Yes, Inflation/Deflation is Hard to Measure

Posted by Jim Luke — February 6, 2012

One of the hardest concepts for ~~Principles students~~, ~~politicians and pundits~~, oh heck, just about everyone to fully grasp is inflation. A big part of the reason is because inflation is an abstract concept that is not directly measurable. We can conceive of it, but we can’t measure it. I’m no physicist (and open to correction) but it strikes me that it’s a bit on par with “momentum” or “latent energy” in physics. We don’t have direct-measuring energy-o-meters. We measure the effects and infer the energy. Inflation is similar. We can conceive of a generalized, across-the-economy, sustained trend pushing all/most prices upward such that the unit of money is losing real value in general terms. Inflation is the sustained push behind all prices. We can’t measure that directly. But we can measure the effect it has: rising prices. The problem comes in that not all prices will be rising at the same time or by the same amount. Further, during any time period, at least part of the change in price for any good is it’s change in real price relative to all other goods (supply and demand as taught in micro).

We try to deal with this measurement issue by creating a price index – an index that tracks the changes in shopping list of goods over time. But any price index is a just a subset of all the prices. Even the Billion Price Project index at MIT admittedly misses most services and lots of consumer goods that aren’t available online. Price indices are very imperfect beasts. They have many faults, not the least of them being that they often tend to be volatile in nature. Since we’re looking for an estimate of inflation which means sustained increases, we need to massage the data further by creating some kind of “core inflation” measure or “trimmed means” type price index. I’ll explain those some other time.

What prompted today’s post is an article in Bloomberg and a post by Krugman about it. Together they illustrate one of the reasons so many people want to believe we have greater inflation than we really do. Companies like to disguise price changes. They don’t want to be known that prices could be cut in response to demand. Example: auto company offers $2000 rebate on $20,000 car but won’t cut price by 10%, or a firm offers a “value meal”, or they offer a freebie bundled product. Similarly they often disguise price increases by reducing sizes or portions or by changing the financing. From Krugman:

Good article in Bloomberg:

Procter & Gamble Co.’s failure to raise the price of Cascade dishwashing soap shows why investors are buying Treasuries at the lowest yields in history, giving the Federal Reserve more scope to boost the economy.

The world’s largest consumer-products company rolled back prices after an 8 percent increase lost the firm 7 percentage points of market share. Kimberly-Clark Corp. (KMB) started offering coupons on Huggies after resistance to the diapers’ cost. Darden Restaurants Inc. (DRI) raised prices at less than the inflation rate as patrons order more of Olive Garden’s discounted stuffed rigatoni than it anticipated.

This is basic economics; prices tend to fall, or at least slow their rise, when there is vast excess capacity and weak demand.

As both the article and Krugman’s excerpt show, we’re closer to deflation than most people realize. They don’t see the failed attempts to raise prices. They don’t see the shifts in portions or increase in coupons that reduce effective prices. What they do see and remember is the $.50 increase in a loaf of bread or the $.70 increase in a gallon of gas. But even with the gas, they selectively remember the $.70 price increase in summer, but forget the $.75 price drop in autumn. Inflation and deflation are tricky things to measure.

Government and the Slow Jobs “Recovery”

Posted by Jim Luke — February 3, 2012

Government finally starts to get out of the way of recovery. In an earlier post today on the good news of the January 2012 employment report, I observed that one of the major factors resulting in an improved (but not good enough) jobs report was that government employment numbers stopped dragging down the total. I wanted to briefly expand on that idea here.

First, let’s make no mistake the “recovery” from this last recession has been very, very weak. Private sector growth has been anemic at best. In employment, the recovery has largely been missing in action. Today, 31 months after the supposed end of the recession, we have only recovered 1/3 of the jobs we lost during the 19 months of recession. As I’ve mentioned before, we are well on our way to a lost decade or more before we regain full employment. A huge part of the weak recovery has been slow and at times negative growth in private sector employment.

But a bigger problem has been government. Government has a three-fold impact on employment during a recovery. Government spending by itself will create employment in the private sector. For example, if the government chooses to react to a recession and high cyclical unemployment by increasing it’s spending it can create new private sector employment. This would be a classical stimulus program. The government could embark on highway, bridge, or school construction. The spending with construction contractors causes those contractors to hire employees. That’s direct private sector employment through government spending. As long as there are significant unemployed resources (workers), such government spending will increase employment. Arguments about crowding out do not apply when large unemployed resources exist.

The increased government spending then has a second effect, a “multiplier” effect. The multiplier effect reflects the idea that workers who got jobs in the initial round of spending themselves spend their incomes and create more demand for more goods. This increased demand for goods results in even more employment. In other words, the construction workers hired to build the new bridges or schools spend their paychecks. The firms selling those workers goods then have to hire in order to produce the goods/services the construction workers want. The exact size of the multiplier effect is uncertain and subject to dispute depending on the econometric methods used to measure it. However, it’s clear that as long there were substantial unemployed resources to begin with, there is a positive multiplier effect on private employment from increased government spending.

