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The Deflationary Trap: Europe Has Already Fallen Print
Friday, 17 October 2014 06:55

The NYT had an interesting piece about growing opposition to Germany's creationist economics. The piece reports that France and Italy are leading the opposition to German's insistence that austerity is the key to economic growth, in the face of massive amounts of evidence showing that the euro zone needs stimulus to boost growth. 

At one point the piece points to worries over "the prospect of falling into a deflationary trap." It is difficult to see what anyone would be worried about. The euro zone already has an inflation rate that is far too low. The latest data show inflation to be 0.4 percent over the last year, well below its 2.0 percent target, which is itself almost certainly too low to allow for effective monetary policy given the severity of the downturn.

Lower inflation will make matters worse, but nothing happens when the number turns negative. In other words, whatever concerns people have about a future of negative inflation they should already have now about a current inflation rate that is far too low.


More Handouts to the Financial Industry Print
Friday, 17 October 2014 04:38

We all know that the Wall Street types find it hard to get by without a helping hand from the government (like the bailouts), but many people don't realize all the different ways in which the financial industry manages to siphon away income from the productive economy. Floyd Norris has an interesting piece about a lawsuit coming before the Supreme Court in which an employer (Edison International) is being sued by its workers for deliberately picking a 401(k) plan with high administrative costs.

There is a procedural issue which the court must decide about how far back in time plaintiffs can go for bringing a suit. However there is also an important substantive issue. The workers are claiming that the company deliberately chose a higher cost plan, with the fees coming out of workers' accounts, because the fund manager gave Edison a kickback.

There is a considerable amount of money at stake with this issue. Norris puts the gap in costs at roughly one-third of a percentage point. If this were applied to the more $8 trillion currently held in 401(k) type accounts, it would come to more than $25 billion a year. This is effectively money taken away from workers and given to the financial industry. This is a bit more than 30 percent of what the government is projected to spend on food stamps this year.

China is Bigger Than the U.S., but Roger Cohen Thinks Jacking Up Drug Prices Will Restore U.S. Power in Asia Print
Friday, 17 October 2014 04:06

Some of the ideas of elite pundit types are truly amazing. Roger Cohen's NYT column today was about the fact that China's influence in Asia is rising at the expense of the United States. He tells readers:

"A new Chinese assertiveness in the South China Sea and elsewhere is palpable. By contrast, the United States seems less focused on the region since former Secretary of State Hillary Clinton left office."

The reality is that China has a larger economy than the United States. Its economy is already about 4 percent larger (adding in Hong Kong) and in five years it will be more than 25 percent larger and the gap is projected to continue to grow rapidly. Cohen apparently thinks that the personal interests of the secretary of state can overcome these differences in relative size.

Incredibly, among the specific policies that ranks high on his list for restoring U.S. influence in Asia is the Trans-Pacific Partnership (TPP), which Cohen describes as an ambitious free-trade agreement for the region. He blames President Obama for his "underwhelming" commitment to the pact.

In fact the TPP is very far from being a free trade deal. It's mostly about imposing a business friendly regulatory structure on the parties to the agreement. High on the list are a series of measures that would strengthen patent monopolies and related protections, especially in the case of prescription drugs. Of course protectionism is the opposite of free trade. It means higher prices to consumers and slower growth. But apparently to Cohen, forcing consumers throughout the region (and the United States) to pay higher prices for Pfizer's drugs is the key to restoring U.S. influence in Asia.

Debt Is Hitting Its Limits: That Is Why Interest Rates Are Plummeting Print
Thursday, 16 October 2014 21:08

Yes, Robert Samuelson is warning about debt again. Apparently the sharp drop in interest rates around the world leads him to believe that investors are about to lose confidence in the ability of countries to repay their debt.

It's great that we have Samuelson to give us these warnings, otherwise people might think that low interest rates (i.e. high bond prices) meant the markets were telling us that there is not enough debt. After all, high prices usually means demand exceeds supply.

Thankfully Jeff Bezos and the Washington Post give us Robert Samuelson to tell us to ignore textbook economics, don't get any ideas about boosting the economy by building up infrastructure and other public investments.

"Can we avoid a global debt trap and regain faster economic growth rates that foster stability and human well-being? Whatever debt’s virtues as a first response to deep slumps, it has its limits. We cannot promote prosperity simply by piling new debts atop the old. We need to build a stronger economic foundation."

Instead we should just be really worried because Robert Samuelson apparently has no clue what is going on.



