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Many conservatives loved pointing to Europe when its debt crisis seemed to be spiraling out of control. A cautionary tale, they said, of what can happen when government spending goes wild. But they had the story wrong, or at least incomplete. Europe’s sovereign debt crisis was as much about slow growth as high debt. Anyway, these folks don’t talk much about Europe any more. And maybe that’s because it is now a cautionary tale of what happens when you combine fiscal austerity and tight money. That’s the exact deflationary formula some have been recommending for America the past few years. And as Europe’s experience shows, that would have been an utter disaster. Economist Michael Darda of MKM Partners:
The US and the UK have dramatically outperformed the EZ over the last four years despite even more contractionary fiscal policy. This can only be explained by differing central bank policies, in our view. In short, what the Market Monetarists call monetary offset has succeeded in propelling NGDP forward at a slow, steady pace (just over 70% of the pre-crisis trend) in both the US and UK despite persistent fiscal headwinds. By contrast, a chronically behind the curve/too tight ECB has led to a NGDP trend in the EZ that is just 45% of its pre-crisis average. … The US and the UK have enjoyed steady but unspectacular growth while the EZ has barely crept out of a monetary policy-induced double-dip recession and now faces the prospect of stagnation and deflation. … We simply do not know of another natural experiment as powerful as this for assessing whether QE/forward guidance “worked.” Relative to the ECB’s disastrous policies, it has been a smashing success.
Could have been better, of course. Adding a nominal GDP level target would likely have enhanced the effectiveness of Fed action, maybe even requiring less bond buying. But still a powerful counterfactual that will hopefully influence future policy debates.
On CNBC this morning, AEI’s Jim Pethokoukis discussed what chance the Republicans have of taking the Senate. According to him, the odds aren’t that bad, due to Obama’s low approval rating. Watch his appearance below:
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And from this a thousand conspiracy-themed blog posts will be born. Here is Capital Economics on the surprisingly strong (3.5% vs. 3.0% forecast) third-quarter US GDP report:
– The reported leap in third-quarter defence spending, which added 0.7 percentage points to annualised GDP growth was, as far as we can tell, largely due to a failure of the BEA’s seasonal adjustment process. As a result, we expect defence spending to plunge this quarter, subtracting a similar amount from fourth-quarter GDP growth.
– All of the upside surprise in third-quarter GDP growth (the 3.5% outturn was well above the consensus forecast of 3.0%) can be explained by the 4.6% increase in government spending, which added 0.8 percentage points (ppts) to overall growth. Moreover, nearly all of that boost was due to a 21% leap in Federal defence consumption. That’s the largest increase since the second Iraq war in early 2003. Drilling down further, more than two-thirds of the rise was due to a 74% annualised leap in defence spending on support services for installation, weapons and personnel. This is unusual given that spending on such services typically makes up just 25% of total defence spending.
– Some of the rise in the third quarter could be due to the escalation in military action in the Middle East, but most of it appears to be due to a failure of the seasonal adjustment process. Looking at the averages over the past five years, defence support services spending has increased by 38% annualised in the third quarter only to fall by an average of 34% annualised in the fourth quarter. (See Chart 2.) The BEA all-but confirmed this problem when in an email it told us that it is “trying to determine if any methodology changes are necessary”.
Wow. Given that Bureau of Economic Analysis (part of the Commerce Department) email, it looks like there may be, if not a mistake committed, then at least sub-optimal methodology at play. Now I don’t think this was intentional or nefarious in any way. So relax. But given that this report came out just before the midterms, I am sure some will view it with great suspicion. By the way, here is what the White House had to say when the report was released:
Economic growth in the third quarter was strong, consistent with a broad range of other indicators showing improvement in the labor market, rising consumer sentiment, increasing domestic energy security, and continued low health cost growth. Since the financial crisis, the U.S. economy has bounced back more strongly than most others around the world, and the recent data highlight that the United States is continuing to lead the global recovery. Nevertheless, more must still be done to boost growth both in the United States and around the world by investing in infrastructure, manufacturing, and innovation; and to ensure that workers are feeling the benefits of that growth, by pushing to raise the minimum wage and supporting equal pay.
