Binyamin Appelbaum had an interesting post about how many economists would like to see a higher rate of inflation to help recover from the downturn. The piece emphasizes the role of inflation in lowering real wages, with the argument that lower real wages are necessary to increase employment.
While there may be some truth to this point, it is worth fleshing out the argument more fully. At any point in time, there are sectors in which demand is increasing and we would expect to see rising real wages and also sectors where demand is falling and we would expect to see real wages do the same (e.g. Wall Street traders — okay, that was a dream).
Anyhow, when inflation is very low, the only way to bring about declines in real wages in these sectors is by having lower nominal wages. Since workers resist nominal pay cuts, we end up not having this adjustment and therefore we end up with fewer jobs than would otherwise be the case. However it is an important qualification in this story that it is not about reducing real wages for all workers, only for some subset.
The other important point is that higher inflation promotes growth in other ways. First and foremost it makes investment more profitable by reducing real interest rates. Firms are considering spending money today to sell more output (e.g. software, computers, Twitter derivatives etc.) in the future. If they expect to sell this output for higher prices because of inflation, then they will find it more profitable to invest today. If we can keep interest rates more or less constant and raise the expected rate of inflation, then firms will have much more incentive to invest. This process seems to be working successfully in Japan at the moment.
Finally, inflation reduces debt burdens. Everyone who has debt in nominal dollars, such as homeowners, students, state and local governments, and the national government, will see the real value of its debt fall in response to inflation. This reduces their debt burden and makes it easier to spend. This would likely also be an important source of demand growth from higher inflation.
While many economists do emphasize the wage story, to my mind the other parts are likely more important. And, if higher inflation leads to more employment, this will increase workers’ bargaining power and allow them to achieve wage gains that are likely to quickly offset any losses due to inflation — although the Wall Street traders may not make up the lost ground.
Addendum:
Let me make a quick comment to clear up unnecessary confusion (can’t do much about the deliberate confusion). The notion of inflation being a way to lower wages in the U.S. refers to the wages of some workers, not all workers. There are always industries seeing increased demand and some seeing reduced demand. The response to the latter would be lower wages. That is difficult to bring about in a situation of near zero inflation and nominal wage rigidity. By having higher inflation so that real wages can fall in these industries, we can increase employment, output, and real wages more generally. That is the argument. Folks can say why that may not work, but it’s really not worth anyone’s time to deliberately misrepresent it so you can say it’s stupid.
Binyamin Appelbaum had an interesting post about how many economists would like to see a higher rate of inflation to help recover from the downturn. The piece emphasizes the role of inflation in lowering real wages, with the argument that lower real wages are necessary to increase employment.
While there may be some truth to this point, it is worth fleshing out the argument more fully. At any point in time, there are sectors in which demand is increasing and we would expect to see rising real wages and also sectors where demand is falling and we would expect to see real wages do the same (e.g. Wall Street traders — okay, that was a dream).
Anyhow, when inflation is very low, the only way to bring about declines in real wages in these sectors is by having lower nominal wages. Since workers resist nominal pay cuts, we end up not having this adjustment and therefore we end up with fewer jobs than would otherwise be the case. However it is an important qualification in this story that it is not about reducing real wages for all workers, only for some subset.
The other important point is that higher inflation promotes growth in other ways. First and foremost it makes investment more profitable by reducing real interest rates. Firms are considering spending money today to sell more output (e.g. software, computers, Twitter derivatives etc.) in the future. If they expect to sell this output for higher prices because of inflation, then they will find it more profitable to invest today. If we can keep interest rates more or less constant and raise the expected rate of inflation, then firms will have much more incentive to invest. This process seems to be working successfully in Japan at the moment.
Finally, inflation reduces debt burdens. Everyone who has debt in nominal dollars, such as homeowners, students, state and local governments, and the national government, will see the real value of its debt fall in response to inflation. This reduces their debt burden and makes it easier to spend. This would likely also be an important source of demand growth from higher inflation.
