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The Fed and Inequality Print
Thursday, 18 September 2014 06:49

Charles Lane has a column in the Washington Post arguing that the Fed has contributed to inequality with its low interest policy. Essentially the argument is that low interest rates have helped to push up asset values, most importantly stock prices. Since the rich have stock and most people don't, this means the rich are getting richer relative to everyone else. Since a lot of people who should know better have made this argument, it is worth addressing.

First, it is important to understand the nature of the inequality. If we're looking at wealth, the issue is pretty clear. Higher stock prices mean people who own stock are wealthier relative to the population as a whole. (Remember this when you hear reporters tell you the good news that the stock market is up.)

But note the nature of the increase implied here. Grabbing our old "other things equal," lower interest rates mean higher stock prices. However, this also means that higher interest rates will mean lower stock prices. Most people expect that at some point interest rates will rise due to a strengthening economy. (Many economists want the Fed to raise interest rates now.) So we can expect the wealth inequality the Fed has created with its low interest rate and quantitative easing policies to go away once the economy is approaching its potential level of output.

In that case we are looking at an explicitly temporary increase in inequality. Should we be upset by this?

The situation is even more striking if we look at income. If we count the capital gains in the stock market as income, then we have seen a huge increase in income inequality as stock prices roared back from their 2009 lows. Here also part of this will be reversed as the rich have capital losses when interest rates go back up. (Some of the increase is just a reversal of a market that was depressed due to fears of economic collapse.)

It's difficult to see the big problem here. Remember, the economy's problem is too little demand. Let's say that a few more times just in case anyone in a policy position in Washington is paying attention. The economy's problem is too little demand.  The economy's problem is too little demand. The economy's problem is too little demand.

Read more...

 

 
Europe Is Already Suffering From the Bad Story With Deflation Print
Thursday, 18 September 2014 04:14

The NYT gave us another article from the cult of zero, which highlighted a modest upward revision in the year over year inflation rate from 0.3 percent to 0.4 percent. The piece told readers:

"The revised figure for August suggests that inflation may have stabilized, but is unlikely to end a debate among economists about whether the eurozone is at risk of deflation — a broad, sustained decline in prices that is associated with depression and high unemployment."

Actually Europe is already facing a period of very low inflation associated with depression and high unemployment. The low inflation rate makes it difficult for the European Central Bank (ECB) to push down the real interest rate so as to boost demand. Even at 0.4 percent the inflation rate is well below the ECB's 2.0 percent target. And given the weakness of the euro zone economy, a higher inflation rate in the range of 3-4 percent would be desirable.

As the piece notes, many countries in the euro zone now actually have deflation. This is the only way they have to regain competitiveness with Germany, as long as Germany maintains a very low inflation rate. If Germany had a higher inflation rate, it would be possible for countries like Greece and Spain to gain competitiveness with moderate positive inflation. As it is, they have no choice but to endure massive unemployment in order to force wages and prices downward.

The piece is also mistaken in telling readers:

"When deflation takes hold, consumers delay major purchases because they expect prices to fall further. Corporate sales and profits suffer, which forces companies to lay off workers, creating a vicious circle of falling demand."

Actually at low rate of inflation many prices are already falling. The overall inflation rate is simply an average of all price changes. When the inflation rate is near zero, many prices will be falling. The positive rate just means that somewhat more prices are rising, or that some prices are rising more rapidly.

Furthermore actual market prices may still be rising even if the measure of prices used in the government data shows falling prices. Statistical agencies use quality adjusted prices. The measures of quality improvement may more than offset a nominal increase in prices. Quality improvements are the main reason that computer prices have shown sharp price declines in government data over the last three decades. They are also the reason that car prices have been virtually unchanged from their level of 18 years ago.

 

 

                                  Consumer Price Index, New Vehicle Component

car prices

                                   Source: Bureau of Labor Statistics.

 
The New York Times Doesn't Like the U.K. Health Care System Print
Wednesday, 17 September 2014 14:15

That is what readers of an article headlined "Health Care for Britain in Harsh Light" would likely conclude. The intention of the article certainly seems to be to put the health care system in Britain in a harsh light.

The substance of the article is that the National Health Service (NHS) refused to pay for a young boy suffering from a brain tumor to go overseas to get a new treatment. The treatment is expensive, and according to his doctors and other medical experts, not the best way to treat the tumor.

It is not clear what the obvious flaw is in the NHS. Few people in the United States have insurance that will pay for expensive procedures that are not considered effective. In fact, in many cases insurers won't pay for expensive procedures even if they are effective.

