Archive for July 2015


Is it time for the Fed to cut rates?

This is a rather shocking data point:

The ECI is widely viewed by policymakers and economists as

one of the better measures of labor market slack. It is also

considered a better predictor of core inflation.

Wages and salaries, which account for 70 percent of

employment costs rose 0.2 percent in the second quarter. They

had increased 0.7 percent in the first quarter.

Private sector wages and salaries also rose 0.2 percent

after gaining 0.7 percent in the prior quarter.

In the 12 months through June, labor costs rose 2.0 percent, the smallest 12-month increase since last year, and slipping further below the 3 percent threshold that economists say is needed to bring inflation closer to the Fed’s 2 percent medium-term target.

Is it the reason stocks rose a few minutes ago?  Nominal wages are probably the single best indicator of whether money is too easy or too tight.  It’s one that Janet Yellen pays a lot of attention to.  If the fed funds target was currently 3.75%, this data point might push the Fed to cut the target rate.  Should the IOR rate now be cut to zero, or even to negative 0.25%?

I’m not quite sure what the Fed should do, because I don’t know what they are trying to achieve.  But if you assume their goal is a labor market that is neither unusually loose or tight, and 2.0% PCE inflation, then the new wage numbers suggest a rate cut is probably appropriate.

PS.  It was the slowest reported wage hike since records began 33 years ago.

Don’t waste time looking for Ratex alternatives

Noah Smith has a new post discussing the current fad of looking for alternatives to the rational expectations model.  The motivation seems to be that we need to explain the collapse of bubble expectations and the rise in the propensity to save (although not actual saving?) during the 2008 recession.  I understand why people want to do this, but it would be a very big mistake.

I’ve always thought that it was patently obvious that the Fed caused the Great Recession with a tight money policy that allowed NGDP expectations to collapse in late 2008. But other people apparently don’t see it as being at all obvious.  They look for alternative explanations.  And yet when you ask them why, they tend to give these really lame “concrete steppes” explanations, such as, “The Fed didn’t raise interest rates on the eve of the Great Recession, so how can you claim that tight money caused the recession?”  Or they show themselves to be completely ignorant of actual Fed policy, and claim that the fed funds target was at zero when NGDP expectations collapsed in 2008.  It wasn’t.

Fortunately, neither of those apply to the ECB, which had positive target interest rates throughout 2007-2012, and which took “concrete steppes” in both 2008 and 2011, tightening money and triggering not one but two plunges in NGDP growth, which led to two recessions.  If there has ever been a more perfect example of the monetary policy/AS/AD model that we teach in our textbooks, I’d like to see it. (OK, maybe 1929-32.) And yet last time I did one of these rants almost no economists were blaming the ECB’s tight money policy for the double dip recession.

Now, I’m seeing progress.  I’m seeing more and more mainstream economists accept the MM claim that the monetary tightening of 2011 caused the second dip in Europe.  In a few more years economists will realize that the ECB tightening of 2008 (which was also “concrete”) caused the 2008 recession as well.

Then economists may begin to notice that the 2008-09 recession in the US was oddly similar to the eurozone recession, which was clearly caused by tight money. The only (minor) difference was that in the US it was “passive tightening”, if the fed funds rate is your preferred policy indicator.

A few economists don’t buy the “nominal shocks have real effects due to sticky wages and prices” model of demand side business cycles.  I don’t agree with them, but it’s fine if people like John Cochrane don’t accept my claim that the ECB didn’t caused the eurozone depression. But as for the rest, the overwhelming majority who think nominal shocks do matter, I’m mystified.  Take the AS/AD model that you see in McConnell, Mankiw, Krugman, Cowen and Tabarrok, Hubbard, or any of the other textbooks.  Why do we even teach this model if confronted with an almost perfect example of a depression caused by tight money, we simply don’t believe it?

Update: John Cochrane informed me that I mischaracterized his views.  He does believe that nominal shocks have real effects, and that wage and price stickiness do exist.  Mea culpa.

