Archive for September 2015


Abenomics after 2 1/2 years

[First a few notes.  An increasing number of comments are getting diverted to spam, where I have to fish them out.  But I won’t know this unless you tell me.  Try leaving a short comment alerting me if your longer one didn’t take.  No, I didn’t kill your comment because you disagree with me—never have. Also, I have a new post at Econlog discussing DeLong and Krugman on Friedman, and yesterday one on Andrew Sentance.]

When Abe took office I expected his policies to raise inflation and NGDP, but not as much as he hoped.  I expected his policies to help the labor market, but cautioned that a fairly low unemployment rate and rapidly falling labor force would limit the gains in RGDP.  I think I got all the big issues right, but missed on some of the components of RGDP.

Inflation figures have recently been whipsawed by both a big sales tax boost and then falling oil prices.  Assuming oil prices don’t fall much further, then when the dust settles next year I expect inflation to be about 1%.  But Abenomics has clearly raised the trend rate of inflation (which was negative under his predecessors.)

NGDP growth has not been all that impressive, until you compare it to NGDP over the previous 2 decades:

1994:1     495 trillion

2012:4    472  trillion  -4.6%

2015:2    500  trillion  +5.9%

Without the sales tax increase last year, I’d guess NGDP would have been up about 4.0% to 5.0%.  That’s a pretty slow rate of growth, less than 2%/year, but quite a turnaround from the previous 2 decades.  Even more impressive, Abe took office just as the boomers were hitting retirement age.  As a result the working age population is now falling much faster than during 1994-2012:

Screen Shot 2015-09-20 at 11.41.53 AMThe working age population is now plunging at 1.4% per year.  That fact alone makes the Japanese trend rate of RGDP growth about 2% lower than in the US, and the US trend rate is itself below 2%.  (The Fed recently reduced their trend rate estimate to 2%; they’ll have to reduce it further in the future.  BTW, with all of their talent it should not be possible for me to forecast which way they will miss, but I can do so, as can many others.)

Any success I had predicting Japanese RGDP growth was dumb luck, as it reflected two offsetting factors that I missed:

1.  Productivity has been horrible, worse than I expected

2.  The labor force has been flat, despite the 1.4% annual decline in working age population.  That’s better than I expected.

I suppose that second fact is mostly due to older Japanese working longer.  Abe has also been trying to boost immigration, and female labor force participation.  Perhaps that’s also played a role.  (Immigrants are currently 1.1% of the workforce.)

The unemployment rate has fallen to 3.3%, the lowest rate in 18 years.

Screen Shot 2015-09-20 at 11.51.08 AM

Many Keynesians thought the big sales tax increase last year would be a mistake, but unemployment continued to decline and total employment rose.  Another “austerity” prediction gone wrong.  (Is anyone still keeping track of these failures? I’ve lost count.) The so-called “recession” of 2014 consisted of Japanese shoppers splurging in March to beat the April 1 tax increase, and then cutting back after the tax increase.  Some Keynesians actually claimed that that showed fiscal policy matters.

Back when Japan had a higher unemployment rate, I emphasized that monetary stimulus could boost growth.  Now with low unemployment and a falling population, I think the strongest argument for faster NGDP growth is their huge public debt.

If the number of 15-64 year olds had remained constant since 1991, Japan’s GDP would now be more than 8% higher (see figure 8).

Demographic decline was not, however, anything like the biggest drag on nominal GDP. That honor belongs to Japan’s stubborn deflation. If prices had remained flat since 1991, Japan’s nominal GDP would now be 20% higher. If prices had instead risen by 2% a year, consistent with international norms of price stability, nominal GDP would be over 80% bigger.

An 80% bigger NGDP would have meant a big fall in the public debt/GDP ratio, even accounting for the fact that nominal interest rates (and hence budget deficits) might have been a bit higher.  Also recall, however, that faster NGDP growth would have meant at least slightly stronger RGDP growth, and also fewer wasteful Japanese fiscal projects such as bridges to nowhere.  Both of those factors would have reduced the deficit.

Why have Abe’s policies been viewed as a mixed bag?  Partly because the third arrow of supply side reforms haven’t had much effect, and hence real wages are still very weak. And while the sales tax increase is fiscally responsible, and necessary (since they can’t seem to cut spending), it’s obviously also painful.

