Archive for April 2015


Overproduction, then and now

In a comment after my previous post, Ken Duda suggested that the authors of this WSJ story may have believed that overproduction was holding back the global economy.  Like almost everything in life, that reminds me of the Great Depression.

In 1933, FDR worried that “overproduction” was leading to deflation and depression.  (Apparently FDR had never read George Selgin.)  FDR first tried to address deflation with monetary stimulus, sharply depreciating the dollar after March 1933.  Industrial production soared by 57% between March and July 1933.  But FDR could not leave well enough alone. Now “overproduction” was getting even worse!  So he ordered firms to cut the workweek from 48 hours to 40 hours, with no change in weekly pay.  This effectively boosted average hourly wages by 20% in just 2 months.

And it worked!!  Industrial production immediately turned negative, and remained below the July 1933 levels as late as May 1935, when that awful Supreme Court that liberals complain about declared the NIRA to be unconstitutional, and saved his presidency.  Industrial production immediately began rising rapidly, until the recovery was again aborted by an FDR wage shock, this time associated with the huge unionization drives following passage of the Wagner Act, which doubled union membership between 1936 and 1938.  With wages rising rapidly the economy stagnated in mid-1937, and then plunged sharply in late 1937 when an adverse demand shock was added to the adverse supply shock of early 1937. The recovery in IP also paused after the minimum wage of late 1938 was instituted, and then again in late 1939 when the minimum wage was raised by another 20%.

PS.  On a related note I highly recommend Alex Tabarrok’s new post on “efficiency wages.”

PPS.  While touring Fallingwater a few days ago the tour guide asked if anyone wanted to guess how much Frank Lloyd Wright paid the unskilled workers at the job site in 1938.  I guessed 25 cents an hour, which turned out to be exactly right. The guide asked how I knew, and I said I just guessed that amount because it was the first minimum wage, instituted in 1938. The rest of the tour group gave me that “who is this jerk showing off” look that I haven’t seen since college.

Pop macroeconomics

Very few people understand economic theories such as supply and demand, the quantity theory of money, comparative advantage, AS/AD, etc.  As a result, if journalists explained things using these economic concepts, their readers would be hopelessly confused.  Thus even the elite news media tends to rely on some version of what Paul Krugman once called “Pop Internationalism.”  It’s hard to blame them, but unfortunately this analytical apparatus uses economic terms in a very different way from how economists use the terms.  So while their readers can follow the articles, I cannot.  Here’s an example of pop macroeconomics from the Wall Street Journal:

The global economy is awash as never before in commodities like oil, cotton and iron ore, but also with capital and labor””a glut that presents several challenges as policy makers struggle to stoke demand.

“What we’re looking at is a low-growth, low-inflation, low-rate environment,” said Megan Greene, chief economist of John Hancock Asset Management, who added that the global economy could spend the next decade “working this off.”

The current state of plenty is confounding on many fronts. The surfeit of commodities depresses prices and stokes concerns of deflation. Global wealth””estimated by Credit Suisse at around $263 trillion, more than double the $117 trillion in 2000″”represents a vast supply of savings and capital, helping to hold down interest rates, undermining the power of monetary policy. And the surplus of workers depresses wages.

Meanwhile, public indebtedness in the U.S., Japan and Europe limits governments’ capacity to fuel growth through public expenditure. That leaves central banks to supply economies with as much liquidity as possible, even though recent rounds of easing haven’t returned these economies anywhere close to their previous growth paths.

“The classic notion is that you cannot have a condition of oversupply,” said Daniel Alpert, an investment banker and author of a book, “The Age of Oversupply,” on what all this abundance means. “The science of economics is all based on shortages.”

I’m not quite sure what the WSJ means by “glut” or “stokes demand” or “oversupply” or “vast supply of savings and capital” or “surplus” or “abundance” or “surfeit of commodities” or “working this off” or “shortage.”  Yes, some of these terms are also used by economists.  For instance, we use the term ‘shortage’ to refer to a situation where quantity supplied exceeds falls short of quantity demanded.  But obviously “the science of economics” is not “all based on shortages.”  The authors obviously mean something entirely different.  Wealth also has a clear meaning in economics, but it is not something that “represents a vast supply of savings and capital, helping to hold down interest rates.”

When they say, “stokes demand” I’d guess they mean boost AD.  But if so, why would a “glut” of commodities make it more difficult to boost AD?  And exactly what does a “glut” of commodities mean?   Does it mean a surplus, reflecting a price above equilibrium?  Then why doesn’t the price fall?  Commodities usually trade in auction-style markets.  And what is “oversupply?  Is it increased supply, or a surplus?  If the “classic” model says you can’t have oversupply, then what’s wrong with the classic model?  We are not told.

Producers have their own share of the blame. In a lower commodity price environment, producers typically are reluctant to cut production in an effort to maintain their market shares.

In some cases, producers even increase their output to make up for the revenue losses due to lower prices, exacerbating the problem of oversupply.

“Generally, this creates a feedback cycle where prices fall further because of the supply glut,” said Dane Davis, a commodity analyst with Barclays.

If the price were artificially held above equilibrium, then it would not fall.  If it falls, then presumably price is determined by the forces of supply and demand.  In that case a “supply glut” presumably means an increase in supply.  But the most notable thing about the world economy in recent years is the extremely slow pace of increase in the aggregate supply curve. Thus even during a period of falling unemployment in the US (2009-15), real GDP growth has been quite slow, and the trend rate of growth (the rate LRAS shifts right) is even slower.  It’s even worse in Britain, the eurozone, and Japan.

