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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. 

Robert Samuelson Tells Us It's All So Complicated! Print
Monday, 13 October 2014 04:39

Unfortunately that is not an exaggeration. He concludes his column this morning about the difficulties the folks at the I.M.F. meetings have in promoting growth by telling readers:

"We’re witnessing a historic break from the past. I think the IMF forecasters deserve some sympathy. They’re dealing with a global economy that strains our intellectual understanding and is outside their personal experience. We don’t know what we don’t know."

Samuelson tells us that there are three huge problems. The first one is:

"Sobered and scared, people and businesses delay consumption and investment. To prepare for the next crisis, they reduce debts (“deleverage”) and increase savings. Firms hoard profits."

The problem is that this is not really true, especially in the United States. Consumption is actually quite high relative to disposable income (which means savings is low), albeit not quite as high as at the peaks of the stock and housing bubbles when people had trillions of dollars of ephemeral wealth.

savings rate

The investment share of GDP is not quite back to its pre-recession peak, but it's above its 2005 share. No one in 2005 was saying that firms were scared and deleveraging.



The New York Times Dream Pension Plan: Lower Benefits and Higher Contributions In Economic Downturns Print
Saturday, 11 October 2014 21:53

Economists usually think it is a good to try to make spending countercyclical. This means that we want more spending when the economy is weak and less when the economy is strong.

Traditional defined benefit pensions in the United States at least partly fit this bill. They do sustain benefit levels in a downturn. In addition, their funding formulas average the impact of market swings so that they don't have to have large increases in contributions if the economy goes into a downturn and their funds take a hit.

A NYT piece by Mary Williams Walsh told readers that pensions in the Netherlands work in the opposite way and that we should all follow their model. The piece tells readers that the Netherlands runs pensions the way they should be run. It celebrates the fact that its method would amplify the impact of cycles:

"After the financial collapse of 2008, workers and retirees in the Netherlands took the bitter medicine needed to rebuild their collective nest eggs quickly, with higher contributions from workers and benefit cuts for pensioners."

This is a policy that had something for everyone. Not only did it reduce the money available to retirees to support themselves, it also took money away from firms to finance investment. It also had something for the young. By reducing demand in the economy, it put more of them out of work.

If someone wanted to do damage to the Netherlands economy it would be difficult to envision a more effective method short of war. Incredibly the economists in the Netherlands all agree that this is the best approach, at least according to the article. It quotes Theo Kocken, an economist who started a risk analysis firm:

"“But all economists now agree. The expected-return approach [which requires this pro-cyclical spending and contribution pattern] is a huge economic offense, hurting younger generations.”

The pension policy promoted by Mr. Kocken, and apparently all of Netherlands' economists, might help to explain why GDP in the Netherlands is still 2.0 percent below its 2008 level, as compared to 7.6 percent higher in the United States. It's not clear how he would tell younger generations that shrinking the economy is good for them, but economists in the United States usually think that a larger economy is better -- unless the shrinkage is due to voluntary leisure. (The U.S. accounting system leads to much less pro-cyclical funding patterns, although it can be improved.)

As a practical matter, there are many deficit cultists in Europe who have insisted on austerity as the best mechanism to get out of the recession. The result has been economic stagnation and ever falling inflation rates that may soon turn negative. Folks that believe in basing theories on evidence would view their policies as a disastrous failure. However, like creationists in the United States, many European economists apparently don't let evidence affect their views of the economy. Most people would not consider that an approach to be emulated in the United States, but apparently the NYT is promoting creationist economics, at least when it comes to pensions. 



For those interested in bringing the impact of the Netherlands' austerity down to a more personal level, the loss in wages and other income due to its economy growing less rapidly than the U.S. economy comes to roughly $4,700 per person a year, or $18,800 a year for a family of four. This can be thought of the country's "austerity tax." But at least they don't have to worry about underfunded pensions.

David Leonhardt Wonders Why It's Cold In the Winter and Wages Aren't Rising Print
Saturday, 11 October 2014 07:19

Sometimes a question can be really annoying. Try asking a homeless person why he doesn't have a nice apartment or Al Gore why he lost the election in 2000. David Leonhardt got in the game of really annoying questions when he speculated as to why wages aren't rising this week. Is it really necessary to ask?

