Another strong jobs report yields critical insights

November 2nd, 2018 at 10:02 am

The nation’s payrolls added 250,000 jobs last month, the unemployment rate held steady at a 49-year low, the closely watched labor force participation rate increased, and year-over-year wage growth broke 3 percent for the first time since 2009. Given that inflation has been running a bit short of 2.5 percent, this means workers are finally seeing real gains in the buying power of their paychecks.

Wages were up 3.1 percent for all private sector workers and 3.2 percent for middle-wage workers, suggesting that the tight labor market is generating broad gains, not just helping those at the top of the earnings scale.

One slight caveat re wage growth is that in the previous October (2017), hourly pay in this series fell four cents in nominal terms, a rare event. Thus, the base off to which this October’s wage gain is compared was unusually low. However, the moving-average figures below, which smooth out such monthly noise, show clear acceleration in the pace of wage gains. Also, averaging over the past three months shows hourly wages growing at a very strong 3.6 percent annual rate compared to the prior three months. This represents a clear acceleration over the prior two “quarters,” when annualized growth was 2.6 and 3 percent, respectively.

In other words, the U.S. job market is tighter than it has been in decades and this dynamic is revealing at least two important insights. The first, which we knew, is that slack matters: the absence of full employment saps worker bargaining power and constrains wage growth. When we move toward full capacity in the job market, workers get back some of the clout they lacked, and employers must share more of the gains with them.

Second, and this most economists did not know, is that there was and still probably is more room-to-run in the labor market than conventional wisdom believed and thus more room for non-inflationary gains. The distributional implications of this critical insight cannot be overstated: full employment provides the biggest gains to the least advantaged, too many of whom have long been left behind in previous economic expansions.

Our monthly smoother, which averages over 3, 6, and 12-month windows to get a better look at the underlying trend of job growth, shows that trend job gains are north of 200,000, more than enough to push our already low unemployment rate down even further. Is this trend persists, and even if it fades some, it will likely take the jobless rate down to below 3.5 percent in coming months.

As noted, the tighter job market has delivered faster wage growth. The smooth trend in the next two figures show a slow staircase of wage gains, from around 2 percent in 2013, to 2.5 percent around 2016, to closing in on around 3 percent now. Contrast this staircase with the “elevator down” shortly after the recession. This pattern of sharp wage-growth losses and slow wage-growth gains is precisely why it is so important for policy makers to preserve and build on the gains generated by the close-to-full-capacity job market.

This admonition is especially the case when we consider how “anchored” price growth has been. The next figure shows that as the unemployment rate has fallen well below the Fed’s estimate of the “natural rate”—the lowest rate they believe to be consistent with stable inflation—price growth remained at the Fed’s 2 percent target. This anchored inflation dynamic has held even as wage growth has picked up.

Based on these relationships, I and others have suggested the Fed consider pausing in their interest-rate hiking campaign. This is a unique moment for a truly data-driven Fed to build on these critically important labor market gains that are finally—nine years into the expansion—deliver some potentially lasting gains to middle- and low-wage workers.

Finally, a political note. In applauding this strong report a few days ahead of a uniquely important midterm, it is impossible (for me, at least) to discuss the current job market apart from its political implications. First, one reason for the very tight labor market is the tax cut and spending bills that were added to the deficit, which at 4 percent of GDP, is far higher than it should be at this stage of the recovery. This deficit spending is boosting the growth rate by perhaps a percentage point, which I (along with most other economists) believe will start to fade later next year.

In other words, the policy agenda of piling onto the budget deficit when the economy is already closing in on full employment has, to its credit, revealed more labor capacity than most economists and the Fed believed was available. But it is also robbing the U.S. Treasury of much needed revenue at a time when we’re going to need more, not less, revenues to meet the fiscal challenges we face.

Moreover, Trump is clearly building on trends he inherited. His constant refrain that the job market was terrible before he got here is the fakest of fake news. And then there’s the reckless trade policy, the hateful rhetoric with its murderous consequences, the chaotic dysfunction at the highest levels, and the never-ending stream of lies.

