Jump on the productivity merry-go-round!

May 18th, 2017 at 5:14 pm

That’s the new game all the nerds are playing. You just write down all the reasons why people say productivity isn’t growing as fast as it was 15 years ago, and you ask noted productivity expert John Fernald: “Whussup with that?”

That’s what Ben and I do in the latest episode of the On the Economy podcast, which you can listen to on SoundcloudiTunesStitchrGoogle Play, and TuneIn.

Of course, while podcasts are fun and convenient, they don’t support graphs, so here’s a graph of year-over-year changes in productivity growth. Fernald points out how noisy the series is, so I’ve added a slow-moving trend which captures the important facts of the data: productivity was growing at around 3% until the mid-1970s. Since then, it’s grown a lot slower than that, though that hump in the latter 1990s is something to which we devote a lot of analysis in the podcast. At any rate, over the last decade, productivity has grown at around 1.2.

Source: BLS, my analysis

Even while we’re crackin’ wise and having fun in the discussion, it’s essential to recognize that when President Trump and Secretary Mnuchin go on about how their awesome program is going to deliver 3% growth, they’re mainly talking about changing that trend in the picture, about which Ben, John, and I are all duly skeptical. (I discuss their real motivation for such nonsense here–the faster growth assumption sops up a bunch of red ink caused by their big, regressive tax cuts.)

Special bonus for OTE’ers: You’ll hear a snippet of Eliane Elias on the podcast, but here’s one of her recent concert performances that’s worth a close listen.

Potential growth and phony budgeting

May 16th, 2017 at 10:29 am

The WSJ has a piece out this AM making an argument that’s become common from economists who think about growth, myself included: there’s no good reason to expect team Trump to achieve their 3 percent GDP growth goal. Many previous pieces have made this case, based on the limits we observe to the two additive components of GDP growth: labor force and productivity growth.

I’ll get to those in a moment, but to me, the important and timely line in the WSJ piece wasn’t so much the analysis of why 3 percent is probably an unrealistic goal (though good for the Journal for amplifying this point). It’s this one sentence, with a factoid you need to know (my bold): “If the economy expands at around a 3% rate over the next decade—a projection Mr. Mnuchin says the administration will make in its budget proposal later this month [next week, actually]—government revenue over the time should be $3.7 trillion more than currently forecast, according to estimates by economists at Goldman Sachs Group Inc.” And those dudes know their trillions.

So that’s the play here. They’re going to pretend to get the extra revenue they need to offset their big tax cut by making an unrealistic growth assumption. The official revenue scorekeepers won’t buy it, so eventually we’ll see a more plausible score with lots of red ink, but when you hear administration officials claim otherwise, you’ll know why they’re wrong.

That said, people who have very reasonably come to distrust economists’ proclamations about growth forecasts might well ask, “how do you know what’s possible re future growth rates?” Fair point. One of the key drivers, as noted, is productivity growth, and economists failed to forecast both the mid-1990s speedup and the subsequent slowdown.

On the labor force—the other growth component—we’re on much more solid ground. Our aging demographics are baked in the cake, so, absent a bunch more immigration, which is possible but unlikely, that’s going to account for 70 percent of the slowdown, as shown in the table below from CBO projections (1% of the 1.4% growth deceleration).

On productivity growth, like I said, we just don’t really have a great bead on what makes it speed up or slow down, so our best move is to assume the long-term trend persists. Over the past 50 years, productivity growth has been around 1.5 percent, about where CBO is in the table above. No one can be too confident in that prediction, but you can be sure that there’s absolutely nothing in the Trump agenda—or anyone else’s agenda—that would justify a predicted jump in that growth rate.

One final point designed to encourage a healthy dose of skepticism about these forecasting exercises. The WSJ includes the figure below, showing the potential growth rate, the same topline variable in the CBO table above. Note how it wiggles up and down over time, suggesting movements in maximum labor force and productivity growth.

Source: WSJ

While there’s definitely some rich analysis that goes into this measure—CBO does the best work one can do on it—it ends up being pretty close to a simple trend extraction. That is, for all our number crunching and forecasting of what’s going to happen, we’re pretty much looking in the rearview mirror and saying, “the future will be a lot like the past,” especially regarding productivity growth.

