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The Seventies Were Not Like the Great Recession Print
Wednesday, 21 May 2014 20:54

I'm back (thanks for all the kind comments) and I see I have to correct some seriously misleading commentary from Robert Samuelson earlier in the week. Samuelson concluded a discussion of Timothy Geithner's new book:

"This is the central lesson of the crisis. Success at stabilizing and stimulating the economy in the short run can destabilize it in the long run. This also happened in the 1960s, when the belief that economists could control the business cycle led to inflation and instability in the 1970s and early 1980s. But the lesson is not acknowledged because its implications are unpopular (an obsession with short-term stability may backfire), and it’s ignored — or even denied — by the post-crisis narratives, including Geithner’s."

Sorry, this one is not quite right. The pain suffered by people in the 1970s is not in the same ballpark as with the Great Recession. In the 1970s the stock market tanked, but since most people own little or no stock, who gives a damn? The economy generated 19.7 million jobs in the decade, an increase of 27.6 percent. By contrast in the 14 years from January of 2000 to January of 2014 the economy created just 6.5 million jobs, an increase of just 5.0 percent.

Most of this difference is explained by demographics (the baby boomers were entering the labor force in the 1970s, they are starting to leave now), but it was still an impressive feat to accommodate such a large expansion of the labor force in a relatively short period of time. In addition, the economy was hit by two large oil shocks that made the process considerably more difficult.

There was no prolonged period in which the economy was below its potential level of output in the 1970s. In fact, the Congressional Budget Office (CBO) puts the economy as operating above potential output for part of the decade. By contrast, CBO calculates that the economy has been roughly 6 percent below potential GDP for most of the last 5 years (@ $1 trillion a year). This represents a massive amount of lost output.

And, in direct contradiction of Samuelson's assertion, the failure to deal with the short-term can lead to serious long-term consequences. A recent paper by the Fed calculates that that potential GDP has fallen sharply as a result of the prolonged downturn. This implies that the failure to carry through short-term stabilization can lead to serious long-term consequences.

In short, Samuelson's central lesson lacks any evidence or logic to support it.

Vacation Time Print
Friday, 09 May 2014 19:09

I am out of here. I'll be back on Thursday, May 22. Remember, until then don't believe anything you read in the newspaper.

More Nonsense on Deflation Print
Friday, 09 May 2014 07:07

In a mostly useful article on the problems facing the euro zone economy, Neil Irwin again raises the prospect that a shock could turn the inflation rate negative.

"The lowflation, as people have taken to calling it, is particularly dangerous in that it could easily turn into outright deflation, or falling prices, should one nasty shock come along. For example, if tension between Ukraine and Russia boils over into a full-scale war, it could easily tip the European economy back into recession and send prices tumbling."

It's not clear what he is talking about here. If a war between Russia and Ukraine threw the European economy into a recession it would be just as bad news for the countries of the region if the inflation rate were now 2.0 percent instead of 0.5 percent. The problem would be a new recession in an area that is already suffering from very high unemployment. The decline in the inflation rate from a low positive to a low negative is a non-issue.

The inflation rate is already lower than would be desired, any further fall makes matters worse, but crossing zero means nothing except for numerologists. Accelerating deflation could be a problem, but we have seen exactly zero instances of this phenomenon in the last 70 years in wealthy countries.

It is worth noting that many economists if they are honest in their beliefs (I know, absurd proposition) must already think that the euro zone inflation rate is negative. The Boskin Commission, which was warmly received by the leading lights in the economics profession, claimed that the consumer price index in the United States overstated inflation by 1.1 percentage points annually. Most of the problems they identified are still present and likely to be worse with European price measurements than in the United States.

Privatizing Fannie and Freddie Shifts Profits to Wall Street, not Risk From the Government Print
Friday, 09 May 2014 06:55

A front page Washington Post article fundamentally misrepresented the main impact of the Johnson-Crapo bill that would privatize Fannie Mae and Freddie Mac. The article told readers that the bill:

"would dismantle the companies in a bid to shift the risks of mortgage lending from the taxpayers to the private sector."