I like a full employment labor market as much—surely more—than anyone. But I guarantee you it’s possible to achieve it without all the hate.

Wage roundup: Amplifying new work on an important topic.

October 23rd, 2018 at 4:02 pm

There’s been some interesting wage analysis in recent days and the findings are worth collecting and amplifying. Some of what follows is technical, but the punchlines are straightforward:

–As I’ve always stressed up in these parts, tight labor markets are especially beneficial to lower-paid workers.

–Even so, wage inequality remains alive, well, and connected to the recent boom in corporate profitability.

–In earlier periods, unemployment rates as low today’s would have generated faster wage growth. The reasons for today’s under-performance are likely slack, slow productivity growth, and weak worker bargaining clout.

This first figure, from my great pal Larry Mishel and Julia Wolfe, uses high quality administrative data to reveal key aspects of the real annual earnings’ story over the past few decades. The top line shows that the average earnings of the top 1 percent—about $720,000 in 2017—are up 157 percent since 1979, compared to 22 percent for the bottom 90 percent (2017 avg: $36,000). FTR, the top 0.1 percent were up 343 percent over these years (2017 avg: $2.8 million).

Moreover, and this is really telling, there are but two periods in the figure when the average for the bottom 90 goes up: the full employment latter 1990s and around 2015. The latter was a year of weirdly low inflation (about zero), so that’s anomalous. But that positive slope in the latter 90s confirms the importance to this discussion of very low unemployment. In fact, unemployment is even lower today, but I’ll get to that in a moment.

The other important pattern in the figure is the sawtooth movements for the top 1 percent around 2000 and 2007. If you follow the stock market, and particularly the patterns in capital gains realizations, those spikes are familiar, but why should they show up in paychecks? The answer is that in these data come right off W2 wage filings, which include exercised stock options. The diverse pattern between the top and bottom lines in the figure underscores the narrow reach of stock market gains.

But why aren’t middle and lower-wage workers seeing much in terms of wage gains these days? This is the topic of very thorough bit of work by Ernie Tedeschi in the New York Times. Ernie goes over pretty much every reason you could come up with regarding the question just posed; here are some of the findings I found most germane:

–If you look solely at unemployment, you’d think the job market is at full capacity. If you look at more broad indicators, you might not be so convinced.

–Low inflation tends to correlate with slower nominal wage growth, but the gap in wage growth between now and 2000—the last time we were at full employment—is only partially explained by slower price growth.

–Contrary to claims by Trump’s CEA, as Larry and I showed a while ago, benefit growth can’t be crowding out wage growth, because nonwage comp isn’t outpacing wages (we showed the nonwage share of comp has been flat in recent years; we also argued, as does Ernie, that demographic change doesn’t explain the wage-growth gap).

–Slow productivity is surely in the mix, but it’s only a partial explanation.

Let’s pause for some analysis of that last point, as productivity is key to this debate (and key to living standards), but sometimes gets short shrift. Also, advocates of this explanation, of which I am one, sometimes argue that it is a more binding constraint than is necessarily the case.

A recent paper by Janet Yellen, which Ernie cites as well, introduces a model that I’ve sort of replicated (I’m using some different data and not imposing some of the constraints she does on the model’s coefficients, though the results I’m about to show are similar if I do so). Yellen’s model includes slack, inflation, and productivity growth. All three variables significantly drive nominal wage growth, but here’s some evidence that slowing productivity growth helps to explain the gap which is the focus of Ernie’s report.

I’ve run the model using my “mash-up” wage series (five different series combined, so as to avoid cherry-picking) through 2010 and then forecasted forward using the actual values for the independent variables. The first figure shows that the model does a decent job of predicting wage growth out-of-sample. Most notably, even with the decline in unemployment (actually, the gap between unemployment and CBO’s estimate of the natural rate), this version of the model does not predict faster wage growth 8 years after the estimation period.

But if I exclude productivity growth (the Yellen model employs a smooth trend in productivity growth), a clear overshoot occurs. It’s not a huge effect, for the record, but it’s there.