But what I want to draw attention to today is direct employment effect of government. One of the greatest reasons why we have had a very slow employment recovery is because government in the U.S. has been aggressively cutting jobs for the last 2-3 years. Conservative critics of government have been partially right. Government has been part of the problem – but not in the way they think. Let’s look at total government employment in recent years:

The data series can be a bit tough to read because government employment has a very seasonal pattern to it. That’s shows up by the regular up-and-down pattern each year. Let’s focus on the trend, smoothing out the ups-and-downs. There’s four patterns. Government employment was essentially flat in 2002 and 2003. Then a period of employment growth in government began running form 2004 through early 2008. During the recession itself government employment was essentially flat. Since 2009, though, government employment has been declining. Cutting government employment is contractionary. It directly reduces retail demand for goods and services by reducing the incomes of what were formerly government workers.

The pattern is a little clearer if we look at the data in a slightly different way. The following graph, courtesy of Menzie Chinn at Econbrowser.com, shows the a smoothed trend. It does this by plotting the 12-month change in government employment (000′s of jobs) by month.

While private employment continues to grow, government employment continues to fall; the decline is most pronounced at the state and local level (Wisconsin is a good example of the contractionary impact of such measures [1] [2]). However, civilian Federal government employment is also declining.

Figure 3: Twelve month change in government local employment (blue), in state employment (red), and government employment ex.-temporary Census workers (geen), 000’s, seasonally adjusted. NBER defined recession dates shaded gray. Source: BLS via FRED, NBER and

One thing I particularly like about this graph is that it shows the relative contribution of federal, state, and local governments. What this graph shows is that before the recession (the grey zone), government was net hiring approximately 250,000 additional jobs per year. Of that, most was at the local level and some at the state. Very little was federal hiring.

Since the end of the recession in June 2009, government has been firing more workers than it hires. It has been reducing employment. The federal government, contrary to popular belief, began shrinking (in employment terms). State governments were largely able to hold the line on employment until early 2011. Then state governments began reducing employment in rapidly increasing numbers. But the big impact again came from local governments. For the last 30 months, they have been laying off large numbers of workers. The reductions have slowed in 2011, but they are still cutting workers at nearly the same rate that they added them in 2007 – hundreds of thousands of lost jobs each year.

There is a temptation among politicians and commenters to think of government employees as representing largely just some bureaucrats mindlessly pushing paper in large bland office buildings. That is not true. At the federal level, most federal government employees are either soldiers or part of some security forces (TSA, FBI, ICE, etc). At the local level, the vast majority of local government employees are police, fire and emergency workers, and teachers. Reductions in local government employment directly translate into fewer services and less education for children.

Why are state and local governments cutting employment? Simple. It’s reduced taxes combined with balanced budget requirements. State and local governments, unlike a sovereign national government, must balance their budgets. They are budget constrained. The recession and weak recovery have hit income and sales taxes hard. Even more significant is that the collapse of home prices a few years ago has translated into lower property tax collections. Either way, state and local governments have been pinched. The response has been to reduce government employment – fire police, firefighters, and teachers.

Paul Krugman notes the how this reduction in state and local government revenue has translated into reduced spending, which in turn has translated into lower employment. Despite the federal government embarking on a stimulus spending program in early 2009, a program which is over and done with now, it was not large enough to offset the reduction in state and local spending.

if you look at what’s being cut, it’s heavily focused on investment:

That is, we’re sacrificing the future as well as the present. Oh, and the cuts that aren’t falling on investment in physical capital are largely falling on human capital, that is, education.

It’s hard to overstate just how wrong all this is. We have a situation in which resources are sitting idle looking for uses — massive unemployment of workers, especially construction workers, capital so bereft of good investment opportunities that it’s available to the federal government at negative real interest rates. Never mind multipliers and all that (although they exist too); this is a time when government investment should be pushed very hard. Instead, it’s being slashed.

What an utter disaster.

On this point, I have to agree with Paul. Unless we reverse course and do it strongly, we are flirting with a long-term disaster. We are under-investing in our future.

A Journey of 100 Months Starts With the First Month

Posted by Jim Luke — February 3, 2012

Finally we are getting some good news. At least most people will consider it good news. Republican Presidential candidates hoping to run against Obama on “weak economy platform” might not happy with the news.

Today the Bureau of Labor Statistics (BLS) released the January 2012 employment data. The unemployment rate has declined again. It is now down to 8.3%. The number of net new jobs was pleasantly above the consensus expectations. Calculated Risk quotes the BLS for us:

From the BLS:

Total nonfarm payroll employment rose by 243,000 in January, and the unemployment rate decreased to 8.3 percent, the U.S. Bureau of Labor Statistics reported today. Job growth was widespread in the private sector, with large employment gains in professional and business services, leisure and hospitality, and manufacturing. Government employment changed little over the month. … Private-sector employment grew by 257,000 …

The change in total nonfarm payroll employment for November was revised from +100,000 to +157,000, and the change for December was revised from +200,000 to +203,000..