Let me show you what I mean. The figure below plots the same potential GDP growth line from the WSJ figure against a smooth trend extracted from actual GDP growth. They’re not the same but they’re close. Interestingly, they diverge significantly at the end, but even if the trend is right, it’s still just about 2 percent, which is, in fact, the underlying GDP growth rate since 2000.

Source: BEA, CBO, HP trend

Summing up, economists’ productivity predictions tend to be off the current trend, which is as it should be, but admits that we’re lousy at catching turning points. Certainly, if you’re budgeting for the future, that’s by far the only prudent play. Any assumption of significantly faster growth should be treated with as much respect as magic beans. Aging demographics, on the other hand, are slowing growth in a way we can somewhat reliably predict. And most of all, fully discount BS revenue projections off of phony growth forecasts.

Housing, justice, jobs, and the flat Phillips Curve: Racial discrimination and a possible role for the Fed

May 15th, 2017 at 11:35 am

Over at WaPo. One attribute of the post is the link to Richard Rothstein’s important new book documenting the “unhidden policies” responsible for racial residential segregation. The rigor of his research creates a bullet proof case for a) the laws, covenants, and zoning practices that kept African-Americans in high-poverty areas, and b) the difficulty unwinding those impacts today. I predict this book is going to be a big deal. At least I hope so.

Here’s the figure showing the constant ratio where black unemployment rates are 2x those of whites. This may be one of the most consistent relationship in economics, which is why I argue for lower overall unemployment in the piece, to tap this powerful elasticity to disproportionately push down the black rate.

Source: BLS

Reflections on Trump et al’s weirder than weird economics interview

May 12th, 2017 at 8:32 am

Yes, there was probably a bit more than the usual dose of cray-cray in President Trump’s interview with The Economist yesterday. But I just can’t muster the energy to crack wise about all that, other than to point out than the bit about how China stopped managing their currency the day Trump won is over-the-moon ridiculous, as one mouse click reveals.* What galled me (and Matt Yglesias) was to hear Sec’y Mnuchin chime in right after Trump made that claim: “Right, as soon as the president got elected they went the other way.”

There are profound, existential questions about the consequences of being governed by people with such a tenuous grasp on reality, but I cannot deal with those questions right now.

Instead, I’d like to contemplate a bit of what Max Ehrenfreund writes about here, particularly about the future path of the budget deficit. I don’t take Trump/Mnuchin’s assertions too seriously, but they do suggest they’re uninterested in the parts of their tax plan that were in there to raise revenues, like ending interest deductibility or the border adjustment tax. They also talked about a tax repatriation scheme which, if it’s like past versions, also scores as a money loser.

When asked if he was OK with the deficit increase implied by all that, Trump said, “It is OK, because it won’t increase it for long.” The tax would trigger growth effects that would offset the deficit.

That’s not gonna happen. Yes, they’ll assume phony growth numbers and magic-asterisk-spending cuts to make the pools of red ink appear to be less deep. Congressional Republicans may impose smaller tax cuts than what I suspect the administration has in mind, though I don’t think they care much about deficits either. So we’re looking at larger budget deficits—I’d guess much larger—than are currently forecasted.

By the way, at this point in the interview, the President got into all that “priming the pump” stuff, but that’s not really their play here. Keynesian pump-priming is a temporary fiscal boost to offset a temporary demand contraction. It is designed to boost growth and jobs during the downturn, but we don’t assume that it will boost the economy’s underlying growth rate. Trump and Mnuchin, however, are claiming “supply-side” effects: tax cuts will boost investment, productivity growth, and labor supply, and thus raise the long-term, potential growth rate.

In this regard, they’re conflating Keynes, who’s been proven right, and Laffer, who hasn’t.

