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Release of Fed Transcripts Shows Fed Scary Ignorant in 2008, WaPo Scary Ignorant in 2014 Print
Saturday, 22 February 2014 09:09

It's great to be an economist in a top policymaking position in the United States. Unlike dishwashers, cab drivers, and most other workers, you are not held accountable for the quality of your work. We already knew that, since almost none of the people responsible for allowing the housing bubble to grow large enough to collapse the economy have paid any career price. (Ben Bernanke is praised for avoiding a second Great Depression. Talk about setting the bar low.)

Anyhow, the release of the 2008 transcripts of the Fed's Open Market Committee (FOMC) meetings once again show a group of people that is frighteningly ignorant of the economy. The housing market was already in a full-fledged collapse by the end of 2007 with prices falling at the rate of 1.5 percent a month. That translates into a loss of $300 billion in household wealth every single month. Yet the transcripts show the Fed debating whether the economy would see a recession until well into 2008. (The pace of decline eventually accelerated to 2.0 percent a month.)

In the transcript of an early January phone call, Dave Stockon presented an update of the Fed's forecasts which included this line:

"House prices have come in a touch lower than we had forecast. We have also lowered our projection on the level of house prices about 1 percentage point in this forecast. Taken together, those lower equity prices and the lower house prices take 0.1 off growth in 2008 and 0.2 off GDP growth in 2009."

Yeah, a touch lower, and reducing growth by 0.1 percentage point in 2008. This is pretty amazing stuff. It's almost as though they didn't have access to the data showing that house prices were already plunging.

The other item that is amazing in these transcripts is that no one seems to know about the Census Bureau's data on housing vacancies. Vacancy rates of ownership units were already about 50 percent above normal levels by the end of 2007. The vacancy rate on rental units was about 30 percent above normal levels. What did the Fed folks think this implied for house prices?

Incredibly, the first mention of vacancy rates in the transcripts doesn't come until June. Maybe someone should give the FOMC a short lesson on government data sources. If they had seen the vacancy data they would have even less excuse for being surprised by the plunge in house prices, unless they also need an intro course on supply and demand.

The transcripts tell a story where the FOMC is seeing the economy collapse around it and is largely clueless to what is taking place. In fairness, there was little it could do to prevent the collapse at that point, but it is still hard to believe that people who are so ignorant of the economy are able to get paid for this work.

As far as the Post coverage of the release, the piece tells readers in reference to the September meeting near the peak of the financial crisis:

"Even so, Bernanke thought the Fed had probably done enough, according to newly released transcripts. So he recommended that the central bank leave its key interest rate unchanged — a move the Fed would come to regret."

Really, the Fed came to regret not lowering the federal funds rate in September of 2008? What difference exactly would this have made in the financial panic and the collapsing of the housing bubble? If we had lowered the federal funds rate to zero at that point can anyone think that the subsequent set of events would have played out very differently? That's absurd on its face, but I suppose it would at least mean that the FOMC members were not oblivious to the fact that the economy was sinking all around them.

As it is, these transcripts should make readers furious that the FOMC members were getting big paychecks for their work and will enjoy fat pensions in retirement. Unlike workers in Detroit and Chicago, they did mess up on their job, big-time. Read em and weep

 

Addendum:

 

Since some folks asked, of course I saw the recession in 2008. I had been warning about the bursting of housing bubble causing a recession since 2002. See here, here, and here for a few of my columns from 2008. And the material on the housing bubble is here. Seeing this one coming was easy for folks who understood the economy. Unfortunately, it seems that not understanding the economy was and perhaps still is a job requirement for holding a top policy position.

 
David Brooks Stumbles Over the Work Force in Attacking the Minimum Wage Print
Friday, 21 February 2014 05:51

David Brooks doesn't like the idea of raising the minimum wage. But the good news is that he thinks it's a good idea to increase the Earned Income Tax Credit (EITC), an alternative mechanism for helping low-paid workers.

In criticizing President Obama's proposal for raising the minimum wage, Brooks refers to the Congressional Budget Office's (CBO) projection that it would lead to 500,000 fewer jobs, but doesn't get the story quite right:

"Democrats embrace a raise in the minimum wage that could drive another half-million workers out of the labor market."

Actually CBO projected that the higher minimum wage would lead to 500,000 fewer jobs, not drive 500,000 people out of the labor market. This isn't just nitpicking.

