A few thoughts on the political economy of a gov’t shutdown

January 18th, 2018 at 10:14 am

I’d put the odds of a government shutdown at a little below half at this point, say 45%. To be clear, what we’re really talking about is a partial shutdown; less than half of federal workers are considered non-essential, so most (~60%) stay on the job; those furloughed typically get paid retroactively.

You can read about the latest details here, including a curve-ball tweet this AM from the president that seems to mess a bit with the R’s strategy: get D’s on board for a short-term budget patch by extending the CHIP program as part of the stopgap package (Trump’s tweet suggested he wants to resolve CHIP outside of the short-term deal; I doubt this changes much, as Congress will and should ignore him; his position has probably flipped n times by now). D’s in the Senate are under pressure to oppose a package that fails to reinstate DACA.

Should a shutdown occur, the economic impact is a function of its length, though much–not all–of what is lost tends to get made up in later quarters post-shutdown. GS Researchers (no link) “estimate that each week of shutdown would reduce real GDP growth in Q1 by 0.2pp…annualized. The effects would be reversed the next quarter however. Shutdowns have also tended to have modest effects on financial markets.”

But what about the political fallout? I think there’s a short-term and longer-term game in play. In the near-term, though it’s hard to know which side will take the hit, shutdowns can and do hurt the party blamed for it by the majority of the public. My guess is the R’s would get blamed this time, just based on the extent to which the public is aware of their chaotic politics. But that’s a weak prediction.

A much stronger prediction stems from the contention I made in this interesting WaPo piece: “These government shutdowns feed into a narrative that is not politically neutral.” The more people believe the government is fundamentally dysfunctional, the more they’ll be OK with de-funding and shrinking it (cutting tax revenues), turning federal programs over to states (“block grants”), and generally accepting the R’s narrative of a feckless government sector that wastes your tax dollars. Why, they can’t even keep the lights on!

This leaves me pretty wary of any short-term advantages from blaming the other side for the shutdown, should it occur.

Links; more on heating vs. overheating.

January 12th, 2018 at 12:22 pm

Medicaid is a highly efficient program (see figure below), delivering health coverage to 70 million low-income persons while conveying many ancillary benefits on its beneficiaries, as Hannah Katch and I point out in the NYT oped.

So, of course, Republicans want to lay waste to it. They were blocked from doing so through their ACA repeal, they did a bit of it in their tax plan, and now they’re going after Medicaid through the waiver process (which skirts Congress), by adding a work requirement. As Hannah and I stress, you can’t feed or house your family on health coverage, so the incentive to work is already built into the program, which is why most able-bodied beneficiaries already work.

At any rate, it’s going to take action at the state level to block this latest attack.

Turning to other current events, I wrote about jittery bond markets yesterday, trying to emphasize that heating is not overheating. We should expect to see inflation and interest rates on the rise, given how low they’ve been and the stage we’re at in the expansion. Though granted, the Fed must try to look around corners, I don’t see much evidence of real resource constraints building up.

Yet, bond rates spiked when the core CPI came out this AM at 0.3% over the month instead of 0.2%. Note that yr/yr core CPI came in at 1.8%, which, given that the CPI runs ~30bps hotter than core PCE, is much like the growth rate of the core PCE, which last come in at 1.5% (Nov/Nov). Both are well below the Fed’s target rate.

As the next figure shows, breakeven rates, a measure of inflation expectations measured as the spread between rates on 10-yr TIPS and 10-yr Treasuries, have spiked a bit in recent days, as has the 10-year yield. But they’re only back to levels from about a year ago, and, as noted, CPI core inflation itself remains well below target (which is 2.3-2.5 for core CPI).

This all comes down to a few key questions:

Q: Are resource constraints building in the economy?

A: Not that you’d see in inflation (realized or expected), interest rates, or wage growth. As for employment, the jobless rate is low but employment rates may have room to run.

Q: Have the benefits of the recovery reached deeply enough into all corners of the country?

A: It’s getting there, but wage growth is under-performing and there are areas where the job market has not yet firmed up.

Perhaps most importantly:

Q: Are the risks to the Fed hitting the growth brakes symmetric or asymmetric?

A: They are asymmetric. Since inflation has been below target for years on end, achieving the Fed’s 2% target, on average, requires some period of  being above the target rate. Similarly, the least advantaged don’t catch a buzz from the recovery until we hit and stay at chock-full employment. Both of these factors point to the likelihood of greater damage from pushing back too hard on growth right now than from maintaining a largely accommodative stance.

