Beat the Press

Beat the press por Dean Baker

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

The New York Times has routinely exaggerated the problems faced by France and other European countries with generous welfare states. Given this history, it should not be surprising that it effectively endorsed French President Emmanual Macron for reelection in a news article.

The piece implied that Macron’s presidency, which involved rolling back the welfare state in many areas, has been a great economic success. While it tells stories about start-ups booming, the only piece of economic data it shares is that France’s current 7.4 percent unemployment rate is the lowest in a decade.

This is not evidence of great success. France still had not gotten its unemployment rate down to its pre-recession lows. In the United States, which had a slow recovery from the Great Recession, the unemployment rate had fallen below its pre-recession low by the middle of 2017.

The weakness of France’s recovery can be seen even more clearly by looking at the employment rate for prime age workers (ages 25 to 54). It peaked at 83.2 percent in 2008. It’s currently at 82.4 percent. While there are many factors other than a president’s policies that effect growth and employment, this is not evidence of a strong economic performance by France.

The piece also caricatures François Hollande, Macron’s Socialist Party predecessor. He presents an apparently famous quote from Hollande: “My enemy is the world of finance.”  The piece implies that Hollande didn’t appreciate the need for a financial sector.

Hollande surely recognized the need for a financial sector to allow businesses to get the capital they need to grow. He also recognized that the financial industry can also become bloated and corrupt and is a major source of inequality in the economy. An efficient financial sector is a small financial sector, with as few resources as necessary going to allocate capital.

The problems of the financial sector are widely recognized by economists and people who lived through the collapse of the housing bubble in 2007-2009 and the resulting financial crisis. This is the reason that Congress passed the Dodd-Frank financial reform bill. All the proponents of this bill understood the need for a financial industry, as did Mr. Hollande. It is absurd to imply that he somehow did not understand its role in the economy.

The New York Times has routinely exaggerated the problems faced by France and other European countries with generous welfare states. Given this history, it should not be surprising that it effectively endorsed French President Emmanual Macron for reelection in a news article.

The piece implied that Macron’s presidency, which involved rolling back the welfare state in many areas, has been a great economic success. While it tells stories about start-ups booming, the only piece of economic data it shares is that France’s current 7.4 percent unemployment rate is the lowest in a decade.

This is not evidence of great success. France still had not gotten its unemployment rate down to its pre-recession lows. In the United States, which had a slow recovery from the Great Recession, the unemployment rate had fallen below its pre-recession low by the middle of 2017.

The weakness of France’s recovery can be seen even more clearly by looking at the employment rate for prime age workers (ages 25 to 54). It peaked at 83.2 percent in 2008. It’s currently at 82.4 percent. While there are many factors other than a president’s policies that effect growth and employment, this is not evidence of a strong economic performance by France.

The piece also caricatures François Hollande, Macron’s Socialist Party predecessor. He presents an apparently famous quote from Hollande: “My enemy is the world of finance.”  The piece implies that Hollande didn’t appreciate the need for a financial sector.

Hollande surely recognized the need for a financial sector to allow businesses to get the capital they need to grow. He also recognized that the financial industry can also become bloated and corrupt and is a major source of inequality in the economy. An efficient financial sector is a small financial sector, with as few resources as necessary going to allocate capital.

The problems of the financial sector are widely recognized by economists and people who lived through the collapse of the housing bubble in 2007-2009 and the resulting financial crisis. This is the reason that Congress passed the Dodd-Frank financial reform bill. All the proponents of this bill understood the need for a financial industry, as did Mr. Hollande. It is absurd to imply that he somehow did not understand its role in the economy.

This week President Biden announced that he would release 1 million barrels per day from the strategic oil reserves. This action was generally derided by politicians and the media, saying that this move would have little effect on the world price of oil. They argued that in a world oil market of just under 100 million barrels per day, Biden’s release would have little impact.

There are a couple of points here worth noting. First, the projected impact of this sort of additional supply would not be all that trivial. The short-term demand elasticity is usually estimated to be quite low, typically around -0.15. That would imply that a 1 percent increase in the supply of oil should lead to a roughly 7 percent decline in oil prices. If we apply that to the current price of gas, that would be a drop of more than 25 cents a gallon.

A price increase of that size would likely be sufficient to prompt a raff of news pieces about how higher gas prices were bankrupting families. A price decline of this size should be equally momentous.

The other point is that it is important to always remember that we have a world oil market, not just when the point is to deride a move by President Biden. Specifically, many Republican politicians are running around saying that if we just produced more oil here, we wouldn’t have to worry about high gas prices.

The numbers indicate otherwise. Let’s say that in the span of a couple of years we could increase domestic production by 2 million barrels per day, an increase of a bit less than 20 percent over current levels. That would be a truly heroic lift, including ignoring a wide range of environmental issues, although perhaps possible in a best-case scenario.

This 2 million barrels per day increment to production, would be a bit more than 2 percent of world production, or twice as large as President Biden’s release from the strategic oil reserves. We should therefore expect that the impact on gas prices would be twice as large as the impact of Biden’s release.

If we view the impact of Biden’s release of oil from the strategic reserve as being trivial, then the impact of a very ambitious increase in domestic oil production is just twice trivial. It will not get us back to $2.50 a gallon gas, or whatever dream Republicans have in their head.

The basic point is that it is hard to have too much impact on world oil prices. Biden’s move will help some. We can do a big push on domestic production, which could also help some, but neither on their own will get us back to pre-pandemic prices.

And of course, burning more fossil fuels will screw our kids as the planet gets warmer, but we know that is not on anyone’s agenda.  

This week President Biden announced that he would release 1 million barrels per day from the strategic oil reserves. This action was generally derided by politicians and the media, saying that this move would have little effect on the world price of oil. They argued that in a world oil market of just under 100 million barrels per day, Biden’s release would have little impact.

There are a couple of points here worth noting. First, the projected impact of this sort of additional supply would not be all that trivial. The short-term demand elasticity is usually estimated to be quite low, typically around -0.15. That would imply that a 1 percent increase in the supply of oil should lead to a roughly 7 percent decline in oil prices. If we apply that to the current price of gas, that would be a drop of more than 25 cents a gallon.

A price increase of that size would likely be sufficient to prompt a raff of news pieces about how higher gas prices were bankrupting families. A price decline of this size should be equally momentous.

The other point is that it is important to always remember that we have a world oil market, not just when the point is to deride a move by President Biden. Specifically, many Republican politicians are running around saying that if we just produced more oil here, we wouldn’t have to worry about high gas prices.

The numbers indicate otherwise. Let’s say that in the span of a couple of years we could increase domestic production by 2 million barrels per day, an increase of a bit less than 20 percent over current levels. That would be a truly heroic lift, including ignoring a wide range of environmental issues, although perhaps possible in a best-case scenario.

This 2 million barrels per day increment to production, would be a bit more than 2 percent of world production, or twice as large as President Biden’s release from the strategic oil reserves. We should therefore expect that the impact on gas prices would be twice as large as the impact of Biden’s release.

If we view the impact of Biden’s release of oil from the strategic reserve as being trivial, then the impact of a very ambitious increase in domestic oil production is just twice trivial. It will not get us back to $2.50 a gallon gas, or whatever dream Republicans have in their head.

