Dr. King and full employment: some evidence

January 17th, 2017 at 7:38 am

I wanted to add some quantitative analysis to my WaPo piece from yesterday, which argued for remembering the importance Dr. King’s “institutional” analysis, which gives a far greater role to power and systemic norms than your basic market-forces analysis.

I noted that Dr. King became increasingly committed to full employment—the slide below is from the March on Washington for Jobs and Freedom—as evidence developed in the 1960s and 1970s was beginning to show the importance of very tight labor markets for African-Americans.

Source: History.com

Here’s a bit of empirical backup. The first figure shows the Census Bureau’s series of black and white real median family incomes against the unemployment rate. The cyclicality of the series is evident, but there are only a few episodes wherein very low unemployment persisted for a few years: mainly in the 1960s and 1990s, periods associated with rising median incomes for blacks and whites.

Sources: Census, BLS

In fact, a simple regression of the log change in real black median income on a flexible specification for the unemployment rate (at t, t-1, and squared) explains 39 percent of the variance in the dependent variable (results for whites are similar), more than you might expect given the fact that income formation is a pretty complex phenomenon.

Turning to low incomes, Census also provides 20th percentile family incomes by race, though the data for blacks begins in the mid-1960s. Not only did black incomes shoot up in the full employment 1990s, but they grew faster than white low incomes, partially closing the racial income gap at the 20th percentile.

Source: Census

Applying the same model just noted to black 20th percentile real incomes and forecasting the series based only on unemployment shows a remarkably good fit given the simplicity of the model (the forecast is “dynamic,” meaning the forecast using predicted, not actual, values for changes in the DV, a tougher test of the model’s accuracy).

Source: Census, BLS, my analysis

OK, some caveats. One reason many economic indicators for blacks were so positive in the 1990s had to do with the disproportionate share of working-age African-Americans in prison, and thus left out of the data (a “selection bias”). And as I stressed in the WaPo piece, tight job markets make it more costly to discriminate; they don’t eradicate discrimination.

This final chart provides a simple way to underscore this last point. It is widely known that the black unemployment rate tends to be twice that of the white rate, but many assume that this is largely due to the lower educational attainment of African-Americans. In fact, black unemployment is higher for every education group. The relative difference is somewhat larger for high-school or less, but the figure reminds us that even were blacks to achieve education parity with whites, their jobless rates would likely remain higher.

Source: BLS

These are both highly relevant caveats re the impact of discrimination and the criminal justice system, but they do not change the fact that it takes persistently very tight labor markets to give black workers the bargaining clout they need to get ahead, a fact Dr. King picked up on long ago.

Especially as team Trump takes the field, it’s especially important for the Federal Reserve to keep these racial dynamics forefront in their plans for balancing full employment and price pressures. Preemptive rate hikes may well dampen or even reverse the real gains blacks (and whites) just started making, as can be seen at the end of the above figures.

Results from my Twitter poll on the legislative prospects of the DBCFT

January 12th, 2017 at 3:47 pm

My statistics professors would legitimately disown me for posting these results from a Twitter poll I ran yesterday on respondents’ guesses re the likelihood that the R’s corporate tax replacement–the destination based cash flow tax (DBCFT)–becomes law.

A “convenience sample,” a sampling framework that makes no attempt at representativeness, is the worst kind of sample, and you can’t trust the results it yields. Suppose I sampled people right outside of a pot shop asking them what they thought of marijuana legalization.

But I will very weakly and limply defend this sample a bit. You can’t randomly sample folks on an obscure topic like this, and the #DBCFT community is a…thing…sort of, that exists in the Twitterverse. You might not want to hang out much with us, but “we’re here, we’re weird, and we’re not going away!”

Anyway, as you can see, slightly more than half of respondents give the tax a low probability of passage.

Source: Twitter

The non-deductibility of imports is a strike against the DBCFT for businesses that a) have significant imported inputs, and b) don’t believe the story about the tax driving an exchange rate adjustment large enough to fully offset the tax (i.e., the value of the dollar goes up enough relative to the currency of foreign suppliers that the lower dollar cost of imports offsets the new tax burden). These businesses have lobbyists, as do the US investors with foreign holdings that would become less valuable in dollar terms when the greenback appreciates. (Note that the businesses oppose because they don’t believe the appreciation story; the investors oppose because they do!)