Sanders and McGovern

In 1972, the nicest man to ever run for president lost 49 states to 1 to the least nice guy to ever run.  In retrospect, America probably would have been better off if McGovern had won.  Not because McGovern would have been a success—I think he would have failed—but America’s neoliberal revolution could have started a few years sooner. (Actually, anyone elected in 1972 would have failed.)

Matt Yglesias has a post comparing McGovern to Sanders, and I think in some ways it’s a good comparison.  In a later post, Yglesias discusses why the young are less allergic to the term ‘socialism’ than those of us old enough to recall how socialism failed in the 20th century.  It wasn’t cool to talk about socialism when Britain was an economic basket case in 1979, or when Russia’s economy was imploding in 1989.  Now that’s all forgotten and it’s cool to be socialist again.

(Except in Jeremy Corbyn’s favorite Latin American country.)

But I see one important difference between Sanders and McGovern.  Sanders has spent his whole life in the public sector, whereas McGovern went out and started a business later in life.  When McGovern learned what a nightmare it is to deal with government regulations, his views on economics shifted to the right.  This is from an editorial he wrote in 1992:

In retrospect, I wish I had known more about the hazards and difficulties of such a business, especially during a recession of the kind that hit New England just as I was acquiring the inn’s 43-year leasehold. I also wish that during the years I was in public office, I had had this firsthand experience about the difficulties business people face every day. That knowledge would have made me a better U.S. senator and a more understanding presidential contender.

Today we are much closer to a general acknowledgment that government must encourage business to expand and grow. Bill Clinton, Paul Tsongas, Bob Kerrey and others have, I believe, changed the debate of our party. We intuitively know that to create job opportunities we need entrepreneurs who will risk their capital against an expected payoff. Too often, however, public policy does not consider whether we are choking off those opportunities.

My own business perspective has been limited to that small hotel and restaurant in Stratford, Conn., with an especially difficult lease and a severe recession. But my business associates and I also lived with federal, state and local rules that were all passed with the objective of helping employees, protecting the environment, raising tax dollars for schools, protecting our customers from fire hazards, etc. While I never have doubted the worthiness of any of these goals, the concept that most often eludes legislators is: “Can we make consumers pay the higher prices for the increased operating costs that accompany public regulation and government reporting requirements with reams of red tape.” It is a simple concern that is nonetheless often ignored by legislators.

For example, the papers today are filled with stories about businesses dropping health coverage for employees. We provided a substantial package for our staff at the Stratford Inn. However, were we operating today, those costs would exceed $150,000 a year for health care on top of salaries and other benefits. There would have been no reasonable way for us to absorb or pass on these costs.

Some of the escalation in the cost of health care is attributed to patients suing doctors. While one cannot assess the merit of all these claims, I’ve also witnessed firsthand the explosion in blame-shifting and scapegoating for every negative experience in life.

Today, despite bankruptcy, we are still dealing with litigation from individuals who fell in or near our restaurant. Despite these injuries, not every misstep is the fault of someone else. Not every such incident should be viewed as a lawsuit instead of an unfortunate accident. And while the business owner may prevail in the end, the endless exposure to frivolous claims and high legal fees is frightening.

.  .  .

It is clear that some businesses have products that can be priced at almost any level. The price of raw materials (e.g., steel and glass) and life-saving drugs and medical care are not easily substituted by consumers.  .  .  .

In services, however, consumers do have a choice when faced with higher prices. You may have to stay in a hotel while on vacation, but you can stay fewer days. You can eat in restaurants fewer times per month, or forgo a number of services from car washes to shoeshines. Every such decision eventually results in job losses for someone. And often these are the people without the skills to help themselves — the people I’ve spent a lifetime trying to help.

[Insert $15 minimum wage discussion here]

In short, “one-size-fits-all” rules for business ignore the reality of the marketplace. And setting thresholds for regulatory guidelines at artificial levels — e.g., 50 employees or more, $500,000 in sales — takes no account of other realities, such as profit margins, labor intensive vs. capital intensive businesses, and local market economics.

The problem we face as legislators is: Where do we set the bar so that it is not too high to clear? I don’t have the answer. I do know that we need to start raising these questions more often.

Maybe Sanders should take some time out to run a bed and breakfast in Vermont.

HT:  Edward,  Travis

PS.  At Econlog I have a follow-up post to my “important issues” post, which suggests that Switzerland may do best.

PPS.  Don’t ya love it when leftists tell you that “actually Corbyn is not that extreme.”