While many economists do emphasize the wage story, to my mind the other parts are likely more important. And, if higher inflation leads to more employment, this will increase workers’ bargaining power and allow them to achieve wage gains that are likely to quickly offset any losses due to inflation — although the Wall Street traders may not make up the lost ground.
Addendum:
Let me make a quick comment to clear up unnecessary confusion (can’t do much about the deliberate confusion). The notion of inflation being a way to lower wages in the U.S. refers to the wages of some workers, not all workers. There are always industries seeing increased demand and some seeing reduced demand. The response to the latter would be lower wages. That is difficult to bring about in a situation of near zero inflation and nominal wage rigidity. By having higher inflation so that real wages can fall in these industries, we can increase employment, output, and real wages more generally. That is the argument. Folks can say why that may not work, but it’s really not worth anyone’s time to deliberately misrepresent it so you can say it’s stupid.
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Eduardo Porter has a good piece on efforts to use the economic crisis to make Europe’s labor market more like the U.S. market. One result is likely to be much higher levels of inequality.
Eduardo Porter has a good piece on efforts to use the economic crisis to make Europe’s labor market more like the U.S. market. One result is likely to be much higher levels of inequality.
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My friend and co-author Jared Bernstein has a good post on the minimum wage this morning. It would benefit from one additional point.
While Jared acknowledges that the minimum wage may lead to some job loss it is important to note that jobs in the low wage labor market tend to be high turnover jobs, although turnover is likely to be slower in response to a higher wage. The reason why this matters is that when we talk about job loss in response to a minimum wage hike, we rarely are talking about people literally losing their jobs. Essentially this means somewhat less employment.
That would play out in the form of workers taking longer to find jobs. This could mean, for example, that workers may expect to work an average of 1 percent fewer hours in response to a hike of 10 percent in the minimum wage because it takes them longer to find a job. However, they could expect to get 10 percent more money for each hour they work. That is the sort of trade-off we would be talking about based on the extensive research on the topic.
My friend and co-author Jared Bernstein has a good post on the minimum wage this morning. It would benefit from one additional point.
While Jared acknowledges that the minimum wage may lead to some job loss it is important to note that jobs in the low wage labor market tend to be high turnover jobs, although turnover is likely to be slower in response to a higher wage. The reason why this matters is that when we talk about job loss in response to a minimum wage hike, we rarely are talking about people literally losing their jobs. Essentially this means somewhat less employment.
That would play out in the form of workers taking longer to find jobs. This could mean, for example, that workers may expect to work an average of 1 percent fewer hours in response to a hike of 10 percent in the minimum wage because it takes them longer to find a job. However, they could expect to get 10 percent more money for each hour they work. That is the sort of trade-off we would be talking about based on the extensive research on the topic.
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Since the NYT decided to devote a Room for Debate on the question of whether the stock market is currently in a bubble, I thought I should join the party as one of the stock bubble warners from the 1990s. To my mind the story for the overall stock market is a fairly simple one. Look at the ratio of stock prices to trend earnings.
This one doesn’t look too terrifying. Obviously the market is hitting record highs measured in nominal dollars, but if we expect the price to earnings ratio to remain more or less constant over time, then we should expect the nominal value to regularly hit new highs as the economy grows. In this context, an S&P at 1800 doesn’t seem especially scary. The S&P had previously peaked at 1525 back in 2007, six years ago.
Since 2007 the price level is up by roughly 9 percent. If we assume potential growth of 2.3 percent, then the economy’s potential GDP would be 14.6 percent higher today. Taking the two together, the S&P would be 25.3 percent higher today, or at 1910, to be as high relative to trend earnings as it was in the fall of 2007. In other words, if we didn’t have a bubble in 2007, then we don’t have one today.
