Trade, trickle down, and the Fed: Revisiting three points from the big debate

September 28th, 2016 at 6:00 am

Before the first presidential debate fades into the next news cycle, there are three economic points that bear revisiting:

We need a new paradigm for trade policy. The outsider campaigns of Trump and Sanders, along with the realities of many people and communities hurt by globalization, have elevated international trade as a major issue in this election. Trump advertises an unrealistic nostalgia, a return to a time when trade flows were a fraction of their current size. His word salad on the issue the other night underscores the fact that there is no coherent plan to get back there even if we wanted to. Clinton correctly points out that “we are 5 percent of the world’s population; we have to trade with the other 95 percent.” She aspires to reshape, not restrain, globalization.

What’s needed is a framework for the type of “smart, fair trade deals” that Clinton says should be the norm. Yes, that framework should include enforceable disciplines against other countries’ currency management, something both candidates support. But much more is needed.

Trade expert Lori Wallach and I just published our proposals in this space, which include both process reforms and new negotiating objectives.  Our ideas, if adopted, would increase the transparency of trade negotiations, reduce corporate influence over the eventual agreements, discontinue protectionist practices and provisions that put sovereign laws and taxpayer dollars at risk, and strengthen environmental, health, and labor standards both here and abroad.

Trickle-down economics still doesn’t work. Trump bragged that his “tax cut is the biggest since Ronald Reagan” and asserted that “[i]t will create tremendous numbers of new jobs.” To say the least, the empirical record belies that assertion, as I and others have often noted.  The graph below shows that, on the individual side of the tax code, there is no historical correlation between the United States’ top marginal tax rate and employment growth, a far different relationship than you’d expect to see if claims like Trump’s were correct.

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On the corporate side of the code, tax expert Bill Gale and his colleagues summarize that “there is virtually no evidence that broad-based [corporate] tax cuts have had a positive effect on [economic] growth…That has been amply demonstrated at the national level, where tax cuts have eroded revenue without discernable effect on economic activity.”

One of the most striking and recent real-world rebuttals to the narrative Trump continues to push comes from Kansas, where one of his top advisors made similarly rosy predictions about a massive tax cut that “have proved strikingly inaccurate.”

As I’ve said before, if facts could kill trickle-down propaganda, it would have died long ago. The one thing I can say is that, while it does seem to be the case that such tax plans may buy some votes from their beneficiaries, the rest of the electorate doesn’t buy it, and there are fortunately a lot more people in the latter group.

Federal Reserve policy matters and deserves discussion during election season. As I recently wrote, Trump’s comments about the Fed’s decision-making were completely wrong.  But the fact that the Fed came up in the debate was a positive; “there’s no reason such an important public institution – one with such a large impact on people’s lives – should be off limits in political debates.”  It was also great to see some discussion of the Fed during the Democratic primary, when both Bernie Sanders and Clinton indicated support for making the nation’s largest bank more representative of the general population.

There’s much beyond these points that matters to the economy, of course, and last night’s debate didn’t even mention several issues that affect millions of people and which the next president absolutely must address: poverty, health care, and immigration, to name a few.  But if we can get our trade policy right, debunk trickle-down tax nonsense once and for all, and inject progressive monetary policy discussions into the political debate, we’ll be introducing a lot more substance than I dared to hope for in an election season that’s been a touch devoid of such matters.

Anatomy of a hawkish dove

September 26th, 2016 at 6:00 am

Eric Rosengren, the President of the Boston Federal Reserve Bank, was one of three dissenting votes in the Fed’s decision last week not to raise the benchmark interest rate they control. Since Rosengren has a pretty dovish record—he’s not one to see spiraling inflation around every corner, when the data say otherwise—his dissent was surprising and interesting.

Perhaps for that reason, he took the somewhat unusual step of explaining his vote in a note posted on the Boston Fed’s website. I’ve pasted in excerpts of his explanation (in italics), followed by my own annotations. I didn’t want to pass up this opportunity to argue with a thoughtful guy about a big decision.

ER: Since the most recent increase in the target for the federal funds rate last December, the economy has made further progress toward achieving the Federal Reserve’s dual mandate (maximum sustainable employment and stable prices). The labor market continued to improve as the U.S. economy added over 1.4 million jobs so far this year. Given these improvements in labor markets, wages have risen gradually – wage growth is now above the roughly 2 percent level that it seemed stubbornly “stuck” at, earlier. The growth rate of core PCE inflation has risen modestly, to 1.6 percent.

JB: All true, but let me add some color. First, ER leaves out a very important point here: the Fed’s “stable price” target is 2 percent, and they’ve missed that on the downside every single month for four years running. Moreover, the metric he cites has come in at 1.6 percent every month this year except one when it was 1.7 percent. In other words, no sign at all of acceleration, even as the job market has tightened and, as ER correctly notes, wage growth has picked up a bit.