The basic point is that it is hard to have too much impact on world oil prices. Biden’s move will help some. We can do a big push on domestic production, which could also help some, but neither on their own will get us back to pre-pandemic prices.

And of course, burning more fossil fuels will screw our kids as the planet gets warmer, but we know that is not on anyone’s agenda.  

In the general telling of popular history, the Reagan years were a period of a booming economy and general prosperity. Reagan was of course reelected in a landslide. And, for the only time since Calvin Coolidge, he was succeeded by an elected president of his own party.

In spite of the celebration of the Reagan economy, most workers actually lost ground in the 1980s. Their wages did not keep pace with inflation. And, unlike the current situation, where a war is pushing up the world price of oil and other commodities, in the 1980s world oil prices declined sharply from peaks reached following the Iranian revolution.

Here’s the picture.

Year over Year Change in Average Hourly Wage: 1980-89

The inflation adjusted average hourly wage was 1 cent lower in January 1985, the end of Reagan’s first term, than it had been when he took office in 1981.[1] The rate of decline accelerated in Reagan’s second term so that in January 1989 it was 1.7 percent lower than when Reagan took office. This means that over his two terms in office, rather than sharing in the gains from growth, workers actually lost ground.

This history provides a notable contrast to the current situation. The media were happy to completely ignore the reality of declining real wages throughout the Reagan era. By contrast, they are happy to jump on a drop in real wages in the last year due to the reopening from the pandemic (the jump in inflation is worldwide) and the war in Ukraine.

The focus on inflation in reporting has been so intense that most people tell pollsters that they think we lost jobs last year, even though it was the strongest year for job growth ever. I’m an economist, not a psychologist, I don’t know how people form their views of the economy. But I can say that the media have not been giving an accurate picture of the economy, nor one that is consistent with their reporting during the Reagan era.    

[1] This is for production and non-supervisory workers, a group that comprises roughly 80 percent of the workforce.  

In the general telling of popular history, the Reagan years were a period of a booming economy and general prosperity. Reagan was of course reelected in a landslide. And, for the only time since Calvin Coolidge, he was succeeded by an elected president of his own party.

In spite of the celebration of the Reagan economy, most workers actually lost ground in the 1980s. Their wages did not keep pace with inflation. And, unlike the current situation, where a war is pushing up the world price of oil and other commodities, in the 1980s world oil prices declined sharply from peaks reached following the Iranian revolution.

Here’s the picture.

Year over Year Change in Average Hourly Wage: 1980-89

The inflation adjusted average hourly wage was 1 cent lower in January 1985, the end of Reagan’s first term, than it had been when he took office in 1981.[1] The rate of decline accelerated in Reagan’s second term so that in January 1989 it was 1.7 percent lower than when Reagan took office. This means that over his two terms in office, rather than sharing in the gains from growth, workers actually lost ground.

This history provides a notable contrast to the current situation. The media were happy to completely ignore the reality of declining real wages throughout the Reagan era. By contrast, they are happy to jump on a drop in real wages in the last year due to the reopening from the pandemic (the jump in inflation is worldwide) and the war in Ukraine.

The focus on inflation in reporting has been so intense that most people tell pollsters that they think we lost jobs last year, even though it was the strongest year for job growth ever. I’m an economist, not a psychologist, I don’t know how people form their views of the economy. But I can say that the media have not been giving an accurate picture of the economy, nor one that is consistent with their reporting during the Reagan era.    

[1] This is for production and non-supervisory workers, a group that comprises roughly 80 percent of the workforce.  

The folks who are opposed to actions to slow global warming act like believing in global warming is optional, in the same way that we might think that enjoying baseball is optional. Of course, people can believe whatever they want, but the fact is that the planet is getting warmer, and we stand to get screwed in a thousand different ways if we don’t take steps to stop it.

And, nothing changes in this story by people opting not to believe in global warming. Their beliefs are not going to help the billions of people who will suffer the consequences in the decades ahead, just like it doesn’t help a shooting victim if the guy pulling the trigger doesn’t believe that bullets hurt people.

A great example of nonsense antienvironmental beliefs affecting action is the effort to construct the Lake Powell Pipeline (LPP). This is a pipeline that would transport 83,800 acre-feet of water a year from Lake Powell to Washington County, Utah. Washington County has a rapidly growing population, and the argument is that it will need water from Lake Powell to serve its needs.

Apart from the question of whether the pipeline is really needed, there is also the problem that Lake Powell doesn’t have the water. Even without the pipeline draining more than 80,000 acre-feet of water a year, the lake is already approaching the critical level at which point the Glen Canyon dam will no longer be able to supply power to 5 million people in the Southwest.

While the lake’s level is already below the danger point, where it no longer has the targeted margin, it would have been even closer if we had LPP operating for the last fifteen years. We would already be below the critical level of 3490 feet if the LPP had been operating for the last 30 years.

Source: Bureau of Reclamation and author’s calculations.

Incredibly, our antienvironmentalists are still pushing for the pipeline spending, millions of dollars on planning and studies. It’s hard to imagine a worse use of money, except for actually building the pipeline.

The reality is that because of global warming, we are seeing much less rain and snowfall in the area than in prior decades. There is no reason to think this picture will get better in the years ahead. That means we will have problems maintaining energy production from the dam even without the LPP. If we were to build the LPP, we would very quickly need another energy source for 5 million people in the area.

But, the antienvironmentalists are like little kids. They have to be humored with the idea that we could build the LPP, even though it makes no sense. So, we will spend millions more doing pointless analyses of the LPP’s costs and benefits, even when its obvious that costs swamp the benefits, since the water simply is not there.

It is expensive to have a large segment of the population living in Never-Never Land.  

The folks who are opposed to actions to slow global warming act like believing in global warming is optional, in the same way that we might think that enjoying baseball is optional. Of course, people can believe whatever they want, but the fact is that the planet is getting warmer, and we stand to get screwed in a thousand different ways if we don’t take steps to stop it.

And, nothing changes in this story by people opting not to believe in global warming. Their beliefs are not going to help the billions of people who will suffer the consequences in the decades ahead, just like it doesn’t help a shooting victim if the guy pulling the trigger doesn’t believe that bullets hurt people.

A great example of nonsense antienvironmental beliefs affecting action is the effort to construct the Lake Powell Pipeline (LPP). This is a pipeline that would transport 83,800 acre-feet of water a year from Lake Powell to Washington County, Utah. Washington County has a rapidly growing population, and the argument is that it will need water from Lake Powell to serve its needs.

Apart from the question of whether the pipeline is really needed, there is also the problem that Lake Powell doesn’t have the water. Even without the pipeline draining more than 80,000 acre-feet of water a year, the lake is already approaching the critical level at which point the Glen Canyon dam will no longer be able to supply power to 5 million people in the Southwest.

While the lake’s level is already below the danger point, where it no longer has the targeted margin, it would have been even closer if we had LPP operating for the last fifteen years. We would already be below the critical level of 3490 feet if the LPP had been operating for the last 30 years.

Source: Bureau of Reclamation and author’s calculations.

Incredibly, our antienvironmentalists are still pushing for the pipeline spending, millions of dollars on planning and studies. It’s hard to imagine a worse use of money, except for actually building the pipeline.