Still, these results are a bit more optimistic re passage than I would have guessed. Of course, such guesses would surely become more optimistic if team Trump were to embrace the change, which, to my knowledge, they have not.

OK, my bad for already saying too much based on such a non-representative sample.

A few other DBCFT docs just out:

–Here’s a useful, and pretty favorable, Bill Gale take. He says: “The corporate tax is ripe for reform [Tru dat! JB]. The DBCFT is an excellent way to kick-start the needed discussion.”

I found this point of Bill’s to be particularly resonant: “4)  However, precisely because the DBCFT does not have the negative incentive effects of the corporate income tax, there is no good reason to reduce the tax rate to 25/20 percent.  Indeed, the tax rate should be equal to the top rate on individual income, so as to reduce incentives to reclassify wage income as business income.”

Of course, as I’ve stressed, the higher the rate, the larger the $ adjustment needs to occur to offset, so if you’re already skeptical about that…

–Here are results from a national poll by the US Consumer Coalition wherein they ask a number of questions about the DBCFT. Definitely interesting, but I’m hard-pressed to imagine how those who haven’t closely followed this debate have much of an informed opinion, meaning these results must be highly sensitive to the wording of the questions.

Paul Krugman goes all “crowd out” on us. Is he right?

January 9th, 2017 at 5:09 pm

Progressives’ Keynesian economist in chief, Paul Krugman, has been second to none in calling out policymakers’ focus on reducing budget deficits when economies were still weak (also known as “austerity”). Given that record, his oped in today’s NYT may surprise some readers. He argued that, as the economy closes in on full employment, fiscal budget deficits could crowd out private borrowing, pushing up interest rates and slowing growth.

Paul’s argument in the oped shouldn’t actually be surprising; he has long depended on a very simple and, as the record shows, very insightful, application of the ISLM model, a diagram of how interest rates and output interact in key markets in the macroeconomy. See here for his useful discussion of how the model ticks.

But is Paul right? Despite the fact that he invariably turns out to be so–i.e., correct–I’m not nearly so worried about interest-rate crowd-out resulting from the big, wasteful tax cut team  Trump and his Congressional allies will pass, I fear, sometime later this year. What I’m worried out is what their raid on the coffers of the US Treasury will do to the programs we increasingly need to meet the many challenges we face.

Let me explain.

Here at OTE, we maintain that all economic models are wrong but some are sometimes useful. For years, at the end of the ISLM section of economics courses, there’s been this little section that shows how the model changes in a particular type of recession when two things happen: demand significantly contracts and interest rates fall to around zero (the dreaded liquidity trap). At that point you get the diagram Paul put in his link above (ignore for a moment the “IS Now” line, which I plugged in there, as did Paul in a post today).

Source: Paul Krugman

The point of the ISLM-in-recession model is that policy makers can do a lot to boost demand without worrying about crowding out private investment, inflation, or push-back from the Fed. So let the fiscal stimulus rip. The question in such moments shifts from “is the deficit too large?” to “is the deficit large enough?!”

But according to the model, you should only let it rip up until the point when the IS curve shifts enough to the right (“IS Now”) that the economy is back in a place where increased demand will invoke those negative outcomes just noted.

One implication Paul draws from these dynamics is that Republicans, motivated not by improving the economy but by bashing Obama and the D’s, inveighed against deficits when we needed them and are about to shift to not caring about them when deficits – again, according to the model – could actually do some harm.

But how reliable is this crowd-out hypothesis? It’s actually pretty hard to find a correlation between larger budget deficits and higher interest rates in the data.

There are some obvious reasons why that’s the case. Oftentimes, like in the Great Recession, a large budget deficit corresponds with demand contraction and very low rates, so that messes up the predicted correlation. The budget deficit got to -10% of GDP in 2009 and interest rates were stuck around zero. That also implies rates can’t fall as deficits have become less negative.

To see if anything jumps out, the figure plots real rates on the 10-year bond against the deficit from 1990 to 2007, years chosen because the deficit moved around a lot in those years, including into surplus at the end of the 1990s, and the Fed wasn’t nearly as much in the interest-rate setting mix as they’ve been since then. But it’s just pretty much a random plot (if you plot changes in the variables, it still looks random; same with nominal rates; same with corp bonds, etc.).