Even if governments have the capacity for more fiscal stimulus, few have the political will to unleash it. That has left central banks to step into the void. The Federal Reserve and Bank of England have both expanded their balance sheets to nearly 25% of annual gross domestic product from around 6% in 2008. The European Central Bank’s has climbed to 23% from 14% and the Bank of Japan to nearly 66% from 22%.

In more normal times, this would have been sufficient to get economies rolling again,

This is a rather odd way of making the point.  Yes, an increase in the monetary base is usually associated with a rise in AD. But it is not the case that an increase in the base/GDP ratio is normally associated with higher AD, in fact just the opposite. Higher base/GDP ratios are usually associated with monetary policies that stop economies from “rolling again.”

Here’s how I’d look at the global picture:

1.  The data suggests that global productivity growth is slowing, as is global growth in the labor force.  The global AS curve is still shifting right, but more slowly.  The Wicksellian equilibrium real interest rate is falling.

2.  In some areas (particularly the eurozone) AD is too low because money was far too tight around 2011-12, leading to high unemployment.

I’m not sure what all the “glut” discussion adds to this.  But maybe that’s because I’m an economist who doesn’t live in the real world.  Or at least that’s what my commenters keep telling me.

HT:  Ken Duda

The Progressive Community defends America’s honor

I found this over at CommonDreams: Breaking News and Views For the Progressive Community:

Some of Obama’s claims about TPP on Friday took some creative license with the truth. He said that he wanted a trade deal that would allow American automakers to sell more cars overseas, without mentioning that Ford and autoworker unions do not support the pact. He also said that he had not included any language barring currency manipulation — a key tactic by which Japan and China undercut American production — because it might hamper the Federal Reserve’s monetary policy operations. That scenario would only be possible if the pact defined “currency manipulation” in a particularly bizarre manner.

Yes, the Japanese have recently engaged in some aggressive QE, and I would not deny that currency appreciation was a hoped for side effect.  But it’s absurd to claim the Fed would ever contemplate doing something similar.  Yes, the dollar fell 6 cents against the euro on the day QE1 was announced, but that was just an unintended side effect.  Imagine people concocting “particularly bizarre” theories that the United States of America would act selfishly to create jobs at home by “manipulating” the value of our currency.  President Obama is one of those people that Jeane Kirkpatrick used to call “blame America first” liberals.  I’m glad to see America’s progressives standing with Scott Walker and Pat Buchanan in their vigorous defense of America’s working class, and against the soulless cosmopolitanism of the man who spent his childhood in Honolulu and Jakarta.

Progress in America can only occur if we cut down on those service jobs and send Starbucks baristas off to do real work in factories making t-shirts and Christmas ornaments.

PS. I just got back from 6 days of traveling, and as you might have noticed I’m burned out. I’ll try to get back to real blogging soon.

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PPS.  Is this Pat Buchanan’s favorite flag?

PPPS.  Philip Johnson called it the “greatest house of the 20th century”, and now I’ve finally seen it.  By an odd coincidence, my favorite American artist grew up in the same town as I did.  Don’t miss nearby Kentuck Knob, with an amazing invisible window.

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A poll of central bankers

Ignacio Morales of the Costa Rica Central Bank sent me the following, which is from a poll of central bankers readers of Central

Screen Shot 2015-04-21 at 10.07.16 AMI will be traveling over the next few days, so blogging will be intermittent.

High interest rates are not “ammunition”

This caught my eye:

Unlike these past five major rate hike cycles, today’s Fed will not be moving to fight inflation or cool economic growth. Inflation is running below their target and current U.S. GDP readings are not exactly red hot. What the Fed wants (or needs) to do is raise the target rate in order to have ammunition for the next time our economy stumbles. A well-telegraphed series of small rate increases could allow the Fed to “reload” while having only a minimal to modest impact on overall economic activity. It would be another spectacular tight rope act for the Fed to pull off, but their recent track record suggests it is something possible. One certainty that exists is the fact that the Fed will do no harm to the market or the economy, especially with the next presidential election cycle beginning already.

I guess once people start reasoning from an interest rate change there’s no telling where it will lead.  Of course he has things exactly backwards; if the Fed wants more (conventional) ammunition, it needs to delay raising interest rates to speed up NGDP growth.

The mistake here is that the author assumes the ability to cut rates represents “ammunition.”  In fact, if you insist on thinking in Keynesian terms, then ammunition is represented by a higher Wicksellian equilibrium nominal interest rate, not a higher actual rate.  The farther above zero is the Wicksellian rate, the more ability the Fed has to stimulate using conventional interest rate cuts.  But here’s the problem.  If the Fed raises rates today with a tight money policy then they will be reducing NGDP growth, and hence reducing the Wicksellian equilibrium rate.  They’ll have less ammo.

Now it’s conceivable that the author was suggesting that the Fed could get more ammunition by raising interest rates via a Neo-Fisherian channel (easier money), say by raising the inflation target to 4%.  Sure, that would work, but I sort of doubt that’s what the author had in mind.  Again, a tighter monetary policy gives the Fed less ammo, not more.

PS.  Russ Roberts has a new podcast interviewing me on interest rates.

Update:  The Washington Examiner has a list of 28 “New Voices.”  I was pleased to see my name, and even more pleased to see Matthew Rognlie.  Matt always left extremely thoughtful comments, and I considered him to be one of the rising young stars even before his famous post on the Piketty data issue.  It’s great to see how the internet can give a voice to talented students like Matt (as well as Evan Soltas, Yichuan Wang, etc.)

Update#2:  Ramesh Ponnuru has a very good article on Bernanke’s discussion of NGDP targeting.