That second quarter GDP report: should we be worried?

August 1st, 2016 at 8:14 am

I didn’t much like that GDP report from last Friday, showing that the economy expanded at an annual rate of 1.2% in the second quarter. OTEers know my methods: I prefer to smooth out the quarterly noise by looking at year-over-year trends. However, as the figure below shows, that doesn’t help so much. In fact, by that measure real GDP growth has decelerated for each of the last six quarters.

Source: BEA

Source: BEA

But before getting too wound up, consider the following:

–Real inventories were a big negative last quarter, reducing the top-line number by 1.2 ppts. Inventories are by far the most volatile component of GDP growth, and over the long term tend to balance out around zero. You can see what I mean in the figure below, which looks like an EKG from someone who’s consumed a few too many grande lattes. Why are inventories such a noisy component of GDP? Because unlike all the other components, the underlying inventory measure is already a “delta”—a change, i.e., an inventory build-up or draw-down—so the quarterly change is a “change-in-a-change,” which is invariably more variable and thus indubitably more doubtable in any given quarter.)

Source: BEA

Source: BEA

–The next question should then be: OK, what’s the trend in real “final sales,” which leaves out the noisy inventory component. That’s averaged a steady 2% over the past four quarters, which is about the economy’s trend growth rate right now, though in the prior four quarters, real final sales grew a point faster.

–The Obama economics team, while they’ve obviously got an angle, provide thoughtful and objective summaries of these reports (you just have to get past the usual “President Obama wakes up every morning thinking about how to boost non-residential fixed investment!”—JK, CEA!). They argue, based on statistical evidence, that a stripped-down version of GDP, comprised of just consumption and investment outside of inventories, provides the best take on where the economy is heading (this breakdown is called “private domestic final purchases” or PDFP). Here’s their take from Friday:

“In recent quarters, weaker foreign demand has dampened business investment, and low oil prices have weighed on energy-related investment, both of which have typically led to slower PDFP growth. In the second quarter, though, these drags on growth were offset by strong consumer spending, resulting in a solid pace of PDFP growth. The gap between PDFP and GDP growth this quarter is more than accounted for by movements in inventory investment. Overall, PDFP rose 2.2 percent over the past four quarters, above the 1.2-percent growth in GDP over the same period.”

So, while I don’t love the deceleration in top-line GDP (Figure 1 above) one bit, I’m not wetting the bed over it, either. The pace of employment and even wage growth, including real wage growth, remains solid. Quarterly GDP is a noisy indicator beset by various factors like inventories that tend to lower the signal-to-noise ratio. The advance report, meaning the first of three releases, is subject to significant revisions. Unusually low energy prices are climbing back a bit and the dollar is weakening, both of which could boost production in coming quarters (net exports were a plus in q2, adding 0.23 ppts to real GDP growth).

If you want to worry about something I have two excellent candidates for you. First, slow productivity growth. I’ve already written a bunch about the deceleration in output-per-hour, and one point I’ve made is that as the job market tightens and labor costs rise, that could create some pressure on firms to squeeze out inefficiencies that they could afford when there was lots of labor market slack (I’ve called this the FEPM: full employment productivity multiplier). We’ll see, but these things turn very slowly.

Second, if, in fact, GDP really does slow down enough to threaten recession, then we’ve got a serious problem. The Fed won’t be able to lower rates much because they’re already quite low. And the fiscal authorities—the Congress—simply can’t be trusted to quickly legislate the needed discretionary spending.

So it will all be about the automatic stabilizers. They’ve proven to be very helpful, for sure—Unemployment Insurance, food stamps, and Medicaid all performed admirably in the last recession (they all benefitted from ramped-up discretionary assistance from the federal gov’t as part of the stimulus). But unless the downturn is very shallow, both of the recessionary-fighting forces may well prove inadequate to the task.

In other words, stay tuned…

House cleaning…and where’s Jared?

July 28th, 2016 at 5:53 pm

Sorry, OTE’ers. I’ve been remiss. Not only have I failed to post much here of late, but I haven’t been providing links to posts I’ve placed elsewhere.

EG, over at PostEverything:

From today, a discussion about very recent wage trends. They’ve turned up due both to tighter job markets, a central prediction of so much of my work. Also, low inflation is helping to generate real gains. Obviously, these recent trends must be placed in the long-term context of wage stagnation, but they’re real [sic] and relevant to the election, I’d argue.

A number of posts re political economy, including this one on some fundamental differences to my eyes and ears between where the DNC and RNC are at on globalization, this one on the policy agenda we need to be talking about, and this one on the misguided nostalgia of today’s Republicans, who describe an America that I, for one, hardly recognize.

Finally, be sure to give this one a read as I’m pretty convinced we’re going to be hearing a lot more about how, through magic modelling (versus what happens in real life), big tax cuts largely pay for themselves.