Some folks may recall CBO's analysis of the ACA. This concluded that the ACA would reduce the supply of labor by roughly 2 percent. That was a case where people would be leaving the labor force or reducing their supply of labor. The issue here was that the ACA made it possible to get health insurance outside of employment. This would mean that many near retirees or people in bad health might decide to quit their jobs or work fewer hours as a result. Many parents of young children may also decide to work fewer hours or take time off from work to be with their kids.

Opponents of the ACA jumped on the CBO analysis. Some wrongly claimed that CBO concluded the ACA will kill jobs. More informed critics decried the negative incentives for work created by the ACA. And this is partly true. The ACA provides substantial health care subsidies for low and moderate income workers that are phased out as income rises. This phase out is equivalent to a higher tax rate.

For example, if a $4,000 subsidy is phased out as income rises by $20,000, this is equivalent to a 20 percent marginal tax rate. This provides a disincentive to work. (You get to keep 20 cents less of each dollar you earn.) There is reason for thinking the effect of this disincentive is small, but it nonetheless exists.

Now let's get back to David Brooks support for a higher EITC as an alternative to raising the minimum wage. President Obama wants to raise the minimum wage by $2.85 over three years. This would put another $5,700 in the pockets of a full-time full-year worker.

Suppose that we agreed with Brooks and said this is the wrong way to go, instead we will be clever conservatives and give workers the equivalent increase in income through the EITC. Currently, the EITC peaks at a bit under $5,500 for a single person with two kids. This credit is phased out at a rate of 21 cents on the dollar for income above $18,000. This means that for every $1,000 earned above $18,000, workers will lose $210 of their tax credit. This means that the credit falls to zero at an income level around $44,000.

After being convinced by David Brooks that a higher EITC is the better route to go than raising the minimum wage, we decide to raise the maximum EITC by $5,700 a year. This puts the maximum a bit under $11,200. Now we have a little arithmetic problem. Currently we phase out the EITC over roughly a $26,000 income range (from $18,000 to $44,000). If we phase out a $11,200 credit over the same range, then we would need to take back 42 cents of every additional dollar earned ($420 out of every $1,000). This would be a very large increase in the marginal tax rate faced by moderate income workers, giving them a much larger disincentive to work. Is this what David Brooks and his fellow conservatives want?

Alternatively, we could keep the same rate of phase out, but then we would have people earning almost $70,000 a year getting the EITC. That's a pretty expensive alternative to raising the minimum wage.

Of course we could do a mix of a higher tax rate and a higher peak income level, but that still gives us some serious work disincentives and an expensive EITC. There is no way around this problem. Of course we also have the problem of fraud for which David Brooks' plan would provide considerable incentive. Suppose the government gives you $11,200 if you claim that you earned $12,000 last year. There would be a strong incentive for people who are not working to get a friend or family member to say they paid them $12,000 last year to clean their house or take care of their yard.

Conservatives tend to exaggerate the amount of fraud associated with the EITC, but the level is not zero. If the EITC is doubled then the incentive for fraud is increased proportionately. 

As a practical matter, if we were actually debating a large increase in the EITC it is likely that David Brooks' conservative friends, if not Brooks himself, would be raising these concerns about the disincentives to work and the incentives for fraud. But, as long as the higher EITC is just being thrown out as a reason not to raise the minimum wage, these issues won't get into the debate. But that's the service we provide at Beat the Press. 

 

Typos corrected -- thanks Robert Salzberg.

 

 
Differences in Inequality by City Are Worse Than Brookings Says Print
Thursday, 20 February 2014 06:05

The NYT reported on a Brookings study that examined inequality by city. The study showed that the largest and fastest growing cities tended to have the most inequality. In fact, the study understated the differences in inequality for two reasons.

First its focus was on the 95th percentile of the income distribution compared to the 20th percentile. While the 95th percentile had gotten at least an even share of the country's income growth over the last three decades, the big gains have been concentrated in the one percent. For this reason, the analysis would be missing most of the impact of rising inequality since 1979.

The other factor, which is likely more important, is that it doesn't take account of differences in housing costs by area. While the price of food doesn't differ much from city to city, housing prices vary enormously. And housing will almost certainly take up a much larger share of a lower income household's budget in an expensive city than in a cheaper one. For example, the median rent in San Francisco is $2,146 a month. By comparison, the median rent in Wichita, Kansas, one of them equal cities in the study, was just $793 a month. While a moderate income household can reasonably expect to afford housing in Wichita, there is no way that a moderate income household in San Francisco would be able to afford a housing unit there. An analysis that accurately measured differences in income would have to factor in the differences in housing costs by city. 