So what accounts for the increase? As the BLS states, large gains were widespread – services, hospitality/leisure, and manufacturing. But overall positive effect compared to what was expected and to what we’ve grown accustomed is strongly due to two factors we didn’t see. We didn’t see reductions in government employment dragging down the total numbers. I’ll have another post on that later today. The other effect is that the weather was nice – the exact opposite of last January (2011) when the weather adversely affected the numbers.

Nonetheless, a solid increase is a solid increase and something to feel good about. But in keeping with my skeptical self, it’s also very important to not declare victory yet. We’re not out of the woods by a long shot. I can think of four reasons right away.

First, we’ve been here before. As Calculated Risk explains,

Job growth started picking up early last year, but then the economy was hit by a series of shocks (oil price increase, tsunami in Japan, debt ceiling debate) – and now it appears job growth is picking up again.

Click on graph for larger image.

This is the third or fourth time in this “recovery” that it appeared employment would finally be accelerating into the kind of “V-shaped” recovery we really need. Each time before, something (often politics) interfered.

A second reason for caution involves both the employment-population ratio and the labor-force-participation rate. Both rates are at lows we haven’t seen for 30 some years. Both ratios indicate that large numbers of people have left the labor force and simply aren’t looking for work. If they change their minds and start to look for work, then the unemployment rate could easily begin rising again as the denominator of the unemployment rate rises faster than employment (the numerator).

A third reason is that there are still too many unknowns on the horizon and most of them carry downside risk. The UK and the Eurozone continue their self-inflicted austerity march into recession and flirtation with banking and default crises. House prices have continued to decline, threatening the ability of households to sustain increases in consumer spending. And there’s always the completely unknown. Twelve months ago nobody would have considered the risk to economic growth from an earthquake that created a nuclear disaster.

The fourth reason to be cautious is the mismatch between the positive increase in employment we’ve just seen and the size of the employment gap we are facing. This is the graph we need to keep in mind. Again from Calculated Risk:

… third graph shows the job losses from the start of the employment recession, in percentage terms. The dotted line is ex-Census hiring.

This shows the depth of the recent employment recession – much worst than any other post-war recession – and the relatively slow recovery due to the lingering effects of the housing bust and financial crisis.

We are far, far from leaving this employment depression behind. Dean Baker of the Center for Economic Policy and Research cautioned today that, while it appears that we are on stronger path, it is still too weak. January’s numbers seem strong only because we have grown accustomed to such abysmal recovery for the last 2-3 years. Even at the pace January showed, it will still be 2020 before we regain full employment. That’s 8 years away – 100 months. Government and central banks easily lose focus on growth in a period that long. Congress and the President, while returning to jobs now in this election season, have already shown that they couldn’t sustain a focus on job growth last year as they turned to imaginary concerns over government debt instead.

We have a long way to go. We should be running but we’re only walking. Nonetheless, at least we’re walking forward now instead of backwards they way we were in mid-2011.

The Problem in One Graph

Posted by Jim Luke — January 8, 2012

Yesterday I said I was reluctant to get over-optimistic about the recent slight upturn in employment data. This year may truly be different from the last few, but there’s a nagging feeling that we’ve seen this movie before. I’m not alone in the feeling. As 2012 dawns, Tim Duy summarizes the problem in one graph (emphasis is mine):

I have been hesitant to embrace the recent positive data flow - once bitten, twice shy perhaps. Something about the current dynamics that seems a little too familiar. Indeed, I felt something of relief when FT Alphaville came to a similar conclusion in the waning days of 2011. Cardiff Garcia reports on a Nomura research note that details a new bias in the seasonal adjustment process, noting:

Up next, writes Nomura, you can expect exaggeratedly strong readings from the Chicago PMI later this month and the next ISM manufacturing survey at the start of January.

I imagine it is premature to call the readings “exaggerated,” but both did surprise on the upside, as much data has of late. Read the whole piece – it is worth the time.

Indeed, flirtations with either excessive optimism or excessive pessimism were not richly rewarded last year, as on average the economy simply edged upward in pretty unremarkable fashion:

It seems reasonable to expect the same in 2012, at least as a baseline – a slow “recovery” that is really more of an adjustment to what appears to be the economy’s new equilibrium path, one that is decisively subpar to the pre-recession trend. I don’t believe that such an adjustment is necessary, as in my view it simply reflects a shortfall of aggregate demand. That said, the longer the cyclical downturn grinds on, the more likely it is that we will indeed see a new equilibrium path. A greater percentage of the cyclical unemployment will become structural unemployment or permanent shifts in the labor force participation rate. In addition, investments will go unmade as firms hoard cash. And, increasingly, policymakers will manage policy along the new equilibrium path, forgetting entirely the pre-recession path.

The gap in the above graph, the gap between the green trend line of what we’re capable of doing and the blue-red trend from Jan 2009 onward of we’re actually doing is the challenge. We are slowly becoming an economy that simply cut-off 7% or so of our economy in 2008 and we aren’t recovering it. Instead it increasingly appears that the 90-93% of the economy that survived, those of us still with good jobs, are simply going on our way leaving behind those who lost out a few years ago.