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Who says the left has no big ideas? And you have to appreciate the honesty and candor of equalitarian, left-wing economists Thomas Piketty and Emmauel Saez, a duo very much admired by Democrats. As they explain in this Guardian note, they think high incomes pretty much reflect the ability of one percenters to manipulate corporate boards rather than their own productivity and value-creating power. And under that theory, lower taxes only increase such rent-seeking efforts by increasing the reward for success at manipulation. So crank up the rates!
Again, data show that there is no correlation between cuts in top tax rates and average annual real GDP-per-capita growth since the 1970s. For example, countries that made large cuts in top tax rates, such as the United Kingdom or the United States, have not grown significantly faster than countries that did not, such as Germany or Denmark. What that tells us is that a substantial fraction of the response of pre-tax top incomes to top tax rates may be due to increased rent-seeking at the top (that is, scenario three), rather than increased productive effort. …
In the end, the future of top tax rates depends on what the public believes about whether top pay fairly reflects productivity or whether top pay, rather unfairly, arises from rent-seeking. With higher income concentration, top earners have more economic resources to influence both social beliefs (through thinktanks and media) and policies (through lobbying), thereby creating some “reverse causality” between income inequality, perceptions, and policies. The job of economists should be to make a top rate tax level of 80% at least “thinkable” again.
The job of economists? I don’t know. The job of public intellectuals operating as policy entrepreneurs and advocates? Sure. Anyway, their basic point is that tax rates don’t matter for economic growth — at least not until rates get much, much higher. This is a topic about which I’ve written frequently, including here, here, and here. And clearly I think Piketty and Saez are wrong, as a quick glance at those links will indicate.
But let me take a different angle here. Innovation drives productivity, which drives growth over the long term. Now it doesn’t necessarily matter so much where innovation happens, as long as an economy is open and can obtain and use that innovation. But someone needs to generate the innovation. And the US generates a whole lot of it. The US pushes the technological frontier.
One novel way to measure US innovation is by how many billionaire entrepreneurs we generate. The US creates 2-3 times as many per million people as other large advanced economies. (The gap between the US and high-tax France, the home country of Piketty and Saez is even larger.) As Swedish researchers Magnus Henrekson and Tino Sanandaji find (see below chart): “Countries with higher income, higher trust, lower taxes, more venture capital investment, and lower regulatory burdens have higher billionaire entrepreneurship rates.” I think that is an interesting correlation that should at least give the high taxers pause.
And given that innovation spillover effect, global policymakers and policy entrepreneurs should be hesitant that the US follow the advice of Piketty and Saez. A less innovative America could mean a less prosperous world, economists Daron Acemoglu, James A Robinson, Thierry Verdier argue:
We show that, under plausible assumptions, the world equilibrium is asymmetric: some countries will opt for a type of “cutthroat capitalism” that generates greater inequality and more innovation and will become the technology leaders, while others will free- ride on the cutthroat incentives of the leaders and choose a more “cuddly” form of capitalism. Paradoxically, those with cuddly reward structures, though poorer, may have higher welfare than cutthroat capitalists; but in the world equilibrium, it is not a best response for the cutthroat capitalists to switch to a more cuddly form of capitalism.
Free riders beware Frenchman bearing policy advice for sky-high tax rates!
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Shock and awe. From the Financial Times:
On Friday morning, a report in the Nikkei newspaper that the national pension fund was poised to double its allocation to domestic stocks set pulses racing. But that was nothing compared with the excitement unleashed at 1:44pm, when the BoJ said it would crank up its already-aggressive monetary easing programme, buying 60 per cent more bonds and tripling purchases of stocks to head off a recent slide in inflation. The twin announcements did the trick, sending the yen to a new six-year low of 110.9 against the US dollar while pushing the Nikkei 225 stock average up almost 5 per cent, the biggest daily rise since last year’s “taper tantrum”. For investors in Japanese assets, the one-two punch was a reminder that the key institutions are lined up squarely behind the prime minister in his mission to haul Japan out of more than a decade of deflation.
Why did the Bank of Japan act (narrowly, by a 5-4 majority vote)?
First, Japan’s core CPI, notes IHS Global Insight, had “eased to near 1% y/y and the weakness is partially reflected in slowing domestic demand.” And although a lower oil price would tend to support the economy over the medium-term, right now it only adds to deflationary pressures.
Second, both those things are happening in the wake of an economy-slowing April increase in the nation’s consumption tax, a tax which is scheduled to increase again next year.