If we go further back to the bubble days of 2000, we had a peak S&P of roughly 1500. Since then prices have risen by roughly 30 percent. Actual growth from 2000 to 2007 was 18.4 percent. If we multiply that by my calculation of potential growth since 2007, we get a growth in potential GDP of 35.7 percent since 2000. (I am using actual growth from 2000 to 2007 since I am assuming that the economy’s growth over this period was pretty much in line with its potential.) Multiplying this 35.7 potential growth figure by the rise in prices gives us an increase of 75.6 percent since 2000, which implies that the S&P would be a bit over 2430 if it were as high relative to potential GDP today as it was at the peak of the 1990s stock bubble.
Another way to put this is that, relative to the potential of the economy, the stock market is about 68 percent of its bubble peak. Would this mean we have a bubble now? By my assessment the answer is no. The PEs at the peak in 2000 were above 30 to 1 (using trend earnings, defined as the average share of profits in GDP). That was more than double the historical average. The current ratio would put the PEs around 20. This is still well above the historical average, but not obviously in bubble territory.
There are two reasons that a higher than normal PE might be justified. The first is simply that we have unusually low interest rates. The real short-term interest rate is -1.5 percent and the real interest rate on 10-year Treasury bonds is hovering around 1.0 percent. These low rates would justify higher than normal stock prices.
The other reason that stock prices might reasonably be higher than normal is that people may feel more comfortable holding stocks today, with the easy availability of low-cost index funds, than they did in prior decades. This implies a reduced risk premium. That would mean both higher PE ratios (plausibly around 20 in my view) and lower future returns on stock. (Real returns going forward would average @ 5 percent, instead of the 7 percent return in the past.)
I could be wrong, but that’s my take — No Bubble!
Since the NYT decided to devote a Room for Debate on the question of whether the stock market is currently in a bubble, I thought I should join the party as one of the stock bubble warners from the 1990s. To my mind the story for the overall stock market is a fairly simple one. Look at the ratio of stock prices to trend earnings.
This one doesn’t look too terrifying. Obviously the market is hitting record highs measured in nominal dollars, but if we expect the price to earnings ratio to remain more or less constant over time, then we should expect the nominal value to regularly hit new highs as the economy grows. In this context, an S&P at 1800 doesn’t seem especially scary. The S&P had previously peaked at 1525 back in 2007, six years ago.
Since 2007 the price level is up by roughly 9 percent. If we assume potential growth of 2.3 percent, then the economy’s potential GDP would be 14.6 percent higher today. Taking the two together, the S&P would be 25.3 percent higher today, or at 1910, to be as high relative to trend earnings as it was in the fall of 2007. In other words, if we didn’t have a bubble in 2007, then we don’t have one today.
If we go further back to the bubble days of 2000, we had a peak S&P of roughly 1500. Since then prices have risen by roughly 30 percent. Actual growth from 2000 to 2007 was 18.4 percent. If we multiply that by my calculation of potential growth since 2007, we get a growth in potential GDP of 35.7 percent since 2000. (I am using actual growth from 2000 to 2007 since I am assuming that the economy’s growth over this period was pretty much in line with its potential.) Multiplying this 35.7 potential growth figure by the rise in prices gives us an increase of 75.6 percent since 2000, which implies that the S&P would be a bit over 2430 if it were as high relative to potential GDP today as it was at the peak of the 1990s stock bubble.
Another way to put this is that, relative to the potential of the economy, the stock market is about 68 percent of its bubble peak. Would this mean we have a bubble now? By my assessment the answer is no. The PEs at the peak in 2000 were above 30 to 1 (using trend earnings, defined as the average share of profits in GDP). That was more than double the historical average. The current ratio would put the PEs around 20. This is still well above the historical average, but not obviously in bubble territory.
There are two reasons that a higher than normal PE might be justified. The first is simply that we have unusually low interest rates. The real short-term interest rate is -1.5 percent and the real interest rate on 10-year Treasury bonds is hovering around 1.0 percent. These low rates would justify higher than normal stock prices.
The other reason that stock prices might reasonably be higher than normal is that people may feel more comfortable holding stocks today, with the easy availability of low-cost index funds, than they did in prior decades. This implies a reduced risk premium. That would mean both higher PE ratios (plausibly around 20 in my view) and lower future returns on stock. (Real returns going forward would average @ 5 percent, instead of the 7 percent return in the past.)