But Fed officials must worry not just about actual inflation, but inflationary expectations, right? Well, according to the Cleveland Fed, “[Our] latest estimate of 10-year expected inflation is 1.72 percent. In other words, the public currently expects the inflation rate to be less than 2 percent on average over the next decade.”

As far as employment’s concerned, ER’s right again that jobs are up about 1.4 million so far this year, an annualized growth rate of 1.5 percent. But last year at this time they were up 1.7 million, an annual growth rate of 1.9 percent. Again, no acceleration.

In other words, hard to see what there is in the data ER cites that would explain his dissent.

ER: This progress has occurred despite significant headwinds from abroad, including a slowdown in China’s economy, a surprising “Brexit” vote, and continued problems in some European banking organizations.

JB: True dat. We’ve got a highly resilient economy (though our exposure to Brexit was never much, and while it’s still early–the UK is still in the EU–predictions of a Brexit slump for the UK have not come to pass).

But the relevant question here is: how does slower growth abroad feed into monetary policy? With low interest rates everywhere else, even a small rise in the Fed’s rate can pull in capital from abroad seeking safe haven in dollar-denominated investments. This further strengthens the dollar, which in turn pushes back on inflation (more target-missing) and boosts the trade deficit. The key point is that an unwarranted rate hike can serve as a conduit through which weaknesses abroad can enter the U.S. economy.

ER: The economic progress since the last tightening in December might, by itself, be sufficient to justify a further increase in the rate target. However, it is in considering the implications of current policy for the sustainability of the expansion that the case for raising rates has now become even more compelling.

JB: OK, this is the first thing he says that completely loses me: “We raised rates a little and things look basically fine, so hey, let’s keep going.” I get that this is just a short note which leaves out a lot of ER’s thinking, but that’s just not analysis. Surely, in the age of Yellen and a data-driven Fed, what’s “sufficient to justify a further increase” must be some evidence of pressure building, of overheating. This is especially germane when you consider that the recovery is just now beginning to reach middle- and low-income families who’ve heretofore been left behind. (FTR, last time I visited the Boston Fed, I learned about some great projects that Rosengren and his staff were running in less advantaged communities, so this inequality problem is well known to him.)

ER: Federal Reserve staff forecasts, like those of the bulk of private forecasters, see the labor market tightening considerably over the next three years – and this is the case even assuming more rate increases than are currently anticipated by market participants and reflected in market rates. By 2019, I expect the unemployment rate to have declined below 4.5 percent. While I have a long track record of advocating for policy that supports robust labor market conditions, that is below the rate that I believe is sustainable in the long run.

JB: It’s been widely observed that the vast majority of forecasts, especially for GDP and interest rates, have been too optimistic in recent years (see figure here for an example of what I’m talking about). But put that aside, as it’s a good bet that the labor market continues to tighten (especially if the Fed keeps their feet off the brakes!).

Where ER goes seriously wrong here, at least IMHO (and he’s got a big staff and big brains behind him, so I’m willing to be corrected), is in his confidence that he can identify the “natural rate” of unemployment: the lowest unemployment rate consistent with stable prices.

As I show here, citing work by President Obama’s CEA, these days the confidence interval, or margin of error, around natural rate estimates runs from around zero to about 6 percent. Earlier work from top macro-statisticians identified a similar problem, and that work was done before the decline in correlation between unemployment and inflation (the model from which the natural rate calculation derives), which further widens the confidence interval.

ER’s claim about his advocacy record is true and admirable, but I’d strongly urge more humility here about economists’ ability to accurately predict the impact of falling unemployment on inflation. No question, there’s evidence that this relationship is alive and well, but given the uncertainty, the responsible analytic position right now is to be far more data-driven than model-driven. Such caution is especially warranted given the asymmetric risk scenario recently outlined by Fed governor Lael Brainard (the risks of weaker demand are greater than those of accelerating price growth).

ER: Unemployment this low may well have the desirable effect of bringing more workers into the labor force – but, unfortunately, only temporarily. Historical experience suggests it also risks overheating the economy, the effects of which include heightened pressure on inflation and potentially increasing financial-market imbalances.

JB: No, it doesn’t, at least not always (“historical experience suggests…”). I was paying close attention back in the 1990s, when many economists believed the “natural rate” was 6 percent. Chairman Greenspan, to his credit, thought otherwise, and as the rate fell to 5 and then 4 percent, he convinced the committee to hold their fire. The benefits of the 1990s expansion finally began to show up big-time in the real wages and incomes of low- and middle-income families, and here’s the kicker: inflation did not, I repeat, did not, accelerate anything like the models predicted it would.

Granted, key to these dynamics was Greenspan’s recognition that the 1990s acceleration in productivity growth could pay for non-inflationary wage gains (i.e., stable unit labor costs). Today, productivity growth is worryingly slow. But it’s also the case that recent research shows little evidence of wage growth bleeding into price growth, so again, uncertainty, in tandem with the data on actual and expected inflation, should yield caution.