1.  Wants the UK to exit NATO.

2.  Wants to impose rent controls.

3.  Wants to renationalize transportation, energy, etc.

4.  Doesn’t think the UK healthcare is socialist enough.  Ditto for education.

5.  Wants to give a “right to buy” to tenants.

6.  Thinks the Ukraine crisis was caused by the West.

7.  Loves Chavez.

8.  Wants to reverse Labour’s welfare cuts.

9.  Wants to try Tony Blair as a war criminal.

10.  Wants a “Peoples QE”, aka hyperinflation.

Those comments from the left don’t tell me much about Corbyn, but they are quite revealing as to the state of the left, circa 2015.  As long as you are at least slightly to the right of Pol Pot, you are in the mainstream.


Further thoughts on Thursday

I’ve seen a lot of interpretation of Thursday’s money supply announcement.  But it’s important not to overreach, just because we might find a particular theory attractive:

1.  The theory needs to be consistent with what we know about past reactions to Fed announcements.

2.  The theory needs to be consistent with the timing of the reaction.

3.  The theory needs to be consistent with the other market responses.

For instance, some argue that the market responded as if the Fed knew more than they do.  But that’s not the reaction we typically observe.  Why would that be the case this time, but not other times?  On the other hand I see why this theory is attractive, as the secondary (negative) reaction after 2:50 pm. does look like a response to bearish news about the economy—stocks, bond yields and the dollar all fell.  But I’m still reluctant to accept that interpretation unless someone can find a plausible explanation as to why the market would believe the Fed knew more this time, but not other times.  And also explain what new information about the Fed’s view of the economy came out after 2:50.

Here’s a graph showing the stock market reaction to the 2pm announcement:

Screen Shot 2015-09-19 at 9.56.41 AM
























I highlighted 2:35, which is about when the Yellen press conference began. Both the sharp (almost 1%) increase and the even bigger subsequent decline occurred during the press conference.  But I have trouble seeing what Yellen said that would have made markets more bullish around 2:40 made more bearish after 2:50.  Still, just because I don’t see it, doesn’t mean the market didn’t see something meaningful.  Despite my skepticism, I still think Yellen’s comments were the most plausible cause of the market swings.

If you look at the forex markets, you see an interesting pattern.  The commodity currencies like the Australian and Canadian dollars rose sharply on the announcement, and then even further when the US stock market rose sharply during the early part of Yellen’s talk.  Then both currencies immediately plunged almost all the way back down just a few minutes later, in tandem with the fall in US stocks.  Risk on, then off?  Here’s the Aussie dollar:

Screen Shot 2015-09-19 at 11.38.58 AM























In contrast, currencies like the euro and yen rose sharply and stayed higher for the rest of the day.  (Although the euro did fall the next day, but it’s hard to see how that relates to the Fed.)

You might wonder why I don’t just accept:

1.  It was already priced in.

But if that were true, why did other markets respond so strongly?

2.  The stock market didn’t much care either way.

That’s more plausible.  But stocks usually respond strongly to unexpected monetary policy announcements.

3.  Yes, the stock market usually cares, but with unemployment at 5.1% the market thought the risks were balanced in this case.

That’s an even better argument (and essentially what Tyler Cowen suggests).  But I still have this nagging feeling that stocks would have fallen on a .25% rate increase, partly because in the lead up to the announcement stocks often seemed to swing significantly on news about whether the Fed was going to raise rates—things like statements by key Fed officials.

Here’s an analogy.  A few months back US stocks were very volatile during the Greek crisis.  Suppose that on Monday the Greek government announced it had printed up currency in secret and was leaving the euro.  And suppose the US stock market did not react.  Wouldn’t you be surprised, even if you thought there was no valid reason for stocks to respond?  Even if you thought the stock market had been foolish to respond to the Greek crisis in July, wouldn’t you expect another response if they actually left the euro?

And finally, don’t forget that the other markets did provide useful information.  For instance, we know that the TIPS spreads remained quite low, which I believe supports Kocherlakota’s claim that we need a rate cut.  People laugh at how far behind Kocherlakota is on the dot graph, like the little boy that can’t keep up with his Boy Scout troop:

Screen Shot 2015-09-19 at 11.49.40 AM

Only 1% interest rates in 2017?  Yes, that’s probably too low, but it wouldn’t surprise me all that much if Kocherlakota had the last laugh.  His 1% forecast is certainly far more plausible than the official who predicts 4% in 2017.  Consider that Japan and probably even the eurozone are still going to be at zero in 2017.  How plausible is it that the US has 4% rates when the rest of the developed world is at zero? Especially given that we are growing at just over 2% in a period of rapidly falling unemployment, and the unemployment rate will stop falling by 2017, and hence RGDP growth will slow sharply from the current pathetic levels.  We might even have another recession, recall that America has never had an expansion that lasted 10 years.

