Archive for October 2013


Why we need 5% NGDPLT

Morgan Warstler sent me the following story by Matthew Boesler:

The consensus on Wall Street is that U.S. economic growth finally takes off in 2014, which will give the Fed the opportunity to taper.

But what if it doesn’t? Consider this: some believe the U.S. economy is actually entering a “late-cycle stage” “” in other words, the upward acceleration may not be coming.

“A growing number of indicators are showing late-cycle dynamics, and while this need not imply a recession it might well indicate a shift into a period of slower growth and lower inflation,” says Deutsche Bank global head of rates research Dominic Konstam.

“So much for animal spirits,” he writes in a recent note to clients:

.  .  .

Labor input is high relative to productivity, which typically predicts a sharply slower labor market 2 years ahead. In fact, simply conditioning on the relative gaps of labor input to productivity when it is negative predicts an almost stagnant labor market. In the absence of further fiscal or monetary stimulus, a lower household savings rate, or some combination of these, the implication is lower, not higher, rates.

“This is hardly a recipe for above trend growth,” says Konstam. “We note that recent trend real growth is less than 2%, so if inflation is stuck in the 1-1.5% range, then nominal growth is stuck closer to 3%, not 4%. In that environment, nominal yields become restrictive over 3% and become inhibitive to growth.”

There’s a reason NGDP growth slows “late-cycle.”  The Fed tightens monetary policy to cool an overheated economy.  Falling NGDP growth is tight money.  Tight money is falling NGDP growth.

But the economy is not overheated today.

As I said a few days ago, MOAR.

More reasons to ignore inflation

I frequently argue that inflation is a highly misleading variable, and should be dropped from macroeconomic analysis.  To replace it, we’d be better off looking at variables such as NGDP growth and nominal hourly wage rates.  Tyler Cowen found a paper by Coibion and Gorodnichenko that illustrates the problems with using inflation (although they reach very different conclusions.)  The paper starts off with a quote from Bob Hall:

Prior to the recent deep worldwide recession, macroeconomists of all schools took a negative relation between slack and declining inflation as an axiom. Few seem to have awakened to the recent experience as a contradiction to the axiom.” Bob Hall (2013)

Not my school!!  In my book on the Great Depression (which my publisher seems determined shall never see the light of day) I argue that the standard model is wrong, slack does not cause disinflation.  For instance, prices rose sharply after March 1933, despite the greatest level of slack in US history.  Rather falling NGDP causes slack, and is often associated with falling inflation.

Here’s what they discovered about inflation expectations:

Specifically, we show that an expectations-augmented Phillips curve, using household inflation expectations as measured by the Michigan Survey of Consumers, can account for the absence of strong disinflationary pressures since 2009. The primary reason for the success of a household inflation expectation-augmented Phillips curve is that household inflation expectations experienced a sharp rise starting in 2009, going from a low of 2.5% to around 4% in 2013, whereas other measures of inflation expectations such as those from financial markets or professional forecasters have hovered in the close neighborhood of 2% over the same period.

During the housing price collapse I had great fun talking to average people about inflation.  When they would point to rising gasoline and food prices, I pointed out that housing prices were plummeting, making houses much more affordable.  They always gave me a strange look; “but aren’t falling houses prices bad?”  That’s when it hit me; most people don’t know what inflation is.  They confused “cost of living” with “standard of living.” The phrases do sound similar.  I confirmed this by asking each of my classes “If all prices rise by 10%, and all incomes also rise by 10%, has the cost of living actually increased?”  Almost everyone gets it wrong.  And these are good students.  Try it with your class.

Just as I expected, Coibion and Gorodnichenko found that the public’s confusion was due to the fact that they focused on price increases from the supply-side, i.e. those that reduce living standards, not the demand-side:

We document that more than half of the historical differences in inflation forecasts between households and professionals can be accounted for by the level of oil prices. With oil prices having risen sharply since 2009, this provides a quantitatively successful explanation for the rise in household inflation expectations.