Actually, the government would still be on the hook for 90 percent of the value of privately issued mortgage backed securities (MBS). As a result of the perverse incentives created by the system envisioned under the bill, this would likely mean more risk to the taxpayers rather than less. Private investment banks would stand to profit from securitizing bad mortgages. Unlike the years of the housing bubble, when investors stood to lose 100 percent of what they paid for a MBS, investment banks could tell their customers that in a worst case scenario they would only lose 10 percent of their investment with the government picking up the rest of the tab.

For this reason it is hard to see Johnson-Crapo as a "bid to shift the risks of mortgage lending" to the private sector. The most obvious way to accomplish such a shift would be to simply get the government out of the business.

The most obvious effect of Johnson-Crapo is to shift the profits that Fannie and Freddie are now earning to the financial industry. Presumably the bill's proponents recognize this fact.

People Are Getting Insurance: A Factor the Post's Polling Experts Never Considered In Their Assessment of Attitudes Towards Obamacare Print
Thursday, 08 May 2014 05:29

There are 8 million people who are getting health insurance through the exchanges now. This number will continue to grow throughout the year as people experience "life events" that allow them to sign up for the exchanges after the end of the open enrollment period. (Life events include losing insurance due to job loss, a death in the family, and divorce. Job loss is the most common item in this group with close to 4 million workers changing jobs every month.)

The fact that the exchanges are now up and running means that millions of people will have direct knowledge of Obamacare rather than just hearing the media and politicians talk about it. While this direct knowledge is likely to influence their view of the program, this possibility is never taken into consideration in the discussion of public attitudes toward Obamacare in the Post's "The Fix" column.

It is likely that many people would be opposed to the idea of a government-run insurance program that pays for most of the health care costs of people over age 65. However, Medicare is a hugely popular program even among Tea Party conservatives. People's direct experience with Obamacare will likely have more impact on their attitudes toward the program than what they are being told about the program by the media.

Is the Fed Committed to Keeping Inflation Below 2.0 Percent? Print
Thursday, 08 May 2014 05:00

In its coverage of Fed Chair Janet Yellen's testimony before the Joint Economic Committee, the NYT told readers:

"Ms. Yellen, in a similar exchange with Representative Richard Hanna, a New York Republican, strongly defended the Fed’s commitment to control inflation. She said the high inflation of the 1970s had been a formative experience for the entirety of the Fed’s leadership, and they were determined to keep inflation below the 2 percent annual pace the Fed has described as its target."

This statement implies that the Yellen is treating 2.0 inflation as a ceiling rather than an average. If so, this would be a marked departure from past statements of Fed policy and imply a considerably more hawkish stance of the Fed toward inflation. With inflation running below 2.0 percent for the last five years the Fed could allow the inflation rate to rise above 2.0 percent for a period of time and still maintain a 2.0 percent average.

If the Fed now views 2.0 percent inflation as a ceiling, it means that it would have to act earlier and more strongly to slow economic growth and prevent the unemployment rate from falling. The implication would be that many more workers would remain unemployed or underemployed and that tens of millions would have less bargaining power to boost their wages. This Fed policy would be helping to foster the upward redistribution of income we have been seeing over the last three decades.

Thomas Friedman's Big Deal on Fracking and Global Warming Print
Wednesday, 07 May 2014 04:53

Thomas Friedman wants to "go big, get crazy" when it comes to energy policy in order to both deal with Vladimir Putin and global warming. The idea is that if the United States can drastically reduce its demand for foreign oil it would put downward pressure on world prices and thereby hurt Russia's economy. His way of reducing demand for foreign oil is a combination of promoting clean energy and allowing increased oil drilling and fracking, "but only at the highest environmental standards." He also would allow the XL pipeline, but a quid pro quo would be a revenue neutral carbon tax.

There are a few problems in Friedman's story. First, it's hard to see why the frackers would take it. The main limit on fracking at the moment is not regulation but low gas prices. In real terms, natural gas prices are less than half of their pre-recession levels and less than a third of their 2008 peaks. In states like Pennsylvania, where they have a drill everywhere policy, production is dropping because new sites are not profitable.