Source: BEA, Fed

The raw data miss a potentially important expectations component often in play regarding movements in rates. Very recently, investors’ expectations of Trump-induced fiscal expansion, along with the Fed’s plans to hike rates, have pushed up inflation and interest rate expectations. But it’s not at all clear how much of that relates to the expectation that deficits will crowd out private borrowing.

So is Paul making a mistake to continue to depend on the model that has heretofore served him—and anyone else willing to listen—so well? My guess is that deficit crowd-out is not likely to be a big problem, as in posing a measurable threat to growth, anytime soon, even if deficits, which are headed up anyway according to CBO, were to rise more than expected.

The global supply of loanable funds is robust and, in recent years, rising rates have drawn in more capital (pushing out the LM curve). Larger firms have enjoyed many years of profitability without a ton of investment so they could use retained earnings (the fact of unimpressive investment at very low rates presents another challenge to this broad model). And most importantly, while we’re surely closer to full employment, there are still a lot of prime-age workers who could be drawn in to the job market if demand really did accelerate.

(This, by the way, is the only part of Paul’s rap today that I found a bit confusing. He’s a strong advocate of the secular stagnation hypothesis, wherein secular forces suppress demand and hold rates down, even in mature recoveries. His prediction today seems at odds with that view.)

And yet, I’m still really worried—profoundly so—about crowd-out, just not the interest-rate type that Paul’s worried about. What keeps me up at night is that if Republicans are able to waste a bunch of money on deficit-inducing tax cuts that go mostly to rich people, there will be too few resources to support the safety net, public goods, health care, and possibly even social insurance.

This, I’ve long maintained, is the true target of trickle-down tax cuts: force the government to shrink by cutting off its revenue oxygen. And this is a particularly damaging time to be cutting revenues; our demographics alone mean we’re going to need more, not less, revenues in coming years. And I’m not even talking about what we’ll need to address the challenges posed by climate change, inequality, poverty, our infrastructure needs, geopolitics, and Buddha-knows what else.

So I stand firmly against big, dumb wasteful tax cuts. Not because I think they’re going to raise interest rates that much (though I could be wrong and PK is typically right), but because they’re going to shut down the federal government’s ability to do what needs to be done.

Jobs Report: 2.2 million jobs gained in 2016; Unemployment ends year at a low 4.7%

January 6th, 2017 at 9:26 am

Payrolls rose 156,000 last month and the unemployment rate ticked up slightly to 4.7, as the US job market continues to post solid and steady gains. Over 2016, average hourly wage growth is up 2.9 percent, the fastest yearly gain thus far in the recovery that began in 2009. Coupled with low inflation, this means the job market is delivering real gains to paychecks.

JBs monthly smoother (average monthly gains over 3, 6, and 12-month periods) shows that the pace of job growth has slowed over the year, in part due to weaker GDP growth, but also as is characteristic of maturing recoveries. The Federal Reserve’s rate hikes, albeit small, may also be in the mix as they too are intended to tap the growth brakes.

The 2.9 percent increase in average hourly pay over 2016 is the fastest pace of wage growth since mid-2009, when the current expansion got underway. (Do not make a big deal out of the big monthly bump of 0.4 percent–that’s a bounce back from last month’s nominal wage decline.) While this number may spook some inflation hawks, it should not:

–nominal wage growth of 3-3.5 percent is considered non-inflationary by the Fed;
–after years of stagnation, wage earners have a lot to make up, and part of that should come from the non-inflationary source of shifting some national income from the profit to the wage side;
–there’s little evidence of wage growth bleeding into price growth in recent years; as wage growth has accelerated, prices have not;
–for 80 percent of the private workforce who are blue collar and non-managerial workers, pay is up 2.5 percent over the past year, so the gains may not fully be reaching all corners of the job market.

As noted, 2016 ended with the unemployment rate at a low 4.7 percent. While that measure is about what the Federal Reserve considers full employment (and thus a rationale for their December rate hike), other indicators, while also improved, are not there yet. For example, underemployment, a broader measure of labor market slack that includes 5.6 million part-timers who’d want but can’t find full-time work, remains somewhat elevated at 9.2 percent. Note that this is down from almost 10 percent over the year, and the lowest it’s been yet over the recovery.