It is perhaps worth reminding folks that interest payments in many cases are quite low at present, even though debt might be high. For example, even though Japan has a debt to GDP ratio of close 250 percent, its interest payments are less than 0.8 percent of GDP. In the U.S. interest payments on publicly held debt are a bit over 1.0 percent of GDP, well below the levels hit in the early 1990s. While many people raise the alarm that interest rates might rise and suddenly increase this burden, they ignore the fact that if interest rates rise, the market value of debt falls. In other words, if the interest rate on long-term debt issued by Japan were to jump to 2.0 percent from the current level of around 0.6 percent, the price of its debt would fall. Depending on the exact issue price and maturity, the drop could easily be more than 50 percent. This would go a long way toward making the current debt burdens appear much less dramatic. In short, there isn't much of a scare story here.

Quick Note on Heavy Babies and GDP Accounting Print
Thursday, 16 October 2014 06:52

David Leonhardt and Amanda Cox had an interesting Upshot piece about new research showing that heavier babies do better in school. One implication is that many of the induced births that doctors have performed in recent decades have actually been counterproductive from the standpoint of the health of the child. (Obviously the health of the mother must also be considered.)

This is an interesting finding, although I'll leave it to medical professionals to assess the strength of the evidence here. But it does raise an interesting issue from the standpoint of GDP accounting and measurements of living standards.

Let's assume that this finding is accurate and that many of the c-sections and other methods to hasten child birth have actually been a net negative from the standpoint of the child's health and neutral with respect to the mother's health. All of these procedures get counted in GDP as part of the economy's output. This means that we were counting services that were making us worse off as part of GDP. If we didn't have these procedures, other things equal, our GDP would be lower.

This issue arises in health care all the time for the simple reason that most of us are not in a position to assess the best medical treatment and must rely on the wisdom of our doctors and the medical profession. This differs from something like clothes, where we might think we are the best judges of the clothes that we should wear. (Okay, can the snide comments about my wardrobe.) At the end of the day what we value is our health, not the number of tests, procedures, and drugs we get. 

This is why I have always thought that for purposes like constructing cost-of-living indexes, we are best off just pulling out the money we spend on health care and measuring the price increases of non-health care consumption against the income we have left over after paying for health care expenses. This would treat spending on health care like a tax. If we want to then incorporate changes in our health into our assessment of living standards then we look directly at outcome measures (e.g. life expectancy, morbidity rates, self-rated health conditions), not the volume of health services we are consuming.

It Doesn't Matter That Oil Is Priced in Dollars Print
Thursday, 16 October 2014 04:57

Morning Edition committed one of the seven deadly sins of economic reporting when it told listeners that Europe is hurt and we are helped because oil is priced in dollars and the dollar is rising. (The biggest sin is reporting large budget numbers without any context -- which will result in an unpleasant afterlife for most budget reporters.) It actually doesn't matter that oil is priced in dollars, as some simple arithmetic quickly shows.

Let's imagine that oil is priced in wheat. Assume the price of a barrel of oil is 20 bushels of wheat. That would translate into roughly $130 a barrel. Now suppose the dollar rises in value against the euro by 25 percent, so that instead of a euro being worth $1.35, it is only worth $1.08. If the price of oil is unchanged in wheat and the price of wheat in unchanged in dollar terms, people in the United States will now be able to buy oil for 25 percent fewer dollars than before, or roughly $104 a barrel. This means we have to give up fewer dollars to get a barrel of oil.

However is Europe hurt in this story? Under the assumptions of a constant dollar price of wheat and a constant wheat price of oil, people living in the euro zone would be paying the same number of euros for a barrel of oil as before. (It would be priced at just over 96 euros a barrel in both cases.)

Now suppose we changed everything and said that instead of being priced in wheat oil really is priced in dollars and the dollar price fell from $130 a barrel to $104 a barrel and the dollar rose by 25 percent against the euro. How is this switch from wheat pricing to dollar pricing any different from the standpoint of people living in the euro zone?

If you answered not at all, you get a free tank of gas. (Bring your copy of BTP to your favorite gas station.)

There is a very minor point that the transactions generally (but not always) take place in dollars. This means that for one millisecond it is necessary for euro zone residents and others to get dollars to buy their oil. This trivially increases the demand for dollars. (You only need the dollar for the millisecond when the transaction occurs.) Also, there is no law that requires oil to be sold for dollars. If a Russian oil company feels like contracting for oil with euro zone customers where the payment takes place in euros, there is nothing to stop them and such transactions do sometimes take place.