If we put new regulations on fracking, for example making the industry subject to the Safe Drinking Water Act and thereby forcing it to disclose the chemicals it uses, that would likely mean less fracking rather than more. That means both that the industry is not likely to buy it and that his policy would go the wrong way in terms of increasing U.S. production.

The same applies to his proposal for a carbon tax coupled with approving the XL pipeline. The tar sands oil that would go through the pipeline would be especially hard hit by a carbon tax. That would likely make it unprofitable, a point that Friedman himself notes. For this reason the industry is unlikely to see the XL pipeline as much of quid pro quo for a carbon tax. In short, it doesn't seem like he has much of the basis for a deal here.

His description of the Europeans, and in particular the Germans, is also inconsistent with his description of his "big" and "crazy" plan. Friedman tells readers:

"Europe’s response has been more hand-wringing about Putin than neck-wringing of Putin. They talk softly and carry a big baguette."

Actually Europe and in particular Germany have done a great deal to reduce their use of fossil fuels over the last two decades. Germany's energy intensity of production (energy use per dollar of GDP) has fallen by 30 percent over the last two decades to a level about half of the U.S. level. Almost a quarter of its energy comes from clean sources and this share is increasing by 2 percentage points a year. 

In short, Europe has been doing a great deal to reduce its demand for fossil fuels. It certainly could do more, but if the United States had been following the European path over the last two decades, the price of fossil fuels would certainly be much lower than it is today. Of course, a big part of the story is that Europeans are more likely to carry a big baguette than to drive a big SUV.



A friend reminded me of one of Thomas Friedman's great energy plans from the past, this time with China as a partner. The piece is here and my comment here.

Back in the Old Days, Rich Countries Were Supposed to Run Trade Surpluses Print
Wednesday, 07 May 2014 04:10

Paul Krugman outlines his story of secular stagnation in a blog post this morning. The odd part of the story is that the trade deficit is nowhere in sight. The punchline is that a slower rate of labor force growth should lead to a reduction in demand. The simple arithmetic is that if the rate of labor force growth slows by 1.0 percentage point, then this would be expected to reduce investment by 3.0 percentage points of GDP.

This is a story of a demand gap that could be hard to fill, but how does that compare to a trade deficit that peaked at just shy of 6.0 percent of GDP in 2005 and is still close to 3.0 percent of GDP today? Why are we not supposed to be worried about this cause of a shortfall in demand?

Back in the days before the United States began running persistent trade deficits, the standard theory held that rich countries like the United States should be running trade surpluses. The argument was that capital was plentiful in rich countries, therefore they should be exporting it to poor countries where capital is scarce. This would lead to both a better return on capital and also allow developing countries to grow more rapidly.

We have seen the opposite story in the United States, especially after the run-up in the dollar following the East Asian financial crisis. This has contributed in a big way to the "secular stagnation" problem, but for some reason there continues to be a reluctance to talk about it. (No, being the reserve currency does not mean we have to run a trade deficit.)

Do Republican Politicians Really "Fear" Efforts to Slow Global Warming Will Cost the Jobs of Miners and Hurt the Economy? Print
Tuesday, 06 May 2014 13:45

In an article on the release of a report that documents the impact to date of climate change on the United States, the NYT told readers:

"Other Republicans concede that climate change caused by human activity is real, but nonetheless fear — as do some Democrats — that the president’s policies will destroy jobs for miners and hurt the broader economy."

While politicians obviously say they are concerned about job loss for miners and damage to the economy, does the NYT know that they really "fear" this prospect? Few Republicans or Democrats expressed concern about surface top mining that both causes damage to the environment and displaced tens of thousands of underground miners. If they feared the destruction of jobs for miners it would have been reasonable to insist that environmental restrictions be tightly enforced in order to limit this practice. The fact that they didn't suggests that concern about jobs for miners is not a high priority for these Republicans.