To be clear, I could have done the same exercise with inflation and slack but economists have focused on slow productivity growth because it is, as I show in this post, an essential indicator of potential (average) wage growth, and its slowdown is therefore a real constraint on living standards more broadly.

However, as I also stress in the link just above, the role of bargaining power must not be overlooked in this productivity discussion. Even at low productivity growth, wages can grow more for some groups than others (distribution within the national wage share of income), and the wage share of national income, which has tanked in recent years, can rebalance in favor of workers. In fact, that dynamic is attractive from the Fed’s perspective, as it supports non-inflationary wage growth.

The final recent wage report to bring to your attention comes from researchers at Goldman Sachs (no link); it focuses on the distribution of wage pressures as the job market tightens up. Their table below makes a point I’ve long stressed: the less you earn, the more tight labor markets help you. The coefficient on slack (top row) is 2x that for low-wage as upper-middle-wage workers, and it is insignificant for high-wage workers. Note also, as in the Mishel/Wolfe chart above, the correlation between corporate profits and high-wage growth.

The other important finding from their regressions is the structural downshift of the model’s parameters in the post-2010 period, though not for low-wage workers (state minimum wage increases are likely in play here). The last figure shows that using the parameters from their full model predicts average wage growth close to 4 percent by late next year. But if the prediction is made based on the more recent, diminished correlations, then wage growth hardly budges from its current pace, even as they predict the unemployment rate to fall significantly below today’s levels.

Source: GS Research

Putting it all together, tight labor markets are as important as ever, though slow productivity growth and weak bargaining clout are still, even at 3.7 percent unemployment, operating as wedge between growth and broadly shared prosperity. The policy implications point towards the importance of patience at the Fed and more collective bargaining (and much better labor policies, including minimum wages/overtime, but that’s for another post). Workers need both tight labor markets and the power to steer more of the benefits of a full capacity economy into paychecks, not profits.

An important correction: The U.S. does have a carbon tax. But it needs some serious attention.

October 22nd, 2018 at 3:57 pm

I’m am avid listener to the NY Times podcast, The Daily, and I much enjoyed, if that’s the right word given the difficult topic, last Friday’s show on the urgency of pushing back on climate change. The show included an insightful discussion with recent Nobel laureate William Nordhaus on the importance of taxing carbon.

But somewhere in there (not in the Nordhaus section), it was asserted that the U.S. federal government does not tax carbon. In fact, such a tax exists: it’s the federal gas tax. Given that this is the carbon-tax-that-time-forgot, I can understand the mistake (the reporter was probably thinking about more sweeping, new taxes on carbon emissions). But there are two strong reasons for raising it. One, to more accurately price the social cost of carbon consumption, and two, to pay for our eroding transportation infrastructure.

The federal gas tax has been stuck–in nominal terms!–at 18.3 cents per gallon since 1993. It hasn’t been adjusted for consumer inflation, for the increased cost of transportation maintenance, for the improved fuel efficiency of today’s fleet, or for the slower growth over the past decade in total miles driven (see the figure below, showing a 12-month rolling average of total vehicle miles driven, in billions; people traveled a lot less in the downturn, such that miles driven are down by 480 billion relative to the pre-2007 trend; that’s good for the climate; bad for the trust fund coffers).

To be clear, those last two factors are roundly welcomed. But they also mean we’re collecting a lot less than we should be, which besides under-pricing carbon, is why a) the federal transportation trust fund is always broke, and b) our roads and mass transit suffer from persistent under-investment, especially in state that haven’t picked up some of the slack (the average state gas tax is 24 cents/gallon).

The tax analysts at ITEP do an excellent job of following this issue, but it is one that should be far more prominent. They calculate that to keep pace with the factors just noted, the federal gas tax today would need to be about 50 cents/gallon.

Since the federal gas tax was introduced in the 1930, this is the longest we’ve gone without raising it. Even President Reagan raised the damn thing (from 4 to 9 cents, in 1983)! As I document here, every once and a while, grown-up politicians propose an increase, often a bipartisan one. (BTW, as electric vehicles become more common–they don’t use gas; they do use roads–a per-mile user fee may be necessary to support transportation infrastructure).