 
Household Debt Rose Because Foreclosures Fell Print
Wednesday, 19 February 2014 07:32

The NYT had an article discussing a release of data on household debt by the NY Fed. The article noted that debt rose rapidly and highlighted the increase in mortgage debt in the fourth quarter, the first since before the downturn.

Actually, the main reason that mortgage debt increased in the fourth quarter, as compared to declines in prior quarters, was due to a lower rate of write-downs of bad debt. There was no surge in new mortgage debt in the fourth quarter.

 
The Differing Labor Market Experience of the UK and US: Explaining Things That Didn't Happen, #25,317 Print
Wednesday, 19 February 2014 05:33

Today's target is the usually astute Ryan Avent. Writing in the Economist, Ryan tells readers:

"Two rich economies, relatively similar in structure, reacted very differently to the global financial shock of late 2008. In America output sank sharply but then rebounded to new highs. Employment, by contrast, fell dramatically and has recovered much more slowly; it has yet to regain the pre-crisis peak. In Britain the trends were reversed; employment is setting new highs while output suffered an L-shaped recovery."

The piece goes on to explain that because of a drop in real wages, firms in the U.K. hired more workers. By contrast, in the U.S. firms went the route of adopting productivity enhancing technology.

The problem with this story is that employment has actually followed a similar path in the U.K. and the U.S. in the upturn. According to OECD data, in the U.K. between 2010 and the third quarter of 2013, the employment to population ratio for workers between the ages of 16 to 64 rose from 69.5 percent in 2010 to 70.8 percent. That's a rise of 1.3 percentage points. By contrast, in the U.S. the increase was from 69.7 percent to 70.4 percent, a rise of 0.7 percentage points. 

While 1.3 percentage points is more than 0.7 percentage points, it doesn't describe a qualitatively different situation. Furthermore, the gap would largely disappear if we looked at hours worked. The OECD data shows the average number of hours per worker increasing by 0.6 percent in the U.S. between 2010 and 2012 compared to a rise of just 0.1 percent in the UK. In other words, the story that firms in the U.K. are turning to hiring labor because it is cheaper simply is not true. The labor might be cheaper, but isn't lead to more hiring.

I actually think there is a great deal to Ryan's larger point, that productivity is to a large extent a response to wages. In the U.S. we have lots of low productivity jobs that exist because people are desperate for work, such as the midnight shift at convenience stores. If wages were higher, these jobs would disappear, leading to a rise in productivity. So the story is reasonable, it just doesn't apply to the situation being examined.

Since I am on the topic of explaining things that didn't happen, I will turn to my favorite, the weak consumption in the wake of the downturn. We have had endless tracks explaining why people are not spending as much in the recovery as they did before the downturn. Most of this centers on debt overhangs and the like. I would hate to destroy so much job creating potential for economists, but it is worth pointing out that people actually are spending.

Here's the simple story, the saving rate is actually relatively low right now, which means that consumption is relatively high.

savings rate

The current saving rate is near 4.0 percent. That's higher than the lows hit at the peaks of housing bubble in the last decade or the stock bubble in the 1990s, but it is considerably lower than the averages for the 1960s, 1970s, 1980s, and even the 1990s.

This means that people are actually spending an unusually high share of their income. They are not spending as high a share of they did in 1999-2000 or 2004-2007, but that's because they had trillions of dollars of bubble generated wealth in those years. The concept of a wealth effect, whereby people spend based in part on their wealth, goes back at least 80 years, so economists should be familiar with it.

Anyhow, just because there is no falloff in consumption doesn't mean lots of economists can't devote their time to explaining it. After all, what else do they have to do?

 
CBO Projects Employment Loss from Minimum Wage Hike Would be Comparable to Impact of Iraq War Size Increase in Military Spending Print
Tuesday, 18 February 2014 21:15

The Congressional Budget Office (CBO) released a report today on the impact of an increase in the minimum wage, which projected that it would lead to a loss of 500,000 jobs. This was quickly seized on by opponents of the minimum wage hike as implying a disastrous loss of jobs. Unfortunately, some of the reporting on the issue was less clear than it could have been.

The CBO projections imply that 500,000 fewer people will be employed at low wage jobs. It did not say that 500,000 people would lose their jobs. This is an important distinction. These jobs tend to be high turnover jobs, with workers often staying at their jobs for just a few months. While there will undoubtedly be cases where companies go out of business due to the minimum wage hike (many small businesses are always at the edge, so anything can push them over) the vast majority of the lost jobs are likely to be in a situations where businesses don't replace a person who leaves or don't hire additional workers as quickly in response to an uptick in demand.

