent over the last twelve months, still below the Fed’s target.
Second, the Fed’s target is explicitly an average rate of inflation, not a ceiling. Many of us think that the 2.0 percent target is arbitrary and unreasonably low, but even if we accept this level, the inflation rate has a long way to go upward before the Fed will have even hit this target. We could have 4 years of 3.0 percent inflation and still be pretty much on target over the prior decade.
The third point is that the modest uptick in the inflation rate shown in the CPI is largely coming from rising rents. Here is the index the Bureau of Labor Statistics constructs for a core index that excludes shelter (mostly rent).
Source: Bureau of Labor Statistics.
There is a very small uptick in this index also, but only to 1.5 percent inflation over the last year. (There was a much larger uptick at the start of 2011.) We are still well below the Fed’s 2.0 percent inflation target if we pull out rent.
This matters, because if higher inflation is being driven by rising rents, it is not clear that higher interest rates are the right tool to bring prices down. Every Econ 101 textbook tells us about supply and demand. The main factor pushing up rents is more demand for the limited supply of housing. The best way to address this situation is to construct more housing.
But housing is perhaps the most interest sensitive component of demand. If we raise interest rates, then builders are likely to put up fewer new units. This will create more pressure on the housing stock and push rents up further.
Yes, the fuller picture is more complicated. Zoning restrictions often prevent housing from being built and there are many issues about what type of housing gets built. But as a general rule, more housing means lower rents, and if the Fed’s interest rate hikes lead to less construction, they will likely lead to a higher rate of rental inflation, the opposite of its stated intention.
The moral of the story is that the Fed should keep its fingers off the trigger. There is no reason for concern about inflation in the economy in general and in the one major sector where it is somewhat of a problem, higher interest rates will make the situation worse.
The job killers (proponents of Fed rate hikes) seized on some modest upticks in the January inflation data to argue that the economy is near capacity and the Fed should be pushing up interest rates. After all, the core (excluding food and energy) consumer price index (CPI) rose by 2.2 percent over the last year, somewhat over the Fed’s 2.0 percent target. That’s pretty scary stuff.
I’ll make a few quick points here. First, the Fed officially targets the core personal consumption expenditure deflator. That index has risen by just 1.7 percent over the last twelve months, still below the Fed’s target.
Second, the Fed’s target is explicitly an average rate of inflation, not a ceiling. Many of us think that the 2.0 percent target is arbitrary and unreasonably low, but even if we accept this level, the inflation rate has a long way to go upward before the Fed will have even hit this target. We could have 4 years of 3.0 percent inflation and still be pretty much on target over the prior decade.
The third point is that the modest uptick in the inflation rate shown in the CPI is largely coming from rising rents. Here is the index the Bureau of Labor Statistics constructs for a core index that excludes shelter (mostly rent).
Source: Bureau of Labor Statistics.
There is a very small uptick in this index also, but only to 1.5 percent inflation over the last year. (There was a much larger uptick at the start of 2011.) We are still well below the Fed’s 2.0 percent inflation target if we pull out rent.
This matters, because if higher inflation is being driven by rising rents, it is not clear that higher interest rates are the right tool to bring prices down. Every Econ 101 textbook tells us about supply and demand. The main factor pushing up rents is more demand for the limited supply of housing. The best way to address this situation is to construct more housing.
But housing is perhaps the most interest sensitive component of demand. If we raise interest rates, then builders are likely to put up fewer new units. This will create more pressure on the housing stock and push rents up further.
Yes, the fuller picture is more complicated. Zoning restrictions often prevent housing from being built and there are many issues about what type of housing gets built. But as a general rule, more housing means lower rents, and if the Fed’s interest rate hikes lead to less construction, they will likely lead to a higher rate of rental inflation, the opposite of its stated intention.
The moral of the story is that the Fed should keep its fingers off the trigger. There is no reason for concern about inflation in the economy in general and in the one major sector where it is somewhat of a problem, higher interest rates will make the situation worse.