Again, IHS: “The aggressive monetary policy will support economic activity through higher corporate profits and encourage investment and wage increases. But the IHS view is that the BoJ still has a long way to go to reach its target of inflation of 2%.” Of course, dour expectation such as those expressed in the IHS comments are the sort of thing working against the BOJ and Abenomics. Japan has been in a funk for a long, long time. And Abenomics has just arrived. Who knows its staying power? The split BOJ is hardly reassuring in that conext. Scott Sumner addressed these very issues last August:
Asset markets tend to be very pessimistic about the prospects for reflation after monetary policy has had a severe failure. This suggests that markets believe the political barriers to reflation are formidable. Japan is a perfect case study. Asset markets took off after mid-November 2012, when then candidate Abe first indicated he was going to push for a 2% inflation target. The yen fell from about 80 to the dollar to 103 today, while the Nikkei rose from under 8700 to over 15,300 today. So the asset price gains have been sustained. And we did see a rise in the Japanese price level, RGDP and NGDP. So in one sense Abenomics “worked.” On the other hand the Japanese 10 year bond yield is 0.51%, vs. 2.50% in the US, and the 30 year bond yield is 1.67%, vs. 3.30% in the US. That tells me that the bond market probably expects Japanese inflation to remain well below US levels in the long run, perhaps close to zero. And that suggests that Japanese asset markets believe that the political obstacles remain formidable. After all, Abe won’t be the prime minister forever. And yet if the BOJ did another round of stimulus—enough to push the yen down to 120, there is little doubt that stocks would rally again and GDP growth would pick up (at least nominal, and probably real as well.) The problems are political, not technical.
As Sumner has put it on various occasions, “No fiat money central bank ever tried to inflate and failed.” It’s a matter of effort not expertise,with the former affected by politics. I would add this: Japan is worried about its fiscal situation, thus the consumption tax increases. But wouldn’t faster nominal GDP do plenty to lower that debt burden? Tax hikes that work against the BOJ look like self sabotage. Growth needs to be Japan’s top priority, both in terms of monetary policy and structural reforms.
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The Federal Reserve said it would end its long-running bond-purchase program, concluding a historic experiment that stirred disagreement among policy makers, economists and investors about its impact.
Now the WSJ headline put it is this way, “Fed Closes Chapter on Easy Money.” But easy money, from one perspective, is still here with interest rates so low. And to some economists, it’s the stock – the size of the Fed balance, currently at some $4.5 trillion — rather than flow from more bond buying that matters.
Then again, the slow pace of nominal GDP growth and the gap between actual NGDP and the path of potential NGDP suggests the Fed’s easy money policy really never was so easy. The point of quantitative easing was to boost growth through higher assets prices and through expectations – that expectations of higher future NGDP tend to boost current spending. QE might have been more effective if paired with an explicit NGDP level target. But it still left the US economy in better shape than the eurozone’s — victimized by the tight-money ECB. There’s your counterfactual. The US is growing and adding jobs, while the EZ may be slipping into a triple-dip recession and a return to prosperity is nowhere in sight. QE will surely remain part of the central bank’s toolkit.
One can also argue that a helicopter drop would have been more effective than bond buying, getting money directly into the hands of consumers rather than through a “wealth effect” that also increased inequality. But again, I give you the eurozone.
Now it’s time for Washington to get busy with the tax and regulatory reform necessary to raise the economy’s potential growth rate, which may be just half of what it was in 2000.
But as for the Bernanke-Yellen Fed:
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The US economy did better in the third quarter than what economists expected, growing at 3.5% annual pace (inflation adjusted) vs. the 3.0% consensus forecast. Combined with the second quarter’s 4.6% gain, we’ve now seen the strongest back-to-back readings since the last six months of 2003, according to Bloomberg. But, as always, you have to dig into the numbers. And economist Robert Brusca wasn’t so pleased with what he found:
I have termed the advance GDP report for the third quarter as lipstick on a pig. This expression implies that you can put lipstick on a pig, but it doesn’t make it look any better. It’s still a pig. And so is this Q3 report despite its pretty headline. … The real issue here is that GDP growth has decelerated, not just overall, but in each of the private sector components: Each One; exceptions ZERO.