There are over 13 million unemployed workers. Over 5.6 million of them have been searching fruitlessly for a new job for more than 6 months. These are the people who got kicked off the American economy bus some time ago. Unfortunately, even at the recently improved rate of 150-200,000 new jobs per month, there won’t be any room on the bus for them again. Instead, the bus is moving on and they are left behind.

This is new. This is not the normal pattern. In past recessions, public policy, both fiscal and monetary, was managed to restore full employment rapidly after a recession. It didn’t always succeed but the effort was made. Now it is not. Now we focus more on long-term debt issues and spending concerns. Politicians run on platforms of fear of some future default or financial crisis. This despite the fact that the government is able to borrow at record low rates of interest.

We are on path to a “new normal”, a “normal” that says it’s OK to have millions of long-term unemployed who have no hope. I don’t think I like the “new normal”.

Below Market Wages Belies Claims of Structural Unemployment

Posted by Jim Luke — December 7, 2011

Continuing what has turned into a short series on unemployment and structural unemployment in particular (see Monday and yesterday’s posts), let us look at some of the claims that structural unemployment.

First up, Brad Delong points us to Kevin Drum who tells the following story:

Kevin Drum:

Skilled Jobs Go Begging? Not Quite: The Wall Street Journal has a piece up this weekend about the difficulty that many companies are having hiring skilled workers in certain areas…. Here’s a description of some skilled job openings at Union Pacific railroad:

When the railroad had openings for diesel electricians earlier this year, it took [Ferrie] Bailey 10 hiring sessions to fill 24 jobs….Known as “installation technicians,” the workers are responsible for putting in and maintaining a sprawling network of cable, microwave relays and related equipment that enables the railroad to monitor 850 trains running daily along its 32,000 miles of track.

This doesn’t require a bachelor’s degree but demands technical skills gained either through an associates’ degree or four years of experience in electronics. And it is grueling work. Technicians have to climb 50-foot communications towers, clamber up utility poles and work outdoors through Wyoming winters and Kansas summers. They put in 10-hour days, in clusters of eight or ten days, and are routinely away from home more than half of each month.

….Standing at the front of the room, Ms. Bailey described the deal. As installation technicians, they would earn $21.64 an hour, or close to $48,000 a year for the railroad’s regular work schedule.

Then there’s this:

After a website job posting, Ms. Bailey initially drew 58 applicants. Of them, she deemed about two dozen sufficiently qualified so that she invited them to take a $25 aptitude test, at their own expense.

Let me get this straight. Union Pacific is supposedly desperate for candidates and can barely fill all their open positions. And yet, when they identify 24 qualified applicants, they aren’t even willing to maximize their hiring pool by ponying up $600 to make sure they all take the aptitude test. Then, later in the story, there’s this:

Ms. Bailey faced more stiff competition at a job fair the next day, because then she was up against several other employers looking for the same sort skilled people as she was. “Make $70,000 – $80,000 the first year with FULL BENEFITS,” read a sign at a booth right across from Ms. Bailey’s at the job fair, put on by the U.S. Army in Fort Carson, Colo., largely to help departing soldiers ease back to civilian life.

So here’s the story. Union Pacific is offering $48,000 per year for skilled, highly specialized, journeyman work that’s physically grueling and requires workers to be away from home about half of each month. The competition is offering 50% more, but not only is UP not willing to increase their starting wage, they’re so certain they can fill all their positions that they make qualified candidates pay for their own aptitude test. And despite all this, they filled all 24 of their positions in ten hiring sessions.

It doesn’t sound to me like there’s a huge shortage of qualified workers here. It sounds to me like Union Pacific is whining about the fact that it took them all of ten hiring sessions to fill their quota even though this is a really tough job and they aren’t paying market rates for workers. It’s as if they think that actually having to make a modest effort to attract job candidates is an inversion of the natural order or something. Speaking for myself, I think I’ll hold off on breaking out the violins.

Kevin has done an excellent job of taking the structural claims apart, but I’ll pile on anyway. The claim that unemployment is structural is a claim that the labor market is segmented into different labor markets for jobs with different skills. Further it asserts that there is no elasticity of supply between these different labor markets – in other words, if either have the skills or you don’t, there’s no on-the-job training or adaptable skills possible. Finally, if unemployment is structural then we are saying that there’s a shortage (lack of supply) of workers in that skill category in that geographic area. The Wall Street Journal is claiming that because Union Pacific cannot find enough willing sellers (workers) at the price (wage) Union Pacific is offering then there must be a shortage of qualified sellers. Umm, how do I put this? No. Rather it’s evidence that the Union Pacific simply wants to pay below-market prices to labor. That’s all. Saying this is evidence of structural unemployment is like me claiming there’s a structural supply shortage of new automobiles because no dealer will sell me a new Porsche for $15,000.