The reality is that because of global warming, we are seeing much less rain and snowfall in the area than in prior decades. There is no reason to think this picture will get better in the years ahead. That means we will have problems maintaining energy production from the dam even without the LPP. If we were to build the LPP, we would very quickly need another energy source for 5 million people in the area.

But, the antienvironmentalists are like little kids. They have to be humored with the idea that we could build the LPP, even though it makes no sense. So, we will spend millions more doing pointless analyses of the LPP’s costs and benefits, even when its obvious that costs swamp the benefits, since the water simply is not there.

It is expensive to have a large segment of the population living in Never-Never Land.  

I’m sure everyone remembers the 2014 Ebola crisis. A grand total of 4 people were diagnosed with Ebola in the United States, 11 were treated, and a total of 2 died. Ebola was a serious crisis in West Africa, but not in the United States.

Nonetheless CNN chose to make the threat to people in the United States a major topic of its news coverage, at least until the 2014 midterm elections. CNN ran 355 pieces on Ebola in the four weeks before the election. That number fell to just ten pieces in the two weeks after the election. (There is research showing that people who were fearful about Ebola were more likely to vote Republican.)

This history is worth remembering in the context of CNN’s all inflation, all the time coverage of the economy. On Friday, we got a jobs report for March that was outstanding in just about every respect. Nonetheless, CNN’s coverage of the report quickly turned to inflation. In its more general coverage of the economy, the jobs report — which tells us about the employment and earnings situation for more than 160 million people — was barely a blip.

CNN’s history with Ebola should be kept in mind in considering its endless hyping of inflation. We must remember also remember that CNN is a network whose president prepped a politician (former New York Governor Andrew Cuomo) for interviews on the network. In other words, it does not maintain the commitment to objective reporting that is expected of non-Fox news outlets.

This doesn’t mean that the network doesn’t have many outstanding reporters. Its coverage of the war in Ukraine has generally been outstanding, with many reporters stationed in war zones at great personal risk. Nonetheless, the network obviously feels comfortable pushing a political agenda, rather than trying to inform its audience about the economy.

I’m sure everyone remembers the 2014 Ebola crisis. A grand total of 4 people were diagnosed with Ebola in the United States, 11 were treated, and a total of 2 died. Ebola was a serious crisis in West Africa, but not in the United States.

Nonetheless CNN chose to make the threat to people in the United States a major topic of its news coverage, at least until the 2014 midterm elections. CNN ran 355 pieces on Ebola in the four weeks before the election. That number fell to just ten pieces in the two weeks after the election. (There is research showing that people who were fearful about Ebola were more likely to vote Republican.)

This history is worth remembering in the context of CNN’s all inflation, all the time coverage of the economy. On Friday, we got a jobs report for March that was outstanding in just about every respect. Nonetheless, CNN’s coverage of the report quickly turned to inflation. In its more general coverage of the economy, the jobs report — which tells us about the employment and earnings situation for more than 160 million people — was barely a blip.

CNN’s history with Ebola should be kept in mind in considering its endless hyping of inflation. We must remember also remember that CNN is a network whose president prepped a politician (former New York Governor Andrew Cuomo) for interviews on the network. In other words, it does not maintain the commitment to objective reporting that is expected of non-Fox news outlets.

This doesn’t mean that the network doesn’t have many outstanding reporters. Its coverage of the war in Ukraine has generally been outstanding, with many reporters stationed in war zones at great personal risk. Nonetheless, the network obviously feels comfortable pushing a political agenda, rather than trying to inform its audience about the economy.

Many of us have highlighted both the strong pace of job growth and the drop in unemployment in March. This is great news. We are now looking at a labor market that is as strong as at any point in the last fifty years.

This should be cause for celebration, but all the Republicans have said they don’t give a damn about people getting jobs, the issue is inflation. And, most media commentators seem to agree. Hey, what difference does it make if someone can find a job, what about the price of gas?

I’m not sure how much gas people who don’t have jobs can buy, but in any case, there was some good news about inflation in this report as well. The scary story about inflation being pushed by inflation hawks like Larry Summers, is that we are facing a wage-price spiral.

In this story, we are not concerned about just a one-time increase in the inflation rate. The real problem is that the inflation rate will continue to increase unless the Fed raises interest rates enough to give us a severe recession. So, the choice is either an inflation rate that spirals ever upward or a stretch of high, maybe even double-digit, unemployment.

On this front, the March data did indeed have good news. First and most importantly, there is some evidence that wage growth is slowing.

The average hourly rose by 5.6 percent over the last year, but it increased at a just a 5.1 percent annual rate comparing last three months (Jan-Mar) with the prior three months (Oct-Dec). There is a similar story with the pay of production and non-supervisory workers. Their average hourly wage increased 6.7 percent year over year, but rose at just a 6.0 percent annual rate comparing last three months with the prior three months. Pay for production workers in leisure and hospitality, which had been soaring, slowed from a 14.9 percent year over year increase, to an 8.3 percent annual rate comparing last three months, with the prior three months.

The wage data are erratic, and the picture may look very different next month, but the evidence in the March report is that wage growth is slowing, not accelerating. That is not consistent with the wage-price spiral story we keep hearing.

Other data in the report also suggest some weakening of the labor market. The length of the average workweek fell by 0.1 hour in March. This left the index of aggregate hours unchanged, in spite of the 431,000 jobs created in the month. This is consistent with the labor shortage becoming less severe.

The length of the average workweek has been consistently higher than the pre-pandemic level over the last year. This is consistent with a story where employers, facing difficulty getting new workers, have their existing workforce put in more hours. The shortening of the workweek in the March data could indicate that employers are facing fewer difficulties in hiring.

The other item in this report suggesting some weakening of the labor market is the drop in the share of unemployment due to people who voluntarily quit their jobs. This percentage dropped from 15.1 percent in February to 13.0 percent. This is an important measure of labor market strength, since it indicates the extent to which workers are sufficiently confident of their labor market prospects that they are willing to quit a job before they have another job lined up.

As I always note, these monthly data are erratic, and April may tell a different story, but the March data are consistent with some weakening of the labor market. To be clear, a labor market where workers cannot count on pay increases and quit a job they dislike is not good news. But the concern that the labor market was too strong, and would lead to serious problems with inflation, was real. The March report suggests this is less likely to be the case.

I will also add two points that are often overlooked in the inflation discussion. There has been a big shift from wages to profits in the last two years. The profit share of national income has risen by 1.1 percentage points between 2019 and 2021. This is not consistent with the wage-price spiral story told by inflation hawks. If the profit share is increasing, then wages clearly are not driving higher prices.

The other point, is that productivity growth has actually sped up over the last three years, compared to the prior decade. It has average 2.3 percent annually from the fourth quarter of 2018 to the fourth quarter of 2021. It averaged less than 0.8 percent annually from the fourth quarter of 2010 to the fourth quarter of 2018.

This is the opposite of the story we saw with the 1970s inflation. In the 1970s, productivity growth slowed to just over 1.0 percent annually after rising at a 2.5 percent annual rate in the prior quarter century. Workers had long become accustomed to substantial real wage gains year by year. That was no longer possible in the 1970s, with productivity growth slowing to a crawl.

