Archive for November 2018


Investment bleg

Here’s Paul Krugman:

The political payoff, of course, never arrived. And the economic results have been disappointing. True, we’ve had two quarters of fairly fast economic growth, but such growth spurts are fairly common — there was a substantially bigger spurt in 2014, and hardly anyone noticed. And this growth was driven largely by consumer spending and, surprise, government spending, which wasn’t what the tax cutters promised.

Meanwhile, there’s no sign of the vast investment boom the law’s backers promised. Corporations have used the tax cut’s proceeds largely to buy back their own stock rather than to add jobs and expand capacity.

He’s right about GDP growth in 2014, but I’m not seeing data to support his claims about investment. Am I misinterpreting the investment data?

[BTW, in early 2014 Krugman thought the elimination of extended unemployment benefits would hurt employment growth.  I thought it would help.  It helped a lot.]

The Fred data site reports that both total investment and business investment are rising at a pace of about 8% per year, which is roughly 6% in real terms.  Isn’t that consistent with the corporate tax cut helping?  And job growth has been stronger than many (including me) expected, given the low rate of unemployment.  Of course it’s nothing like the miracle Trump promised when he suggested the real unemployment rate was 20% to 40% (and I expect growth to slow next year), but that’s a separate question from the issue of whether the corporate tax cut helped the economy.  The data suggest it has, unless I’m missing something.  This graph shows growth rates for business investment:

Screen Shot 2018-11-22 at 1.30.16 PMPS.  Why is Trump trying to drive down oil prices?  In the second half of this post, I showed that high oil prices now tend to boost industrial production—mostly due to fracking.  Doesn’t Trump want more industrial production?  Look at investment growth in late 2015 and 2016, when oil prices were low.

PPS.  The criticism of the Trump tax cuts that people should be making relates to the budget deficit.  But many on the left have lost credibility on that issue, and hence they tend to keep quiet.

PPPS.  Happy Thanksgiving everyone!

Beckworth interviews Ozimek

David Beckworth recently interviewed Adam Ozimek for his podcast series, and the discussion focused on monetary policy.  Ozimek pointed out that not enough attention was being paid to the lessons to be learned from the past three years of Fed policy.  The Fed began raising rates in December 2015, and even Fed officials now admit that this was too soon.  Or do they?  That’s one of the issues they discussed.

Ozimek points to interviews with some top Fed policymakers who seem to agree that the natural rate of unemployment is considerably lower than what the Fed estimated back in 2015, and also that the stance of monetary policy back then was less accommodative than the Fed had assumed.  Ozimek wants them to draw the obvious implication from that fact—that policy was too contractionary in late 2015.  There’s really no other plausible interpretation of the statements he cites, but Fed officials don’t quite seem to come out and explicitly make that admission.  This relates to my recent Mercatus policy brief, where I call on Congress to insist that the Fed periodically evaluate previous policy decisions, based on incoming data.

I also tended to view Fed policy as being slightly too expansionary contractionary during 2015-16, although mostly based on their undershooting of the 2% inflation target.  Like the Fed, I underestimated the extent of the decline in the natural rate of unemployment (Ozimek and Beckworth were ahead of me on that point.)  So what implications can we draw from this episode?

1. I believe it’s important to put this policy error in perspective.  It was a consequential error, perhaps costing hundreds of thousands of jobs for a couple of years.  That’s hardly trivial.  At the same time, the error was an order of magnitude less damaging and an order of magnitude less inexcusable that the policy errors of 2008-15.  When figuring out what went wrong with monetary policy, we need to focus almost all our attention on the mistakes of 2008-15.  That’s the elephant in the room.

2.  This episode illustrates the danger of basing Fed policy on estimates of the natural rate of unemployment (Un).  The Fed cannot accurately estimate the natural rate in real time, and hence it’s an exceedingly poor guide to policymakers.  The lesson is not “next time do a better job estimating Un”, it’s “stop trying to estimate Un, and start focusing on variables than you can measure, like NGDP.”  Under NGDP level targeting, there is no need to even measure the unemployment rate—it plays no role in monetary policymaking.

Unfortunately, the Fed is forced to rely on natural rate estimates as long as it targets inflation under a dual mandate approach, as the unemployment rate helps it to determine how much “catch-up” they need to do after a policy miss.  One of the advantages of NGDPLT is that the Fed is no longer forced to try to do the impossible—estimate Un.