Private sector growth, clearly, is slowing – it’s slowing everywhere. But growth in the quarter is pumped up because government spending accelerated to a 4.6% annual rate from 1.7% in the second quarter, and because of the sharp decline and contraction of imports. The contraction of imports speaks usually to reduced domestic demand and we see that up and down the line across the domestic private sector components that is what is happening. As a result, we have to conclude that the sector by sector analysis of GDP suggests that the report is worse rather than better and that it has been dressed up by the lipstick applied by surging government spending on military operations (the highest in five years) and by dropping imports, which is itself a double-edged sword to balance expectations of growth upon.
And here is JPMorgan:
The upside surprise was mostly located in defense spending, inventories and, to a lesser extent, net foreign trade. All three of these categories tend to be associated with payback the following quarter. As a result we are lowering our early estimate for Q4 GDP growth from 3.0% to 2.5%. … Consumer spending is still plodding along in a steady, but unspectacular, manner.
Indeed, 0.83 percentage point of the GDP gain came from government. A better measure of the fundamental economic health is private sector GDP, the part of the economy generating consumer-relevant value. In the third quarter, private GDP — consumer spending plus business investment — contributed 1.39 percentage points to GDP. By comparison, private GDP grew by 4% a year during the Reagan and Clinton expansions. Another data point, perhaps, that suggests the economy’s growth potential has declined sharply in recent years, especially given the Fed’s increasingly upbeat economic outlook. After all, if the economy is growing slowly but this is about as fast as it can grow, then the Fed’s job is pretty much done.
Less income inequality is self recommending, according to the left. Full stop. Reducing the income gap as much as possible — while still, of course, leaving some incentive for wealth creation — should be a top priority of government. Maybe the top priority. As President Obama said late last year: “The combined trends of increased inequality and decreasing mobility pose a fundamental threat to the American dream, our way of life and what we stand for around the globe.”
We know now, however, that mobility has not been decreasing. Economic research also suggests that income inequality — at least so far — is not a fundamental threat to the American way of life. The Manhattan Institute’s Scott Winship draws the following conclusions from his review of the literature:
1.) Across the developed world, countries with more inequality tend to have, if anything, higher living standards. The exception is that countries with higher income concentration tend to have poorer low-income populations.
2.) However, when changes in income concentration and living standards are considered across countries—a more rigorous approach to assessing causality—larger increases in inequality correspond with sharper rises in living standards for the middle class and the poor alike.
3.) In developed nations, greater inequality tends to accompany stronger economic growth. This stronger growth may explain how it is that when the top gets a bigger share of the economic pie, the amount of pie received by the middle class and the poor is nevertheless greater than it otherwise would have been. Greater inequality can increase the size of the pie.
4.) Below the top 1 percent of households—and prior to government redistribution—developed nations display levels of inequality squarely in the middle ranks of nations globally. American income inequality below the top 1 percent is of the same magnitude as that of our rich-country peers in continental Europe and the Anglosphere.
5.) In the English-speaking world, income concentration at the top is higher than in most of continental Europe; in the U.S., income concentration is higher than in the rest of the Anglosphere.
6.) Yet—with the exception of small countries that are oil-rich, international financial centers, or vacation destinations for the affluent—America’s middle class enjoys living standards as high as, or higher than, any other nation.
7.) America’s poor have higher living standards than their counterparts across much of Europe and the Anglosphere, while faring worse than poor residents of Scandinavia, Germany, Austria, Switzerland, the Low Countries, and Canada.
So income inequality doesn’t seem to correlate with lower living standards in advanced economies, particularly America’s. And income inequality doesn’t seem to be reducing upward mobility. These would seem to be an important conclusions to acknowledge before beginning an all-out War on Inequality.
Likewise, it’s important to have a deep understanding of the American economy — an economy that is the most innovative in the world and created 50 million jobs over the past three decades — before government implements policies that might alter its essential, unique nature. Example: Before raising investment taxes “on the rich,” consideration should be given to the impact on venture capital investment. Do we want fewer billionaires, even ones that get rich by creating wonderful new products or services rather than, say, inheriting their wealth or benefiting from government favor? A less dynamic and entrepreneurial economy may be one with less inequality and less opportunity. And more opportunity is what we want even if some folks get really wealthy as a result.