Here’s another problem with using inflation:

And to the extent that this rise in inflationary expectations may have prevented the onset of pernicious deflationary dynamics, the rise in oil prices should perhaps be interpreted as a lucky break for policymakers, generating the very rise in inflationary expectations which policymakers have only recently begun to push aggressively toward in the form of forward guidance.

This is a beautiful example of “never reason from a price change.”  Increases in inflation can be expansionary, but only if caused by more aggregate demand. That’s why you want to use NGDP growth, not inflation. Oil shocks don’t tend to raise NGDP, and hence aren’t expansionary.

Phillips did the original Phillips curve with wage inflation, and Paul Samuelson made a big mistake in switching over to price inflation.  The Coibion and Gorodnichenko study shows that price disinflation was far less than expected during the recent period of high unemployment, but the wage version of the Phillips curve works just fine:

As with the two other measures of wage inflation, we find that the slope of the wage Phillips curve appears to have been stable across the pre-Great Recession sample and that wage outcomes during the Great Recession period are fully in line with what the earlier historical experience would have led one to expect.

Macroeconomists need to start ignoring inflation (unless they are trying to compare living standards across time–a pretty hopeless enterprise.)  And they need to start focusing on the nominal aggregates that really matter, NGDP and nominal hourly wages.  It’s the W/NGDP ratio, stupid.  (And always has been.)

To end a drought, have everyone carry umbrellas

Michael Darda sent me the following email:

Ronald McKinnon in the WSJ today offers a good (sad?) example of how economists mix up cause and effect and give disastrous policy advise as a consequence. Yes, low rates are associated with weak growth, but it doesn’t stand to reason that they therefore are the cause of it. Moreover, if equilibrium rates are low, raising rates prematurely is quite unlikely to “spur faster growth” and would simply serve to depress the business cycle. Assuming the Fed both raised the IOER/Fed funds and kept QE going at its current pace, we would likely have a step up in money/safe asset demand relative to current and expected money supply (thus a further decline in velocity) and slower NGDP. Apparently McKinnon isn’t familiar with the ECB’s two rate hikes in 2011, which produced a two year double dip recession. Or Japan’s premature attempt to exit the ZLB in 2000 and 2006, which slowed NGDP and thus failed. Or the Fed’s error in 1937, which also precipitated recession and thus necessitated an even longer period of near zero short rates. On an A to F scale, this was an F.

Here is the WSJ story that Michael was commenting on:

Yet there is no doubt that the U.S. needs to break out of its near-zero interest-rate trap in order to avoid perpetual stagnation, where real returns on new investments are also driven toward zero. But is there an efficient way out of the trap that the Fed has set for itself? I believe there is.

The Fed can start by raising short-term interest rates, currently near zero, while leaving QE3 on hold.

Update:  Yikes, I had a nagging feeling I was plagiarizing someone.  (Andy Harless)

Makers and takers and data fakers

I notice lots of people claiming that more Americans are on welfare than working.  To say this data is misleading would be an understatement.  Consider an imaginary country of 300 million.  It is composed of 100 million families, each with 3 members.  Of that total, 74 million families are headed by a worker and 26 million families are on welfare.

Does that seem like a country where most people are on welfare?  Not to me.  But it seems that way to lots of other people, who point out that 26 million times 3 is 78 million.  So there are 78 million “people” getting benefits, and only 74 million “people” working.

Yes, and tell me again why I should care . . .

PS.  Speaking of misleading data, how about this headline by Matt Yglesias’s substitute:

Less Than 1 Percent Growth Is Somehow Good News for the U.K., Sort Of

Nowhere in the post does Sean Vitka mention that growth was at an annual rate of 3.2%.  Britain reports growth on a quarter-over-quarter basis.

Come back soon Matt.