They also discussed some research Ozimek did on the relationship between population growth and inflation.  I have not read the research, but if I’m not mistaken the study found a positive correlation between growth in working age population and inflation, both cross sectionally and over time.  Ozimek hypothesizes that this may relate to the impact of population growth on real estate prices.

The cross sectional correlation makes sense to me.  Cities that are growing fast tend to have higher real estate prices than cities shrinking in population, such as Detroit.  The time series correlation is less intuitive. Inflation is determined by monetary policy.  It seems unlikely that the optimal monetary policy calls for higher inflation when population growth is more rapid.  So what’s going on?  My best guess is that the correlation somehow relates to the link between population growth and interest rates, or perhaps population growth and the natural rate of unemployment:

1.  Under the gold standard, price levels were positively correlated with nominal interest rates.  That’s because higher nominal interest rates boosted the opportunity cost of holding gold, which led to less demand for gold, which is inflationary under a gold standard.  Because the expected rate of inflation is roughly zero under a gold standard, anything that boosted the real interest rate, such as faster population growth, also boosted the nominal interest rate, and hence inflation.

2.  In Japan, shocks that reduce the real interest rate seem to be deflationary, as they reduce the opportunity cost of holding yen, thus boosting the demand for yen and the value of yen.  Lower population growth might reduce the real interest rate in Japan.  Of course the BOJ should offset this, but they often do not do so.  Interestingly, they seem to have done better since 2013, enough so that the inflation rate in Japan has risen slightly, even as growth in the working age population has fallen sharply.  Over longer periods of time, however, the inflation/population growth correlation in Japan supports Ozimek’s claim.

3.  Baby boomers started entering the labor force in the late 1960s.  By itself, that’s not inflationary at all, even if it boosted real estate prices.  Recall that real estate prices are a relative price, and relative price increases are not inflationary unless they reduce aggregate supply.  But faster population growth does not reduce AS.  So what explains the Great Inflation?  One factor may have been a misinterpretation of the Phillips Curve relationship.  The faster growth in the labor force (especially among the young and women), led to a rise in the natural rate of unemployment during the 1970s.  At the time, the Fed made exactly the opposite mistake as in 2015—they underestimated Un.  This caused monetary policy to be too expansionary, in a futile attempt at holding down the unemployment rate.  Just one more reason not to use monetary policy to target unemployment.

4.  Reverse causation.  If monetary policy is procyclical then inflation will also be procyclical.  In that case, rising inflation will be associated with growing RGDP.  It will also be associated with a rising population, as the boom draws in immigrants from places like Mexico.

Note that all four of these explanations are entirely ad hoc, so I wouldn’t necessarily expect the correlation between population growth and inflation to hold in the future, at least at the national level.  Basically any correlation one finds is evidence of sub-optimal monetary policy, just as the Phillips Curve relationship is evidence of suboptimal monetary policy.

Misconceptions about corporate welfare

There are many distortions in the US economy.  As a result, a decision by a corporation to move to a new area often has important spillover benefits.  Indeed this is also true of many individuals.  California would gain significant net benefits if Warren Buffett were to move here from Nebraska.  These are not good reasons, however, to oppose a national policy that discourages sweetheart deals that try to induce interstate migration.

Here’s an analogy.  The fact that Barry Bonds hit more home runs after using steroids is not a good argument against a major league ban on steroid use.  (There may be good arguments against such a ban–I’m agnostic.  But the effectiveness of steroids for individual players is not such an argument.)

Suppose that California collects $10 billion in revenue from corporate income taxes.  Also suppose that the optimal corporate tax rate is zero.  Now assume that California raises the tax rate on most corporations, in order to cut the rate on a favored few.  Revenue stays at $10 billion.  If you look at the select few beneficiaries in isolation, it might look like the subsidies make sense.  They may add net benefits to the state, even at the reduced tax rate.  But that ignores what Bastiat called “the unseen”.  The negative effect on non-favored companies.

New York may gain net benefits from attracting Amazon.  But how many firms will leave New York as a result of the higher taxes imposed on other companies, as a result of the subsidies provided to Amazon. In my view, states should compete for business and for individuals by offering an attractive economic climate for all people.

I do understand that other approaches are possible.  You could have state officials in California visit billionaires in New York, offering a 5-year income tax holidays if they moved west.  These billionaires would pay more in sales and property taxes than they’d use in public services. Meanwhile, New York officials could do the same.

Does this make sense from a national perspective?  It’s hard to see how—even if you think state income taxes are a bad idea.  For instance, this type of policy regime tends to encourage corruption.  Resources are wasted on the negotiations.  Individuals will game the system by moving around to earn tax holidays.  Companies will do the same.  Politicians are babes in the woods compared to big corporations—look how Wisconsin’s governor got taken to the cleaners by Foxconn.