Anyhow, I continue to stress the shift to profits in the pandemic and the uptick in productivity growth as two important differences between the current situation and the 1970s. We’ll see how things play out in the quarters and years ahead, however the key point here is that the March jobs report not only had very good news on employment, it also had encouraging news on inflation. The latter point has gone mostly unnoticed.

Many of us have highlighted both the strong pace of job growth and the drop in unemployment in March. This is great news. We are now looking at a labor market that is as strong as at any point in the last fifty years.

This should be cause for celebration, but all the Republicans have said they don’t give a damn about people getting jobs, the issue is inflation. And, most media commentators seem to agree. Hey, what difference does it make if someone can find a job, what about the price of gas?

I’m not sure how much gas people who don’t have jobs can buy, but in any case, there was some good news about inflation in this report as well. The scary story about inflation being pushed by inflation hawks like Larry Summers, is that we are facing a wage-price spiral.

In this story, we are not concerned about just a one-time increase in the inflation rate. The real problem is that the inflation rate will continue to increase unless the Fed raises interest rates enough to give us a severe recession. So, the choice is either an inflation rate that spirals ever upward or a stretch of high, maybe even double-digit, unemployment.

On this front, the March data did indeed have good news. First and most importantly, there is some evidence that wage growth is slowing.

The average hourly rose by 5.6 percent over the last year, but it increased at a just a 5.1 percent annual rate comparing last three months (Jan-Mar) with the prior three months (Oct-Dec). There is a similar story with the pay of production and non-supervisory workers. Their average hourly wage increased 6.7 percent year over year, but rose at just a 6.0 percent annual rate comparing last three months with the prior three months. Pay for production workers in leisure and hospitality, which had been soaring, slowed from a 14.9 percent year over year increase, to an 8.3 percent annual rate comparing last three months, with the prior three months.

The wage data are erratic, and the picture may look very different next month, but the evidence in the March report is that wage growth is slowing, not accelerating. That is not consistent with the wage-price spiral story we keep hearing.

Other data in the report also suggest some weakening of the labor market. The length of the average workweek fell by 0.1 hour in March. This left the index of aggregate hours unchanged, in spite of the 431,000 jobs created in the month. This is consistent with the labor shortage becoming less severe.

The length of the average workweek has been consistently higher than the pre-pandemic level over the last year. This is consistent with a story where employers, facing difficulty getting new workers, have their existing workforce put in more hours. The shortening of the workweek in the March data could indicate that employers are facing fewer difficulties in hiring.

The other item in this report suggesting some weakening of the labor market is the drop in the share of unemployment due to people who voluntarily quit their jobs. This percentage dropped from 15.1 percent in February to 13.0 percent. This is an important measure of labor market strength, since it indicates the extent to which workers are sufficiently confident of their labor market prospects that they are willing to quit a job before they have another job lined up.

As I always note, these monthly data are erratic, and April may tell a different story, but the March data are consistent with some weakening of the labor market. To be clear, a labor market where workers cannot count on pay increases and quit a job they dislike is not good news. But the concern that the labor market was too strong, and would lead to serious problems with inflation, was real. The March report suggests this is less likely to be the case.

I will also add two points that are often overlooked in the inflation discussion. There has been a big shift from wages to profits in the last two years. The profit share of national income has risen by 1.1 percentage points between 2019 and 2021. This is not consistent with the wage-price spiral story told by inflation hawks. If the profit share is increasing, then wages clearly are not driving higher prices.

The other point, is that productivity growth has actually sped up over the last three years, compared to the prior decade. It has average 2.3 percent annually from the fourth quarter of 2018 to the fourth quarter of 2021. It averaged less than 0.8 percent annually from the fourth quarter of 2010 to the fourth quarter of 2018.

This is the opposite of the story we saw with the 1970s inflation. In the 1970s, productivity growth slowed to just over 1.0 percent annually after rising at a 2.5 percent annual rate in the prior quarter century. Workers had long become accustomed to substantial real wage gains year by year. That was no longer possible in the 1970s, with productivity growth slowing to a crawl.

Anyhow, I continue to stress the shift to profits in the pandemic and the uptick in productivity growth as two important differences between the current situation and the 1970s. We’ll see how things play out in the quarters and years ahead, however the key point here is that the March jobs report not only had very good news on employment, it also had encouraging news on inflation. The latter point has gone mostly unnoticed.

Okay, this is not 100 percent kosher, but since we seem to have entered the political silly season, and the media have jumped in with both feet, these are real numbers from the Commerce Department. The $1.2 trillion increase refers to all labor income, which counts employer provided health care insurance, pensions, and other benefits. More importantly, these data are not adjusted for inflation, but even when price increases are factored in, labor income is still up by 1.6 percent from when President Biden took office.

This is worth noting, because the news media have filled their pages and broadcasts with stories of workers who are suffering because of the rise in gas prices and inflation more generally. There are undoubtedly many workers who are seriously suffering, but this is always true. Since labor income is higher today than it was before the pandemic, we can reasonably infer that many more workers were having trouble making ends meet in 2019 than today. If we hear more stories of hardship now, it is because of the decision by the media to give us more stories of hardship, not because more stories exist in the world.

For those who want a picture of how labor income growth since Biden took office compares with prior years, here’s the picture since 2010.

 

Source: Bureau of Economic Analysis, Bureau of Labor Statistics, and author’s calculations.

 

As can be seen, labor income generally rises. The one exception was 2011, when austerity measures slowed job growth and high unemployment dampened wage growth.

The other item that jumps out in this picture is that in 2014 and 2015, which were the second and third strongest year for labor income growth, oil prices fell sharply. Since wage growth and job growth don’t usually change much year by year, changes in the rate of inflation are a major determinant of the pace of real labor income growth. Oil and energy prices in turn, are major factors in the rate of inflation.

The jump in oil prices since the pandemic ended, which has been aggravated by disruptions, and the threat of disruptions, associated with the Russian invasion of Ukraine, has been a major factor depressing real labor income growth since President Biden took office. The impact of higher oil prices, and other supply chain issues associated with the pandemic, have led to a big jump in inflation rates everywhere. For example, in the United Kingdom inflation has risen by 6.2 percent over the last year. In Germany, inflation has been 7.6 percent.

It is understandable that Republicans don’t like to call attention to the extent that the pandemic is responsible for higher inflation and its negative impact on living standards. It is a bit harder to understand why ostensibly neutral reporters don’t like to call attention to this fact. It’s a bit like reporting on a rise in homelessness in an area, without mentioning that much of the housing stock had been wiped out by a hurricane. But such is the state of reporting in the United States today.  

 

Okay, this is not 100 percent kosher, but since we seem to have entered the political silly season, and the media have jumped in with both feet, these are real numbers from the Commerce Department. The $1.2 trillion increase refers to all labor income, which counts employer provided health care insurance, pensions, and other benefits. More importantly, these data are not adjusted for inflation, but even when price increases are factored in, labor income is still up by 1.6 percent from when President Biden took office.

This is worth noting, because the news media have filled their pages and broadcasts with stories of workers who are suffering because of the rise in gas prices and inflation more generally. There are undoubtedly many workers who are seriously suffering, but this is always true. Since labor income is higher today than it was before the pandemic, we can reasonably infer that many more workers were having trouble making ends meet in 2019 than today. If we hear more stories of hardship now, it is because of the decision by the media to give us more stories of hardship, not because more stories exist in the world.