Oh–and over at Vox: a teaser for a longer piece coming out shortly on the new rules of the road for progressive trade agreements–the kind that put working people at their core, not corporate interests.

I’ve also been busy with summer travel, including looking at colleges with one of the kids…which so far makes me really want to go back to college and start all over again.

Anyone know where I am here??



I’m not in the USA (but to win, you need to name both the country and the city).

They’re having a bit of a housing bubble but at least they’re trying to deflate it by taxing foreign home purchases.

Unlike us, they’re able to implement policies to try to meet their challenges, including robust carbon taxes and a recent expansion of retirement income security.

One way they’re able to maintain much smarter politics than we are is that their civil service comprises a much thicker slice of their government employment. IE, many fewer political appointees, which has the effect of fostering less ideological nonsense, less dog-whistle blowing to constituents vs. actual policy work, and thus less time wasting.


Poverty and income predictions for 2015

July 22nd, 2016 at 9:41 am

I know–why predict 2015 outcomes. That’s last year, right?

Right. But the Census Bureau publishes estimates of household income and poverty results with a lag. This year, their results for 2015 will come out on Sept. 13. I’ll write them up that day, as is my wont, but for reasons I can’t explain, I always like to try to forecast them.

My track record isn’t great. Last year, I was fairly confident that poverty fell in 2014, but it held at 14.8%, meaning that’s the share of the population with 2014 incomes below the poverty thresholds (plural because the thresholds change by family size). However, the 2014 results were somewhat ambiguous because Census did some redesigning of their income questions. There may have been some comparability issues with the samples used to compute the changes in poverty and income.

(I took some solace in that my forecasts matched the results from a different Census survey–the American Community Survey–which comes out a couple of days after the one discussed here. I think the ACS data were more reliable last year.)

This year, I’m moderately confident that I’m right, at least directionally. My forecasts are:

–poverty fell half-a-percentage point, from 14.8% to 14.3%.

–real median HH income rose 1%.

The poverty change would be statistically significant; the income change would not be.

For a variety of reasons, we could see more of an upside than a downside surprise–i.e., a greater fall in poverty and rise in income than I’m predicting. For one, I think the survey changes may have missed the decline in 2014, so there’s some pent-up juice there. For another, inflation was almost 0 last year, and that turns out to matter in these data.

The poverty thresholds are adjusted by the rate of inflation. So if inflation is very low, the thresholds hardly change at all. Meanwhile, people’s nominal incomes tend to rise year-over-year, especially when the job market’s tightening, as it was in 2015. That should push up the real HH median income and bring down the poverty rate.

My model runs off of mostly inflation and labor market variables, and since I have these outcomes for 2015, I can make the prediction.

So, based on very low inflation and the growth in jobs and real wages last year, I think the results will be a marked improvement over last year’s. That doesn’t imply happy days, ftr. After six years of recovery, both variables will still have not returned to their pre-recession levels back in 2007.

The politics of this are always interesting in an election year. The R’s just finished a convention that painted what I’d bet is the most negative picture of America ever to come out of party’s nomination process. If I’m in the ballpark, the results may cause some dissonance, though that assumes an acceptance of data/facts–a strong assumption, indeed.

My response to the Tax Foundation’s response to me: evidence first, assumptions later.

July 18th, 2016 at 2:05 pm

Unsurprisingly, the Tax Foundation objected to my critique of their pumped-up growth results from evaluating the House GOP tax cut. Their response makes a bad point and a good point (so, on net, they got nothin’!).

Their bad point is blowing smoke around net and gross numbers. This is just obfuscation, and not worth arguing about. The TF themselves prominently report the following as a “Key Finding” from their analysis of the House GOP tax cut (it’s their bullet #3):

“The plan would reduce federal revenue by $2.4 trillion over the first decade on a static basis. However, due to the larger economy and the broader tax base, the plan would reduce revenue by $191 billion over the first decade.”

Like me, they don’t get into net or gross either here. What matters, and what I and anyone else who worries about smart fiscal policy must question, is their implausible claim that the growth effects from the plan would turn a $2.4 trillion revenue loss into one that’s 92 percent smaller.

Their second point is much better, and warrants a response. As have many other critics of their model, I pointed out that by assuming away “crowd-out”—the idea that budget deficits compete with private borrowing and thus lead to higher interest rates, which in turn slow investment and growth—the TF model gets results that are far, far more favorable to tax cuts than the official scorekeepers.