This means that we are not going to see 500,000 designated losers who are permanently unemployed as a result of this policy. Rather, the projection implies that workers are likely to find it more difficult to find new jobs when they leave an old job or when they first enter the workforce. With 25 million people projected to be in the pool of beneficiaries from a higher minimum wage, this means that we can expect affected workers to put in on average about 2 percent fewer hours a year. However when they do work, those at the bottom will see a 39.3 percent increase in pay.

There are two other points worth noting on the CBO report. First, there is considerable research indicating that there might be no employment effect from a minimum wage hike of this magnitude. Based on this body of research, it is certainly possible that CBO has overstated the employment effect of this proposed increase in the minimum wage.

The other point is that we have often implemented policies that have had a comparable impact on employment and never even given the job loss a moment's consideration. A few years back we commissioned Global Insight, one of the country's leading economic forecasting firms, to project the impact on jobs and growth of an increase in military spending equal to one percentage point of GDP, roughly the annual cost of the Iraq war from 2003 to 2010. Their model showed that after 10 years it cost 464,000 jobs and after 20  years the economy would have 668,000 fewer jobs as a result of higher military spending.

Interestingly, the job loss associated with higher military spending never got mentioned in discussions of the Iraq War, nor is it mentioned in ongoing debates over the appropriate level of defense spending. If members of Congress and the media don't feel that job loss of this magnitude is worth mentioning in reference to defense spending, it is difficult to see why it would be so important in discussions of the minimum wage.

 
Deflation Phobia on the NYT Editorial Page Print
Tuesday, 18 February 2014 08:12

It's baaaaaaaaaaaaack! Those silly warnings about the menace of deflation, this time in a NYT editorial. Come on folks, this one is really simple; the problem of deflation is an inflation rate that it is too low. Even an economist can figure this one out.

When you have near zero inflation many prices are already falling. What's the difference if the price of 55 percent of goods and services are declining instead of 45 percent? Besides these are all quality adjusted prices, so in many cases the actual purchase price of most items might be rising even in a period of deflation.

This matters because it leads people to believe that keeping the inflation rate above zero is somehow an accomplishment, with things getting bad only if the aggregate figure goes negative. This is not true, there is no magic to zero. The problem in the euro zone and in the United States is that inflation is too low. If it goes negative then it will be an even bigger problem, but that is only because it will be a lower inflation rate, crossing zero means nothing.

 
Weak Wage Growth Is Bigger Problem for Housing Market Than Student Debt Print
Tuesday, 18 February 2014 07:51

The Washington Post had a somewhat confused front page piece claiming that student debt burdens are a major obstacle to the recovery of the housing market. First, it should be noted that by most measures the housing market has already recovered. Prices are above their trend levels. Sales are also at or above trend levels. Construction has not yet recovered, but this will not happen until the inventory of vacant housing units is further reduced.

However, the piece is seriously misleading in implying that student loan debt is a main factor impeding home buying. (Bizarrely, it discusses the situation of someone looking to buy an $800,000 home, four times the median house price.) While student loan debt undoubtedly does make it more difficult for people to buy homes, so do low wages. This is a much bigger problem for people without college degrees who have historically accounted for the vast majority of homeowners.

According to a recent study by Pew, the median 25-32 year-old with an associate degree earned $30,000 in 2012. Those with only a high school degree earned $28,000. Both are less in real terms than what they would have earned in 1979. If we assume that their mortgage payments and taxes should not exceed 30 percent of their gross income, this means that they cannot afford a house that costs more than $153,500, roughly 75 percent of the median house price. This assumes a 4.5 percent interest rate, a 20 percent down payment, and no need for mortgage insurance. If this were to rise to 5.5 percent, either due to higher interest rates or a need to get mortgage insurance, then they would only be able to afford a home costing $139,500.

The study showed the median high school grad earned $28,000, which means that in these cases the most expensive house they could afford would be $143,300 in the case of a 4.5 percent interest rate and $130,200 in the case of 5.5 percent interest rate. As a result, most young people without college degrees will not be earning enough money to buy a house. It is worth noting that the Pew study showed that the median wage of college grads has barely risen for the typical college grad over the last three decades also. They have also been victims of the upward redistribution during this period, although not quite to the same extent as those with less education.