For those who want a picture of how labor income growth since Biden took office compares with prior years, here’s the picture since 2010.

 

Source: Bureau of Economic Analysis, Bureau of Labor Statistics, and author’s calculations.

 

As can be seen, labor income generally rises. The one exception was 2011, when austerity measures slowed job growth and high unemployment dampened wage growth.

The other item that jumps out in this picture is that in 2014 and 2015, which were the second and third strongest year for labor income growth, oil prices fell sharply. Since wage growth and job growth don’t usually change much year by year, changes in the rate of inflation are a major determinant of the pace of real labor income growth. Oil and energy prices in turn, are major factors in the rate of inflation.

The jump in oil prices since the pandemic ended, which has been aggravated by disruptions, and the threat of disruptions, associated with the Russian invasion of Ukraine, has been a major factor depressing real labor income growth since President Biden took office. The impact of higher oil prices, and other supply chain issues associated with the pandemic, have led to a big jump in inflation rates everywhere. For example, in the United Kingdom inflation has risen by 6.2 percent over the last year. In Germany, inflation has been 7.6 percent.

It is understandable that Republicans don’t like to call attention to the extent that the pandemic is responsible for higher inflation and its negative impact on living standards. It is a bit harder to understand why ostensibly neutral reporters don’t like to call attention to this fact. It’s a bit like reporting on a rise in homelessness in an area, without mentioning that much of the housing stock had been wiped out by a hurricane. But such is the state of reporting in the United States today.  

 

We have heard much about the supply chain crisis as we recover from the pandemic recession. As the economy has bounced back there have been shortages of many items with the economy unable to produce and ship the volume of goods that is being demanded. Many of us see this supply chain crisis as the main factor behind the upsurge in inflation that we have witnessed over the last year.

My expectation has been that the many items that have soared in price over the last year will see prices stabilize and fall when the supply chain crunch eases. I have repeatedly used the case of televisions as an example. Television prices had been on a downward path for decades, but the CPI index for televisions rose 8.7 percent between March and August of last year. The index then turned around, and has since dropped by 6.3 percent, reversing most of the prior increase.

Used cars provide another example. Used car prices soared in 2020 and 2021, with the index rising by more than 50 percent between February 2020 and January 2022. However, prices began falling in February. In one private price index, by the middle of March, used car prices had fallen almost 6.0 percent from their January peak.

If we see a comparable price decline in other items that have had extraordinary runups in prices in the last year, like appliances, clothing, and household furnishing, it will sharply dampen the inflation rate going forward. The key factor in this story is resolving the supply chain crisis.

This is where inventories come in. Inventories fell sharply in 2020, as many businesses sharply cut back production or shutdown altogether at the start of the pandemic. Inventories did begin to increase later in the year, but not as fast as consumption. Large parts of the service sector remained shut, so people shifted their consumption from areas like restaurants and travel, to cars, televisions, and appliances.

But, demand is now shifting back the other way. People are going to restaurants at pretty much the same rate as before the pandemic. While air travel is still somewhat below the pre-pandemic pace, most of the remaining gap is likely explained by reduced business travel. (I had a number of flights last week and they were all packed.)

Anyhow, this shift to services means that people must either be cutting back on their demand for goods, or spending a larger share of their income, and thereby saving less. Thus far in the recovery, the saving rate has remained relatively high, even as the pandemic payments and unemployment insurance supplements fade into the past.

It’s possible that this will change going forward, as people spend out of the savings they accumulated during the pandemic. However, it’s also possible that they will pay for their increased demand for services, by reducing their demand for goods.

In this story, it is worth noting that overall consumption is not especially high right now. Overall consumption in January, the last month for which we have data, was 5.0 percent higher, after adjusting for inflation, than in the fourth quarter of 2019. This implies a 2.3 percent annual rate of growth, pretty much in line with longer term trends.

While overall consumption is not out of line with its longer-term trend, demand for goods is. Durable goods consumption was 25.7 percent higher in January than in the fourth quarter of 2019 and consumption of non-durables was 13.0 percent higher, implying respective annual growth rates of 10.9 percent and 5.7 percent. If consumption of goods falls back closer to its trend growth path, then we will see an inventory glut.

Here’s the picture for retail non-car inventories.[1]

As can be seen, there has been there has been a sharp rise in recent months, with the level in January standing 16.1 percent above the February 2020 level. We saw a further 1.2 percent rise in non-car inventories in February, putting them 17.4 percent above their pre-pandemic level. The cumulative inflation in non-car goods over this period has been 12.1 percent (much of this is higher gasoline prices), which means that if consumption of goods fell back to its trend level, we would be back to pre-pandemic inventory-to-sales ratios and the supply chain crisis would be largely behind us.

The picture looks even better at the wholesale level.

 

These data (which include inventories of vehicles) have risen even more sharply in recent months. If we include the 2.1 percent jump in February, wholesale inventories were 20.8 percent above their pre-pandemic level. And, wholesale inventories usually end up as retail inventories in the not distant future.

These data suggest that in many categories of goods, we should have a very adequate supply in the not distant future. This will be especially true if we see consumption of goods and services revert to more normal patterns.

In this respect it is worth noting that large bursts of goods consumption tend to be followed by lower consumption in future periods. If people buy a new car or refrigerator in 2021, they are not likely to buy another car or refrigerator in 2022 or 2023. The huge burst of goods consumption that we saw in 2020 and 2021 should be another factor, in addition to the winding down of the pandemic, leading to a shift to services.

In short, the inventory data indicate that we should be getting to the end of shortages due to supply chain problems. This doesn’t mean that there will not still be many items, most notably new cars, that are in short supply, but these will be the exception rather than the rule. In that story, we will likely see price declines in a wide range of items, pulling down inflation in the rest of 2022.

[1] The supply of cars has been limited by a worldwide shortage of semi-conductors due to a fire in a large semi-conductor factory in Japan. This is a separate issue from more general supply chain problems.

We have heard much about the supply chain crisis as we recover from the pandemic recession. As the economy has bounced back there have been shortages of many items with the economy unable to produce and ship the volume of goods that is being demanded. Many of us see this supply chain crisis as the main factor behind the upsurge in inflation that we have witnessed over the last year.

My expectation has been that the many items that have soared in price over the last year will see prices stabilize and fall when the supply chain crunch eases. I have repeatedly used the case of televisions as an example. Television prices had been on a downward path for decades, but the CPI index for televisions rose 8.7 percent between March and August of last year. The index then turned around, and has since dropped by 6.3 percent, reversing most of the prior increase.

Used cars provide another example. Used car prices soared in 2020 and 2021, with the index rising by more than 50 percent between February 2020 and January 2022. However, prices began falling in February. In one private price index, by the middle of March, used car prices had fallen almost 6.0 percent from their January peak.

If we see a comparable price decline in other items that have had extraordinary runups in prices in the last year, like appliances, clothing, and household furnishing, it will sharply dampen the inflation rate going forward. The key factor in this story is resolving the supply chain crisis.

This is where inventories come in. Inventories fell sharply in 2020, as many businesses sharply cut back production or shutdown altogether at the start of the pandemic. Inventories did begin to increase later in the year, but not as fast as consumption. Large parts of the service sector remained shut, so people shifted their consumption from areas like restaurants and travel, to cars, televisions, and appliances.