Just say no.

To summarize:

1. When considering the benefits from attracting favored firms, one needs to consider the indirect effect on non-favored firms.

2. Even in the rare case where corporate sweetheart deals help a given state after accounting for the negative effect on other firms, it’s still probably in the national interest to a have a policy that discourages such deals.  As an analogy, even if monopsony power means that the optimal tariff for big countries is positive, it probably makes sense for the US and the Eurozone to sign a free trade agreement with zero tariffs.

Let’s adopt a policy of treating individuals equally, and also treating companies equally.  That policy is likely to be best in the long run, even if there are occasions where favoring a certain person or company might produce local benefits. Don’t underestimate the value of simple, clear and transparent tax regimes that treat everyone equally.


What can Congress do to improve monetary policy?

This past Friday I visited Capitol Hill, and spoke to staffers for three different senators and one congressman.  In my view, it is not appropriate for Congress to tell the Fed exactly how to do monetary policy—it’s better to set broad objectives.  Thus I do not think Congress should mandate NGDP targeting, although I favor having the Fed adopt that policy.  But I also believe that there needs to be more transparency and accountability in monetary policy.  I gave each staffer a Mercatus policy brief on my views in this area; here’s a short excerpt:

In this paper, I’ll propose an alternative approach to accountability and transparency, which I believe is both more useful and more politically acceptable. In this regime, the Fed would first set specific quantifiable goals, then conduct annual evaluations of past policy decisions. The Fed would then tell Congress whether, in retrospect, the previous year’s policy stance had been too expansionary or too contractionary, and it would also provide specific metrics to justify this appraisal. . . .


While previous proposals to “audit the Fed” have been fiercely resisted by the Fed leadership, this proposal for boosting transparency and accountability is likely to be uncontroversial, with appeal to both political parties. No institution can seriously argue that its performance leaves no room for improvement or that it cannot learn from past mistakes. Indeed, the proposal has several features that might actually be attractive to the Fed chair. First, it will help Congress to better understand the Fed’s motives when unusual policy steps are needed. Second, it will tend to unify the Fed’s own decision-making process. The Fed chair will be less likely to feel like a person “herding cats” with differing views on how to make the dual mandate operational.

Unlike other reform proposals, the Fed will retain its current level of independence under this proposal. It will continue to be free to decide how to interpret the meaning of its dual mandate, to decide which policy instrument settings are best able to implement its vision of the dual mandate, and it will also be given the discretion to decide for itself how to evaluate whether past policy settings were too expansionary or too contractionary. That’s an enormous amount of independence for such a key policymaking institution. As a result, it’s hard to imagine the Fed putting up much resistance to the proposal.

Read the whole thing.

PS.  There’s a “Straussian reading” of the proposal, which would be much more impactful than it might appear at first glance.

Saving regret

Suppose everyone were rational in their saving decisions.  Now assume that a social scientist decides to interview 10,000 people, to see if they regret how much they had saved when young.  Of this group, 8000 are old people who are still alive, 650 are in heaven, and 1350 are in hell.  The average person expresses no regret—they saved the right amount.  However, there is an interesting pattern.  On average, the 8000 living interviewees express regret for not saving more, while the 2000 who are dead express regret for saving too much when young.

This thought experiment may have some relevance to a study by Axel H. Börsch-Supan, Tabea Bucher-Koenen, Michael D. Hurd, and Susann Rohweddery, linked to by Tyler Cowen:

We define saving regret as the wish in hindsight to have saved more earlier in life. We measured saving regret and possible determinants in a survey of a probability sample of those aged 60-79. We investigate two main causes of saving regret: procrastination along with other psychological traits, and the role of shocks, both positive and negative. We find high levels of saving regret but relatively little of the variation is explained by procrastination and psychological factors. Shocks such as unemployment, health and divorce explain much more of the variation. The results have important implications for retirement saving policies.

This study excluded the dead population, and only interviewed those still living.  Further support for my “survivor bias” hypothesis comes from this finding, on page 29:

A third conclusion is that, by a number of self-assessed measures, a substantial percentage of respondents view their economic preparation to be adequate, yet they nonetheless express saving regret.

I’m unusual in having extremely strong saving regret in the other decision.  I strongly regret saving too much when young, and even when middle-aged.  (I’m now 63.)

Off topic, here’s the county where I live, and where Reagan said good Republicans go to die, in the two most recent elections:

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