Some responses to the responses to my “4-economic mistakes” piece.

July 22nd, 2019 at 8:54 am

I got lots of interesting feedback on a piece I wrote for Vox about long-held but empirically wrong assumptions in some key areas of economics, assumptions that have been asymmetrically harmful. That is, their costs consistently fall on those with low- and moderate incomes and their benefits help the wealthy.

Some argued that I didn’t go far enough. Dean Baker, a friend and frequent co-author, argued that I pulled punches regarding globalization, which “…was designed to hurt workers. We could have had globalization where we reduced IP barriers and trade in professional services (e.g. doctors).” (Baker explores such themes in his book Rigged, a close, older cousin of themes in my Vox piece.) Various respondents added other harmful policies supported by bad economics, such as Kevin Drum’s reference to supply-side tax cuts.

But the main complaint was that I was too blaming of economists, not all of whom promote these wrong ideas, and that I conflated economists and policy makers. In fact, I explicitly tried not make that conflation in the piece, which starts with arguably the most important economic official in the world, Fed chair Jerome Powell (a lawyer, not an economist, but still…), agreeing that estimates of the “natural rate” of unemployment have been too high.

On globalization, I emphasize that trade theory itself is very clear that expanded trade generates winners and losers, and explicitly tagged policymakers:

“But the theory never said expanded trade would be win-win for all. Instead, it (and its more contemporary extensions) explicitly said that expanded trade generates winners and losers, and that the latter would be our blue-collar production workers exposed to international competition. True, the theory maintained (correctly in my view) that the benefits to the winners were large enough to offset the costs to the losers and still come out ahead. But as trade between nations expanded, policymakers quickly forgot about the need to compensate for the losses.”

But I also want to be careful to not be overly exonerating. In trade debates in the 1990s, as any Economic Policy Institute veteran will tell you, pure win-win arguments, like the one I pulled out of the 1994 Economic Report of the President, dominated among economists. EPI’s arguments that elevated the plight of those hurt by trade were treated as heresy, and not just by politicians trying to pass NAFTA, but by economists. Just ask EPIers like Rob Scott, Thea Lee, and Larry Mishel, who have the scars to prove it.

On the minimum wage, I personally recall debates with economists—and such debates persist to this day (though I readily grant that there are now fewer of them)—that essentially argue “if you raise the price of something, people will buy less of it, full stop.” As Robert Cherry reveals in this survey of older textbooks, the notion that increases in minimum wages could help low-wage workers was, as I said, treated as akin to believing that water flowed uphill.

Also, the piece stressed the point that prominent, powerfully placed economists were motivated by “crowd-out” arguments in the pretty recent past.

To underscore a theme that maybe didn’t come across strongly enough, excellent, evidence-based work is throwing off many of these old chains. The piece was again explicit about the important minimum-wage analysis by economists to test the assumption that increases mostly harm their intended beneficiaries (I mention the late Alan Krueger, as he was a trailblazer, but he was far from alone). There’s been similarly important work on the folly of budget austerity, like the renown Blanchard analysis I review here. So, while I understand where my fellow econo-travelers would take umbrage (justifiably provoked by some of the writing), the point is not that every economist always makes these mistakes. It’s that these mistakes were, and in some cases, still are, made with high frequency, and at great cost. There’s even a credible argument that the denial of trade’s downsides helped elect Trump, especially when you consider how the geography of the electoral college intersects with the people and places most hurt by expanded, imbalanced trade.

Something else I didn’t emphasize enough is that none of these relationships is etched in stone. The Phillips Curve could steepen (i.e., the negative correlation between unemployment and inflation could revive); excessive public borrowing could push up interest rates; it’s of course possible to set the minimum wage too high. The key economic point of the piece is that these, and every other asserted relationship in economics, must constantly be empirically evaluated. (The “constantly” is important. Elasticities change over time.)

The key political point is that the first-order assumptions I challenge invariably support capital over labor, and that this power bias is a big reason such bad economics persist, even in the face of better economics.

Finally, a few people asked what we should do in the four areas upon which I focused. I’ve written reams about that and don’t have the patience to dig up links. But on estimates of the too-high natural rate, the key is to be evidence-based, as was/is the practice of the Yellen/Powell Fed. Absent price/wage pressures, realized and expected, it’s hard to make a convincing case that actual unemployment is below the “natural rate.” On globalization, I’ve written tons on ideas to help, some of which I tick off in the piece. On austerity, see the link above re the Blanchard piece re good debt, bad debt. On the minimum wage…raise it!