But, demand is now shifting back the other way. People are going to restaurants at pretty much the same rate as before the pandemic. While air travel is still somewhat below the pre-pandemic pace, most of the remaining gap is likely explained by reduced business travel. (I had a number of flights last week and they were all packed.)

Anyhow, this shift to services means that people must either be cutting back on their demand for goods, or spending a larger share of their income, and thereby saving less. Thus far in the recovery, the saving rate has remained relatively high, even as the pandemic payments and unemployment insurance supplements fade into the past.

It’s possible that this will change going forward, as people spend out of the savings they accumulated during the pandemic. However, it’s also possible that they will pay for their increased demand for services, by reducing their demand for goods.

In this story, it is worth noting that overall consumption is not especially high right now. Overall consumption in January, the last month for which we have data, was 5.0 percent higher, after adjusting for inflation, than in the fourth quarter of 2019. This implies a 2.3 percent annual rate of growth, pretty much in line with longer term trends.

While overall consumption is not out of line with its longer-term trend, demand for goods is. Durable goods consumption was 25.7 percent higher in January than in the fourth quarter of 2019 and consumption of non-durables was 13.0 percent higher, implying respective annual growth rates of 10.9 percent and 5.7 percent. If consumption of goods falls back closer to its trend growth path, then we will see an inventory glut.

Here’s the picture for retail non-car inventories.[1]

As can be seen, there has been there has been a sharp rise in recent months, with the level in January standing 16.1 percent above the February 2020 level. We saw a further 1.2 percent rise in non-car inventories in February, putting them 17.4 percent above their pre-pandemic level. The cumulative inflation in non-car goods over this period has been 12.1 percent (much of this is higher gasoline prices), which means that if consumption of goods fell back to its trend level, we would be back to pre-pandemic inventory-to-sales ratios and the supply chain crisis would be largely behind us.

The picture looks even better at the wholesale level.

 

These data (which include inventories of vehicles) have risen even more sharply in recent months. If we include the 2.1 percent jump in February, wholesale inventories were 20.8 percent above their pre-pandemic level. And, wholesale inventories usually end up as retail inventories in the not distant future.

These data suggest that in many categories of goods, we should have a very adequate supply in the not distant future. This will be especially true if we see consumption of goods and services revert to more normal patterns.

In this respect it is worth noting that large bursts of goods consumption tend to be followed by lower consumption in future periods. If people buy a new car or refrigerator in 2021, they are not likely to buy another car or refrigerator in 2022 or 2023. The huge burst of goods consumption that we saw in 2020 and 2021 should be another factor, in addition to the winding down of the pandemic, leading to a shift to services.

In short, the inventory data indicate that we should be getting to the end of shortages due to supply chain problems. This doesn’t mean that there will not still be many items, most notably new cars, that are in short supply, but these will be the exception rather than the rule. In that story, we will likely see price declines in a wide range of items, pulling down inflation in the rest of 2022.

[1] The supply of cars has been limited by a worldwide shortage of semi-conductors due to a fire in a large semi-conductor factory in Japan. This is a separate issue from more general supply chain problems.

There is a story of a football coach who ran running plays near the end of a game, when he clearly should have been passing. Apparently, he had seen data showing that teams that win, on average, run on a certain number of plays. His team was below this number, so he decided that he had to have more runs if his team was going to win.

This is a classic case of confusing correlation with causation. (For those not familiar with football, when a team is ahead, it generally uses running plays to take lots of time off the clock. They run because they are winning, they don’t win because they run.) This distinction is important when considering various predictions for a recession in the current environment.

There are many features of an economy that we commonly see before a recession. For example, we typically see higher prices for oil, wheat, and other commodities before a recession. We also often see an inverted yield curve, where the interest rate on short-term Treasury debt (e.g., 90-day or 2-year notes) exceed the interest rate on 10-year Treasury bonds.

We are currently seeing a serious run-up in many commodity prices. It’s very plausible that we will see an inverted yield curve in the next year or so. The question is whether this means we should be expecting a recession in the near future?

While I would not rule out a recession beginning this year or next, we have to be careful to ask about the causation and not just look for events that tend to be correlated with recessions. Neither high commodity prices nor an inverted yield curve should be sufficient grounds for believing we will see a recession.

The Problem of High Commodity Prices

Taking these in turn, the impact of high commodity prices on economic growth is ambiguous. Higher prices for gas and food (insofar as commodity prices get passed on in food prices) will take money out of households’ pockets, meaning that they have less money to spend on other things. In this way, they can be thought of as being comparable to tax increases.

However, there is a flip side to these tax increases. Higher commodity prices, especially in the case of oil, provide incentive to invest more money in the search for more oil. With the explosion of fracking in the United States, much of this investment is likely to take place here. This investment will provide a boost to demand that can partially, or even fully, offset the extent to which higher oil and gas prices reduce consumption.

There is a complicating factor in this story. The plunge in oil prices from 2014 to 2015, which took prices from over $100 a barrel to roughly $40 barrel, brought a quick end to the fracking boom. The whole industry was hard hit and many companies went bankrupt.

This history has made many companies reluctant to invest in a big way, even as oil prices again soar to over $100 a barrel. Nonetheless, the number of oil rigs is up by more than 50 percent from its year ago level, even though it is still far below the pre-recession figure. It seems likely that if oil prices stay high that we will see continued rapid growth in drilling, with the investment largely offsetting the drop in consumption due to higher gas prices.

The story with other commodities is similarly ambiguous. Higher grain prices mean higher incomes for farmers. Also, the price of grain is a relatively small factor in our food prices. (They matter much more for people in the developing world.) Most of the increase in food costs since the pandemic reflect higher shipping costs and increased profits, not a rise in grain prices.

It is also important to remember that commodity prices are hugely volatile with both upward and downward swings that are often far larger than is warranted by market fundamentals. This could be the case with sharp rise in many prices since the Russian invasion of Ukraine.

For example, much discussion of the oil market has treated as a serious possibility the complete loss to world markets of Russia’s exports of five million barrels a day. As a practical matter, that scenario is almost impossible. While the United States and some other countries are now boycotting Russian oil, most of Europe is still buying it.

However, even if the European Union were to go along with a Russian oil boycott, most of this oil would still not be lost to world markets. In all probability, many other countries, most importantly China and India would still be buying Russian oil. These countries would likely buy most of the oil that the US and EU were boycotting, presumably get a discount off the world price for their willingness to flaunt sanctions.

Since demand for oil in China and India is not going to increase to absorb the Russian oil, the Russian oil will displace oil that they are currently importing from other countries. This means that oil from Saudi Arabia, the United Arab Emirates, and other countries, that used to go to China and India, will instead be going to the EU or the United States. There clearly will be some oil lost in this story (not all oil is perfectly substitutable) but the net effect will be hugely less than the full amount of Russia’s exports.

There is a similar story with grain prices. In many places grains can be easily substituted for each other. This means that if wheat prices rise a great deal, due to the loss of production from Ukraine, people in many areas may switch to corn, rice, or other grains. This will limit the extent of the price increase in areas where people have no choice but to buy wheat.

There are many factors that can affect commodity prices over the next couple of years and it is possible that the price of oil, wheat and other commodities will rise even further. But the claims that have often been made in the media do not justify the price increases that we have seen to date.