I was inspired to do this post by an excellent recent paper on the eurozone depression, by David Beckworth.

HT: Gordon


Letter to the NYT, etc.

My posting will be relatively infrequent for the next couple of weeks. I just returned from DC, where I finally got a chance to meet John Cochrane.  He’s taken a position at the Hoover Institute.  Although we disagree on sticky wages, we have uncannily similar views on a wide range of other issues, such as immigration, health care reform and financial system reform.  I also got a chance to meet quite a few of the Mercatus scholars, and came away very impressed with the organization.

[BTW, the acronym for the new monetary program is POMP (Program on Monetary Policy.)  My enemies are thinking, “I always knew Sumner was a pompous ass.”  Or perhaps “pomp” indicates that it will eventually be regarded as the queen of the monetary policy programs.]

Over at Econlog I have a post on Krugman’s recent minimum wage column. Caroline Baum (you’ve probably seen her columns at Bloomberg, and elsewhere) responded to the column with a letter to the NYT.  They didn’t print it, so I thought it would be a good idea to post it here.  The rest of the column is her letter.  I request that commenters be more polite than usual.  I don’t mind obnoxious comments, but let’s please treat her as a guest—if you disagree, do so respectfully:

To the Editor:

In his July 15 op-ed, “Liberals and Wages,” Paul Krugman states definitively: “There’s just no evidence that raising the minimum wage costs jobs, at least when the starting point is as low as it is in modern America.” In support of his no-evidence conclusion, he cites a widely discredited 1994 study by economists David Card and Alan B. Krueger.

So flawed was the study – it relied on telephone surveys of fast food restaurants in neighboring counties in New Jersey and Pennsylvania after New Jersey raised its minimum wage – that Card and Krueger were forced to redo it. Using official employment data the second time around instead of a telephone survey, they re-published their findings in 2000, claiming similar results to the first study.

Economists who have reviewed the body of literature on the effect of an increase in the minimum wage have criticized both the methodology and the results of the second Card/Krueger study. David Neumark and William Wascher, both widely respected for their work in the field, cite the vastly different patterns of teenage employment in the two states that pre-dated the study, disqualifying Pennsylvania as a good “control” group. They also find that the depressing effect of a minimum wage hike on employment occurs with a lag, not within Card/Krueger’s short-term time frame. (Neumark and Wascher’s study can be found here:

What’s more, unlike a randomized controlled trial for a new drug, Card and Krueger have no way of measuring what would have happened to fast-food employment in New Jersey absent a minimum wage increase.

It is disingenuous for Mr. Krugman to ignore the wide body of evidence demonstrating that an increase in the minimum wage deprives entry-level workers of an opportunity to enter the workforce. Instead he relies on the findings of an outlier study that contradicts basic economic theory. An increase in the price of any good or service, including labor, results in a decrease in demand for it.

No one will argue with Mr. Krugman’s point that paying workers a higher wage and providing good benefits increases employee loyalty. Businesses choose to do it all the time. Henry Ford didn’t double his workers wages to $5 a day in 1914 because he wanted them to buy Model T’s. He paid his workers more because he wanted to reduce turnover on the assembly line, which proved to be a hard, unappealing line of work.

When the government mandates a floor on wages, many low-margin businesses can’t absorb the higher costs and raise their prices. Even high-margin businesses pass the cost along to their customers.

The New York Times does a disservice to its readers when it allows a Nobel prize winning economist to dissemble to make a political point. Progressive economists may argue in favor of a minimum wage on compassionate grounds, but they all understand the economics of supply and demand. The non-partisan Congressional Budget Office reported last year that raising the federal minimum wage to $10.10 an hour from the current $7.25 would eliminate 500,000 jobs nationwide. (Currently 29 states have minimum wages higher than $7.25.)

And yes, a higher minimum wage is great for those who keep their jobs. But it’s an impediment to those starting out in the workforce.