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The confusion on inflation continues. The NYT ran a Reuters piece on the latest inflation data from Japan. The piece began by telling readers:
“Japan’s core consumer prices were unchanged in January from a year earlier, suggesting that persistent falls in energy costs will keep inflation well below the central bank’s 2 percent target.
“While falling fuel costs may be a boon for corporate profits, low energy prices suppress inflation which in turn may discourage companies from raising wages or the prices of their goods.”
Okay, let’s step back a second. The reason that folks care about having higher inflation is to give firms more incentive to invest. If the goods and services they are selling rise in price by 2.0 percent a year, as opposed to staying flat, then they have more incentive to invest at the same nominal interest rate. We’ll call this 2.0 percent inflation case “Scenario I.”
Now let’s imagine Scenario II. Suppose that the prices of the goods and services firms in Japan produce rise by 2.0 percent a year, as in Scenario I, but the prices of oil and other items that Japan imports fall rapidly. The result is that the overall inflation rate is zero.
Your brainteaser for tonight is: do Japanese firms have any less incentive to invest in the Scenario II than Scenario I?
Addendum
I should mention that cheap oil is horrible for the environment since it encourages people to use more of the stuff and makes it more difficult to promote clean energy. This may be obvious, but is worth repeating.
The confusion on inflation continues. The NYT ran a Reuters piece on the latest inflation data from Japan. The piece began by telling readers:
“Japan’s core consumer prices were unchanged in January from a year earlier, suggesting that persistent falls in energy costs will keep inflation well below the central bank’s 2 percent target.
“While falling fuel costs may be a boon for corporate profits, low energy prices suppress inflation which in turn may discourage companies from raising wages or the prices of their goods.”
Okay, let’s step back a second. The reason that folks care about having higher inflation is to give firms more incentive to invest. If the goods and services they are selling rise in price by 2.0 percent a year, as opposed to staying flat, then they have more incentive to invest at the same nominal interest rate. We’ll call this 2.0 percent inflation case “Scenario I.”
Now let’s imagine Scenario II. Suppose that the prices of the goods and services firms in Japan produce rise by 2.0 percent a year, as in Scenario I, but the prices of oil and other items that Japan imports fall rapidly. The result is that the overall inflation rate is zero.
Your brainteaser for tonight is: do Japanese firms have any less incentive to invest in the Scenario II than Scenario I?
Addendum
I should mention that cheap oil is horrible for the environment since it encourages people to use more of the stuff and makes it more difficult to promote clean energy. This may be obvious, but is worth repeating.
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The Washington Post headlined a Reuters’ piece on the Commerce Department’s release of January data on durable goods orders “new orders for durable goods increased in January.” The first sentence told readers:”New orders for long-lasting U.S. manufactured goods in January rose by the most in 10 months as demand picked up broadly, offering a ray of hope for the downtrodden manufacturing sector.”This is more than a bit misleading. The 4.9 percent jump in January looks much less impressive when considered with a 4.6 percent decline in December and a 0.5 percent decline in November. The monthly data in this series are highly erratic.
The large drop reported for December was almost certainly a measurment error and did not reflect an actual decline in orders. This means that the January jump was primarily attributable to the series again more accurately reflecting the true level of orders in the economy. Looking over a longer period, nominal orders are up by less than 1.0 percent over the last year. While this is not a horrible story of collapsing manufacturing, it is wrong to imply there is any evidence of a bounce back in this sector.
The Washington Post headlined a Reuters’ piece on the Commerce Department’s release of January data on durable goods orders “new orders for durable goods increased in January.” The first sentence told readers:”New orders for long-lasting U.S. manufactured goods in January rose by the most in 10 months as demand picked up broadly, offering a ray of hope for the downtrodden manufacturing sector.”This is more than a bit misleading. The 4.9 percent jump in January looks much less impressive when considered with a 4.6 percent decline in December and a 0.5 percent decline in November. The monthly data in this series are highly erratic.
