Archive for July 2019


Is it becoming more difficult to raise inflation?

The short answer is no. So why does the WSJ suggest otherwise?

One reason the Federal Reserve is likely to cut interest rates this week is that inflation is running below its 2% target. New research shows why getting it higher has proved so difficult: many of the prices consumers pay don’t respond to the strength or weakness of the economy. . . .

Recent studies have shown prices in some sectors—such as housing—do indeed rise faster when growth is in full swing, unemployment low and markets frothy. But a large chunk of the economy, from health care to durable goods, appears insensitive to rising or falling demand.

That’s the sticky price argument.  If only it were true.  Imagine if the Fed could raise demand at 8% or 10%/year, and yet inflation stayed close to 2%.  Living standards would soar.

Later, the WSJ switches from the sticky price argument to the fast productivity growth argument:

Federal policies such as restraint on Medicare and Medicaid payments to hospitals and doctors and increased approvals of generic drugs have ended a decades long trend of rapid health-care inflation.

Growth in the power and speed of computer processors has pushed down prices for most electronics and slowed inflation in services like telecommunications and photo processing. The fracking revolution, enabled by sensors and software that allow energy companies to better locate hydrocarbons, has kept oil and natural-gas prices in check throughout the expansion.

In fact, productivity growth since 2004 has been slow.

So that doesn’t explain the low rates of inflation.  What does?

Monetary policy has produced NGDP growth of roughly 4%/ year since 2009, and RGDP growth has average slightly above 2%.  That’s why inflation has averaged slightly below 2%.  If you want slightly higher inflation, then create slightly higher growth in demand, aka NGDP.  Adopt a more expansionary monetary policy. It’s that simple.

Why America is losing the trade war with China

Gordon Chang has a new piece in the WSJ that can only be described as slightly hysterical:

Yet for more than a decade, President Xi has been dropping audacious hints that China is the world’s only sovereign state.

Tyler Cowen provides another example, from the same article:

From the WSJ Op-Ed:

“Mr. Trump is the only thing that stands between us and a world dominated by China.”

From the author’s bio:

“Mr. Chang is author of “The Coming Collapse of China.””

The Amazon reviews of Chang’s book don’t sound promising:

Be aware that this book was written 20 years ago, is over priced, and everything it predicts would happen has not happened.

I have not read the book, but I do know that China did not collapse after the book was published in 2001. So at least the title is wrong.

If we are counting on Trump to stop China, then we are in big trouble:

President Donald Trump said China may wait until after the 2020 U.S. presidential election to sign a trade agreement because Beijing would prefer to reach a deal with a Democrat.

“I think that China will probably say, ‘let’s wait,’” Trump told reporters in the Oval Office on Friday.

The Chinese have basically been told that Trump’s willing to wait until after the 2020 election. China now has no incentive to negotiate with a US President that the betting markets indicate has only a 50% chance of being re-elected.

I’ve been arguing that China’s in a much stronger negotiating position than has been widely assumed, and now that claim seems to be confirmed by events. Trump is worried about being re-elected in 2020, while Xi’s position is secure. Trump’s advisors are telling him that an all out trade war with China risks pushing the US into a recession (and stock market crash) right before the election. Xi has no more incentive to negotiate with Trump than does North Korea’s Kim Jong Un:

Trump is letting Kim Jong Un do almost anything he wants

Trump’s defenders will insist that the trade war is a sideshow, and the actual goal is to force China to become more like a western country. In fact, the trade war is doing the exact opposite:

Within China, President Xi Jinping has successfully portrayed the trade war as a US attempt to inflict national humiliation. His faction within the Communist party gains legitimacy by not going soft on the US.

The faction of economic liberals has been largely silenced. This group is represented by the princelings and elites, many of them educated in the US, who fostered China’s integration into the global system over the past three decades under former Chinese premier Zhu Rongji, and his protégé vice-president Wang Qishan.

This is what happens when we elect someone with no knowledge of foreign affairs. Trump’s trade war with China may end up being an even worse disaster than Bush’s ill-fated adventure in Iraq. Let’s hope the Dems win in 2020. They are also skeptical of China, but they aren’t likely to choose advisors who are fanatically obsessed with humiliating the world’s largest economy.

PS. I hope I’m wrong and that a trade deal is signed very soon. But the signs are not good.

PPS. We currently live in a world dominated by the US. That has produced some very good things since 1945, but it is an increasingly ugly sight.