The Inverted Yield Curve

The other recession scare story, the inverted real curve, has more foundation in reality. Most recessions in the post-World War II era have been caused by the Federal Reserve Board raising interest rates to slow the economy. A slower economy reduced job growth, which reduces inflationary pressures, by putting downward pressure on wages. The exceptions were the 2001 recession, which was caused by the collapse of the stock bubble, the 2007-09 recession which was caused by the collapse of the housing bubble, and the 2020 recession, which was the result of the pandemic.

Short-term interest rates move much more than longer term rates. If the overnight money rate, that the Fed directly controls, rises by 2.0-2.5 percentage points over the next year and a half, as is now widely expected, it is likely to far exceed the increases in longer term interest rates. This creates the possibility of an inverted yield curve, where shorter term rates exceed longer term rates.

In this situation, we may well expect to see a recession, but the key factor is the Fed’s increase in shorter term rates. The Fed’s goal in raising rates is to slow the economy. If it pushes the economy into a recession, then it will have gone too far.

We may also see an inverted yield curve in this situation, as short-term rates are pushed higher by the Fed. In addition to not rising as much as short-term rates, long-term rates may also be held down by an expectation that a recession will imply lower short-term interest rates in the future. But the inverted yield curve is not the cause of the recession. It is a phenomenon that goes along with a recession.

Will We See a Recession?

There is a real risk that in the effort to slow inflation, the Fed goes too far and pushes the economy into a recession, but this is still very far from a done deal. The economy had been growing very rapidly in the fourth quarter of 2021. It would have to slow sharply from that pace to push the economy into a recession.

That is a possible story. Rapid consumption growth was the biggest factor pushing GDP higher in the recovery. This growth was fueled in part by the pandemic checks sent out to people in the CARES Acts and the Biden recovery package, as well as the unemployment insurance supplements. These payments are now in the past. People still have more money in their bank accounts than before the pandemic, but thus far they have not spent from these savings to any substantial extent.

Higher interest rates will also directly discourage consumption of items typically bought on credit, like cars and major appliances. Higher rates also have already put an end to a refinancing boom, that allowed for interest savings of thousands of dollars a year for tens of millions of homeowners. Also, to some extent the spending we saw over the last year and a half will directly depress future consumption. If someone bought a new car in 2021, they are unlikely to buy another one in 2022.

For these reasons, it is very likely that we will see a sharp slowing of consumption in 2022, which will in turn depress overall growth. But, the flip side of this slowing of consumption growth is that it should alleviate the supply chain problems that have played such a central role in driving up inflation. If the demand falls for cars, refrigerators, and other goods that people bought in large quantities in 2020 and 2021, we may see their prices fall back towards pre-pandemic levels.

We have already seen this story with televisions, where a 6.3 percent drop in prices over the last five months, has largely reversed an 8.7 percent increase between March and August of last year. We also may be seeing this story with used cars. Used car prices soared in 2020 and 2021, with the index rising by more than 50 percent between February 2020 and January 2022. However, prices began falling in February. In one private price index, by the middle of March, used car prices had fallen almost 6.0 percent from their January peak.  

If these price reversals continue, and are seen in other items that saw rapid inflation during the pandemic, then we will have much less inflation for the Fed to fight. This presumably means fewer rate hikes and less of a hit to the economy.

It is also worth noting that growth in other sectors is likely to help support the economy, even if consumption growth is weak. We are seeing a boom in housing construction, which is likely to persist, even in the face of rising interest rates. House prices have risen by more than 30 percent over the last two years, which should mean that builders can still make healthy profits even if they have to pay somewhat higher interest on the money they borrow.  

Nonresidential investment has also been strong, in spite of weakness in the construction of office buildings and other non-residential structures. And, the government sector should also be boosting growth, as the Biden infrastructure package takes effect and state and local governments spend more of the money they accumulated from the various pandemic rescue packages.  

In short, while there are real grounds for being concerned about the risk of a recession, there are also good reasons for believing that the economy can continue to grow at a healthy pace. In any case, we should keep our eyes on the forces that actually drive the economy, and not be distracted by quirky recession signals that don’t tell us anything.

There is a story of a football coach who ran running plays near the end of a game, when he clearly should have been passing. Apparently, he had seen data showing that teams that win, on average, run on a certain number of plays. His team was below this number, so he decided that he had to have more runs if his team was going to win.

This is a classic case of confusing correlation with causation. (For those not familiar with football, when a team is ahead, it generally uses running plays to take lots of time off the clock. They run because they are winning, they don’t win because they run.) This distinction is important when considering various predictions for a recession in the current environment.

There are many features of an economy that we commonly see before a recession. For example, we typically see higher prices for oil, wheat, and other commodities before a recession. We also often see an inverted yield curve, where the interest rate on short-term Treasury debt (e.g., 90-day or 2-year notes) exceed the interest rate on 10-year Treasury bonds.

We are currently seeing a serious run-up in many commodity prices. It’s very plausible that we will see an inverted yield curve in the next year or so. The question is whether this means we should be expecting a recession in the near future?

While I would not rule out a recession beginning this year or next, we have to be careful to ask about the causation and not just look for events that tend to be correlated with recessions. Neither high commodity prices nor an inverted yield curve should be sufficient grounds for believing we will see a recession.

The Problem of High Commodity Prices

Taking these in turn, the impact of high commodity prices on economic growth is ambiguous. Higher prices for gas and food (insofar as commodity prices get passed on in food prices) will take money out of households’ pockets, meaning that they have less money to spend on other things. In this way, they can be thought of as being comparable to tax increases.

However, there is a flip side to these tax increases. Higher commodity prices, especially in the case of oil, provide incentive to invest more money in the search for more oil. With the explosion of fracking in the United States, much of this investment is likely to take place here. This investment will provide a boost to demand that can partially, or even fully, offset the extent to which higher oil and gas prices reduce consumption.

There is a complicating factor in this story. The plunge in oil prices from 2014 to 2015, which took prices from over $100 a barrel to roughly $40 barrel, brought a quick end to the fracking boom. The whole industry was hard hit and many companies went bankrupt.

This history has made many companies reluctant to invest in a big way, even as oil prices again soar to over $100 a barrel. Nonetheless, the number of oil rigs is up by more than 50 percent from its year ago level, even though it is still far below the pre-recession figure. It seems likely that if oil prices stay high that we will see continued rapid growth in drilling, with the investment largely offsetting the drop in consumption due to higher gas prices.

The story with other commodities is similarly ambiguous. Higher grain prices mean higher incomes for farmers. Also, the price of grain is a relatively small factor in our food prices. (They matter much more for people in the developing world.) Most of the increase in food costs since the pandemic reflect higher shipping costs and increased profits, not a rise in grain prices.

It is also important to remember that commodity prices are hugely volatile with both upward and downward swings that are often far larger than is warranted by market fundamentals. This could be the case with sharp rise in many prices since the Russian invasion of Ukraine.

For example, much discussion of the oil market has treated as a serious possibility the complete loss to world markets of Russia’s exports of five million barrels a day. As a practical matter, that scenario is almost impossible. While the United States and some other countries are now boycotting Russian oil, most of Europe is still buying it.