I could be wrong, but that’s my take — No Bubble!
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That’s more than half of the money appropriated for the program. Yes, some folks will know that the $40 billion refers to a cut over 10 years. But is there some reason that the NYT can’t provide such information in the article and not risk misleading a large share of its readers.
That comes to roughly 5 percent of the cost of the program. To give readers a bit more context, the NYT could have used CEPR’s nifty Responsible Budget Calculator to inform readers that the cut amounts to 0.09 percent of projected federal spending over this period. In short, this cut may be a big deal to the people affected, it means little in terms of the deficit or anyone’s tax bill.
The NYT is supposed to be committed to putting numbers like this in a context that makes them understandable to readers. Would anyone at the NYT really want to claim this piece expressed the proposed cuts in a way that made them understandable to most of their readers?
That’s more than half of the money appropriated for the program. Yes, some folks will know that the $40 billion refers to a cut over 10 years. But is there some reason that the NYT can’t provide such information in the article and not risk misleading a large share of its readers.
That comes to roughly 5 percent of the cost of the program. To give readers a bit more context, the NYT could have used CEPR’s nifty Responsible Budget Calculator to inform readers that the cut amounts to 0.09 percent of projected federal spending over this period. In short, this cut may be a big deal to the people affected, it means little in terms of the deficit or anyone’s tax bill.
The NYT is supposed to be committed to putting numbers like this in a context that makes them understandable to readers. Would anyone at the NYT really want to claim this piece expressed the proposed cuts in a way that made them understandable to most of their readers?
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It seems that he can’t. In his column today on finding a word for the continuing downturn he tells readers:
“Why? Unlike Hansen, today’s stagnationists haven’t identified causes [of secular stagnation]. The problem might not be a dearth of investments so much as a surplus of risk aversion. For that, candidates abound: the traumatic impact of the Great Recession on confidence; a backlash against globalization, reduced cross-border investments by multinational firms; uncertain government policies; aging societies burdened by diminishing innovation and costly welfare states.
“Whatever the cause, we are in unfamiliar territory.”
Actually the most obvious cause for most of the shortfall in demand is the trade deficit. The deficit of more than $500 billion (@ 3 percent of GDP) is income generated in the United States that is creating demand elsewhere, not in the United States. This deficit in turn was a result of the over-valued dollar that followed the botched bailout from the East Asian financial crisis. We offset this deficit in the last 1990s with the demand created by the stock bubble. We offset it in the last decade with the demand created by the housing bubble.
Without another bubble we don’t have any source of demand to offset the trade deficit other than the budget deficit, which folks like Samuelson want to reduce. So there is no real mystery to anyone who is familiar with the national income accounts.
Samuelson is just wrong when he complains about “a surplus of risk aversion.” Investment is almost back to its pre-recession level measured as a share of GDP. Clearly this is not a problem.
There is likely an issue that consumption would have fallen relative to GDP in the absence of bubbles, as income has been redistributed upward (this is a main theme of my free book, Plunder and Blunder: The Rise and Fall of the Bubble Economy), but that is very different from an aversion to risk story.
It seems that he can’t. In his column today on finding a word for the continuing downturn he tells readers:
“Why? Unlike Hansen, today’s stagnationists haven’t identified causes [of secular stagnation]. The problem might not be a dearth of investments so much as a surplus of risk aversion. For that, candidates abound: the traumatic impact of the Great Recession on confidence; a backlash against globalization, reduced cross-border investments by multinational firms; uncertain government policies; aging societies burdened by diminishing innovation and costly welfare states.
“Whatever the cause, we are in unfamiliar territory.”
Actually the most obvious cause for most of the shortfall in demand is the trade deficit. The deficit of more than $500 billion (@ 3 percent of GDP) is income generated in the United States that is creating demand elsewhere, not in the United States. This deficit in turn was a result of the over-valued dollar that followed the botched bailout from the East Asian financial crisis. We offset this deficit in the last 1990s with the demand created by the stock bubble. We offset it in the last decade with the demand created by the housing bubble.