As the Daily podcast stressed, there are policy makers who increasingly realize we must tax carbon, though especially in the age of Trump, they tend not to speak up much in this country. Moreover, it’s typically easier to add to an existing tax than introduce a new one.

Of course, I admit that it’s awfully hard to imagine a federal gas tax increase getting anywhere these days. But we’ve got to try, and we certainly can’t forget that it exists!


Source: DOT, Fed Highway Admin.


What’s wrong with upside-down Keynesianism?

October 17th, 2018 at 5:00 pm



I’ve got a piece in today’s WaPo focusing on how the tax cuts have broken an important, fiscal linkage between budget deficits and the strength of the economy.

“When we close on full economic capacity, as is currently the case, tax revenues as a share of the economy should significantly rise, and deficits should fall. Instead, revenues have come way down, and deficits have climbed.

Why is the deficit 17 percent higher than last year, especially when the economy is growing faster, and unemployment is lower?

It’s primarily because the tax cuts have significantly reduced the amount of federal tax revenue the economy will spin off for any given growth rate. Increased spending also played a role but not as large a one as the tax cuts…

Consider these numbers. Using data back to the mid-1940s, I calculated the average deficit as a share of GDP over every year since the late 1940s that the unemployment rate was lower than or equal to 4.5 percent (it’s currently 3.7 percent). That average is -0.4 percent, as opposed to the -3.9 percent noted above for 2018. By the way, if I take this and last year’s deficit (-3.5 percent) out of that average, the result is a small surplus (0.1 percent).

This figure below shows this heretofore tight correlation between deficit and unemployment rate. To make the relationship easier to see, I’ve inverted the unemployment rate, so e.g., 4 becomes -4. When the economy tightened up, deficits used to come down. But the circled area at the end of the figure shows that under today’s fiscal policy that is no longer the case.”

You can see, in the circled part at the end of the figure, that the two lines were tracking each other as usual (meaning the economy was strengthening and the deficit was falling) but changed course in just the past few years. My WaPo piece gets into some details of how this relates to the tax cuts/spending increases and what should be done to rejoin the lines.

But this piece is on the economics and political economy of what’s going on in that circle; what one might call “upside-down Keynesianism” (UDK), or stimulating an economy that’s already closing in on full employment.

Before I get into the analysis, however, in case there’s anyone here unfamiliar with my rants of last year, I should clarify that this conversation abstracts from the fact that the Republican tax cut is a regressive, wasteful mess of tax complexity that is already exacerbating income and wealth inequality while opening up new loopholes that will promote tax avoidance and evasion until it is reversed. But this post isn’t about that. It’s about the macroeconomics of stimulating an already strong economy, not the composition of the stimulus.

What are the upsides and downsides of UDK?

The most obvious upside of UDK in the current economy is the extent to which the stimulus—deficit spending on tax cuts and spending programs—is pushing the economy closer to full capacity than would otherwise have occurred. In fact, there is both theoretical and empirical support for this upside.

First, “secular stagnation” argues that structural factors—inequality, aging demographics, persistent trade deficits—prevent the U.S. (and other advanced economies) from achieving truly full employment absent a push from “non-market” sources, such as fiscal stimulus or accommodative monetary policy.

The other theoretical support for UDK’s upsides is that economists must admit that we do not know our stars (u*, y*, r*)—the economy’s capacity indicators (the lowest unemployment rate consistent with stable prices, the level of potential GDP, the neutral interest rate)—within a policy-relevant confidence interval, and we’ve generally erred on the side of caution.

Therefore, stimulus at alleged full employment can help achieve actual full employment. In fact, the next figure shows that as actual unemployment has fallen well below the Fed’s estimates of u*, inflation is just now, after years of downside misses, hitting their 2 percent target (FWIW, I recently wrote up a related analysis which argues that their u* is about right; it’s just that inflation is really well anchored; as far as UDK is concerned, the upside is the same).

Empirically, even if we accept that standard estimates of u* (e.g.) are not too high, actual unemployment has been above the CBO’s u* for two-thirds of the quarters since 1980. In other words, the U.S. labor market has been slack far more often than not, a huge market failure, a significant factor in weakening worker bargaining power over these years, and a strong case for pushing beyond conventional measures of full employment.