Here’s a simple way to tell if someone (like the Nat’ Restaurant Assoc.) is abusing numbers to mislead.

July 19th, 2019 at 7:44 am

One sure way to tell in someone is making a biased argument is showing up in various statements by those who oppose the proposal to raise the minimum wage. I wanted to be sure to elevate this dastardly ploy, as it’s a tell that someone is trying to win an argument based on their bias, not on the evidence.

Here’s a tweet from the National Restaurant Association, a group that’s honor bound to oppose the minimum wage, and here’s the same ploy from a Texas Republican member of Congress. In both cases, they exclusively characterize the CBO’s job loss estimate from the agency’s recent minimum wage report as “as many as 3.7 million.”

Now, if you’ve been following the debate over the CBO’s findings, you’ve probably heard the number of jobs lost cited as 1.3 million, not 3.7 million. Here’s how the budget agency summarized their results (my bold).

In an average week in 2025, the $15 option would boost the wages of 17 million workers who would otherwise earn less than $15 per hour. Another 10 million workers otherwise earning slightly more than $15 per hour might see their wages rise as well. But 1.3 million other workers would become jobless, according to CBO’s median estimate. There is a two-thirds chance that the change in employment would be between about zero and a decrease of 3.7 million workers. The number of people with annual income below the poverty threshold in 2025 would fall by 1.3 million.

Put aside the benefit-cost argument as to whether the gains to 27 million are worth pursuing given the estimated median loss to 1.3 million (I get into that here). My point here regards the practice of exclusively citing the upper bound.

First, it’s not wrong. The “as many as” phrasing is the correct way to characterize the upper bound. But it is clearly biased. It would be equally correct—and equally biased—to say the CBO found “as few as zero workers would lose their jobs from the increase.”

Economic estimates like this are highly uncertain and CBO gets extra credit for being explicit about the range. The more of that, the better (see, for example, the top figure on page 4 here where CBO gives us the range of possible outcomes for their long-term debt/GDP forecast). But publishing a range clearly offers ripe fruit to cherry pickers.

The moral of this little tale is simple. When someone—and it will almost always be an advocate for a position supported by their funders—uses exclusively the “as many as” frame, without giving the central estimate and the range, you can be sure they’re all about winning the argument and not about seriously considering the evidence. As such, they should be summarily ignored by anyone honestly trying to figure out what’s actually going on.

No question, the unemployment rate paints an incomplete picture…and yet…

July 15th, 2019 at 9:34 am

It’s long been understood by anyone trying to assess the labor market that the unemployment rate is, by itself, not up to the task. Most importantly, it leaves out those not looking for work, but it’s also not adjusted for demographic change, nor does it factor in those who are working fewer hours than they’d like. It combines racial groups with persistently different levels of unemployment. At times like now, these shortcomings can lead this premiere indicator to underestimate the extent of slack in the job market.

This WSJ article from yesterday–“For decoding labor market, unemployment rate may not do the job”–is but the latest salvo in this healthy discussion about the need for a dashboard, not a single dial.

And yet, most of us, when trying to provide a quick overview of economic conditions, still cite the top-line rate, a practice I’d like to defend here, with at least moderate conviction, based on the correlation matrix below. The  data run from 1994 through now, and the variables are the u-6 underemployment rate, the prime-age employment rate, the Richmond Fed’s non-employment index, both with and w/out those involuntary part-timers, and the black unemployment rate.

Sources: BLS, Richmond Fed

As you see, if we’re comparing levels, the unemployment rate correlates highly–close to unity in most cases–with the other variables in the table. Even the non-employment index, “an alternative to the standard unemployment rate that includes all non-employed individuals and accounts for persistent differences in their labor market attachment,” correlates with unemployment at 0.99.

Of course, we don’t just look at levels. We also pay a lot of attention to changes in these variables, and, as is always the case, change correlations are a lot lower than level correlations. We also see some interesting variation. When it comes to both prime-age epops and the black unemployment rate, changes carry different information relative to the topline jobless rate than do the levels. For African-Americans, this is due to their “high-Beta” relationship with the overall rate: a one-point change in unemployment correlates with a 1.5 change in the black rate. That’s a great elasticity to tap in high-pressure labor markets, and a hugely negative one in recessions.

Feel free to add other variables to the comparison, of course, as this is surely an incomplete list. And let me be unequivocal about the need for a dashboard of indicators, including very importantly, “price” variables like wage and price growth (see the subhead of the WSJ piece: “wage growth has been muted and inflation weak, leading economists to come up with new measures of joblessness”). The fact of moderate-at-best wage growth in recent months is one of the main reasons I suspect there’s still some slack in the U.S. job market, even at 3.7 percent unemployment.