Fixes for Unemployment Depend on Whether It’s Cyclical (It Is) or Structural (It Isn’t)

Posted by Jim Luke — December 6, 2011

Yesterday I recapped the November employment report. The employment picture remains grim. The workers depression continues.

As my favorite graph from Calculated Risk shows here, regardless of what happens to the unemployment rate, our recovery from the jobs lost in the recession is incredibly slow. At the pace we have been on for the last 2-3 years, we won’t recover the jobs lost in the recession until around 2018 – a full lost decade.

Thanks partly to the #OccupyWallStreet movement, these 14 million unemployed aren’t so invisible as they seemed last summer when the policy debates were all about debt and deficits. Since denial of a problem has failed, folks who argue against any attempts by the government to stimulate the economy need a different pitch.

That revised pitch is that the unemployment problem is “structural”, not “cyclical”. Now before I move on to show the problem is not structural, let me explain the difference. I’ve looked at structural vs. cyclical before here and here, but I’ll summarize. In economist-talk, “unemployed” means you are part of the labor force but you don’t have a job. To be part of the labor force, you must be actively looking (“willing and able”) to work. Those numbers come from government surveys. Economists unofficially classify those unemployed workers according to why they don’t have a job. There’s four possibilities:

Frictional – there’s a job for them, they simply haven’t been matched with it yet.
Seasonal – the job will exist again next year when the season is right (think downhill ski instructors in July)
Structural – empty jobs exist but the unemployed workers either don’t have the right skills or aren’t in the right location. Train the workers or move them and unemployment disappears.
Cyclical – there simply aren’t enough empty jobs for the number of unemployed workers. If the GDP were larger and spending greater, then jobs would be created and the people put back to work.

For policy reasons we aren’t concerned with frictional or seasonal. Time cures those individual unemployment situations. But if we only had frictional or seasonal unemployment, our unemployment rate would be much, much lower – 4% or even lower. Clearly we have either have a lot of structural or cyclical or both.

Which we have matters for policy reasons. If unemployment is structural, then we can effectively blame the unemployed for their fate. They didn’t get the right skills. They chose to live in the wrong place. From a policy standpoint, the government might adopt policies that support re-training but that’s about it. If, however, unemployment is cyclical, then government has plenty of room to reduce unemployment through stimulus programs, either effective tax cuts and/or increased government direct spending.

Brad Delong points us to David Wessel of The Wall Street Journal who tells us how and why today’s high unemployment is not structural. In other words, we could bring down the unemployment very dramatically and very quickly if we chose to. Politicians in Washington simply choose not to do so. (bold emphases are mine)

DW:

Untangling Long-Term Unemployment: Herman Cain, the Republican presidential candidate, avoids carefully calibrated talking points. “If you don’t have a job and you’re not rich, blame yourself,” he said in a Wall Street Journal interview.

Beneath Mr. Cain’s blunt words lurks an economic hypothesis: that there’s nothing much government policy can do to bring unemployment down from today’s 9.1% rate…. [I]f the unemployed aren’t willing or able to fill jobs that muscular stimulus might produce then there’s little wisdom in borrowing more money or chancing inflation. We just have to suck it up.

But according to Fed governor Daniel Tarullo, a veteran of the Clinton White House and Obama presidential campaign who has spent the past few months consulting with Fed and other labor economists for a speech on the job market he is to deliver Thursday at Columbia University, there is little evidence that the bulk of today’s unemployed would still be unemployed if the economy were growing faster or that the bulk of today’s unemployment is, in the jargon of economists, “structural.”…

The Labor Department counts 14 million unemployed and 3.1 million job openings, or 4.6 jobless workers per job opening. Before the recession, the ratio was 1.5. If every opening were filled instantly, there would still be many unemployed.

Wages aren’t rising. “We don’t see rapid wage growth almost anywhere, which is what you would expect if firms were bidding up the wages of qualified workers and were unable to find qualified workers among the unemployed,” said Harvard University’s Lawrence Katz.

Unemployment is up across ages, occupations, industries and years of schooling. “We had a fast-advancing economic decline with layoffs and hiring freezes in a broad range of sectors of the economy. That is not consistent with an increase in structural unemployment being the big explanation,” Mr. Tarullo said…

November Employment and Revised 3rd Qtr 2011 GDP

Posted by Jim Luke — December 5, 2011

I’m a few days late but I wanted to note the latest employment (jobs) report and the first revision to 3rd quarter GDP. There’s really not much news here – it’s the same old story. The economy continues to move along somewhat like a zombie. Not really dead, but definitely not anything you could call “living”. That’s particularly true if you’re one of millions of unemployed who need a job to “make a living” but can’t get one.

CalculatedRisk Blog tells us:

From MarketWatch: U.S. economy adds 120,000 jobs in November

The U.S. gained 120,000 jobs in November and the unemployment rate fell to 8.6% from 9.0%, the Labor Department said Friday. The government also revised jobs data for October and September to show that 72,000 additional jobs were created. … Hiring in October was revised up to 100,000 from 80,000 and the job gains in September were revised up to 210,00 from 158,000. In November, companies in the private sector hired 140,000 workers … Government cut 20,000 jobs…

Click on graph for larger image.