The most obvious downside of UDK is overheating. Though the inflation line in the previous figure shows little evidence of such pressures so far, these dynamics can be non-linear, as long-dormant correlations can reawaken at high capacity levels. In their new World Outlook chapter assessing current risks, the IMF worries that since “the US economy [is] already operating above potential, expansionary fiscal policy could lead to an inflation surprise, which may trigger a faster-than-currently anticipated rise in US interest rates, a tightening of global financial conditions, and further US dollar appreciation, with potentially negative spillovers for the global economy.”

The IMF are worrywarts about such developments, but economist Dean Baker, with whom I frequently collaborate on ways to gin up more demand, is clearly not. Yet, even he recently said that ”…we are likely getting close to full employment, so we probably don’t want too much larger of a deficit.”

But there’s a less obvious downside to UDK, one I raised in the WaPo piece and the one which concerns me most. Remember, Keynesian interventions are temporary injections of deficit spending to get over a negative, macro shock. But the tax cuts are intended to permanently damage our revenue-base, and as such, they are merely the latest installment of the Republicans’ longer-term agenda to never raise, but always cut, federal taxes. As I argued in the WaPo, the dangers to this low-revenue path strike me as acute and threatening in real time:

“Based on our aging demographics alone, we’ve long known that we will need more revenue over the next decade, not less. Add in geopolitical threats, climate change and the damage from increasingly intense storms (which is tied to the warmer climate), infrastructure, the need to push back on poverty and inequality, counter-cyclical fiscal policy that will be needed for the next downturn, and, it’s not hard to understand why a rising deficit at full economic capacity is so ill-advised. That is, unless you’re being paid not to understand these fiscal realities.”

In this regard, one of the biggest threats from the tax cuts that must be considered, even in the context of UDK, is the role it plays in emptying the Treasury’s coffers so that Republicans can point to all that debt as a rationale for cutting social insurance and safety net programs.

Keynes v. Laffer

If I’m correct about that threat, UDK may be a misnomer, as Keynesian stimulus is by definition temporary and, though they made some of the their tax cuts temporary for budget scoring purposes, the advocates of the cuts want them to be permanent. And yet, if you look at any credible economic projection, you find Keynesian dynamics in the forecasts: as fiscal stimulus fades in late 2019, as shown in the next figure, the forecasts expect GDP growth to slow and unemployment to rise. This expected reversal in fiscal impulse is behind the Fed’s latest forecast, which has real GDP up 3, 2.5, and 2 percent, 2018-20.

Source: GS Research

Advocates of the tax cuts, however, view this forecast as wrong, as it discounts Laffer effects, wherein the cuts allegedly pump up supply-side variables—capital investment, productivity, labor supply—such that GDP moves to a permanently higher growth path (roughly 3 percent as opposed to 2 percent).

In other words, barring another round of significant deficit spending, which, ftr, I would not rule out, in a few quarters we’ll have a real-time, cage-match between Keynes and Laffer.

If GDP slows from its current underlying, short-term trend of around 3 percent to its pre-tax-cut trend closer to 2 percent, as the forecasts predict, Laffer loses…again. To be clear, as the WaPo piece argues, he and his disciples have already lost on the assertion that tax cuts pay for themselves, but that was never even remotely believable.

There is, however, a wild card in play, one I’ve written about under the rubric of the FEPM: the full employment productivity multiplier. This idea, for which there’s suggestive evidence, is that in slack economies, firms can maintain profitability without being particularly efficient. However, at chock full employment, and especially with anchored inflation expectations, rising labor costs are a disciplining mechanism, enforcing the discovery of efficiency gains if firms are to maintain profit margins. These dynamics can also drive more capital investment that would not have been “necessary” in slack labor markets.

Thus far we haven’t seen much to suggest the “sugar-high” forecasts are wrong. Business investment is up, but no more than you’d expect at this point in the recovery. Productivity growth is still too low.