There’s yet another wrinkle to all this. To fit within the budget rules, the Trump tax cuts are probably going to have to sunset after some number of years (probably 10). Even in theory, for tax cuts to generate any supply-side effects at all—there’s no argument that they “pay for themselves”—they must be permanent. Investors and labor suppliers won’t change their behaviors if rates are just going to go back up outside the budget window. So, the budget rules are actually pushing Trump more towards “temporary” pump priming (though 10 years is not exactly temporary), even while their own scoring will be based permanent supply-side effects.

Again, this is all theory, about much of which I’m skeptical. But the official scorers—the Joint Committee on Taxation—will factor in this non-permanence and give the administration very little by way of growth effects. And if the deficits grow as large as I suspect they will, JCT will ding them such that their dynamic score could be negative on growth.

That said, criticizing Trump’s economic musings is like criticizing the architectural soundness of a five-year-old’s sand castle. It’s not real, so what’s the point? Just feels mean…

Anyway, you might think that all this tax-cut induced pump-priming will help push the unemployment rate down even further, and you might well be right, but don’t forget about the Fed. One thing they do over there is pay attention to federal fiscal actions with an eye to their impact on the macroeconomy. From a Goldman Sachs review (no link) of the Fed’s reaction to fiscal policy changes:

First, Fed staff updated their fiscal projections in real time, often before bills were even introduced, and had fully accounted for the impact of past packages by the time they became law. Second, FOMC participants updated their own fiscal expectations nearly as quickly. Third, participants began to cite fiscal policy changes in support of their views on appropriate monetary policy closer to the time the bills became law.

So, if the macroeconomy is around where it is now when these tax cuts come online, there’s a good chance that Fed will push back on any pump-priming by taking away the punch bowl. (Do you know what I mean by that? I just came up with it a couple of days ago and I thought it was good.)

I was talking with my friend Joe Gagnon about this stuff the other day, and he raised the possibility that more US demand and higher interest rates could draw in more capital, raise the value of the dollar, and worsen the trade deficit.

Sounds plausible to me, but the president isn’t going to like that.

*Speaking of Joe Gagnon, he and Fred Bergsten have a very important new book coming out–I read the proofs–any day now on currency conflicts and trade policy. On China, they clearly show that while China clearly depreciated their currency at various times to gain an export advantage, they have not done so since 2015. To the contrary, the helped us out in 2015-16 by selling dollars long before President Trump was even nominated.

Flat Phills, all around

May 7th, 2017 at 12:26 pm

I’ve got a piece in today’s WaPo on the diminished correlation between the tightening labor market and wage and price growth. This is evidence of the well-known flattening of the “Phillips Curve,” the statistical relationship between nominal wages, prices, and tightness in the job market.

The figure below shows annualized growth rates of a) core PCE inflation and b) nominal wages of blue-collar factory workers and non-managers in services over numerous periods of falling unemployment. Since the 1980s, those growth rates have been falling. In the current episode of falling unemployment, price growth has been particularly slow. Those familiar with this phenomenon will recognize this observation as the flipside of the question we were asking when unemployment was 10 percent: “why isn’t the rate of inflation falling.”

Source: BLS, BEA

My WaPo piece gets into the why’s and why-this-matters. Here, I just wanted to post some complementary evidence.

A simple model does a decent job of predicting yearly changes in the ECI wage index. The model includes two lags of the dependent variable and a measure of full employment: u-u*, or unemployment minus the CBOs estimate of the full employment rate.

The figure shows that the model tracks wage growth through the tight-labor market of the 1990s, but over-predicts in the 2000s. Toward the end of the series, there’s a hint that ECI wage growth may start to underperform the forecast.

The growth in the blue-collar, non-managerial hourly wage has also flattened in recent months, even as the job market has tightened further (the smooth line is a 6-mos moving average).

Finally, Kalman filtering is a useful statistical technique to test whether and how much an economic relationship–in this case, the correlation between ECI wage growth and u-u*, or labor market tightness–is changing over time. The last figure shows that in a model with yearly ECI changes as the dependent variable, the coefficient on u-u* has drifted up and is about zero now. Moreover, the upward drift accelerated a lot in the last few years.

I say what I think this means–and cite many explanations from others whom I bugged about it–in Monday’s paper. But the facts of the case look pretty solid to me, at least for now.