Mr. Krugman is entitled to his own opinion; after all he writes opinion pieces. But he is not entitled to his own facts. As an opinion writer myself for three decades, my work is always fact-checked for accuracy. Perhaps the Times should make accuracy in support of opinions a priority.

Caroline Baum

West Tisbury, Mass.

Government and culture

Matt Yglesias:

My view is that the biggest relevance of Southern Europe to the United States is the current high social prestige enjoyed by the twin ideas that the social responsibility of a corporation is to be profitable and that the primary moral and legal obligation of a corporate manager is to enrich shareholders. These ideas combine to create a toxic moral climate that is undermining the social context in which a successful market economy can flourish.

In a healthy society, a business leader might invest time and resources in rent-seeking but he wouldn’t brag about doing so and certainly he might choose to take the honorable path and not do it. But the current paradigm in the implicit US political philosophy is that he has a moral obligation to divert resources away from R&D and toward lobbying if the ROI on lobbying is higher. It says he has a moral obligation to find ways to trick customers into overpaying if he can find them. It says he has a moral obligation to violate regulations if the Net Present Value of paying the fines when you are caught exceeds the cost of compliance.

In other words, it replicates Banfield’s amoral familism but with shareholders replacing the nuclear family as the local of ethical thinking.

This is all further exacerbated by the ideas of Public Choice Economics which tend to move from (correctly) asserting that government institutions’ performance is often undermined to some extent by the self-interest of government officials to a kind of perverse fatalism which suggests that wholly selfish and inept behavior is all that is possible from public institutions.

I once talked to an investment banker from northern Europe who was surprised at how much money American banks spent on lobbying.  His bank did didn’t even have a lobbying department.  I suppose you can think about that in one of two ways. Banking regulation in his country was probably far less complex than in the US, and so there was less need for lobbyists. Or perhaps the culture was less corrupt than in America—which is itself a less corrupt than average culture, by global standards (at least if you believe survey data, and/or ratings like Transparency international.) So which is it?

My hunch is that it’s both.  More importantly, I think the two interact.  Bad culture producing bad governance, and bad governance produces bad culture.  And by “bad governance” I mean complex regulations, which push firms away from wealth creation and towards rent seeking.  I’ve talking talked to more than one businessman who straight out told me that his business was regulatory arbitrage in the financial sector.  They made money by talking taking advantage of poorly designed regulations. Over time, that surely must have a negative effect on culture. Lobbyists would try to get even more government regulation, to open up more rent-seeking opportunities.

Off topic, also over at there is an article on whether you should drive with one foot or two feet.  Over at Econlog I have a new post that mentions my daughter getting a learners permit.  The Vox article suggests that driving with two feet is safer, if you drive an automatic transmission car.  That’s actually the way I’ve always driven, and it feels safer to me.  But I was told that mine was the wrong way, and hence I was planning on teaching my daughter the “right way.” Now I don’t know what to do.  Any thoughts?  Keep in mind that’s it’s extremely unlikely that my daughter would every drive a manual transmission car.  Like 1000 to 1 against, even if she learned to drive the standard way.  (My Italian readers are requested not to reply to this question; I already know what you are going to say.)

PS.  When they ask how much you’ve given to charity, how come they never ask about the auto insurance we are forced to buy?  I’ve contributed maybe $20,000, and (knock on wood) never pulled out a cent (except when a branch fell on my car.)  I’m subsidizing the horrible Boston drivers—why isn’t that charity?

HT:  TravisV

Germany doesn’t benefit from a weak euro

The past week it’s been open season on Germany.  Even I have occasionally bashed them for their views on monetary policy.  In a way this is odd, because in many respects Germany has been (since 1945) almost like a model country.  Other countries should try to be more like Germany.  It’s also odd because Germany’s views are completely typical of the eurozone–so why single out that one country?  Yes, France and Italy are a bit more moderate, but the other 15 are just as upset with Greece as is Germany.