Trump’s policies after 2.5 years

The second quarter RGDP growth came in at 2.1%, slightly above estimates. But there’s also some bad news in the report:

But the GDP data released on Friday included revisions to earlier years that showed the US economy was not as strong as previously thought. Last year, the US economy grew at a pace of 2.5 per cent, rather than the 3 per cent rate that the commerce department had previously reported.

Don’t look for any Trump tweets correcting his previous claims.

Over the past 2 1/2 years, RGDP growth has averaged 2.64%, slightly above the 2.2% of the previous 7 1/2 years.  Thus you might argue that Trump’s supply-side policies boosted annual growth by 0.44%, adding roughly an extra 1.1% to RGDP over 2.5 years.

There are two other factors to consider:

1. Growth might normally be expected to be faster in the early years of an expansion, as there are lots of unemployed workers to draw on.  (Recall 1983-84)  That makes recent growth look better.

2.  Monetary policy has become more stimulative over the past 2.5 years, as NGDP growth accelerated from 3.8% to 4.77%.  That makes recent growth look worse.

In my view, these two factors roughly offset, so I’ll stick with the claim that Trump’s policies boosted the current level of RGDP by a total of roughly 1.1%.

I am on record claiming the tax cuts would boost growth by a total of about 2% over 10 years, with most of the increase front-loaded.  Thus the outcome so far is consistent with my forecast.  It’s fun to be right!!

I’ve also been claiming that 1.5% is the new normal for trend RGDP.  Growth in RGDP has averaged 1.68% over the past 12 years, but I believe the trend rate is now lower due to the ongoing retirement of boomers.

PS.  At a recent cabinet meeting, Trump officials discussed Peter Navarro’s proposal to weaken the dollar via capital controls.  Fortunately, calmer heads prevailed.  But what if Trump is re-elected?  How will he be restrained when advisors can no longer use the argument that rash actions risk his re-election prospects?  Here’s Politico:

Trump’s ‘don’t screw it up’ caucus keeps winning

The president, for now, is listening to advisers telling him to keep his cool on trade, spending and the Fed — at least through November 2020.

Meanwhile the Dems seem intent on committing suicide.  Polls show that Biden is the only one who can beat Trump in key Rust Belt states like Ohio, and yet the party seems to be moving toward candidates who want to eliminate private health insurance policies.  Easy pickings for a demagogue.  I predict that Biden will win if nominated, but I also predict he won’t be nominated and that Trump will be re-elected.  The betting markets are swinging this way.

Then we get to see what Trump will do when the shackles are taken off.  And you think the recent tweets are racist!

PPS.  Even a loser Democrat will beat Trump by about 4 million in the popular vote, so the Dems can at least have the consolation of a moral victory.  They would have won in 2020 if we were a democracy.  And it could be worse.  Boris Johnson was just elected leader of the UK with fewer than 100,000 total votes in a country of 66 million.  Not a margin of 100,000, I’m taking about total votes.   I don’t speak Greek, so I’ll call the UK a “grouchy old white guy-ocracy”

PPPS.  This is the only good article I’ve seen on the Mueller hearings:

Actually, Robert Mueller Was Awesome

History will show that he had one big goal, and nailed it.

Putting NGDP into macro models

David Beckworth directed me to a new paper by Roger Farmer and  Giovanni Nicolò, recently published in The Manchester School.

They develop a different type of Keynesian model, which replaces the Phillips curve with an equation describing NGDP growth expectations:

In contrast to the NK-Phillips curve, the third equation of the FM-model is a belief function. Following Farmer (1993, 2012), the functional form for the belief function that we use in this study is described by Equation (3.b),

(3.b) Et [xt+1] = γxt + (1 − γ)Et−1 [xt ] ,

where xt ≡ πt+(yt − yt−1) is the growth rate of nominal GDP. The belief function is a mapping from current and past observable variables to probability distributions over future economic variables and the functional form that we chose for the belief function, captured by Equation (3.b), asserts that agents’ expectations about future nominal GDP growth are adaptive. When we estimated the model, we found that the data strongly favour the parameter restriction, γ = 1 and in Section V we report the estimates of the FM-model under this restriction. When we incorporate this restriction into the belief function, our model implies that beliefs about future nominal income growth are equal to current nominal income growth. By modeling beliefs about future nominal income growth as a new fundamental we resolve both dynamic and static indeterminacy.

Their model does still use the other two standard NK equations:

The FM- and the NK-models that we estimate in our empirical work have two equations in common. One of these is a generalization of the NK IS curve that arises from the Euler equation of a representative agent. The other is a policy rule that describes how the Fed sets the fed funds rate.