PS.  Frederic Mishkin really hit the nail on the head.  I wish he were still on the FOMC.

The Fed’s wise decision

I thought yesterday’s policy announcement would offer a nice natural experiment, but instead it served up perhaps the most muddled stock market response I’ve ever seen.  Indecision, then a big move upwards, then an even bigger move downwards.

One problem is that it’s harder to interpret market responses when the more likely outcome occurs.  The response to “new information” will be much smaller.  But even so, there was some genuine uncertainty.  And if you look at other markets you could see a clear response.  Indeed it almost looks like Wall Street was hit by two shocks—easier than expected money, and then (an hour later) slower than expected RGDP growth.

I still believe a 1/4% rate increase would have reduced stock prices, but of course the response to yesterday’s announcement doesn’t really provide any support for that.  One alternative is that the announcement didn’t matter at all.  But then why did the other markets clearly respond?  Most likely, the various markets were hit by two shocks, easier money and weaker expected growth.  In the equity markets those two shocks worked as cross purposes, whereas in the bond and forex markets they both pushed in the same direction. Both shocks tended to depreciate the dollar and also reduce bond yields.

And it doesn’t even end there.  European markets plunged today, and the dollar regained the ground lost yesterday.  Go figure.

The only thing I have some confidence in saying is that it was a wise policy decision.  Even today the bond markets are clearly signaling the Fed will fall short of its inflation target; next year, next 10 years, next 30 years.  Money is still too tight, and Kocherlakota (who called for a rate cut) is the only one who got it right.  As usual, the VSPs laughed at him like he was your crazy uncle, hid away in the attic—the usual reaction when someone points out that the conventional opinion in monetary policy is wrong.

Although money is too tight to hit the Fed’s goals, it’s not necessary too tight for a well functioning US economy, and that also might help explain the muddled response.

Off topic, a commenter directed me to a very interesting podcast on Chinese data.  The five China data experts all seemed to think the Chinese data was not manipulated for political reasons, and that the statisticians in Beijing do the best job they can under difficult circumstances.  I learned that a lot of what you read in the press is misinformation.  For instance, this LA Times story on bad Chinese data is based on interviews with one of the people in the podcast, but totally mischaracterizes her views—making her seem much more of a China skeptic than she actually is.

Over at Econlog I have another post on Chinese data accuracy, for those who aren’t sick of the subject.  (I tried to inject some humor this time.)

And I highly recommend this Lars Christensen post, which discusses the echoes of the 1930s in the current political environment.

The problem with “existing store sales”

Quick follow up to my previous post.  Some commenters seem confused about the distinction between existing retailers and new retailers.  New retailers can have a dramatic impact on growth rates, even if a small part of the total.  For simplicity, assume that 94% of the Chinese retail sector is more than year old, and 6% is comprised of new brick and mortar retailers. (Many retailers in China are small family firms, and the country is urbanizing rapidly.)  Also assume that the growth rate of sales at existing brick and mortar retailers (plus those that closed down) is 0%. The growth rate of online is 33% and they comprise 15% of retail.  The new firms might not seem to be a big enough share of the market to dramatically impact the overall growth rate.  In fact, if new firms are 6% of the market, then their contribution to retail sales growth would also be 6%, as (by assumption) they were zero percent of the market one year earlier.

I’d guess that about 5% of China’s 11% retail growth is from online firms, another 6% from new firms, and essentially zero from existing firms.  (That’s based on information in a recent Tyler Cowen post that suggests existing retailer sales are flat.)

I’m sticking with my 6% RGDP forecast for 2016.

Off topic, suppose markets are OK with 1/8% but not 1/4%. How should they respond if this is the Fed’s strategy?

At VTB, global strategist Neil MacKinnon says a 1/8 percentage point increase — which would be the first such move since December 1986 — should be accompanied by a signal from Chair Janet Yellen that the Fed will act again in October if the initial shift has proved acceptable to markets.

And are all Cretans still liars?