There is something about taxes, spending and the name “Bush” that can set conservatives on edge, especially now that Jeb Bush is talking like a man who might run for president.
The latest example came earlier this month when testimony Mr. Bush gave at a 2012 House Budget Committee hearing suddenly resurfaced in a news story. In those two-year-old comments, Mr. Bush said he could accept a fiscal deal of $1 in tax increases for every $10 in spending cuts that Democrats would agree to — a position that drew sharp criticism from one of the nation’s fiscal hawks.
“Jeb stabbed Republicans in the back just when they were unified in insisting on major spending cuts with no tax increases,” Americans for Tax Reform President Grover Norquist told The Washington Times.
Of course, the Bush comments reference the 2011 GOP presidential debate when none of the candidates expressed support for a hypothetical 10-to-1 budget deal. Now whatever the real-time political impact of what Bush said, the fiscal analysis supporting it is sound.
Consider: the federal budget is on track to raise government spending by something like 50% over the coming decades from around 20% of GDP to 30% of GDP. Would a GOP president really not accept an entitlement reform deal somehow that kept spending at 20% but only raised revenue to 18.4% of GDP from its postwar average of 17.4%?
Look at Paul Ryan’s much-celebrated — at least in conservative circles — Roadmap for America. According to its budget plan, government spending in 2039 would be 23.7% of GDP with revenue of 19.0%. Now according to CBO’s alternate budget forecast, 2039 spending is currently on path to be 25.9%.
So the Ryan plan would increase historical tax revenue by just less than two percentage points while reducing projected spending by just more than two percentage points. That is nowhere close to 10-to-1. It’s not even 2-to-1. Oh, and by the way, it will be extraordinarily difficult to keep future federal spending close to its historical average given demographics. A Republican president who struck a deal that accomplished such sweeping reform at such a low cost would have achieved a tremendous victory for limited government and America’s long-term fiscal health.
If Hillary Clinton is right, then how did the US economy create 50 million jobs even as the minimum wage was falling?
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Hillary Clinton, at a rally for Massachusetts gubernatorial candidate Martha Coakley, on how the American free-enterprise system really works:
And don’t let anybody tell you that raising the minimum wage will kill jobs. They always say that. I’ve been through this. My husband gave working families a raise in the 1990s. I voted to raise the minimum wage and guess what? Millions of jobs were created or paid better and more families were more secure. … And don’t let anybody tell you that, you know, it’s corporation and businesses that create jobs. You know, that old theory, trickle-down economics. That has been tried. That has failed. It has failed rather spectacularly.
So raising the minimum wage is what creates jobs and greater prosperity over the long-term? Not investment in physical and human capital, or business commercializing innovative new ideas that generate new goods and services? You know, all the stuff that boosts productivity?
I dunno. All I know about economics is what I’ve learned from Nobel laureate and New York Times columnist Paul Krugman, and he famously said, “Productivity isn’t everything, but in the long run it is almost everything.”
Oh, I see what’s happening here. Clinton is embracing the new left-wing theory of economic growth called “middle-out” economics. I have written before on why this theory is nonsense and goes against anything even close to mainstream economics. It’s sloganeering masquerading as science.
But let me give you an illustrative bit of data. From 1981 through 2007, the US economy created nearly 50 million jobs. (Also, the jobless rate fell from a high of 10.6% to 4.4%.) Over that same span, the minimum wage declined in value — using the consumer price index — by 30% since it only rose to $5.85 an hour from $3.35, while to stay even with CPI inflation it needed to rise to $8.43.
So even as the minimum wage was declining, the US saw an incredible surge of job growth that raised medium incomes by 40%. If anything, it looks like an interesting correlation between a falling minimum wage and high job growth — during a period that saw a restructuring of Corporate America and the rise of Silicon Valley.
One more thing on the minimum wage: Clinton says it’s settled science that raising the minimum wage does not cost jobs. This from the new paper “More on Recent Evidence on the Effects of Minimum Wages in the United States” by David Neumark, J.M. Ian Salas, William Wascher:
A central issue in estimating the employment effects of minimum wages is the appropriate comparison group for states (or other regions) that adopt or increase the minimum wage. … In general, we find little basis for their analyses and conclusions, and argue that the best evidence still points to job loss from minimum wages for very low-skilled workers – in particular, for teens.