Is it getting a little warm around here?

January 11th, 2018 at 10:01 am

The front page of my WSJ this AM, above the fold, screams: “Treasury Yields Ripple Through Markets.” The 10-year yield was up for five days straight as of yesterday, approach a 52-week high at 2.609%.

The 10-year “breakeven rate,” a market-based measure of inflation expectations (it’s the difference between the 10-year rate on inflation-protected bonds (TIPS) and the 10-year Treasury yield; thus, a measure of expected inflation, 10-years out), rose sharply in recent days, and has cracked 2% for the first time since last spring.

The stock market continues to climb.

The unemployment rate remains below most measures of the “natural rate,” i.e., the rate thought to be consistent with stable inflation. FTR, we cannot measure the natural rate with any degree of precision, so I wouldn’t make much of this one.

What’s more important to that part of the discussion (low unemployment) is what I wrote about at the WaPo today: we are, in 2018, throwing considerably more fiscal stimulus at an economy with already low unemployment than has historically been the case.

How unusual is [this]? Well, looking at data back to the late 1940s, the average deficit-to-GDP ratio when unemployment was below 5 percent was close to zero. Since 1980, that same calculation yields an average deficit-to-GDP ratio of 0.5 percent. As I mentioned, the jobless rate this year may average less than 4 percent while the deficit-to-GDP ratio could be about the same, and closer to 5 percent next year. So, pretty unusual.

All of which begs the question: are we starting to overheat?

My answer is “no.” Heat does not imply overheat. True, both realized and expected rates of interest and inflation are rising, but that’s what I’d expect at this point in the recovery, and they’re still at relatively low levels. Yes, the job market is tightening, but both wages and employment rates imply it is not overly hot.

10 YEAR BREAKEVEN RATES (INFLATION EXPECTATIONS) AND 10-YEAR TREASURY YIELD: HEAT, SURE. OVERHEAT, NAH.

Moreover, especially as regards inflation, which still remains below the Fed’s 2% target—core PCE was last seen up a mere 1.5% (Nov16/Nov17). After running cold for so long, it would be a mistake for the Fed to push back on price growth any faster than they are already: their target is an average, not a ceiling. (Yes, this invokes much argumentation, as per this must-view Brookings conference on whether the Fed should rethink its 2% inflation target. I think so, and so do most of the speakers.)

As the figure shows, bond yields and the breakeven rate are climbing but their levels are within safe, historical ranges. I’m not at all discounting their growth rates, but it’s not unusual for stocks and bond yields to both be on the rise at this point in the expansion. It’s a pattern that points to positive expectations about growth, profitability, and inflation. The question is: are there clear utilization constraints in sight?

I don’t see them. Instead, I see a number of reasons why interest and inflation rates are up a bit, and I don’t think any of them are scary:

–Solid, slightly faster US growth rates, with even productivity growth up the last few quarters. That’s not a new, structural trend, btw, just the predictable outcome of slower employment growth as we close in on full employment and slightly faster GDP growth. (It is consistent with the full-emp productivity multiplier I go on about, but way too soon to call this one.)

–“Synchronized” global growth. Most economies are growing closer to their potential at this point in the global cycle, and the WTO tell us that the global output gap is now closed.

–At least some of the equity rally makes sense in the context of high realized and expected corporate profits. Re the latter, the tax cut lavished large goodies on the corporate sector, so even stagnant expected pre-tax profits should show up in the stock market as higher expected post-tax profits. (To clarify, I don’t find this “scary” from a heat perspective. I find it highly undesirable from an economic inequality perspective.)

–Tight job market but no obvious wage pressures, at least on the national scene. I’ve seen anecdotes of wage pressures in places with very low unemployment, but that’s as it should be. Anyone making a case that full employment is juicing wages and that’s juicing prices does not have the data on their side, at least not yet.

–Other measures of inflation expectations, like those computed by the Cleveland Fed, are slowly trending up but don’t yet show the same spike as the breakevens (though they’re lagged relative to the market measure).

–No obvious bubbles outside of bitcoin, and it is not “systemically connected” to credit markets, thank Keynes, Buddha, [your favorite deity here].

Sure, there’s some heat. After all, we’re in year nine of an economic expansion that started off pretty tepid. But heat ain’t overheat, and there’s a heckuva a lot of catching up to do out there, whether we’re talking macro-indicators like inflation, or most importantly from my perspective, wages and incomes of middle and low-income households.