The large drop reported for December was almost certainly a measurment error and did not reflect an actual decline in orders. This means that the January jump was primarily attributable to the series again more accurately reflecting the true level of orders in the economy. Looking over a longer period, nominal orders are up by less than 1.0 percent over the last year. While this is not a horrible story of collapsing manufacturing, it is wrong to imply there is any evidence of a bounce back in this sector.
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Since I had been critical of elite economists for using their authority rather than evidence to trash Gerald Friedman’s analysis of Bernie Sanders’ program, I should acknowledge a serious effort to do exactly the sort of analysis I advocated. Christina Romer, one of the four former heads of the Council of Economic Advisers who signed the earlier letter criticizing Friedman’s analysis, along with David Romer (both of whom are now Berkeley economics professors), did a detailed critique of the Friedman analysis.
I could quibble with aspects of their critique, but I would say it is basically right. There clearly is still a large amount of slack in the economy which would allow for 2–4 years of exceptionally strong growth (e.g. 4–5 percent). However, it is very hard to envision a story where this sort of growth rate is maintained for a full eight years of a Sanders’ administration.
Furthermore, many aspects of Sanders’ agenda point to slower growth. For example, universal Medicare and expanded Social Security will make it easier for older people not to work, as will free college for young people. Also, mandated vacations will mean fewer hours per worker, on average. These may all be good things (I happen to think so), but they are likely to mean less GDP growth than would otherwise be the case.
Anyhow, I appreciate that Romer and Romer took the time to do the analysis. We should be having a discussion about how much better the economy can be doing than it is now. This analysis is a step in that direction.
Since I had been critical of elite economists for using their authority rather than evidence to trash Gerald Friedman’s analysis of Bernie Sanders’ program, I should acknowledge a serious effort to do exactly the sort of analysis I advocated. Christina Romer, one of the four former heads of the Council of Economic Advisers who signed the earlier letter criticizing Friedman’s analysis, along with David Romer (both of whom are now Berkeley economics professors), did a detailed critique of the Friedman analysis.
I could quibble with aspects of their critique, but I would say it is basically right. There clearly is still a large amount of slack in the economy which would allow for 2–4 years of exceptionally strong growth (e.g. 4–5 percent). However, it is very hard to envision a story where this sort of growth rate is maintained for a full eight years of a Sanders’ administration.
Furthermore, many aspects of Sanders’ agenda point to slower growth. For example, universal Medicare and expanded Social Security will make it easier for older people not to work, as will free college for young people. Also, mandated vacations will mean fewer hours per worker, on average. These may all be good things (I happen to think so), but they are likely to mean less GDP growth than would otherwise be the case.
Anyhow, I appreciate that Romer and Romer took the time to do the analysis. We should be having a discussion about how much better the economy can be doing than it is now. This analysis is a step in that direction.
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Are rivers flowing upstream? Has anyone seen four horsemen? Anyhow, it seems that the Washington Post editorial board is now acknowledging that a financial transactions tax [FTT] could be a serious policy. It ran an editorial which included a few derisive comments directed towards Senator Bernie Sanders, who has advocated a financial transactions tax in his presidential campaign, but favorably cited the Tax Policy Center’s analysis and said:
“They [FTTs] represent a ‘tempting’ option that might help the United States raise revenue while curbing speculative excess.”
There are a few points worth adding to the Post’s comments. The Post told readers:
“However, a tax would undoubtedly dampen some productive trading and not necessarily raise that much revenue, the report found — about $50 billion a year, in contrast to the $75 billion figure Mr. Sanders floats.”
As far as the concern for productive trading, the way the tax would reduce this is by raising the cost of trades. However, the cost of trading has fallen sharply over the last four decades. This means that the tax would, depending on the exact rate, only raise the cost of trading part of the way back to where it was four decades ago.
If the tax were set at a 0.1 percent rate on stock, with lower rates for other assets, then it would be raising the cost of trading to the levels of 10–20 years ago. So unless we see much more productive trading in the markets today than we did in the 1990s, we wouldn’t have much to worry about in this respect.