The following graph shows the unemployment rate. The unemployment rate declined to 8.6%.

Some of the decline in the unemployment rate was related to a decline in the number of workers in the labor force.

The second graph shows the job losses from the start of the employment recession, in percentage terms. The dotted line is ex-Census hiring.

This was still a weak report, and slightly below consensus.

The headline unemployment rate declining from 9.0% in October to 8.6% in November is deceptive. It is NOT because economic growth created enough new jobs to start making a significant dent in the millions of unemployed. Instead it was almost entirely due to the labor force shrinking. In other words, approximately 300,000 would-be workers abandoned their search in frustration and discouragement. If the economy starts to grow briskly (not much chance of that happening) then these discouraged and “marginally attached” workers will likely renew their searches and rejoin the work force.

Calculated Risk also tells us how just before Thanksgiving the estimate for 3rd quarter real GDP growth was revised downward.

From the BEA: Gross Domestic Product, Second Quarter 2011 (second estimate

Real gross domestic product — the output of goods and services produced by labor and propertylocated in the United States — increased at an annual rate of 2.0 percent in the third quarter of 2011 (that is, from the second quarter to the third quarter) according to the “second” estimate released by the Bureau of Economic Analysis.

This was revised down from 2.5% and below the consensus of 2.4%.

The downward revisions was mostly due to a large decline in the “change in real private inventories ” – this subtracted 1.55 percentage points from the third-quarter change in real GDP (second estimate) as opposed to 1.08 percentage points in the advance estimate. Final domestic demand was mostly unchanged (the inventories will probably reverse in Q4). Still sluggish growth …

The relatively large revision came from having better data about the change in business inventories. In GDP accounting, when a business produces goods it counts as “production” and part of GDP, even if the goods haven’t been sold yet to a final customer. Additions to inventory then are considered to be a form of “business Investment”. A decline in inventories tells us that businesses (in aggregate) sold more from their inventories (previous production) than they produced. A large decline in inventories can be either a good or bad sign. It’s good if it happens because sales were unexpectedly higher than managements expected. That would suggest that production would be increased in the next quarter. On the other hand, a decline in inventories can also be a sign that businesses expect future sales to be weak and so they didn’t produce as much in advance. We’ll have to see which it is. Regardless of why the inventory adjustment was so large, a 2.0% real growth rate is unacceptable. It wouldn’t even be acceptable at full employment, but with 8.6% unemployment it’s totally unacceptable.

The Top 0.1% Vs. Rest of Us Throughout the 20th Century

Posted by Jim Luke — November 15, 2011

Following up on yesterday’s post about the Global Top Incomes Database, I thought I’d give an example. Here’s what I created:

So what are we looking at? The blue line shows almost a century of the average income of the bottom 90% of American earners (in constant, real 2008 dollars – scale on right side). This represents the typical American worker and the fate of the working/middle classes. Basically it shows nine different trends or periods.

From 1917 until 1929, there was no improvement at all (actually a dip in the 1920-21 depression). Despite all the talk about “roaring twenties”, it wasn’t for the average American worker.
1929-1933, incomes really drop precipitously as the nation falls into the Great Depression.
1933-1937, incomes begin to recover based on the government spending programs of the New Deal and correction of the banking/financial crises of 1932-33. But the progress stumbles in 1938 as Roosevelt and Congress switch course and try to balance the budget before we’re back to full employment (are you listening Obama?).
1938-1943 incomes really grow dramatically as the nation regains full employment and unions gain power. The driver of the recovery is the near unlimited willingness to spend to arm for World War II and the demand for food and other items by warring allies.
1944-1949, incomes stagnate again, partly as a result of demobilization of the war effort.
1949-1973 brings the Golden Age. Real economic growth in the U.S. is the strongest it’s ever been and thanks to Keynesian government policies, a productivity-sharing social contract between managements and unions, and strong world demand, the workers get their share of it. This is the period of fastest U.S. growth.
1973-1993 brings twenty years of declining real incomes for most workers. Part of it is driven by slower growth brought on by two oil price supply shocks. Part is inflation (although only until the mid-80′s). Part is driven by a major political shift towards conservative free market policies (“Reaganomics”). And part is driven by a weakening of unions and union membership. The economy, while it grows, doesn’t grow near as fast as it did in the Golden Age.
1994-2000 shows a slight recovery in incomes during the Clinton administration.
2001 starts another decline and it’s been pretty much downhill ever since. Note that the graph ends in 2008 (last available data), but other more recent data indicates the time series has continued to decline significantly.