 
Larry Summers Is Half Right in Saying That Growth Would be Affected If We Reduced the Incomes of the Very Rich Print
Monday, 17 February 2014 08:36

Unfortunately he is wrong about the direction of change. Apparently Summers has missed the downturn in the last six years and the weak growth since the turn of the century. In his post column today he warns readers:

"If total income were independent of efforts at redistribution, there would be a compelling case for reducing incomes at the top and transferring the proceeds to those in the middle and at the bottom. Unfortunately, this is not the case. It is easy to conceive of policies that would have reduced the earning power of a Bill Gates or a Mark Zuckerberg by making it more difficult to start, grow and globalize businesses. But it is much harder to see how such policies would raise the incomes of the remaining 99.9 percent of the population, and such policies would surely hurt them as consumers."

It's interesting Summers picked Bill Gates. Back in the early 1990s Microsoft helped to lock in its monopoly on operating systems by contracting with major manufacturers so that they paid Microsoft for each computer they shipped that had a competitors' operating system. Needless to say, such deals strongly discouraged Dell, Hewlett-Packard and other major manufacturers from experimenting with niche operating systems that might have potentially had larger uses. Had the Justice Department taken anti-trust law seriously we might have better software today and Bill Gates would be considerably less wealthy.

We could also impose a modest sales tax on financial transactions as even the I.M.F. has advocated. This would both hit many of the fortunes being collected on Wall Street and also reduce the enormous amount of waste in a financial system that consumes five times as large a share of GDP as it did forty years ago.

We could cut back on the fortunes in the pharmaceutical industry and tech sector and get better drugs and technology by moving away from patent supported research. (Yes, there is such a thing as the National Institutes of Health and everyone agrees it does great work.) We could also make it more difficult to bring frivolous patent suits so that Apple, Samsung and the rest will have to compete to make the best products, not in the court rooms.

And we could cut back on the Walton family's fortunes by pushing China and other developing countries to raise the value of their currencies. This would reduce their profit margins on low cost imports. It would also have the great advantage of moving us toward more balanced trade creating millions of jobs and increasing growth. In addition, by getting us closer to full employment, tens of millions of workers would be in a position to get wage gains. 

So Summers is absolutely right. Total income is not independent of distribution and many of the steps we might want to take to equalize distribution would also foster growth.

 
Robert Samuelson Is In the Dark Print
Monday, 17 February 2014 08:17

It must be great to be a columnist for the Washington Post. You get to rewrite the same columns week after week. You never have to pay attention to facts and data or even make sure that you accurately present the arguments you criticize. Hence we have Robert Samuelson telling us this morning that "economists are in the dark."

Of course he is in large part right. Given its colossal failure in recognizing the risks of the housing bubble it would be reasonable for every university to shut down its economics program, recognizing that it has about as much use as a department of astrology. But Samuelson is shooting blanks when he tells us that Keynesian economics has been proven a failure by the downturn.

"This conclusion is surely controversial because many economists attribute the weak recovery to misguided austerity, especially in Europe. Just follow the advice of John Maynard Keynes (1883-1946), they say. When the economy suffers a massive drop in private spending, government should offset the loss by increasing its budget deficits. Europe’s budget cuts were too aggressive, they say, while U.S. 'stimulus' policies were not aggressive enough.

"Perhaps history will vindicate this appeal to Keynesianism. Or perhaps not. The fact is that the United States did respond aggressively under both George W. Bush and Barack Obama. It certainly didn’t embrace austerity. Federal budgets ran massive deficits — $6.2 trillion worth from 2008 to 2013, averaging 6.4 percent of the economy (gross domestic product). Nothing like this had occurred since World War II. Yet, the economy limped along. Why wasn’t this enough?"

Yes, well we have to keep Robert Samuelson away from the really big numbers, he might hurt himself. The reason it wasn't enough is because the shortfall in demand created by the collapse of the housing bubble was even bigger, as some of us yelled at the time. The loss in residential construction was around 4 percentage points of GDP. The loss in consumption due to the loss of housing bubble generated wealth was also around 4 percentage points of GDP. Throw in another 1 percentage point each for the reduction in state and local government spending and non-residential construction and you're up to 10 percentage points of GDP; that comes to almost 1.7 trillion in today's economy.

If we sum that over 6 years we get more than $10 trillion and that's before even factoring in any multiplier effects. So, $6.2 trillion is a really big number, but the actual shortfall in demand created by the collapse of the housing bubble was an even bigger number. And those of us who pay attention to the economy were saying this as loudly and clearly as we could at the time. 

There is no problem with understanding the economy and figuring out how to turn it around. The problem is that the debate is dominated by people like Robert Samuelson who refuse to look seriously at the data and to listen to what the people he criticizes are saying.

 
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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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