As far as the amount of money that would be raised, this depends hugely on the sensitivity of trading volume to the size of the tax. The Tax Policy Center assumed an elasticity of 1.5, meaning that the percentage drop in trading volume would be 1.5 times the percentage increase in trading costs associated with the tax. This elasticity assumption is certainly at the high end of the estimates in the literature. An elasticity assumption closer to 1.0, which is more in the center of the estimates in the research, implies the tax would raise roughly twice as much revenue.
It is also is worth noting that the 1.5 elasticity assumption used by the Tax Policy Center implies that trading volume decreases by a larger percentage than the increase in costs due to the tax. It would mean, for example, that if the tax raised trading costs by 40 percent, then trading volume would decline by close to 60 percent.
This means investors would reduce their trading by a larger amount than their costs per trade increased. As a result, investors would on average spend less money on trading, even including the tax, than they did before the tax was put in place. In that scenario, the entire burden of the tax is borne by the financial industry in the form of lost trading revenue.
Arguably the 1.5 elasticity assumption by the Tax Policy Center is too high, but if it is correct, it does mean the tax will raise less revenue, but it also means a much larger hit to the financial industry. Insofar as a purpose of the tax is to reduce the amount of resources being wasted by shuffling stock and derivatives back and forth all day, an FTT would have a huge effect in this case.
Are rivers flowing upstream? Has anyone seen four horsemen? Anyhow, it seems that the Washington Post editorial board is now acknowledging that a financial transactions tax [FTT] could be a serious policy. It ran an editorial which included a few derisive comments directed towards Senator Bernie Sanders, who has advocated a financial transactions tax in his presidential campaign, but favorably cited the Tax Policy Center’s analysis and said:
“They [FTTs] represent a ‘tempting’ option that might help the United States raise revenue while curbing speculative excess.”
There are a few points worth adding to the Post’s comments. The Post told readers:
“However, a tax would undoubtedly dampen some productive trading and not necessarily raise that much revenue, the report found — about $50 billion a year, in contrast to the $75 billion figure Mr. Sanders floats.”
As far as the concern for productive trading, the way the tax would reduce this is by raising the cost of trades. However, the cost of trading has fallen sharply over the last four decades. This means that the tax would, depending on the exact rate, only raise the cost of trading part of the way back to where it was four decades ago.
If the tax were set at a 0.1 percent rate on stock, with lower rates for other assets, then it would be raising the cost of trading to the levels of 10–20 years ago. So unless we see much more productive trading in the markets today than we did in the 1990s, we wouldn’t have much to worry about in this respect.
As far as the amount of money that would be raised, this depends hugely on the sensitivity of trading volume to the size of the tax. The Tax Policy Center assumed an elasticity of 1.5, meaning that the percentage drop in trading volume would be 1.5 times the percentage increase in trading costs associated with the tax. This elasticity assumption is certainly at the high end of the estimates in the literature. An elasticity assumption closer to 1.0, which is more in the center of the estimates in the research, implies the tax would raise roughly twice as much revenue.
It is also is worth noting that the 1.5 elasticity assumption used by the Tax Policy Center implies that trading volume decreases by a larger percentage than the increase in costs due to the tax. It would mean, for example, that if the tax raised trading costs by 40 percent, then trading volume would decline by close to 60 percent.
This means investors would reduce their trading by a larger amount than their costs per trade increased. As a result, investors would on average spend less money on trading, even including the tax, than they did before the tax was put in place. In that scenario, the entire burden of the tax is borne by the financial industry in the form of lost trading revenue.
Arguably the 1.5 elasticity assumption by the Tax Policy Center is too high, but if it is correct, it does mean the tax will raise less revenue, but it also means a much larger hit to the financial industry. Insofar as a purpose of the tax is to reduce the amount of resources being wasted by shuffling stock and derivatives back and forth all day, an FTT would have a huge effect in this case.
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