So what can we conclude from the typical worker incomes, the blue line of average incomes for the bottom 90%,? Well, yes, as some conservatives and libertarians have been pointing out, today’s incomes are historically high – around $32,000 per worker. And consumption by household is even higher. But consumption has risen despite incomes stagnating recently. It’s because many, many more households now depend on two workers for incomes. Yes today’s incomes are dramatically higher compared to 76 years ago – roughly 6 times higher. But all of the increase happened in the first 38 years after 1932. Today’s incomes per worker are actually lower than they were in 1973 – 38 years ago.

Now let’s consider the red line. This shows the percentage share of the national income ~~earned~~ received by the top 0.1%, the top one tenth of one percent. These are the really, really rich. There are really only three periods here. The period before the Great Depression. Observe that it really was a roaring twenties for the really rich. In the decade of 1920-1929 their share of national income rose from around 3.5% to over 6.5% – all while the average American worker stagnated. The game was rigged. As the U.S. economy grew in total GDP terms in the 20′s and as productivity soared, the benefits of that improved productivity went to the rich, not to workers. The rich lost ground in the Great Depression because the stock market crashed and the banking system imploded.

From 1936 until 1979, the share of income taken by the top 0.1% declines rather steadily and significantly. Why? A dominant factor is that income tax rates were rather progressive with high rates on the very high top end. Now this simply means that the share declined – they took a slightly smaller slice of the pie each year. But the pie was growing very, very fast, so in dollar terms their incomes were still rising too. Do not take away the idea that the rich suffered income declines during this period. On contrary, they did well in absolute terms. They just didn’t do well at the expense of others.

But in 1979 the rich strike back. Their share of income starts rising steadily until it reaches the same very high levels today that are reminiscent of the late 1920′s. What happened? Well the same forces that hurt the working/middle classes during the last 30+ years worked to the rich’s advantage. But another important shift was changes in income tax policies. Initially Carter, but then Reagan and Bush all cut tax rates for the top end. Reagan did even more. He eliminated several top end brackets. This resulted in people in the top 0.1% (multi-millionaires) now paying the same rates as people making $250,000 per year. That didn’t happen in the Golden Age. Back then there were special brackets for the very, very rich top end.

So what can we conclude overall? Well, for one thing, we should definitely bury any idea of “trickle-down” tax cuts helping average workers. When the economy grew the fastest and typical workers did best was when tax rates on the rich were high. When tax rates on the rich are lower, the economy grows more slowly and average worker incomes stagnate. We might also conclude that the OccupyWallStreet movement (#OWS) has a point. The system isn’t fair and it isn’t working for average workers. This isn’t a call for socialism, it’s a call for the vibrant capitalism we had in the mid-20th century. That Golden Age of the middle of the 20th century is the only time when we really didn’t have “class warfare”. We had a social contract that called for sharing the gains from improved productivity. But a little over 30 years ago the really rich declared war on the rest. It’s class warfare and the middle class has been losing.

Awesome Resource – The World Top Incomes Database

Posted by Jim Luke — November 14, 2011

Any student, researcher, or #OWS protestor interested in income distribution and income growth should definitely be aware of this resource: The World’s Top Incomes Database. (hat tip to Krugman, from whom I learned about it). It’s a very powerful database combined with a very easy to use interface that allows you to extract exactly the data you want as a spreadsheet (see the Database tab) or to customize your own graphs.

You can pick from a growing list countries -over 25 already and more under development. It’s particularly interesting because it’s not just the usual developed nation suspects. There’s also data on developing countries and some less-developed nations. Then you can pick your time series and variables. It’s a tremendous variety: share of national income by the top x% (without or with capital gains). In some case, data series are available on actual average real incomes by percentile groups. What’s also nice is that they don’t just leave it at a split between the top 1% and the bottom 90%. You can specify the top 1%, 5%, 10%, 0.1% or even the 0.01%. Amazing. You pick the time frame from early in the 20th century up to 2008. Then you regenerate your graph or data table. The best part is that by right clicking on the graph, you can download and save the graph. Students: are you listening? Understand the implications for research papers?

The Quantity Theory of Money and Fears of Inflation Are Nonsense

Posted by Jim Luke — November 11, 2011

We rarely get to conduct scientific experiments in economics, but for the last 3+ years The Federal Reserve has unintentionally conducted a test of an economic theory called the “Quantity Theory of Money” (QTM). QTM makes some very specific predictions – predictions that Ron Paul, conservatives on Wall Street, and others have been repeating a lot. Unfortunately for them, QTM has failed the test.

First, some background on the theory. The QTM is and has been one of the foundations of both monetarist thought and Austrian economic thought. In it’s base form, it’s based on an accounting identity that must, by definition, be true. The notation sometimes varies, but the quantity theory of money is based on a definition called the equation of exchange. This equation goes like this:

M times V = P times Q
where:
M: Money supply
V: velocity of money, or the number of times the average dollar changes hands and is spent during the same time period as Q is measured.
P: price level
Q: real GDP (sometimes real National Income, Y, is used – same thing essentially)

So what does the equation say? If you look at the left hand, M x V, you get a representation of the total spending in the economy. It’s how much money was in circulation times the number of times that money was spent. The right side, P x Q, gives us the value of nominal GDP. It’s the value of all the real stuff we bought (Q, real GDP) times the Price level P which translates it into today’s prices. Put the two sides together and you’ve got total nominal spending in money terms must be the same as the total value of the things we bought. Duh. Of course it is. It’s an identity. It’s the macro equivalent of saying that if I spend $5 each time (M) on 7 trips to the grocery (V) to buy 70 apples (Q) at $0.50 each (P), then I will spend $35 on $35 worth of stuff.