Questions for the MMTers

January 7th, 2018 at 11:42 am

As their adherents readily, and fairly, remind me, there’s a lot I don’t understand about modern monetary theory (MMT). So, let me ask about some aspects of the theory and see if I might get me some education.

First, I’ve stressed that, as I understand it, there’s no distance between my views and a core principle of MMT: the need for deficit spending when the economy is below full employment. This, of course, as Dean Baker points out, is as much Keynesian as anything else, but as the Chinese saying goes: black cat, white cat; as long as it catches the mouse.

The sad, underappreciated, fact is that for much of the last 35 years (about 70% of quarters, using unemployment minus CBO’s NAIRU; (u-u*)>0 70% of the time since 1980), the US economy has operated below its potential. This is the fundamental problem of macro, the fundamental argument against budget austerity or monetary hawkishness, and the reason why MMT or whomever else argues on behalf of expansionary fiscal policy is correct.

But here’s what I don’t get.

Overheating is possible, and taxing is a lousy mechanism for dealing with it. Though it seems a pretty distant problem given the apparent flatness of the price Phillips Curve, everyone agrees, I think, that economies can overheat. To dial back fiscal stimulus, MMT’ers argue for tax increases.

That’s fine in theory, but how does that work in the real political economy? The president goes to Congress and proposes a tax increase to bring us back down to potential, and Congress says, “sure, boss. We’re on it!”? Presidents and Congresses don’t like tax increases, and they don’t happen quickly (yes, the last tax plan came together pretty quickly—because it was a cut!), they have distributional implications, and there’s a huge industry to fight you tooth and nail.

That’s why we have a Federal Reserve that can quickly and without political interference decide to take money out of the economy (to be clear, monetary policy also has distributional implications). That seems like an immeasurably more reliable way to handle the overheating problem, but I don’t think the MMT crowd agrees, or at least I don’t understand where the Fed and interest rates exist is their cosmology.

What about the Fed? The central bank introduces another piece of the MMT framework about which I’m confused. Suppose, even if the economy is below potential, the Fed decides it doesn’t like all this money-printing and deficit spending advocated by MMTers. Consider current events. Though we’re closing in on full employment, I don’t think we’re quite there yet, and I suspect MMTers and I agree that some deficit spending could be useful right now, as I argued here. To be clear, I’m arguing for, e.g., target jobs programs for people and places left behind even in year nine of the expansion, or a more generous EITC, not cuts in the damn estate tax! But, due to the tax cut, we are going to see considerable deficit spending over the next few years.

The Fed is already pushing back. And they may well decide to push back harder, i.e., speed up their “normalization” campaign by adding more rate hikes, even if the rest of us think there’s still economic room-to-run.

We can argue all day that the Fed is making a mistake to raise in the absence of inflationary pressures, but my point is simply that the Fed exists and has the independence to offset any self-financed government spending as they see fit. For all the MMTers logic around the privilege of sovereign, fiat currency, I don’t understand how they incorporate this reality into their model.

Krugman’s “finance-ability” point: Krugman argues that self-financing is more inflationary that bond issuance, but he’s not making the above points about MMTs flawed (IMO) assumption that tax cuts could handily deal with accelerating prices. He’s worried about currency debasing:

“The point is that under normal, non-liquidity-trap conditions, the direct effects of the deficit on aggregate demand are by no means the whole story; it matters whether the government can issue bonds or has to rely on the printing press. And while it may literally be true that a government with its own currency can’t go bankrupt, it can destroy that currency if it loses fiscal credibility.”

One could argue that the government doesn’t have to sell bonds—it can just print money—but it does sell bonds, it always has and probably always will. Moreover, it doesn’t just sell them to itself. It sells them to open markets of investors who could, under conditions triggered by printing-press reliance, decide not to buy them without an exorbitant risk premium. A model that assumes otherwise may raise interesting ideas, but, like discounting the role of the Fed and interest rate policy, risks being of limited real-world utility.

Timing issues re revenue raising vs. printing money: A theme of my work, to which MMTers often object, I think, is that we need to raise more revenues to pay for public goods. I recently wrote, for example, that, given our aging population, it will take something like 3% more of GDP to meet our obligations to Social Security and Medicare/Medicaid by 2035. MMTers push back that as long as we’re below potential, we can print the money to support government spending, so stop getting so wound up about “payfors.”

