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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It must be tough for flat earth believers; people insist on rejecting their views on the shape of the earth based on evidence. Robert Samuelson seems to be in the same situation. He used his column to complain about economists not caring about balanced budgets, just because there is no evidence that they should.
The immediate provocation for this diatribe is Doug Elmendorf, the former head of the Congressional Budget Office. Elmendorf used to be a big advocate of smaller deficits, but he now is arguing that Congress take advantage of near record low interest rates to undertake a major infrastructure initiative.
Samuelson concluded his piece:
“Destroyed is the pre-1960s consensus: a crude allegiance to a balanced budget. Since 1961, the government has run annual deficits in all but five years. Allowing for desirable deficits when the economy is well below capacity or when there’s a national emergency, we need to go back to the future. Before making vast new commitments — a la Elmendorf — we should balance the ones we already have.”
Ah yes, the country is being destroyed by deficits. That is why the government has to pay almost 2.0 percent to borrow long-term. And the interest on our horrible debt costs us almost 0.8 percent of GDP in annual interest payments. Sound pretty awful? Interest cost us more than 3.0 percent of GDP back in the early 1990s.
It is amazing that people like Samuelson, and more importantly our politicians in Washington, continue to try to run the government based on nostrums they learned from their parents rather than the real world. Elmendorf changed his view on economic priorities based on evidence.
There is a clear story of how excessive deficits can hurt the economy. They drive up interest rates if the Fed does not accommodate them and they lead to inflation if the Fed does. The rationale is simple: excess deficits cause us to push the economy too hard. They lead to too much demand given the economy’s ability to produce goods and services.
We clearly are not seeing this constraint. There are still millions of unemployed or underemployed workers who would like full-time jobs. This means that the concern about balanced budgets is needlessly keeping these people unemployed. And the weakness of the labor market is keeping tens of millions of workers from having the bargaining power necessary to get their share of the benefits from economic growth in higher wages.
Perhaps even worse, the obsession with deficits prevents us from doing things we really need to do. The neglected items form a long list, from early childhood education and affordable college to keeping the kids in Flint from being poisoned.
But hey, why look at the real world when we have the words of wisdom on balanced budgets that Robert Samuelson learned from his parents.
It must be tough for flat earth believers; people insist on rejecting their views on the shape of the earth based on evidence. Robert Samuelson seems to be in the same situation. He used his column to complain about economists not caring about balanced budgets, just because there is no evidence that they should.
The immediate provocation for this diatribe is Doug Elmendorf, the former head of the Congressional Budget Office. Elmendorf used to be a big advocate of smaller deficits, but he now is arguing that Congress take advantage of near record low interest rates to undertake a major infrastructure initiative.
Samuelson concluded his piece:
“Destroyed is the pre-1960s consensus: a crude allegiance to a balanced budget. Since 1961, the government has run annual deficits in all but five years. Allowing for desirable deficits when the economy is well below capacity or when there’s a national emergency, we need to go back to the future. Before making vast new commitments — a la Elmendorf — we should balance the ones we already have.”
Ah yes, the country is being destroyed by deficits. That is why the government has to pay almost 2.0 percent to borrow long-term. And the interest on our horrible debt costs us almost 0.8 percent of GDP in annual interest payments. Sound pretty awful? Interest cost us more than 3.0 percent of GDP back in the early 1990s.
It is amazing that people like Samuelson, and more importantly our politicians in Washington, continue to try to run the government based on nostrums they learned from their parents rather than the real world. Elmendorf changed his view on economic priorities based on evidence.
There is a clear story of how excessive deficits can hurt the economy. They drive up interest rates if the Fed does not accommodate them and they lead to inflation if the Fed does. The rationale is simple: excess deficits cause us to push the economy too hard. They lead to too much demand given the economy’s ability to produce goods and services.
We clearly are not seeing this constraint. There are still millions of unemployed or underemployed workers who would like full-time jobs. This means that the concern about balanced budgets is needlessly keeping these people unemployed. And the weakness of the labor market is keeping tens of millions of workers from having the bargaining power necessary to get their share of the benefits from economic growth in higher wages.
Perhaps even worse, the obsession with deficits prevents us from doing things we really need to do. The neglected items form a long list, from early childhood education and affordable college to keeping the kids in Flint from being poisoned.
But hey, why look at the real world when we have the words of wisdom on balanced budgets that Robert Samuelson learned from his parents.
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Jacob Weisberg wasn’t quite straight with readers when he said that Ronald Reagan supported “Keynesian stimulus” in a NYT column on how the Republican Party has changed since the days of Reagan. The Keynesian stimulus took the form of a large permanent tax cut that was highly skewed toward the wealthy. He also had large increases in military spending.