However, even if the European Union were to go along with a Russian oil boycott, most of this oil would still not be lost to world markets. In all probability, many other countries, most importantly China and India would still be buying Russian oil. These countries would likely buy most of the oil that the US and EU were boycotting, presumably get a discount off the world price for their willingness to flaunt sanctions.

Since demand for oil in China and India is not going to increase to absorb the Russian oil, the Russian oil will displace oil that they are currently importing from other countries. This means that oil from Saudi Arabia, the United Arab Emirates, and other countries, that used to go to China and India, will instead be going to the EU or the United States. There clearly will be some oil lost in this story (not all oil is perfectly substitutable) but the net effect will be hugely less than the full amount of Russia’s exports.

There is a similar story with grain prices. In many places grains can be easily substituted for each other. This means that if wheat prices rise a great deal, due to the loss of production from Ukraine, people in many areas may switch to corn, rice, or other grains. This will limit the extent of the price increase in areas where people have no choice but to buy wheat.

There are many factors that can affect commodity prices over the next couple of years and it is possible that the price of oil, wheat and other commodities will rise even further. But the claims that have often been made in the media do not justify the price increases that we have seen to date.

The Inverted Yield Curve

The other recession scare story, the inverted real curve, has more foundation in reality. Most recessions in the post-World War II era have been caused by the Federal Reserve Board raising interest rates to slow the economy. A slower economy reduced job growth, which reduces inflationary pressures, by putting downward pressure on wages. The exceptions were the 2001 recession, which was caused by the collapse of the stock bubble, the 2007-09 recession which was caused by the collapse of the housing bubble, and the 2020 recession, which was the result of the pandemic.

Short-term interest rates move much more than longer term rates. If the overnight money rate, that the Fed directly controls, rises by 2.0-2.5 percentage points over the next year and a half, as is now widely expected, it is likely to far exceed the increases in longer term interest rates. This creates the possibility of an inverted yield curve, where shorter term rates exceed longer term rates.

In this situation, we may well expect to see a recession, but the key factor is the Fed’s increase in shorter term rates. The Fed’s goal in raising rates is to slow the economy. If it pushes the economy into a recession, then it will have gone too far.

We may also see an inverted yield curve in this situation, as short-term rates are pushed higher by the Fed. In addition to not rising as much as short-term rates, long-term rates may also be held down by an expectation that a recession will imply lower short-term interest rates in the future. But the inverted yield curve is not the cause of the recession. It is a phenomenon that goes along with a recession.

Will We See a Recession?

There is a real risk that in the effort to slow inflation, the Fed goes too far and pushes the economy into a recession, but this is still very far from a done deal. The economy had been growing very rapidly in the fourth quarter of 2021. It would have to slow sharply from that pace to push the economy into a recession.

That is a possible story. Rapid consumption growth was the biggest factor pushing GDP higher in the recovery. This growth was fueled in part by the pandemic checks sent out to people in the CARES Acts and the Biden recovery package, as well as the unemployment insurance supplements. These payments are now in the past. People still have more money in their bank accounts than before the pandemic, but thus far they have not spent from these savings to any substantial extent.

Higher interest rates will also directly discourage consumption of items typically bought on credit, like cars and major appliances. Higher rates also have already put an end to a refinancing boom, that allowed for interest savings of thousands of dollars a year for tens of millions of homeowners. Also, to some extent the spending we saw over the last year and a half will directly depress future consumption. If someone bought a new car in 2021, they are unlikely to buy another one in 2022.

For these reasons, it is very likely that we will see a sharp slowing of consumption in 2022, which will in turn depress overall growth. But, the flip side of this slowing of consumption growth is that it should alleviate the supply chain problems that have played such a central role in driving up inflation. If the demand falls for cars, refrigerators, and other goods that people bought in large quantities in 2020 and 2021, we may see their prices fall back towards pre-pandemic levels.

We have already seen this story with televisions, where a 6.3 percent drop in prices over the last five months, has largely reversed an 8.7 percent increase between March and August of last year. We also may be seeing this story with used cars. Used car prices soared in 2020 and 2021, with the index rising by more than 50 percent between February 2020 and January 2022. However, prices began falling in February. In one private price index, by the middle of March, used car prices had fallen almost 6.0 percent from their January peak.  

If these price reversals continue, and are seen in other items that saw rapid inflation during the pandemic, then we will have much less inflation for the Fed to fight. This presumably means fewer rate hikes and less of a hit to the economy.

It is also worth noting that growth in other sectors is likely to help support the economy, even if consumption growth is weak. We are seeing a boom in housing construction, which is likely to persist, even in the face of rising interest rates. House prices have risen by more than 30 percent over the last two years, which should mean that builders can still make healthy profits even if they have to pay somewhat higher interest on the money they borrow.  

Nonresidential investment has also been strong, in spite of weakness in the construction of office buildings and other non-residential structures. And, the government sector should also be boosting growth, as the Biden infrastructure package takes effect and state and local governments spend more of the money they accumulated from the various pandemic rescue packages.  

In short, while there are real grounds for being concerned about the risk of a recession, there are also good reasons for believing that the economy can continue to grow at a healthy pace. In any case, we should keep our eyes on the forces that actually drive the economy, and not be distracted by quirky recession signals that don’t tell us anything.

The New York Times had a piece today assessing whether we were likely to return to the pre-pandemic situation, with low inflation, low interest rates, and moderate growth. One issue it raised arguing in the opposite direction was that consumer spending has remained exceptionally strong. “And they thought consumer spending would taper off as government pandemic relief checks faded into the rearview mirror. Shoppers have kept at it.”

Actually, savings rates have been pretty much at their pre-pandemic average the last few months.

Consumption would be exceptionally strong if the saving rate had fallen below its pre-recession level, implying that people were spending based on the wealth they accumulated during the pandemic. While that could still happen, to date, there is little evidence that people are spending down their accumulated wealth to any substantial extent.

The labor market has also largely returned to its pre-pandemic state. The employment-to-population ratio for prime age workers (ages 25 to 54) is just a 1.0 percentage points below its pre-pandemic peak, a level above its average for 2018. Most of the remaining gap is easily explained by the 1.2 million people who reported that they were not in the labor force in February because they either had COVID-19, were concerned about getting it, or caring for a family member with COVID-19.

 

The New York Times had a piece today assessing whether we were likely to return to the pre-pandemic situation, with low inflation, low interest rates, and moderate growth. One issue it raised arguing in the opposite direction was that consumer spending has remained exceptionally strong. “And they thought consumer spending would taper off as government pandemic relief checks faded into the rearview mirror. Shoppers have kept at it.”

Actually, savings rates have been pretty much at their pre-pandemic average the last few months.

Consumption would be exceptionally strong if the saving rate had fallen below its pre-recession level, implying that people were spending based on the wealth they accumulated during the pandemic. While that could still happen, to date, there is little evidence that people are spending down their accumulated wealth to any substantial extent.

The labor market has also largely returned to its pre-pandemic state. The employment-to-population ratio for prime age workers (ages 25 to 54) is just a 1.0 percentage points below its pre-pandemic peak, a level above its average for 2018. Most of the remaining gap is easily explained by the 1.2 million people who reported that they were not in the labor force in February because they either had COVID-19, were concerned about getting it, or caring for a family member with COVID-19.

 

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