Okay, so readers should assume that the NYT or one of its editors doesn't like the NHS. This is really the only information conveyed in this article.

 
Crapo-Johnson and Affordable Housing Print
Wednesday, 17 September 2014 06:59

The Post ran a piece today discussing the agenda of Julian Castro, the new secretary of the Department of Housing and Urban Development Secretary. At one point the piece discusses affordable housing. It then refers to the Johnson-Crapo bill for privatizing Fannie Mae and Freddie Mac. This bill has a provision for a fund that would support affordable housing.

It would have been worth noting the size of the fund. It would get its revenue from a 0.1 percent tax on mortgages issued through the system. If an average of $1.5 trillion a year in mortgages are issued, this tax would raise $1.5 billion annually.

If it costs $150,000 to build an average unit of affordable housing, this fund will be able to support construction of roughly 10,000 units a year, an amount equal to roughly 0.007 percent of the housing stock. Alternatively, if this money was used to subsidize rent, it would provide a subsidy of $1,500 a year ($125 a month) to 1 million households.

Both of these routes may be very helpful to the people who benefit, but they are not of a scale necessary to ensure affordable housing to low and moderate income families. It is worth noting in this respect that there is no dispute that the Johnson-Crapo bill proposal would raise the cost of mortgages. The range of estimates are in the neighborhood of 0.5 percentage points to over 2.0 percentage points.

If we assume that the actual impact is close to a 0.5 percentage point increase, this would imply that a family with a $200,000 mortgage would pay an extra $1,000 a year in interest due to Johnson-Crapo. This is likely to have far more impact in making housing less affordable than the subsidies funded through the bill's tax to promote affordable housing. 

 
Timothy Geithner's Revenge: A Broken Bond Rating System Print
Tuesday, 16 September 2014 19:12

One of the factors that made it easy for the housing bubble to be inflated to ever more dangerous levels was the conduct of the credit rating agencies. They gave every subprime mortgage backed security (MBS) in sight top investment grade ratings. This made it easy for Citigroup, Goldman Sachs and the rest to sell their junk bonds all over the world.

There was a simple reason the credit rating agencies rated subprime MBS as AAA: money. The banks issuing the MBS pay the rating agency. If the big three rating agencies (Moody's, Standard and Poor's, and Fitch) wanted more business, they knew they had to give favorable ratings. The banks weren't paying for an honest assessment, they were paying for an investment grade rating.

There is a simple way around this conflict of interest. Have a neutral party select the rating agency. The issuer would still pay for the review, but would have no voice in selecting who got the job.

Senator Al Franken proposed an amendment to Dodd-Frank that would have gone exactly this route. (I worked with his staff on the amendment.) The amendment would have had the Securities and Exchange Commission pick the rating agency. This common sense proposal passed the Senate overwhelmingly with bi-partisan support.

Naturally something this simple and easy couldn't be allowed to pass into law. The amendment was taken out in conference committee and replaced with a requirement for the SEC to study the issue. After being inundated with comments from the industry, the SEC said Franken's proposal would not work because it wouldn't be able to do a good job assigning rating agencies. They might assign a rating agency that wasn't competent to rate an issue. (Think about that one for a moment. What would it mean about the structure of an MBS if professional analysts at Moody's or one of the other agencies didn't understand it?)

Anyhow, as is generally the case in Washington, the industry got its way so the cesspool was left in place. Timothy Geithner apparently is proud of the role he played in protecting the rating agencies since he touted this issue in his autobiography. Geithner is of course making lots of money now as a top figure at the private equity company Warburg Pincus, so everybody is happy.

This is all relevant now because it seems that the rating agencies are back to their old tricks, or so Matt O'Brien tells us in Wonkblog. There has been a flood of new bonds backed by subprime car loans. Apparently Fitch is getting almost none of this rating business because it refuses to rate garbage as AAA.

O'Brien does a good job in calling attention to what is going on in this market, but it would be good to remind everyone of why it is still going on. We do know how to fix the problem. It's just that Timothy Geithner and his friends don't want the problem fixed.

 

 
Trade Deals Do the International Equivalent of Banning State Tax Incentives Print
Tuesday, 16 September 2014 04:58

Emily Badger in Wonkblog had an interesting discussion of the issues around state tax incentives to lure or keep businesses. The piece notes that many economists believe that it would be good to ban these incentives since it ends up being a zero sum game. It then includes many comments implying that any bans would be difficult to enforce.

While it is certainly true that enforcement would be difficult, it is worth noting that parallel issues arise in international trade all the time. A major goal of many trade deals is to prevent countries from subsidizing their own industries to give them an advantage in international competition. There are often major disputes over what constitutes a subsidy. For example, Boeing and Airbus frequently end up in suits before the WTO over allegations of unfair subsidies. Nonetheless, few people dispute the desirability of trade agreements attempt to restrict subsidies.