But we shouldn’t be ashamed to cite the unemployment rate as a key indicator of labor market health. There’s no single, perfectly informative measure, but the good news is that all the imperfect ones are pretty highly correlated.

Judy Shelton and her sponsor—President Trump—want to tie the hands of the Fed

July 10th, 2019 at 7:31 am

When someone seeking confirmation to high office has a paper trail fraught with positions antithetical to their confirmation, their theme song quickly becomes Shaggy’s It Wasn’t Me, as they flip and flop to disavow their earlier convictions.

The most recent purveyor of this strategy is Judy Shelton, one of President Trump’s most recent likely nominees for the Federal Reserve. Ms. Shelton, who worked on Trump’s campaign and transition team, currently holds a Senate-confirmed position as the U.S. representative to the European Bank for Reconstruction and Development.

After reviewing her writings and comparing them with what she’s saying in her current campaign to get the Fed job, I’m convinced that her appointment would be extremely problematic for at least two reasons. One, she would try to undermine the flexibility that’s so important to today’s monetary policy, and two, she’d give the president a voice inside of the Fed, compromising the essential independence of the central bank.

This judgement stems in part from the extent to which Ms. Shelton is trying to remake herself into an easy-money dove in the president’s image, or at least his image since he’s taken office. Before that, both Trump and Shelton lambasted the Fed for helping Obama by holding interest rates down (in fact, the Fed was fighting the recession and initially weak recovery). Now, of course, he wants them to cut rates to help him.

And contrary to everything she’s stood for in the past, Ms. Shelton agrees with him.

To understand the real Ms. Shelton, as opposed to her current incarnation, you need to understand why Larry Kudlow, one of Trump’s top economic advisors, called her “a leading hard money conservative.” “Hard money,” in this context, refers to wresting control of economic policy away from institutions like the Fed and linking the value of money to a fixed base, most typically gold. And, in fact, Ms. Shelton has not only called for the U.S. to go back on the gold standard, but for the world to do so.

What’s wrong with that? Gold bugs like Ms. Shelton maintain a religious—as opposed to an empirical—belief that linking currency to gold will lead to less inflation and more stable economic outcomes. But history teaches the opposite, which is really common sense. When currencies were tied to gold, the supply of the benchmark metal was neither stable, predictable, nor able to grow with populations and demands for greater economic activity.

That didn’t suppress inflation, it just made it more volatile. Same with growth and financial stability, both of which were much rockier when the gold standard ruled.

A key reason for that record is that being locked to the gold standard (or any such fixed regime) results in an inability of policy makers to respond to shocks. For economies across the globe, this has long been understood to be a bug and a major rationale for standing up an independent central bank. But for Ms. Shelton, such inflexibility is a feature.

Or, at least, it was. Now she’s mimicking Trump and is impersonating a monetary dove, calling for the Fed to aggressively cut interest rates (and doing so from the lobby of the Trump Hotel). Still, if you look carefully, you can see a hawk in dove’s feathers.

This gets a little technical, but it’s worth unpacking. In her newfound drive for easy money (low interest rates), Ms. Shelton has called for the Fed to stop paying interest on “excess reserves” held by its member banks. To stimulate lending during the Great Recession, the Fed loaned banks a lot more money than in the past (this is often described as the Fed “expanding their balance sheet”). Now, as the Fed slowly unwinds all this borrowing, it either pays interest on these reserves or it loses control of its benchmark interest rate. Were the central bank not to pay interest on these reserves, member banks would compete with each other to lend them out at ever lower rates until the target rate hit zero.

This decline in lending rates would please Ms. Shelton’s sponsor (Trump) to no end. But the next thing that would happen is that to regain control of their funds rate, the Fed would have to quickly get those excess reserves off their books. That means taking a lot money out of the banking system, and quickly. Such tightening would push the other way from Ms. Shelton’s scheme, raising rates.

In other words, in making a play for low rates, Ms. Shelton’s plan would deliver higher rates. At this point, I have no idea what she really wants. All I know is that she’s incoherent.

That said, there’s a theme to this plan that’s consistent with her previously held views, and it’s a way in which both Ms. Shelton and Trump want the same thing: to tie the hands of the Fed. Whether it’s her old gold standard or her new opposition to the way the Fed controls its funds rate, my foremost concern about her nomination is that Ms. Shelton will be Trump’s agent inside the bank and will do his bidding regardless of what the real economy needs.

