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Article Artículo

More Confusion on Inflation: Lower Oil Prices Helps, Rather than Hurts Japan

Confused thinking on inflation continues to abound, and not just from the folks convinced that hyper-inflation is just around the corner or already here. Recall that until recently we were supposed to be terrified that those low inflation rates in the euro zone might shift from being small positives to small negatives, and then the world would end.

Fortunately the I.M.F., among others, is now pointing out that the problem is simply an inflation rate that is too low. An inflation rate of -0.5 is more too low low than inflation of 0.5 percent, but this is just in the same way that an inflation rate of 0.5 percent is more too low than an inflation rate of 1.5 percent. The problem is that we would like the inflation rate to be higher to both facilitate declines in real wages in sectors seeing less demand (commentators please note, the issue of real wages being too high is in certain sectors, not a general problem) and to reduce the real value of outstanding debt. A higher rate of inflation will also reduce the real interest rate, which will encourage firms to invest more.

This brings us to a Reuters story that ran in the NYT telling readers that falling oil prices will make it harder for Japan to hit its 2.0 percent inflation target, therefore implying that low oil prices are bad for Japan's economy. Let's think this one through for a moment.

First, if we check the base paths, we see that Japan is almost 100 percent dependent on imported oil. This is different from the U.S. which has a substantial oil producing sector. That should make the story pretty unambiguous. In the U.S. we can say that areas like North Dakota and Texas might take a hit, even if other parts of the country will benefit from lower oil prices. Japan doesn't have a North Dakota or Texas, which means that they are only looking at paying less for their energy.

So how is this bad? Well, the Reuters piece says it means lower inflation. This is true, but we have to think of why lower inflation could be a problem. Let's imagine that if the price of oil were unchanged, then Japan's central bank would be hitting its 2.0 percent inflation target. Now because of lower oil prices, the overall rate of inflation will come in substantially under 2.0 percent.

Dean Baker / December 26, 2014

Article Artículo

On the Economic Boom: Too Much Eggnog?

I hate to put a damper on the party, but the some of the reporting on the economy is getting a bit out of hand. The Post gave us an example, with a piece on the revised fourth quarter GDP numbers headlined, "Robust Economic Growth in the third quarter raises hopes that a boom is on horizon." That's not what Mr. Arithmetic says.

First, just to be clear, the third quarter numbers were definitely good news. Five percent GDP growth is a solid economic performance by any measure, so there is no doubt that it is a big step forward by any measure. The economy is clearly growing, and likely at a reasonably respectable rate. The issue is whether the term "boom" is appropriate.

As this article and other reporting notes, the third quarter follows a strong second quarter of 4.6 percent growth, which in turn followed a first quarter where GDP shrank by 2.1 percent. The piece dismisses the drop in first quarter GDP as the result of bad weather. This is surely true, but the strong growth in the subsequent two quarters is clearly related to the drop in the first quarter. The growth in these quarters was a reversal of the decline in the first quarter.

If we take the average growth over the last three quarters, we get a 2.5 percent annual growth rate. This isn't bad, but it's hardly anything to write home about. If we assume the economy has a potential growth rate (the rate of growth of the labor force plus productivity) in the range of 2.2-2.4 percent, then with the 2014 growth rate we are filling the gap in output at the rate of between 0.1-0.3  percentage points a year. CBO estimates that the gap between potential GDP and actual GDP is still close to 4 percentage points. This means that at the 2014 growth rate we can look to fill that gap in somewhere between 13 and 40 years. Perhaps we should put a hold on that champagne.

Dean Baker / December 24, 2014

Article Artículo

John Cochrane Versus the Keynesians, #23,127

I see that John Cochrane is once again attacking Keynesian economics, giving an “autopsy for Keynesians” in the Wall Street Journal. His central line is that Keynesian economics has been repeatedly proven wrong in the recovery. He sees the U.K.’s turn to austerity as a brilliant success; and the continued U.S. growth, in spite of deficit reduction, as further proof of the failures of Keynesian economics. He tells us that even Greece and Italy are sticking with the euro, rejecting the course of “devaluation and inflation.”

I understand that Cochrane’s polemic is directed at Paul Krugman, but as a card carrying Keynesian, I will take up the defense. First, it requires some serious re-writing of history to pronounce the Keynesians wrong at every turn in this recession and recovery. Going back to the days of Great Moderation, some of us Keynesian types noticed the economy was being driven by a housing bubble long before the beginning of the Great Recession.

I’m not sure where bubbles fit in Cochrane’s world, but in this economy they are run-ups in asset prices that are not consistent with the fundamentals of the market. In most cases they are not of great consequence for the economy as a whole, only for the markets directly affected. However when the market is a massive market, like the U.S. housing market, and the bubble grows to the neighborhood of $8 trillion (@ $10 trillion in today’s economy), it is a big deal. The housing bubble raised residential construction to a record share of GDP. The associated wealth effect led to a huge consumption boom with the saving rate pushed to a record low.

When the bubble burst, there was no component of GDP that would magically replace these sources of demand. The outcome was a severe recession. The real world followed pretty well on this Keynesian’s line of thinking.

Cochrane somehow thinks the Keynesians blundered in believing that the stimulus would set everything right:

“Our first big stimulus fell flat, leaving Keynesians to argue that the recession would have been worse otherwise.”

Well, some of us were arguing at the time that the stimulus was far too small to get the economy back on its feet, so we were hardly surprised when our prognostications proved correct. (Krugman made the same case in a far more visible forum.)

Dean Baker / December 23, 2014

Article Artículo

Are We Doing Better Than We Thought? Median Family Income 1979-2010

The Congressional Budget Office (CBO) recently updated its analysis of changes in before-tax and after-tax family income. In some ways the new analysis showed a brighter picture for middle income families than other work highlighting stagnation. Focusing on the middle quintile of households with children, the new CBO analysis showed a gain in before-tax income of 25.2 percent from 1979. The gain in after-tax, after-transfer income was 46.7 percent. This may not amount to huge gains over a 31-year period, but it is not zero. It is worth looking at these numbers more closely.

Focusing on the before-tax side, the CBO numbers show income for the middle quintile rising from $61,200 in 1979 to $76,600 in 2010 (in 2010 dollars). By far the biggest single chunk of this increase is wages. According to CBO, wage income for this group rose by 14.3 percent over this period, a 0.4 percent annual rate. This is bit better than what we would see looking at the standard wage data. For example, the Economic Policy Institute (EPI) shows the median hourly wage rising by just 5.6 percent over this period.

It turns out that the difference can be explained entirely by differences in price indices used to deflate earnings. (There are also issues about hours worked, the average work year increased somewhat over this period as more women worked full-time jobs, but it would take a more careful analysis to see how hours changed for families in the middle quintile.) CBO used the PCE deflator, the index used to deflate consumption expenditures by households and spending by non-profit organizations. This shows a rate of inflation that averages 0.24 percentage points less than the CPI-URS used by EPI.

There are differences in the expenditures covered by the two indices, and also some minor methodological differences, but the main reason for the gap is that the PCE deflator allows for substitution. If people change their consumption patterns in response to price changes (for example, buying more cell phones and fewer land lines due to a drop in cell phone prices), the PCE deflator will increase its weight on the item people are buying more frequently (cell phones) and reduce the weight on the item people are buying less frequently (land lines). By contrast, the CPI-URS, ignore the change in purchasing patterns over the course of a year and assumes that peoples' purchases of cell phones and land lines is unchanged.

CEPR / December 22, 2014