Without another bubble we don’t have any source of demand to offset the trade deficit other than the budget deficit, which folks like Samuelson want to reduce. So there is no real mystery to anyone who is familiar with the national income accounts.
Samuelson is just wrong when he complains about “a surplus of risk aversion.” Investment is almost back to its pre-recession level measured as a share of GDP. Clearly this is not a problem.
There is likely an issue that consumption would have fallen relative to GDP in the absence of bubbles, as income has been redistributed upward (this is a main theme of my free book, Plunder and Blunder: The Rise and Fall of the Bubble Economy), but that is very different from an aversion to risk story.
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The NYT had a piece about the use of German-style apprenticeship programs in South Carolina. At one point it noted that, while the apprenticeship program is one factor attracting German and other foreign manufacturers to the state:
“there are other reasons foreign companies have moved here. For starters, wages are lower than the national average. Even more important for many manufacturers, unions have made few inroads in South Carolina.”
It is worth noting that the German companies locating in South Carolina are used to working with unions and/or workers’ councils in Germany. In Germany, every company with more than 50 workers has a workers’ council that has input into most management decisions. In fact Volkswagen plans to set up a workers’ council in a facility in Tennessee. For at least some of these companies, escaping unions is not likely to be a major factor in their location decision.
The NYT had a piece about the use of German-style apprenticeship programs in South Carolina. At one point it noted that, while the apprenticeship program is one factor attracting German and other foreign manufacturers to the state:
“there are other reasons foreign companies have moved here. For starters, wages are lower than the national average. Even more important for many manufacturers, unions have made few inroads in South Carolina.”
It is worth noting that the German companies locating in South Carolina are used to working with unions and/or workers’ councils in Germany. In Germany, every company with more than 50 workers has a workers’ council that has input into most management decisions. In fact Volkswagen plans to set up a workers’ council in a facility in Tennessee. For at least some of these companies, escaping unions is not likely to be a major factor in their location decision.
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The NYT had an interesting piece on the extent to which companies are shifting production to the United States in response to desires by consumers to buy American made products. At one point the piece tells readers;
“Americans spend more than $340 billion a year on clothes and shoes, more than double what they spend on new cars, according to the American Apparel and Footwear Association.”
Actually, the Commerce Department reported that consumers spent more than $230 billion last year on new autos, which is considerably more than half of the $340 billion figure noted here. This does not count autos purchased by businesses or used car purchases.
The piece also notes a plan by Walmart to increase its sales of American made goods by $50 billion over the next decade. It is not clear whether this refers to an annual sales target or a total over the decade. Walmart’s annual sales are currently just $450 billion. If they grow in step with the economy they should be over $700 billion in ten years. This would imply an annual target of $50 billion in addition sales would mean roughly 7 percent of sales. On the other hand, $50 billion over the next decade as a cumulative goal would be considerably less than 1.0 percent of total sales.
The NYT had an interesting piece on the extent to which companies are shifting production to the United States in response to desires by consumers to buy American made products. At one point the piece tells readers;
“Americans spend more than $340 billion a year on clothes and shoes, more than double what they spend on new cars, according to the American Apparel and Footwear Association.”
Actually, the Commerce Department reported that consumers spent more than $230 billion last year on new autos, which is considerably more than half of the $340 billion figure noted here. This does not count autos purchased by businesses or used car purchases.
The piece also notes a plan by Walmart to increase its sales of American made goods by $50 billion over the next decade. It is not clear whether this refers to an annual sales target or a total over the decade. Walmart’s annual sales are currently just $450 billion. If they grow in step with the economy they should be over $700 billion in ten years. This would imply an annual target of $50 billion in addition sales would mean roughly 7 percent of sales. On the other hand, $50 billion over the next decade as a cumulative goal would be considerably less than 1.0 percent of total sales.