The situation at the state level is comparable. There will always be grey areas as states try to push the limits of acceptable subsidies, but that doesn't mean it is not desirable to outlaw the general practice. Just as with international trade, such an agreement can be expected to substantially reduce the amount of money committed to firm specific subsidies.

 
NYT Does Mind Reading on Rhode Island Gubernatorial Candidate Print
Monday, 15 September 2014 04:09

The NYT engaged in some mind reading on Gina Raimondo, the Democratic nominee for governor of Rhode Island. In reference to Raimondo it told readers:

"Growing up in a Democratic household, she believed in activist government. (Her father had gone to college on the G.I. Bill.) She also thought pension benefits needed to be curbed to save other government services, not to mention the pension system itself."

It's great that the NYT is able to tell us what Raimondo actually believes about activist government and cutting pension benefits. Most newspapers would just have to report what Raimondo said about her views.

As long as the NYT was doing mind reading it might have been helpful if it told readers whether Raimondo thinks that Rhode Island can break contracts with anyone or whether she only thinks the state has the right to break contracts with its workers. It could also have told readers whether she believes the state has the obligation to respect the law in other areas.

For example, if she wants to provide government services but doesn't want to raise the taxes to pay for them, does she think the state should just seize property to cover the cost, and if so, whose property?

Instead of spending so much effort on mind reading, it might have been more useful to readers if the paper had spent more time examining the specifics of Raimondo's pension proposal. In addition to taking back part of the money the state had committed to pay workers, Raimondo's pension plan also will mean giving hundreds of millions of dollars in fees to Wall Street hedge funds. These fees could easily reduce the pension fund's return by more than a full percentage point.

 

 
Ensuring that Airbnb Renters Comply With the Law: It's Simple! Print
Sunday, 14 September 2014 07:09

The Washington Post's Wonkblog had an interesting piece on efforts by San Francisco and other cities to set up rules for short-term rental services like Airbnb. At one point it tells readers:

"critics of any new regulation will likely argue that it imposes onerous bureaucracy on would-be hosts, while setting up a complex system that the city can't maintain."

Actually, it should be fairly easy to enforce regulations by simply holding Airbnb responsible for people who rent through its service. This would leave the enforcement problem with Airbnb. If Airbnb lacks the competence to ensure that its rental units comply with the law, then it will replaced by a more competent business. That is the way markets are supposed to work.

 
It Really Wasn't Hard to See the Dangers Posed by the Housing Bubble Print
Saturday, 13 September 2014 04:36

At its peak in 2006, the housing bubble had caused nationwide house prices to rise more than 70 percent above their trend level. This run-up occurred in spite of the fact that rents had not outpaced inflation and there was a record nationwide vacancy rate.

The dangers of the bubble also should have been clear. Residential construction peaked at almost 6.5 percent of GDP compared to long period average of close to 4.0 percent. The housing wealth effect had led to a consumption boom that pushed the saving rate to near zero.

Also, the flood of dubious loans was hardly a secret. The National Association of Realtors reported that nearly half of first-time homebuyers had put down zero or less on their homes in 2005. The spread of NINJA (no income, no job, and no assets) loans was a common joke in the industry.

These points are worth noting in reference to an article discussing the Fed's efforts to increase its ability to detect dangerous asset bubbles. An asset that actually poses a major threat to the economy is not hard to find. It kind of stands out, sort of like an invasion by a foreign army. The failure of the Fed to recognize the housing bubble and the dangers it posed was due to an extraordinary level of incompetence, not the inherent difficulty of the mission.

 
Manufacturing Employment Is Down Everywhere, Not Just Michigan Print
Saturday, 13 September 2014 04:23

A NYT article reporting on the economic and political situation in Michigan noted that in spite of the improvement in its economy since the recession, manufacturing employment is still far below prior peaks. It told readers:

"Manufacturing has come back, with payrolls rising to 567,900 this June from 440,600 in June 2009, bringing manufacturing payrolls back to July 2008 levels, but short of the peak of 906,900 in September 1999."

Actually Michigan's experience is not very different from the situation for the country as a whole. Manufacturing employment hit 17,640,000 in 1998. In the most recent data it was at 12,160,000 a drop of 31.2 percent. The 37.4 percent drop in Michigan is obviously larger, but not qualitatively different. The drop did matter more for Michigan because manufacturing was a larger share of employment in Michigan than in the nation as a whole.

 
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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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