The current crew of Republican presidential candidates seems to be very much in this same mode, also urging large tax cuts that would primarily benefit the wealthy and spending more on the military. Reagan did agree to roll back some of his tax cut when it appeared that deficits were getting too large in 1982 and 1983. We can’t know whether the Republican candidates would be prepared to raise taxes again if deficits were leading to high interest rates and/or inflation, but in their platforms they are very much following Reagan, contrary to what Weisberg claims.
Jacob Weisberg wasn’t quite straight with readers when he said that Ronald Reagan supported “Keynesian stimulus” in a NYT column on how the Republican Party has changed since the days of Reagan. The Keynesian stimulus took the form of a large permanent tax cut that was highly skewed toward the wealthy. He also had large increases in military spending.
The current crew of Republican presidential candidates seems to be very much in this same mode, also urging large tax cuts that would primarily benefit the wealthy and spending more on the military. Reagan did agree to roll back some of his tax cut when it appeared that deficits were getting too large in 1982 and 1983. We can’t know whether the Republican candidates would be prepared to raise taxes again if deficits were leading to high interest rates and/or inflation, but in their platforms they are very much following Reagan, contrary to what Weisberg claims.
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The NYT had an article this morning on how European tech start-ups were seeing new capital dry up in the same way as Silicon Valley firms. The piece portrayed this as largely a negative event. Undoubtedly, it is bad news for the founders and top employees of these firms, but it’s not clear it is bad news for the economy.
The huge capitalizations of many start-ups has allowed a small number of people to get very rich, however it is not clear that their valuations bore any resemblance to their value to the economy. For example, both Groupon and Dropbox at one point had market capitalizations of more than $10 billion.
While selling coupons over the web and an efficient offsite Internet storage system are both items that will provide benefits to many individuals, so is combining peanut butter and jelly in a single jar. It is not clear that we should expect to see someone becoming a billionaire for coming up with the idea of combining peanut butter and jelly in one jar, nor is obvious that the contributions of many of these start-ups should cause people to become billionaires.
If capital markets are hugely overpricing start-ups relative to their actual value to the economy, as subsequently determined by the market, then they are effectively redistributing wealth from others to the leading actors in these start-ups. Insofar as the money is coming from other wealthy people, this is simply a matter of money going from the old rich to newly created rich. In this case, it need not be matter of concern for the rest of us. However if pension fund assets or money held in mutual funds through individual retirement accounts are going into over-valued start-ups, then this is a redistribution from the rest of us to the new rich.
Insofar as that is the story of the Silicon Valley boom and the parallel boom in Europe, we should applaud the collapse of the price of these companies’ stock. An over-valued stock price has the same impact on the economy as counterfeit money that passes for real. It gives some individuals purchasing power who should not have a claim to it. Catching the counterfeiter and bringing the stock price back in line with the fundamentals is good news. (Of course in an economy that is operating below its capacity like ours, we actually would benefit from the demand that would be generated by a successful counterfeiter, but that is another story.)
The NYT had an article this morning on how European tech start-ups were seeing new capital dry up in the same way as Silicon Valley firms. The piece portrayed this as largely a negative event. Undoubtedly, it is bad news for the founders and top employees of these firms, but it’s not clear it is bad news for the economy.
The huge capitalizations of many start-ups has allowed a small number of people to get very rich, however it is not clear that their valuations bore any resemblance to their value to the economy. For example, both Groupon and Dropbox at one point had market capitalizations of more than $10 billion.
While selling coupons over the web and an efficient offsite Internet storage system are both items that will provide benefits to many individuals, so is combining peanut butter and jelly in a single jar. It is not clear that we should expect to see someone becoming a billionaire for coming up with the idea of combining peanut butter and jelly in one jar, nor is obvious that the contributions of many of these start-ups should cause people to become billionaires.
If capital markets are hugely overpricing start-ups relative to their actual value to the economy, as subsequently determined by the market, then they are effectively redistributing wealth from others to the leading actors in these start-ups. Insofar as the money is coming from other wealthy people, this is simply a matter of money going from the old rich to newly created rich. In this case, it need not be matter of concern for the rest of us. However if pension fund assets or money held in mutual funds through individual retirement accounts are going into over-valued start-ups, then this is a redistribution from the rest of us to the new rich.
Insofar as that is the story of the Silicon Valley boom and the parallel boom in Europe, we should applaud the collapse of the price of these companies’ stock. An over-valued stock price has the same impact on the economy as counterfeit money that passes for real. It gives some individuals purchasing power who should not have a claim to it. Catching the counterfeiter and bringing the stock price back in line with the fundamentals is good news. (Of course in an economy that is operating below its capacity like ours, we actually would benefit from the demand that would be generated by a successful counterfeiter, but that is another story.)
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