Long and short, a higher valued dollar means cheaper oil for people living in the United States. It doesn't matter that oil is priced in dollars.

David Leonhardt and the Bubble Bath Scenario Print
Thursday, 16 October 2014 04:25

I have a pretty good track record in warning about bubbles and the damage their collapse will cause. I warned frequently and as loudly as I could about the stock bubble in the late 1990s. I quite explicitly predicted that its collapse would lead to a recession (e.g here and here). (This recession was far more serious than generally recognized -- 4 years with zero net job creation). I also  predicted that the collapse would cause troubles for the pension funds whose projections effectively assumed that the stock bubble would grow ever larger.

I was the earliest and clearest warner of the housing bubble. Also pointing out as early as 2002 that it would likely lead to serious trouble for Fannie and Freddie (that was easy), as well as many banks who would be stuck holding the bag at the time of the bust.

Given my past concern about bubbles, I am quite open to the view expressed by David Leonhardt in his Upshot piece that the stock market is over-valued. Leonhardt is right that price to earnings ratios are somewhat higher than their historic average. (I make comparisons of the current market valuation against average profit shares of GDP -- that gets rid of the impact of the extraordinarily high profit share of recent years and the lows of the downturn.) However the key item left out of Leonhardt's analysis is that interest rates are extraordinary low.

The decision to hold stock depends on what alternatives are available. If someone is considering buying a 10-year Treasury bond they would be looking at a nominal return of just over 2.0 percent and a real return of around 0.5 percent. By comparison, in 2000, when price-to-earnings ratios were around 30 percent higher, the nominal return on 10-year Treasury bonds was around 6.0 percent, for a real return of around 3.5 percent. To most folks those numbers would make bonds look considerably more attractive back in 2000, and therefore make stocks less attractive.

The takeaway for fans of arithmetic everywhere is that stock prices are indeed high. If you are expecting the market to give its historic 7.0 percent real returns, contact me immediately so I can sell you some swamp land in Florida. But if you are expecting a collapse like we saw in 2000-2002 or in the housing market from 2007-2011, you are going to be seriously disappointed.


Even When Facing Deflation Lower Oil Prices Are Still Good News (Mostly) Print
Wednesday, 15 October 2014 14:29

Neil Irwin chronicles the evidence of worldwide economic weakness by showing data from a variety of markets in an Upshot piece. He is mostly on the money, most economies do face serious problems of insufficient demand, but his concluding comments could use some qualification.

He tells readers:

"Moreover, investors lack confidence that policy makers have the tools they would need to avert a new slide into recession after years of throwing everything they have at it to try to encourage recovery and prevent deflation, or falling prices. Coincidentally, commodity prices are declining largely because of supply, but the timing of that decline is bad: It makes the risk of deflation that much more severe."

It is worth clarifying the point about policy makers "throwing everything they have." This is true in a political sense, it certainly is not true due to any real economic constraints as the evidence in this piece should make clear. In other words, if the United States, the euro zone countries, the U.K., and Japan were each prepared to spend an amount equal to 2-3 percent of GDP ($350 billion to $525 billion annually in the United States) to installing solar panels, windmills, and providing free bus service, it would provide a huge boost to employment and growth.

These countries can't have this or any other kind of stimulus this because their political leaders are scared of deficits and green monsters hiding under their beds at night. In economies that are obviously demand constrained, there is no reason to think that this sort of spending would create any economic problem, the obstacle is purely political.

The other point is that lower oil and commodity prices are good news (at least for those of us who are primarily consumers) even when facing deflation. Remember, the inflation rate is an average of all price changes in the economy. With the near zero rates in the U.S., and the nearer to zero rates in the euro zone, the prices of many items are already falling.

Suppose now that we add in large declines in oil and gas prices, making our overall average negative. How does this hurt matters? If we have a mortgage debt will it be harder to repay our mortgage now that we have to pay less to drive our car or heat our house? If companies are thinking of investing in expanding a factory or new line of software will lower energy prices and possibly lower long-term interest rates make this less likely?

If you carry through this thought process it is difficult to see how the crossing of zero line, and going from low inflation to low deflation as a result of lower commodity prices makes anything worse. Again, if we exclude the situation of commodity producers, this is a positive for the economy.