Moreover, even if there is a productivity multiplier that gets tapped as we close in on full employment, it will be hard to assign victory to either side. In theory, Keynes wins again, as the capital investments in the FEPM model are not a function of the lower, after-tax cost of capital as much as a Keynesian accelerator story, where full-employment-driven job and wage gains fuel stronger consumer demand. In response to higher demand and the desire to maintain margins, firms ramp up their investment. But empirically, it will be hard to tell one story from the other.

In sum, and abstracting from the awful regressivity, complexity, and aspirational permanence of the tax cuts, UDK has clear upsides. I don’t think the unemployment rate would be as low as it is right now without it. Its almost-50-year low is finally starting to generate wage gains that will reach those who have heretofore been left behind in this expansion, even in year nine.

UDK also invokes the risk of overheating. Yes, the Fed has lots of firepower to deal with that if need be, but the IMF could be right and we could end up with a hard versus a soft landing.

But at the end of the day, my biggest concern is less about UDK and more that we’re not really talking about temporary stimulus. We’re talking about a permanent reduction in revenues, sought by hard-right conservatives who have been gunning for social insurance programs forever, and thus view this current strategy as a twofer to both enrich their donors while starving the Treasury.

What does “full employment” mean in the era of anchored inflation expectations?

October 15th, 2018 at 6:00 am

There’s a new analysis out by a group of economists from the Goldman Sachs economic research team that raises the question of what the concept of full employment means in an era when the central bank expends significant and successful efforts to anchor inflationary expectations.

The paper (which lives behind a paywall) uses four distinct techniques to to derive different estimates of the natural rate of unemployment, aka u*, aka the lowest unemployment rate consistent with stable inflation. The results range from 4 to 4.8 percent, which, as their figure below shows, fit well within other commonly sourced versions, including CBO (4.6 percent) and the Fed (4.5 percent). Note also their forecast for the jobless rate to get to 3 percent (!) by the end of next year. As they say in the old country: “from their lips to Keynes’ ears.”

Source: GS Research

For those who are interested, I’ve pasted in their table at the end of this post which briefly describes their four methods and results, but anyone who still subscribes to Phillips Curve notions of full employment might well ask: “why, if the current unemployment rate is below all these estimates of the natural rate, is there so little acceleration in core inflation?” Here is their conclusion (my italics):

“The actual unemployment rate is already below all of these estimates, and we expect it to fall all the way to 3% in early 2020.  But…such a scenario is not as dramatic as it sounds: with well-anchored inflation expectations, a labor market overshoot is likely to result in above-target inflation, but not persistently accelerating inflation.  This is an important difference with the late 1960s, when labor market overheating led to runaway inflation.”

Now, one of my constant refrains these days is that the Fed’s 2 percent is an average target, not a ceiling. Given the many years of downside misses on the inflation target, we’re long overdue for a period of “above-target inflation.” So, if these analysts are correct, as I suspect they are, then this overshoot is a feature, not a bug.

If that’s true—if an unemployment rate significantly below the Fed’s natural rate estimate means we get something we very much want (super tight labor markets) as opposed to something we very much do not (spiraling inflation)—then, conditional on inflationary expectations remaining well-anchored, being above full employment is precisely where we should aspire to be.

This is an awfully different economic model. In this model, go ahead and bang out estimates of the natural rate if you must, but recognize that (u-u*)<0 (actual unemployment below your estimate) is not a signal to hit the growth brakes. In this model, your real job is to watch the indicators of inflation expectations and realizations. And if, as is currently the case, they seem well-contained, then there’s no reason to overreact.

One interesting aspect of this conclusion is that those of us who have criticized the Fed’s anchoring as being a drag on demand relative to more flexible inflation or level targeting (I’m talking to you, Beckworth) might consider that at least under this framework, solid anchoring enables stronger demand and lower unemployment than would otherwise prevail.

However, for those who benefit the most from such low unemployment to realize such gains, the members of the FOMC would have to recognize these dynamics. I actually think Chair Powell does, and he’s not alone, but there are others who look at that 3 percent at the end of the figure above and think, “not on my watch!”

Source: GS Research