The economy is still way below potential GDP. If Leonhardt ever looked at the data from the Bureau of Labor Statistics or read his own paper, he would know that the employment to population ratio is still close to 4.0 percentage points below its pre-recession level. Even if we restrict the question to prime age workers (people between the ages of 25-54), to eliminate the issue of retirement, the drop is still 3.0 percentage points. The share of the workforce involuntarily working part-time is still more than 50 percent above its pre-recession level. In other words, there is still a large amount of slack in the labor market.

When there is slack in the labor market most workers are not able to get wage gains because they lack bargaining power. That was true in the 1980s, it was true in the 1990s, and surprise surprise, it's still true in this decade. That was the main point of my book with Jared Bernstein. 

With the answer right in front of him, like the French colonel in Casablanca, Leonhardt rushes to round up the usual suspects, naturally seizing on education. Unfortunately, the data refuse to cooperate with him. The unemployment rate for college grads is still almost 50 percent higher than its pre-recession level. The wages for recent college grads has fallen sharply since 2000. Believers in supply and demand would know that more college grads should put even further downward pressure on the wages of college grads. How does this help the wage story?

The obvious issue is that we need more demand in the economy. That can be most easily accomplished with more government spending. We could also get the trade deficit down by lowering the value of the dollar, making our goods more competitive internationally. Alternatively, we could go the path of Germany and try to reduce labor supply with work sharing, paid family and parental leave, and paid vacations.

But the real story here is about as simple as it gets. (Yeah, it might be complicated for economists who couldn't see an $8 trillion housing bubble.) We can understand the need to create more jobs, but creating confusion about simple economic points is not a good make-work project.

Franklin Foer Confuses Amazon's Subsidies from the Government With Profits Print
Friday, 10 October 2014 07:07

Franklin Foer has an interesting, but ultimately badly confused article in the New Republic about Amazon and its growth. The article is debating the appropriate anti-trust approach to Amazon, questioning whether it merits government intervention to protect producers and not just consumers.

This is a reasonable question, but the confusion comes in the first sentence of the second paragraph, which tells readers:

"Rather than pocketing the profits from this creation, Amazon has plowed revenue into bettering itselfinto the construction of well-placed fulfillment centers that further hasten the arrival of its packages, into technologies that attempt to read our acquisitive minds and aptly suggest our next purchase."

The problem here is that there were actually few profits to pocket and what little profits did exist were due to the enormous subsidy Amazon enjoyed from not being required to collect state sales tax. The first point is straightforward. Amazon has always had very thin profits and has had almost as many losing quarters as profitable ones.



Great Mystery at the Post, Why are People Without Jobs Unhappy About the Economy? Print
Friday, 10 October 2014 05:35

Yes folks, they pay people to ask such questions. Steven Mufson uses a Wonkblog piece to speculate on why it is that even though we have been in a recovery for more than five years people are still not happy about the economy. He tells us that President Obama has the same problem as President Bush (I), who got trashed on the economy even though revised data show it had been growing rapidly at the start of 1992.

While Mufson seeks out expert analysis to try to resolve this paradox, he might try looking at the data for a moment. No one sees the economy. They don't what the rate of growth is unless they read about it in the newspaper. What they do know is whether they have a job, whether their job is secure, and their pay is rising.

If you ask about these questions the only mystery is why Mufson is wasting our time. In 1992 the employment to population ratio was still 1.5 percentage points below its pre-recession level. That would translate into roughly 3.2 million fewer people having jobs in today's labor market. The current employment to population ratio is down by close to 4.0 percentage points from pre-recession levels, translating into more than 9.0 million fewer people with jobs. (Some of this is due to retirement of baby boomers.) Wages for most workers have been stagnant or declining in the last five years as was the case in 1992.

So the real question here is why any serious people would have any question about why the public is sour on the economy. People care about their living standards and security, they don't care about GDP numbers produced by the Bureau of Economic Analysis.


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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.