But while assuming full employment is a mistake, so is assuming a) enough slack to warrant all that printing, and b) even more so, the political will to do so. Though we should always be willing to deficit spend in the near term when economic conditions warrant it, should we not structure long-term fiscal policy to avoid structural deficits (a structural deficit is one that persists even at full employment)? At least in a political sense of protecting vital social insurance programs, isn’t the prudent approach, as difficult politically as it may be, to try to lock in a level of revenue collection that meets our future obligations?

Such queries seem often to get under the skin of the MMT crowd. But I come in peace and stress our shared recognition of the horrors of budget austerity. I ask these questions in the spirit of better understanding your arguments.

December jobs report: tight labor market sends black unemployment to historical lows

January 5th, 2018 at 10:00 am

Payrolls rose by 148,000 last month and the unemployment rate held steady at 4.1 percent. While the headline payroll number was below consensus, this is another solid report. Persistently strong job markets are most beneficial to the least advantaged—privileged types do well even in weaker markets—and the December unemployment rate for African-Americans fell to 6.8%, its lowest on record going back to the 1970s. The black-white gap (black minus white unemployment), at 3.1 percentage points, is also the lowest on record.

Especially given weather issues in recent months, it’s essential to look at my monthly smoother, which shows payrolls adding a very solid 204,000, on average, over the past three months (2017q4), a slight acceleration over the longer-term trend. So, while the 148,000 payroll number was below expectations, it should not be over-interpreted. The job market remains strong.

Moreover, there are no signs of overheating. To the contrary, wage growth is uniquely stable, as the next two figures reveal. Average hourly earnings were up 2.5%, year-over-year, for all private-sector workers, and just 2.3% for blue-collar (manufacturing) and non-managerial workers (services). Though some other wage series show more responsiveness to the tightening job market, this remains a missing piece in the current recovery. By this point, I’d have expected more of an acceleration in these two wage series.

With today’s data, we have a first look at the 2017 labor market. Employers added a net of 2.1 million jobs in 2017, an average of 171,000 jobs per month and an annual growth rate of 1.4% (these numbers will be slightly revised in coming months). That’s a bit slower job growth than prior years, as shown in the table below, but this is a typical pattern as the job market closes in on full employment (h/t to the great Lexin Cai for making this table!).

Unemployment ended the year at a cyclical low of 4.1 percent, but as I note below, I suspect it will continue to decline even more this year, perhaps hitting levels we haven’t seen since the 1960s (maybe 3.5% by the end of the year).

Wage growth, as discussed above, grew less quickly last year, barely beating inflation (the inflation rate is from Nov/Nov, as Dec data are not yet available).

The two participation columns in the table are important in terms of labor market dynamics. The labor force participation rate is clearly stuck below 63 percent, which suggests little responsiveness of labor supply to the stronger job market. But check out the next column: the employment rate for prime-age (25-54) workers. This series, which leaves out potential retirees and is thus a more relevant gauge of demand responsiveness, is growing, albeit ploddingly, and is up 4 percentage points since 2010.

It’s still—9 years into the expansion—about a percentage point below its pre-recessionary peak, so I’m not popping champagne corks. But that cyclical response among prime-age workers, who’ve clawed back about 80% of their employment-rate loss, suggests there’s at least some room-to-run in the job market, as do subdued wage and price changes.

If I’m right (and others have made the same prediction), and the jobless rate falls further this year, a key question is whether the Federal Reserve will accommodate or pushback on falling unemployment. Of course, a major factor in their thinking will be the extent to which the tighter market pushes up wages and prices.

I’m speculating, of course, and perhaps my hopes are clouding my judgement, but barring an uexpectedly sharp acceleration in wages/prices, I think the Powell Fed will accommodate the uniquely tight job market. To be clear, I’m not suggesting they’ll pause their “normalization” rate-hike campaign, but I think they’ll tap rather than slam the brakes.

Part of my hopes are based on the racial gains discussed above. This last figure shows the black and white unemployment rates. As is the case in long expansions, the black jobless rate has fallen faster than the white rate, and the gap (black rate minus white rate) is at an all time low.

I cannot overemphasize the importance of this result and how essential it is for the recovery to proceed apace so we can tap this long-awaited elasticity. Especially given the lack of price-pressures, the punch bowl is figuratively screaming at the Fed: “keep your hands off me!”