The reason for the "mostly" in the headline is that we should not be happy about lower oil prices from the standpoint of global warming. This will discourage conservation and the switch to clean energy. Of course an obvious way to prevent this problem would be to impose an energy tax that would offset the decline in prices. Yes, but the politics ....



Getting the Score Right on Dynamic Scoring Print
Wednesday, 15 October 2014 05:05

Matt O'Brien had a good discussion in Wonkblog of dynamic scoring of budget proposals, the holy grail of conservatives everywhere. The idea of dynamic scoring is that people respond to changes in incentives. This means that lower tax rates can lead to more growth and therefore more tax revenue to offset the cost of tax cuts.

O'Brien's point is that this effect is real, but nowhere near as large as many conservatives like to claim. For example, it doesn't mean that tax cuts will pay for themselves.

However O'Brien might have been a bit too generous to the dynamic scorers in his conclusion when he tells readers:

"But it could change the shape of the fiscal debate. Let's go back to tax reform. Dave Camp, the Republican head of the Ways and Means Committee, put forward his own plan that was revenue neutral without any kind of big dynamic effects. The CBO said—in footnote 42 on page 30—that, if it had used dynamic scoring, this would have increased its revenue estimate by 0.5 percent of GDP. That's real money, but not a crazy amount."

That 0.5 percent of GDP figure  (@$85 billion in today's economy) seems a bit high. If we check this famous footnote we find:

"CBO’s reading of the evidence about how the supply of labor responds to changes in tax rates suggests that such a substantial cut in the tax rate would probably increase the labor supply by 2 percent or less. ...Tax restructuring could also boost the capital stock by reducing the effective marginal tax rate on capital income, which would encourage saving, and by generating higher earnings by workers, which would also boost saving. If those effects together increased the long-term capital stock by an amount comparable to the increase in the labor supply, GDP would rise by 2 percent or less.An increase in GDP of that magnitude would boost federal tax revenues by less than half of 1 percent of GDP."


In other words, the 0.5 percent of GDP figure is a maximum, not CBO's central estimate. From the footnote it is clear that the central estimate is less than this amount, although it doesn't directly provide a basis for determining a more precise figure.



CBO scores are generally done from the standpoint of an economy at full employment. This removes the possibility of a demand side effect. (That is not true for their short-term scores of proposals done in the context of an economy that has yet to recover from the downturn.)

Defending Germany from Paul Krugman Print
Monday, 13 October 2014 05:18

I would not typically defend Germany's economic policies against Paul Krugman, but I will say a word in its favor this morning. Krugman trashes Germany for running large trade surpluses, telling us that Germany actually has a weak domestic economy. He concludes a short post by saying that Germany can't be any sort of model, since we can't all run large trade surpluses.

While there is much truth to Krugman's comments, it is worth stepping back for a moment. First, the claim that Germany's domestic economy is weak means that Germans don't want to buy lots of stuff. While Germany does certainly have problems of poverty and inequality, they are nothing like what we see in the United States. It would be great for Germany to spend more to address these problems, both because of the direct benefit and also because of the demand it would provide to the world economy, but it is not necessarily a bad thing that a country doesn't want to buy more stuff.

A really good way to deal with a problem of insufficient demand is to design policies that encourage less supply. Germany has done this to some extent with work sharing, long vacations, paid parental leave, and other policies that have the effect of dividing the available work more evenly among the population. The average work year in Germany is 20 percent shorter than in the United States. Germany can certainly do more to spread the work more evenly and hopefully the income goes with it, but weak domestic demand need not be a problem.

The other point is that, as a rich country with a declining population, we would expect Germany to be running trade surpluses. Capital can be more productively used in poor countries with rapidly growing labor forces. Therefore we should expect capital to flow from rich countries like Germany to developing countries in Asia, Latin America, and Africa.

Of course the size of Germany's surplus is extraordinary. Furthermore, much of it is going to other European countries like Italy and Spain, which also have slow growing (or shrinking) labor forces. These imbalances are due to the fact that they are locked into the euro and therefore their currency can't adjust to move them towards a trade balance with Germany.

Like Krugman, I have repeatedly trashed Germany for its role in enforcing contractionary policy on the rest of the euro zone by opposing more expansionary fiscal and monetary policies. And, its obsession with inflation is proving to be an incredibly costly superstition for the region.

But these policies are the real problem. Even if Germany followed the path I would like to see, it would almost certainly still have substantial trade surpluses, albeit not quite as large as the ones it is now running. 

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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.