Finally, ER writes:

My goal is to achieve a long and durable recovery – a sustainable expansion. For the reasons articulated above, I believe a significant overshoot of the full employment level could shorten, rather than lengthen, the duration of this recovery.

JB: I’m totally with you, dude, and for all my critiques, you may be right and I may be wrong. Also, a small brake-tap (a 25 basis point rate hike) is not likely to do a lot of harm to the macroeconomy, though its impact is amplified among the least advantaged (e.g., black unemployment takes a disproportionate hit).

Still, the unfortunate, though interesting, truth is that we are at a point wherein our understanding of critical, basic macroeconomic relationships—the unemployment/inflation tradeoff, the natural rate of unemployment, wage/price dynamics, the neutral rate of interest, the best target for monetary policy—is uniquely weak. Combine that reality with the fact that the benefits of growth are just now reaching lower- and middle-income households, and, along with the facts I muster above, you get my argument for erring on the side of caution.

The new rules of the road: a progressive approach to globalization.

September 23rd, 2016 at 3:45 pm

For the last few months, Lori Wallach (the director of Public Citizen’s Global Trade Watch) and I have been working on what we think of as new “rules of the road” for global trade. I’ve highlighted some of these ideas already in these parts, and a recent summary of our agenda just ran in The American Prospect; here’s a link to the full white paper.

The intro to the white paper (below) explains our motivation, but it’s really very simple. Like everything else, trade and globalization have upsides and downsides. They create winners and losers. They boost the supply chain of goods and services, holding down price growth, but that also shows up as real wage stagnation and job losses for significant groups of workers.

Unfortunately, both the trade debate and trade negotiations have long been co-opted by multinational corporate interests at the expense of workers and consumers both here and abroad. Fortunately, this election season has finally elevated that reality. The days when elites, both here and elsewhere, could ignore those who perceive themselves as hurt (on net) by globalization are hopefully gone, if not for good, than for a number of years.

That leaves a hole. Trump fills it with nostalgia for a period when America was less exposed to global trade, immigrant flows, and non-whites. Such nostalgia may appeal to certain voters, but that America isn’t coming back (nor, for the record, would I want it to). What should fill the gap? Read on:

The emergence of trade as a top election issue shows that the economic and social costs imposed by our current trade policy model have reached a tipping point. For purveyors of the status quo, this is a crisis, as the inherent inequities in their approach to trade have finally surfaced. For those of us who have long recognized such inequities, the current moment presents an opportunity to craft a new model, a new set of “rules of the road.” Far from trying to set back the clock on globalization, it is only through this new, far more inclusive, non-corporate-centric approach that we can rebuild American support for expanded trade.

This will not occur by continuing to assert that, despite their experiences, those who perceive themselves and their communities as having been hurt by exposure to the forces of globalization are just plain wrong. Or that the next trade agreement will be the one that fixes everything. Or by offering the increasingly large portion of the population who find themselves on the losing side of the current rules some temporary adjustment assistance.

It will only change if we change the content of our trade agreements and, in turn, the process by which we negotiate them. The “new rules of the road” must reflect the economic realities and needs of a much broader group of stakeholders. Crucially, to achieve such rules will require much greater transparency and inclusiveness in the policymaking process, helping to ensure that the resulting substantive rules represent the needs of the majority. This memo focuses on the substantive and procedural changes needed to realize these goals.

Globalization will surely proceed apace. Neither Donald Trump, Brexit voters, nor anyone else can put that toothpaste back in the tube. Nor should they. It is through expanded trade that we seek new markets for U.S. products, expand the supply of goods and services, and provide emerging countries with opportunities to grow by trading with wealthy countries.

But trade and contemporary free trade agreements (FTAs) are far from synonymous. The recent U.S. International Trade Commission (ITC) report on the “likely impacts” of the Trans-Pacific Partnership (TPP) underscores that these agreements are not mainly about cutting tariffs to expand trade nor about jobs, growth, and incomes here in the United States. Rather, they’re about setting expansive rules that determine who wins and who loses.

For years, those advocating for the “winners” that have been able to capture the negotiating process essentially said to those hurt by the resulting agreements: “Don’t worry, this will be great for you too. And, hey, if it isn’t, we will make it all better with adjustment assistance and some training.” The hollowness of these false promises is finally evident to the broad electorate. The rules must be written for all the cars on the road, not just the Lamborghinis.

Our new framework starts from the premise that the current “trade” agreement process has been co-opted by corporate interests whose goal is to establish binding, enforceable global rules that protect their investments and profits. This corporate capture comes at the expense of both peoples’ rights to democratically govern their own affairs and the ability of sovereign governments to effectively enforce worker, consumer, and environmental safeguards.

What follows describes a new set of rules of the road, one that puts the economic needs of working families at its core while excising corporate, protectionist influences from the rules. Achieving such inclusive policies will require a new policymaking process to replace the current system of opaque negotiations, a system heavily influenced by hundreds of official corporate trade advisors while the Fast Track process limits Congress’ role and the public is largely shut out.

Continue here…