On becoming a reactionary

So I see that despite the “Great Recession,” they have to pay blue collar workers $112,000/year to get them to get off their ass and go work in N. Dakota:

What has that brought to North Dakota?
Jobs, money, and people. The state now has the lowest unemployment rate in the country, at 3 percent. Its oil industry employs almost 41,000 people, plus 18,000 jobs in peripheral industries. For those working in the “Oil Patch” in the western part of the state, the average annual salary is $112,462. The only requirements to find work are a government-issued ID and a clean criminal record.

And I see that my school district is planning on tearing down perfectly good elementary schools and replacing them with new schools featuring air conditioning.

That’s right, schools not even open during late June, all of July, and all of August . . .

. . . In Massachusetts!

If you live long enough, and if you live in a society where living standards are advancing, you will eventually become a reactionary.  I don’t mean a right-winger, although that may come with it, but rather someone disgusted at how soft the newest generation has become.

I saw this happen to my dad, who was a life-long liberal Democrat.  I swore it wouldn’t happen to me.  But now I’ve become my dad.  I just found out from my daughter that the other kids at her school have iPhones. I suppose that’s no big deal, but it astounded me.

I used to let my knee-jerk reactionary tendencies affect my politics, but I’ve worked hard to overcome that problem.  Yes, the suffering from unemployment is nowhere near as bad as in the 1930s.  Yes, those “without healthcare” get better healthcare by walking into the ER than than Louis XVI had.  But there’s no reason why the way things used to be should have any bearing on how we live today.  The past is like a sunk cost, it’s irrelevant.

So when my daughter told me that in addition to a cafeteria, her new $200 million high school (which replaced a high school built in the 1970s) has a restaurant with sushi and cinnamon-apple tea, I just had to swallow hard and say “that’s nice.”

And the fact that the unemployed are not really like the 1930s version (which explains why Hollywood doesn’t even try to make films like the Grapes of Wrath anymore), is no reason to support a tight money policy.  Excess unemployment still causes suffering, and the world is better off without it.

Anyway, the world is for the young, old guys like me don’t matter.

PS.  You know those stories you hear from old people about how they had to walk 2 miles to school each day, through deep snow, in below zero temps (below minus 18 for you international readers)?  And the schools never ever closed, no matter how deep the snow?  Yup, that’s my childhood in Madison, WI.  Being a reactionary may be stupid, but it’s still very satisfying to talk about.

The internet now allows you to verify if your memories were correct.  I recall driving from Madison to New York in early 1982, leaving on a morning when it was 26 below zero (minus 33 C?)  The chill factor was minus 70. And there it is:

Screen Shot 2013-10-19 at 5.21.18 PM


Amazing.  And notice the mild summers–global warming really is happening.

PPS.  If the past is irrelevant, then we are equally irrelevant to the people living in 2113.  They don’t care what we think about morality, public policy, fashion, economics, or anything else.  It doesn’t matter what we “decide” about designer babies or anything else.  It’s their world.  They will view us with contempt.  Or with pity.  Get used to it.

PPPS.  I know an economist who had a tough upbringing.  Grew up in a trailer park, broken home, alcoholic dad, etc, etc.  He’s conservative.  What do I tell him about poverty to get him to change his mind about being a conservative? Do I tell him; “you just don’t understand what it’s like to grow up in a disadvantaged household?”  How well do you think that will work? Suppose that growing up he knew other poor kids who chose not to study hard.  Kids that were bullies.  How would that affect his worldview?  As a utilitarian I try to ignore all the emotional framing.  You want me to have my heartstrings pulled by some sad story of a poor person?  Fine, but then I’ll also let my friend’s story work on my emotions.  Which one will win out?

Or shall I try to blot out all the powerful emotional stories on both the left and the right?  Use reason and logic.  Declining marginal utility of consumption suggests we should do some redistribution, but the powerful effect of incentives on wealth creation suggests we need a quite inegalitarian society, even after we are done.

PPPPS.  Now I know I’m getting really out of touch:

The usually dull arena of highway planning has suddenly spawned intense debate and colorful alliances. Libertarians have joined environmental groups in lobbying to allow government to use the little boxes to keep track of the miles you drive, and possibly where you drive them “” then use the information to draw up a tax bill.