The labor force participation rate ticked up slightly to 62.7 percent, the same level as a year ago and well below its pre-recession peak. Below, I discuss the recent history of this important benchmark. Also, the employment rate for prime-age workers (25-54) stayed constant at 78.2 percent last month. While this proxy for labor market demand for a core group of workers (who are generally non-retirees) is up almost 4 percentage points from its trough, it remains about 2 points below its pre-recession peak.

A final indicator that has significant room to improve is manufacturing employment. While factories added a welcome 17,000 jobs last month, jobs in the sector are down 45,000 in 2016 and were up a scant 26,000 last year, compared to being up over 200,000 in 2014. Part of that decline is due to a strengthening dollar making our manufactured exports less competitive, along with slower growth abroad. Given the salience of manufacturing in not just the political debate, but in the economic conditions and opportunities of many American communities, along with its important role in contributing to productivity growth, this is an area of weakness that demands serious policy focus.

With December’s data, we can make a preliminary comparison over full calendar years (forthcoming revisions will alter these results, though typically not by a great deal).  Over the course of 2016 (Dec 2015-last month), payrolls added 2.2 million jobs, an average of 180,000 jobs per month and a 1.5 percent growth rate.

Though still a robust pace of job growth, that’s a deceleration of job growth compared to the prior two years, when payrolls were up about 240,000 per month, on average. As noted, this slowdown is a function of slower real GDP growth in 2016 (and thus less pressing demand for labor) and a characteristic of job markets that are closing in on full employment.

As the figure below shows, tracking this Dec/Dec metric all the way back to 1940, the Great Recession (see circled part of figure) absolutely crushed the labor market, posting historic losses in both absolute (left axis) and percentage terms. As 2017 gets underway, annual payroll gains are back to their historical levels, with percentage gains of around 2 percent, a pace of job growth that is slightly higher than that of the 2000s expansion.

Source: BLS

The table below compares a few other labor market indicators over the last two cyclical peaks (2000, 2007), the bottom of the Great Recession (2009), and, using today’s data, 2016 (I use Q4 averages to smooth out some monthly noise). The unemployment rate is in the same range as in the prior peak years, and much improved, of course, from the depths of the recession. In 2009, the US job market shed a nightmarish 423,000 jobs per month, over 5 million for the year, sending the unemployment rate to almost 10 percent and the underemployment rate to about 17 percent.

Source: BLS, Author’s calculations

The very significant tightening up of the job market since then, in tandem with very low inflation (which has been, in fact, the major source of real wage growth in recent years), has recently led to faster nominal wage growth and higher real wages.

The labor force participation rate remains historically low, about three percentage points below its level at the end of 2007. But note that it fell in the 2000s cycle as well (though not as fast). Part of the decline over these years has been due to weaker job and wage growth failing to pull workers into the job market, while part—most, according to most analyses—relates to aging demographic trends.

If the partisan political dust ever clears, President Obama will be seen as having presided over one of the sharpest labor market recoveries in modern history, a dramatic reversal, as seen in the circled part of the figure above. The actions of his administration, along with the Federal Reserve, helped to hasten a recovery that, once it took hold in the job market, has delivered consistent employment growth since 2010. Wage growth, as noted, was a laggard, and the low LFPR and high underemployment rate suggests there’s still some room to run in the labor market before we’ve achieved full employment.

But the job market that president-elect Donald Trump is inheriting is strong—the “trend is his friend.” Wise application of fiscal policy—investment in infrastructure, for example (one that doesn’t rely on tax credits and projects with user fees)—could help pull more sidelined, prime-age workers into the job market, and could perhaps even help to boost productivity growth, by, for example, improving the quality of transportation infrastructure critical to supply chains.

But high tariffs, trade wars, wasteful tax cuts, deregulating financial markets (thus tempting future recession-inducing bubbles), whacking the safety net, and repealing the ACA will not support but will threaten the favorable jobs trend inherited by the president-elect.

In my experience, outside of recessions (when countercyclical policy is of great importance), presidents have a lot less to do with the good economic news for which they often take credit and the bad news for which they get blamed. That said, they can screw things up, especially when they’re guided by ideology, thin skin, and crony capitalism that pays back their funders. So stay tuned, as we’ll be tracking these developments as closely as ever.