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That is the question that readers of this front page Washington Post piece on the island’s $70 billion debt were undoubtedly asking. For some reason the paper never bothered to give this information, although it did compare the debt to that of other states.
Puerto Rico’s GDP is a bit over $100 billion, which means that its debt-to-GDP ratio is a bit under 70 percent. That is low for wealthy countries; however it would be a very high ratio for a state. Puerto Rico, as a territory of the United States, falls somewhere between the two. Most of its residents are not subject to the federal income tax, which means that the Puerto Rican government has access to money that other state governments would not. On the other hand it is subject to Social Security taxes, but Social Security benefits are a major source of income for people on the island.
Anyhow, it would have been helpful to include information on the size of Puerto Rico’s economy. Without this information it is impossible to assess the size of the burden of the debt.
That is the question that readers of this front page Washington Post piece on the island’s $70 billion debt were undoubtedly asking. For some reason the paper never bothered to give this information, although it did compare the debt to that of other states.
Puerto Rico’s GDP is a bit over $100 billion, which means that its debt-to-GDP ratio is a bit under 70 percent. That is low for wealthy countries; however it would be a very high ratio for a state. Puerto Rico, as a territory of the United States, falls somewhere between the two. Most of its residents are not subject to the federal income tax, which means that the Puerto Rican government has access to money that other state governments would not. On the other hand it is subject to Social Security taxes, but Social Security benefits are a major source of income for people on the island.
Anyhow, it would have been helpful to include information on the size of Puerto Rico’s economy. Without this information it is impossible to assess the size of the burden of the debt.
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For the last three decades the government has pursued a wide range of policies that have had the effect of redistributing income upward. For example our trade policy, by deliberately placing manufacturing workers in direct competition with low paid workers in the developing world, has lowered the wages of large segments of the work force. By contrast, we have left in place the restrictions that protect doctors and other highly paid professionals from foreign competition, ensuring that their pay stays high.
Similarly the too big to fail insurance that the government provides at no cost to large banks like Citigroup and Goldman Sachs allows top executives at these banks to pocket tens of millions of dollars a year. And our budget policy, that keeps tens of millions of workers unemployed or underemployed, lessens the income not only of the unemployed, but reduces the bargaining power and wages of those who are employed.
These and other government measures have the effect of redistributing income from ordinary workers to those at the top of the income distribution. Given this fact, it is peculiar that the Post would tell people in a piece on the growing strength of populists within the Democratic Party:
“many Americans are uncomfortable with the notion of the government redistributing income far beyond what happens today in order to accomplish basic elements of the populist agenda.”
The question at issue is not the amount of redistribution; the question is the direction of the redistribution. The Post seems to want readers to imagine that the upward redistribution of the last three decades was just a fact of nature, as opposed to being an outcome of government policy. That is a major distortion of reality.
For the last three decades the government has pursued a wide range of policies that have had the effect of redistributing income upward. For example our trade policy, by deliberately placing manufacturing workers in direct competition with low paid workers in the developing world, has lowered the wages of large segments of the work force. By contrast, we have left in place the restrictions that protect doctors and other highly paid professionals from foreign competition, ensuring that their pay stays high.
Similarly the too big to fail insurance that the government provides at no cost to large banks like Citigroup and Goldman Sachs allows top executives at these banks to pocket tens of millions of dollars a year. And our budget policy, that keeps tens of millions of workers unemployed or underemployed, lessens the income not only of the unemployed, but reduces the bargaining power and wages of those who are employed.
These and other government measures have the effect of redistributing income from ordinary workers to those at the top of the income distribution. Given this fact, it is peculiar that the Post would tell people in a piece on the growing strength of populists within the Democratic Party:
“many Americans are uncomfortable with the notion of the government redistributing income far beyond what happens today in order to accomplish basic elements of the populist agenda.”
The question at issue is not the amount of redistribution; the question is the direction of the redistribution. The Post seems to want readers to imagine that the upward redistribution of the last three decades was just a fact of nature, as opposed to being an outcome of government policy. That is a major distortion of reality.
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