Similarly, global warming is causing large amounts of economic damage as illustrated in this report. Weather events that are at least partially attributable to global warming have already caused tens of billions of dollars of damage to homes and businesses. Anyone who was concerned about the damage to the economy caused by efforts to slow global warming would presumably also be concerned about the damage to the economy from global warming.

It seems unlikely that the politicians the NYT claims are fearful about the economy have carefully weighed the two effects. It is worth noting that in the context of an economy that is operating well below its full employment level of output, as is the case for the United States economy, spending money to reduce greenhouse gas emissions would be almost costless. We would be putting people to work who would not otherwise be employed.

The reality is the NYT has no clue as to whether the politicians to whom it refers are actually concerned about coal miners' jobs and the economy. They only that they say they are concerned. If they wanted to stop measures that would reduce the profits of the oil and gas industries, it is likely that they would express concerns over jobs and the economy whether or not they had them. It sounds much better for a politician to say that he is concerned about a coal miner's job than Exxon-Mobil's profit.

Rather than telling readers what politicians' actually think, the NYT should focus on telling readers what they do and what they say.

Robert Shiller's Data Say the Last Two Times Have Been Different Print
Tuesday, 06 May 2014 07:29

David Leonhardt presents a somewhat confused warning about stock valuations in his Upshot piece today. Looking at the recent run-up in stock prices the piece tells readers that it's "time to worry about stock bubbles." Actually, it's not. The stock market is high relative to its long-term trend, but there is little basis for fearing a plunge in prices as the piece suggests.

Leonhardt's basic story is that price to earnings ratios are substantially above their long-term average. He uses Robert Shiller's measure the ratio of stock prices to earnings (PE) lagged ten years. He notes that this ratio now stands at 25, which is well above its long term average. Leonhardt then tells readers:

"The average inflation-adjusted return since 1871 (the first year for which Mr. Shiller has data) in the five years after the ratio equals 25 or higher is negative 12 percent."

Leonhardt then warns against any assumptions that things might have changed and that this time is different. In other words, folks should expect some serious negative returns in the years ahead.

Of course folks who look at the data, including Shillers' data (available here), would know better. In the last two decades the stock market has twice hit the 25 PE ratio according to Shiller. The first time was in 1997, when Shiller puts the year-end ratio at 27.5. The average real return over the subsequent five years was -0.7 percent. That's not great, but not exactly a disaster either. Furthermore, the story would look considerably different if we started from the point where the ratio just crossed 25. Shiller puts the 10-year PE at 24.3 at the end of 1996. The average real rate of return for the subsequent five years from that point forward were 8.9 percent. Not much grounds for shedding tears.

The next time the PE crossed the 25 threshold was in 2004 when it hit 27.0. Shiller's data show the real rate of return in the subsequent five years was 1.1 percent. That's not fantastic, but it's probably better than you would have gotten in a money market fund and certainly a hell of a lot better than the negative 12 percent of which Leonhardt warns.

In other words, the last two times the market has crossed this magic 25 PE, investors would have been wrong if they expected a prolonged period of negative real returns. And, since these are the only two times it has crossed this threshold in the last 80 years, we might feel some comfort in using this experience as a basis for expectations of the future.

In fact, projecting stock returns really should not be a great mystery. If we assume that stock prices will on average grow at the same rate as the economy (i.e. we don't see permanently rising or falling PEs or profit shares), then the rate of return will be the rate of growth of the economy plus the portion of profit paid out to shareholders either as dividends or share buybacks. The latter has been in the range of 60- 70 percent in recent decades.

This means that if the ratio of stock prices to current year's earning is around 20 and the rate of growth is between 2.0-2.5 then we should expect real returns averaging between 5-6 percent going forward. (At the low end, we get payouts of 3.0 percent and 2.0 percent real growth. At the high end we get payouts of 3.5 percent and 2.5 percent real growth.) Note, this is a long-term average, not a prediction for next year.

This may take some of the mysticism out of stock returns, but hey, that is the way it is. Unfortunately this is far too simple for economists to understand. You can see a more elegant version of this here.

For those unfamiliar with my writings, I am not a crazy stock market enthusiast. I warned of both the stock bubble and the housing bubble.

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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.