This is great, but my dream model would go even further, eliminating interest rates, inflation and real GDP.  I would replace interest rates with market NGDP growth expectations from an NGDP futures market.  If that market did not exist, then I’d have the central bank estimate NGDP expectations using other market prices.  For simplicity, I’ll assume an NGDP futures market does exist.

NGDP growth expectations would be determined by the monetary policy regime.  An expansionary monetary policy would raise expected future NGDP.  This is what Keynes presumably meant by an increase in “animal spirits”.  The increase in NGDP expectations, aka animal spirits, would cause an increase in current NGDP.  Another equation would link unexpected moves in current NGDP with employment, because nominal wages are sticky in the short run.

The central bank’s dual mandate would be stable growth in NGDP and employment close to the natural rate.  Both goals would be achieved via stable growth in NGDP (i.e. a “divine coincidence”).  And that stable growth in NGDP would be achieved by pegging a NGDP futures contract price at a level where market participants expected stable growth in actual NGDP.

There would be no circularity problem, as the market would be predicting the instrument (monetary base) setting that led to on target NGDP growth.  The central bank would not be responding to changes in NGDP futures prices.

PS.  Josh Hendrickson has a great discussion of the problems with using the Phillips curve in this twitter thread.

China’s best friend?

I’m not sure what’s funnier, Trump’s claim that China’s 6.2% GDP growth shows his trade war is working, or his belief that the Chinese government’s GDP data is not fake news. (I don’t believe it is fake news; I just find it funny that Trump is one of the tiny number of pundits who (like me) trusts the Chinese government’s figures.)

In fact, China’s RGDP growth has been slowing gradually for a decade, just as I predicted, and over the next 5 years it will slow some more, to roughly 5%/year. Nothing has changed.

If anything, Trump’s trade tweets might be helping China:

But Helfenbein does not see retail companies leaving China anytime soon.

“The administration is sending us a signal, they would like us to vacate China. That’s the signal we get, but then they’re also blocking all the roads out,” he said. “You look at the places that we would go, number one is Vietnam, number two is India, number three is Indonesia, Bangladesh, and Mexico. All have been under some sort of threat. So what are my retailers doing now? They’re starting to throw their hands up in the air and say maybe I’ll just tough it out in China.” . . .

Vietnam saw U.S. imports jump 36% this year, according to U.S. Census Bureau. But just last month, Trump threatened Vietnam with tariffs, telling local media that the country is “almost the single worst abuser of everybody.”

Of course Trump’s attacks on Vietnam are just as silly as his attacks on China, but when you are a politician who believes that “bilateral trade deficits” actually mean something, then any country with a trade surplus with us is at risk.

I’m increasingly inclined to believe that Trump is China’s best friend. Xi has recently hardened his stance on the trade negotiations, even as Trump has been furiously backpeddling on Huawei and other issues:

In a meeting with his Chinese counterpart at the g20 summit in Osaka he agreed to extend trade negotiations with China—but only after making concessions, including the reversal of his decision to blacklist Huawei, a Chinese telecoms firm his administration accuses of spying. President Xi Jinping also adopted a less conciliatory public tone than he had before the two leaders’ previous meeting, last year in Argentina. The prospects of a substantial China settlement appear remote. Mr Trump’s subsequently arranged trip to meet Kim Jong Un on the front-line between the two Koreas looked like an effort to divert attention from this climb-down.

Perhaps the Chinese now believe that they have more leverage than the US, something I’ve been suggesting for quite some time.

Even worse for Trump, his group of rapid rabid nationalists don’t seem to know what they want. One group has been demanding that China open its capital markets to the rest of the world, while others are demanding exactly the opposite:

On July 2nd the prime minister, Li Keqiang, said that foreign investors would be allowed to take full ownership of investment banks and insurers in China from 2020, a year earlier than previously promised. Over the past two decades they have been limited to minority shares, and only last year were they permitted 51% stakes. . . .

Meanwhile the trade war looms over all. Some hawks in America want to sever financial ties with China. Marco Rubio, a Republican senator, has challenged MSCI over its inclusion of Chinese shares, accusing it of helping authoritarians. A headhunter in Hong Kong reports that American fund managers slowed their hiring after trade talks between China and America broke down in May. With talks set to resume, they can breathe a sigh of relief—for now. The worry is that, just as China clears away some of the obstacles in their path, America will replace them with new ones.

If we must have a nationalist president, let’s at least give thanks that we have such an incompetent one.  I shudder at the thought of a President Rubio.

PS.  Don Boudreaux has an excellent piece explaining why China’s so-called “IP theft” does not justify US tariffs.