And of this you can be sure: history is littered with economies that were brought to their knees because the central bank came under the thumb of a politician.

To be clear, Ms. Shelton is an accomplished economist and a provocative writer. But she also an actor, a political actor trying to get a part, one for which she’s uniquely unqualified.

Why a Fed rate cut makes sense

July 9th, 2019 at 2:33 pm

[written with Mark Zandi, chief economist of Moody’s Analytics]

This is a post about one-quarter of one percent.

That’s the amount by which the Federal Reserve is expected to reduce the federal funds rate, the key interest rate they control, when they meet at the end of this month. If that sounds like too small a change to get worked up about, we assure you, Fed rate changes can be a big deal, especially when they change direction. The central bank had been steadily raising rates over the past several years, and only just a few months ago was predicting further rate increases this year and next.

The decision to cut rates has become a bit more complicated, as last week’s solid jobs report weakened the case for the cut. Why add interest-rate stimulus to an economy that’s already going strong?

Moreover, this month, the current economic expansion—meaning the time between the end of the last recession and the start of the next one—became the longest on record. Based on growth rates compared to past downturns, it has been more long than strong, but the unemployment rate has been hovering near 50-year lows, and the combination of abundant job creation, low inflation, and better wages have powered that ever-acquisitive creature, the American consumer. Given that our GDP is 70 percent consumer spending—in Europe, it’s 55 percent; in China, it’s 40 percent—the strong labor market can go a long way toward sustaining the expansion.

So, again, why cut rates?

First, for all the July fireworks around last week’s strong job gains (224,000 jobs created, compared to 72,000 the month before), the job market is slowing. The monthly data are noisy, so to get at the underlying trend, you’ve got to average out the noise. Over the first half of this year, employers have added about 170,000 jobs per month. That’s a healthy clip, no doubt, but last year the monthly gain was 235,000.

This slowdown could intensify, courtesy of President Trump’s trade war. While the President has ostensibly agreed to a truce in the war with China – freezing the current tariffs and relaxing restrictions on the Chinese tech-company Huawei – this will do little to reduce the uncertainty and resulting angst of American companies doing business with the rest of the world. In fact, the usual pattern has been periods of truce followed by more chaos, demands, threats, and, in some cases, actions in the form of more or higher tariffs.

This pattern has left businesses demonstrably nervous. Moody’s Analytics measure of global business confidence is as weak as it has been since the economy began to recover from the financial crisis a decade ago. Similarly, businesses’ expectations as to how well they think they’ll be doing later this year have slid to where they were just prior to the financial crisis. Two-thirds of respondents to Duke University’s quarterly survey of company CFOs say a recession is likely by the end of 2020; Morgan Stanley’s business conditions index, designed to capture turning points in the economy, suffered its largest one-month decline on record in May.

As you might expect, such sentiments tend to correspond to weak investment plans. Despite the tax cuts corporations got beginning last year, and contrary to the predictions of advocates for those cuts, investment has flat lined over the past year.

If these sentiments and weak investment behavior persist, eventually businesses will cut back on their hiring. If so, and unemployment rises, even a little bit, and even from very low levels, recession becomes a real possibility. That’s because those consumers powering the economy will quickly sense the weakening job market and turn more cautious in their spending. Businesses will see this and pull-back further on jobs. The virtuous economic cycle that characterizes the economy today, will turn into a vicious one.

A one-quarter percent Fed rate cut at their late July meeting can help forestall this possibility. A small cut is a way by which monetary policy takes out an insurance policy against the impact of the trade war, or any of a litany of other threats from Brexit to another government shutdown.

What’s the argument against a rate cut? It’s that the labor market is already at or near full employment and any extra stimulus might push unemployment down even further, risking overheating and higher inflation.

But even if the aforementioned pressures fade and the expansion continues apace, the Fed has plenty of time and firepower to respond to price pressures. Inflation is low, arguably too low. The Fed wants inflation to hover around 2 percent per year. It’s fine for price growth to be a bit below this target some of the time, but only if it is also above the target other times, so that it averages out to be 2 percent over time. But since the last recession, inflation has never sustainably reached the target, and this undershoot is starting to show up in people’s expectations about the future course of price growth. If these diminished expectations get cemented, it could take a long time to get inflation back on track. Just ask the Japanese, as they’ve been trying for several decades.

No one know when the next recession will occur. But we are confident that growth is slowing, and there are serious threats, mostly of our own making, to the expansion. This warrants a rate cut when the Fed meets in a few weeks.