Here’s what I wrote:

“In fact, in the Congressional Budget Office’s and JCT’s analyses, these types of proposals don’t just generate growth plus-ups based on lower tax rates or capital costs. They also, when they’re not paid for, generate larger budget deficits that crowd out private borrowing, raise interest rates and thus hurt investment. As my Center on Budget and Policy Priorities colleague Chye-Ching Huang notes, “JCT’s analysis of permanent bonus depreciation concluded that in the second and third decade, due to deficits and crowding out, it’s impossible to tell whether counting macroeconomic effects even reduces or increases the cost of the proposal.” The TF model, in effect, assumes away such potential negative impacts.”

That’s unquestionably true, and if TF disagrees, it would be useful to hear about it.

What I didn’t get into is my own views on the crowd-out question, and TF correctly and relevantly point out that in other writings I’ve raised questions about the validity of the crowd-out assumption. In recent years, interest rates have stayed low across many parts of the globe, often irrespective of government finances.

Interestingly, this dynamic is likely related to what economist Larry Summers has dubbed “secular stagnation,” a condition driven by the failure of even low interest rates to generate the investment growth needed to achieve full employment. The TF model ignores this (as do most other such models), yet another reason I consider their results too sunny.

Their accusation is that I’m being inconsistent on crowd-out. In fact, the point of this aspect of my critique was simply to show that they’re making very different assumptions than the official scoring agencies, and that these assumptions are partially driving their big offsetting results. To the extent that my own views on crowding out matter here, I suspect there’s probably less near-term crowding out than CBO/JCT assumes and more than TF assumes.

What would really be inconsistent would be for me to argue, as does TF, that because of this diminished near-term correlation between deficits and interest rates, tax cuts generate enough offsetting revenue to significantly lower their costs. To the contrary, I’ve long argued against the supply-side growth effects that undergird the TF’s favorable scores for big tax cuts.

And that’s what really matters here: how confident can we be that the House GOP plan will pay for 92 percent of its (net) cost? As I wrote in my critique, I suspect we’ll see a lot more of this sort of scoring from the TF, possibly next re a new Trump tax plan.

In this regard, crowding out is but one of the model’s problems. What’s more problematic about TF’s model, as with all hyper-aggressive supply-side models, is their implausible tax-cut responses from “factor inputs,” like labor and capital, a point Josh Barro made in a highly critical recent NYT piece on the TF model. After consulting with top tax economists, he concludes, as I do, that the “Tax Foundation assumptions…take us farther away from accuracy, and make unsupportable promises of tax cuts paying for themselves.”

Consider: as noted re low interest rates, the cost of capital is already very low, and we’ve consistently been tweaking the tax code in recent years with bonus depreciation on investments. Yet we’ve seen nothing like the response to capital investment that TF assumes.

In fact, as I show here (and CBPP colleagues show here; and CRS shows here) there’s little empirical evidence to support the magnitude of these supply-side tax responses on growth and investment.

It’s this empirical evidence that I find most compelling and most damaging to the TF case. I’ve looked under many rocks for actual correlations (a lower bar than causation) between supply side tax cuts and growth. I come up with nothing.

That, instead of modelling assumptions, is what the TF folks, who are capable and serious analysts, need to show. If you want us to take your model more seriously, show us the evidence of past supply-side tax cuts coming anywhere close to paying for themselves, and conversely, the negative growth and revenue impacts from past tax increases.

Evidence first, assumptions later.

Share buybacks, our investment deficit, and bad tax ideas

July 13th, 2016 at 9:08 am

A quick note with more pictures than words.

–Investment, both private business investment and public investment (infrastructure), have been weak of late.

Source: BEA, CBPP

Source: BEA, CBPP

–In fact, as a share of GDP, business investment has consistently hit lower peaks over the last few business cycles.

Source: BEA

Source: BEA

–Yet we know corporate profitability is high and the cost of capital is rock-bottom cheap. If they’re not investing their retained earnings in future growth, what are firms doing with the money? A: Share buybacks.

Source: WSJ

Source: WSJ

–This hurts productivity and boosts inequality. It is, I believe, a source of the capital misallocation that’s in part responsible for one of our most significant economic problems: historically slow productivity growth.

–What to do? Republicans have an idea that’s showing up in all their tax plans: cut the cost of capital by allowing full expensing of new equipment purchases. But as stressed, the cost of capital isn’t the constraint. All full expensing will do is increase the budget deficit, making it increasingly difficult to take the obvious step:

–If pvt investment won’t step up, public investment must do so. As the first figure on the right above shows, the need is there. I agree that economists need to figure out why pvt inv has been so weak (I’d bet: weak demand, higher returns from financial “innovations,” and short-termism (buybacks)), but in the meantime, I’m hearing increasing agreement around the need for infrastructure investment. Economists and many in the biz community get this. Voters, OTOH, are disengaged on this point and that needs to change. There needs to be bottom up pressure–let’s start with not poisoning our kids with lead-infused water pipes.