As an identity definition it’s not really very interesting. It’s when economists begin to use it as a model of future outcomes that problems arise.

The typical way QTM is used, and the simple way folks like Ron Paul and a lot of folks who are upset at Federal Reserve efforts to stimulate the economy, is by thinking of what happens when M, the money supply, is suddenly increased. The thinking is that an increase in M must result in an increase in P in order to keep the equation balanced. This is the foundation of modern inflationary fears in the last few years. Typically folks using the QTM this way don’t say things like “an increase in M must lead to an increase in P”. They say things like “The Fed is printing money like mad and that’s going to lead to inflation” since an increase in the price level, P, is how we measure inflation.

But there’s actually four terms in this equation. Any of them can change. That’s where assumptions come in. The advocates of QTM, whom I’ll call “inflation-phobes” for the moment since they’re always fearful of inflation, make some strong assumptions. They assume three big things. First, they assume that the velocity, V, is constant. In other words, according to them, you and I always spend our money at exactly the same rate. Suppose I spend my whole paycheck every two weeks now. They assume that I’ll always spend my whole paycheck every two weeks no matter how big or small that check is or whether I’m suddenly fearful of losing my job next month. The evidence for the constant velocity assumption is weak. You be the judge using the St.Louis Fed data:

To me, that doesn’t look constant. If V is constant, then any increase in M also increases spending, MxV. But if V isn’t constant, then an increase in M can be offset by simultaneous slowdown in velocity.

The next assumption is that real GDP is always at capacity. In other words, there is no unused capacity in the economy such as unemployed workers or empty office buildings or factories running only 1 shift when they can run 2. This is assumption is essential to the inflation-phobes because it means that Q can’t be increased. This is necessary to their desired outcome because it would imply that the only way for PxQ to rise to meet an increase in MxV is by having P increase. I won’t go to the trouble of showing data and graph to prove that Q isn’t at capacity. If you have doubts, see last week’s update on employment and GDP.

There’s one more unstated assumption by the inflation-phobes. They assume that any increase in base money, which is primarily the bank reserves The Fed makes available to commercial banks, will necessarily translate into M1, money in circulation among the public. This too is a bad assumption. There times, like the last 3 years, when commercial banks don’t want to or can’t lend. In times like this bank reserves just sit there on the books safely tucked away from any kind of productive economic activity or spending. The Fed can push reserves onto the banks’ books, but it can’t turn those reserves into loans or spending by customers. Another weakness in this assumption is the idea that even if the money ends up in private hands it will be used for spending on goods and services. Instead, what we’ve seen is that much of what little lending the big banks have been doing has been to finance financial market trading and speculation – things like oil futures. Speculating in oil futures isn’t the same thing as actually refining and selling oil. The speculation doesn’t create jobs and isn’t part of the circular flow. Production is.

So we’re back to the question of testing the QTM theory. The QTM theory of money as inflation-phobes express it, says that increases in base money (M) necessarily must result in inflation (increases in P) at some time in the near future.

In 2008 and 2009 The Federal Reserve expanded bank reserves greatly. It expanded the monetary base dramatically. The Fed invented a variety of new names and methods for doing it, although almost all of them involved The Fed buying some kind of bond, security or financial asset. If the QTM theory and the hard-money inflation-phobes are right, there should have been a dramatic increase in inflation. They predicted it. Again and again. It simply hasn’t happened. Paul Krugman put together an nice little graph showing the failure of the QTM theory:

The thing is, of course, that the past three years — the post-Lehman era during which the Fed presided over a tripling of the monetary base — have been an excellent test of that model, which has failed with flying colors. Here are the data — I’ve included commodity prices (IMF index) as well as consumer prices for the people who believe that the BLS is hiding true inflation (which it isn’t):

A couple of notes: for the commodity prices it matters which month you start, because they dropped sharply between August and September 2008. I use the IMF index for convenience– easy to download. (Thomson Reuters I use when I just want to snatch a picture from Bloomberg). But none of this should matter: when you triple the monetary base, the resulting inflation shouldn’t be something that depends on the fine details — unless the model is completely wrong.

So, we’ve had a test, a pretty substantial test of the Quantity Theory of Money and the assumption that any increase in monetary base must lead inevitably to an increase in prices and inflation. The theory has failed. It should be put to rest. Milton Friedman, a man as responsible as any other for pusing QTM, once famously claimed that “inflation is anywhere and everywhere always a monetary phenomenon”. He was clearly wrong, there’s more involved than just base money growth.

EconProph

Category Archives: Measures & Statistics