Ben Bernanke recently made some comments on Germany and the eurozone:

Since the global financial crisis, economic outcomes in the euro zone have been deeply disappointing. The failure of European economic policy has two, closely related, aspects: (1) the weak performance of the euro zone as a whole; and (2) the highly asymmetric outcomes among countries within the euro zone. The poor overall performance is illustrated by Figure 1 below, which shows the euro area unemployment rate since 2007, with the U.S. unemployment rate shown for comparison. . . .

In late 2009 and early 2010 unemployment rates in Europe and the United States were roughly equal, at about 10 percent of the labor force. Today the unemployment rate in the United States is 5.3 percent, while the unemployment rate in the euro zone is more than 11 percent. . . .

The slow recovery from the crisis of the euro zone as a whole is the result, among other factors, of (1) political resistance that delayed by many years the implementation of sufficiently aggressive monetary policies by the European Central Bank; (2) excessively tight fiscal policies, especially in countries like Germany that have some amount of “fiscal space” and thus no immediate need to tighten their belts; and (3) delays in taking the necessary steps, analogous to the banking “stress tests” in the United States in the spring of 2009, to restore confidence in the banking system.

So far this is very similar to my views, except the part about fiscal policy.  But here’s where Bernanke loses me:

What about the strength of the German economy (and a few others) relative to the rest of the euro zone, as illustrated by Figure 2? As I discussed in an earlier post, Germany has benefited from having a currency, the euro, with an international value that is significantly weaker than a hypothetical German-only currency would be. Germany’s membership in the euro area has thus proved a major boost to German exports, relative to what they would be with an independent currency.

I see this argument a lot, but it makes no sense on either theoretical or empirical grounds.  Over at Econlog I have a post showing that northern European countries not in the euro have just as big current account surpluses as Germany.  And by the way, even on theoretical grounds joining the euro should not matter at all, if Europe had previously had a fixed exchange rate system.  So I’ll give Bernanke the benefit of the doubt and assume that it’s the fixed exchange rate regime that he thinks actually benefits Germany, not the euro itself.  Let’s also put aside the question of why Bernanke thinks a current account surplus “benefits” a country—that’s not standard economics.  Indeed by that logic Australia would be suffering from its large chronic CA deficits.  The CA surplus is simply domestic saving minus domestic investment; it’s not clear why we should care about it.

There is one way to test Bernanke’s claim.  A country with an undervalued currency will see its real exchange rate appreciate through inflation.  Recall that in the long run monetary policy only affects the nominal exchange rate, the real exchange rate is determined by the fundamentals driving saving and investment.

The counterargument is that prices are sticky, and hence it may take a while for the real exchange rate to reach equilibrium.  Yes, but even so, if this were occurring then you’d see high inflation in Germany during the adjustment process.  Here’s the actual inflation rate in Germany:

Screen Shot 2015-07-18 at 12.41.08 PM

It seems to me that Bernanke’s claim might apply to the early 1990s.  At that time Germany was booming, partly due to the rebuilding involved with re-unification, and the ERM tied Germany to weaker economies like Britain and Sweden.  At that time, the DM was undervalued, and instead of a rise in the nominal exchange rate (prevented by the ERM), inflation rose sharply higher, raising the real exchange rate.

Today German inflation is merely 0.3%, not what you’d expect if the euro were undervalued in Germany.  Indeed I see little evidence of an undervalued currency in Germany since 1995.  Let’s review:

1.  Bernanke’s claim is not consistent with mainstream macro theory, at least in the long run.

2.  Bernanke’s claim is not consistent with the fact that other northern European countries that still have their own currencies also have huge CA surpluses.  Why wouldn’t a Germany with the DM be like Sweden and Switzerland? (I leave out Norway, whose CA surplus may be bolstered by oil.)

3.  And Bernanke’s claim is not consistent with the very low and falling inflation rate in Germany.  If the euro were undervalued in Germany, inflation would be high and rising.