I thought it was worth highlighting the drop in the profit share of corporate income reported for the first quarter of 2021. It did rise slightly from the 2020 average, but it is below the 2019 level. This means that, in spite of the high unemployment in 2020, the wage share actually rose slightly. (The graph is showing annual data, except for the first quarter of 2021.)
Source: Bureau of Economic Analysis and author’s calculations.
If we can maintain a tight labor market going forward, the wage share is likely to continue to rise, making up the ground lost in the Great Recession.
I thought it was worth highlighting the drop in the profit share of corporate income reported for the first quarter of 2021. It did rise slightly from the 2020 average, but it is below the 2019 level. This means that, in spite of the high unemployment in 2020, the wage share actually rose slightly. (The graph is showing annual data, except for the first quarter of 2021.)
Source: Bureau of Economic Analysis and author’s calculations.
If we can maintain a tight labor market going forward, the wage share is likely to continue to rise, making up the ground lost in the Great Recession.
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Both the Post and NYT had pieces today on how China is encouraging families to have more babies in order to counter an alleged demographic crisis. The basic story, which has been repeated many times in the U.S., is that China will be seeing a decline in the ratio of workers to retirees since families have had relatively few children over the last four decades. This is supposed to be really bad news, in fact, a crisis.
In response, China’s government is apparently taking steps to encourage families to have more children. This follows several decades in which it had the opposite policy in place, encouraging families to have just one child.
The crisis story is a bit hard to understand for those of us familiar with arithmetic. Every wealthy country has seen a sharp reduction in the ratio of working-age people to retirees. That is something that happens when better living standards and improved health care allow people to live longer. Also, when countries have gotten wealthier, people have chosen to have fewer children.
This rise in the ratio of retirees to the working-age population has not prevented both working-age people and retirees from enjoying higher living standards. This isn’t magic, productivity rises through time as technology improves and workers become better educated. This means that each worker can produce more output in the hours they work.
The graph below projects the number of effective working-age people per retiree under various productivity assumptions. The first bar shows the 2020 ratio in China of 3.74 working-age people to retiree (people over age 60 for this calculation). This ratio is projected to fall to 1.68 by 2045.
Source: Statistica and author’s calculations.
That only looks bad until we factor in productivity growth over the next 25 years. In an extremely pessimistic case, where productivity growth averages just 1.0 percent annually (the lowest sustained rate the U.S. has ever experienced), the ratio of 2020 equivalent workers per retiree would be 2.15. This would mean that the average worker would have to see a decline in their income relative to retiree’s income (i.e. a tax increase), to ensure that retirees have the same income in 2045 as in 2020. This doesn’t imply a decline in workers’ wages, as will be shown shortly.
The next bar assumes a 2.0 percent annual rate of productivity growth over the next 25 years. That is roughly the average in the United States over the post-World War II era. In this case, the decline in the ratio of 2020 equivalent workers is more modest, dropping to 2.76.
China has actually been seeing very rapid productivity growth over the last four decades. Its productivity growth averaged more than 6.0 percent annually between 2009 and 2019. The next two bars show the ratio of 2020 equivalent workers to retirees assuming alternatively 4.0 percent annual productivity growth over the next quarter-century and 6.0 percent annual productivity growth over this period.
In the former case, the ratio of 2020 equivalent workers to retirees would be 4.48. In the latter case, it would be 7.21. This means that if the goal is to ensure that retirees enjoy the same living standard in 2045 as they did in 2020, this can be easily done without any increase in taxes on the working population. In fact, if the goal is to just maintain retirees’ 2020 living standards, tax on workers can be reduced in these high productivity growth scenarios.
Output Per Person
If we’re looking at how demographics affect living standards, another way to evaluate the picture is to look at output per person. This calculation picks up directly the impact of a smaller segment of the population working. The graph below shows the story, with the same set of productivity assumptions in the earlier figure.
Source: Statistica and author’s calculations.
As can be seen, even in the very low productivity growth scenario, output per person would be slightly higher in 2045 than in 2020. That means that it should be possible to structure distribution so that everyone can see an improvement in living standards over this period, albeit a very small one.
If China’s productivity growth over the next quarter-century matches the U.S. post-World War II average, then incomes will be more than 30 percent higher in 2045 than they were in 2020. That would allow for substantial improvements in living standards for both workers and retirees.
In the 4.0 percent productivity growth scenario per-person income will be more than twice as high in 2045 as in 2020. And if China can sustain the 6.0 percent productivity growth of the last decade, per person income will be 3.4 times as high in 2045 as in 2020.
In short, even modest rates of productivity growth will easily offset the impact of a declining ratio of workers to retirees that China is expecting over the next quarter-century. If the country can sustain productivity growth rates anywhere near what it has been seeing, the impact of the drop in the ratio of workers to retirees will be trivial in comparison.
Four Factors that Make the Demographic Problem Less Serious
There are four major reasons why changing demographics pose even less of a problem than indicated in the discussion above. The first has to do with more accurately calculating the ratio of workers to retirees. I was deliberately sloppy about what we were measuring in using working-age people to retirees (people over age 60). Many people, generally women, between the ages of 20 and 60 are not in the paid labor force. If the share of women in the paid labor force increases over the next quarter-century, then the drop in the ratio of workers to retirees will be smaller than indicated in the calculations above.
There is a similar story on the over 60 part of the calculation. As the country gets richer and the workforce is better educated and healthier, a larger share of the population over age 60 is likely to continue working. This is both because jobs will be less physically demanding on average and also because better-educated people are more likely to have jobs they find inherently rewarding. In the United States in 2019, before the pandemic, 56.0 percent of the people between the ages of 60 and 64 were employed. Of people between the ages of 65 and 69, 33. 3 percent were employed on average. Insofar as a substantial segment of this older group is employed, it both raises the number of workers and reduces the number of retirees who need to be supported by the work of others.
The third issue is the pollution and crowding that would result from efforts to increase the population. These negatives are not picked up in measures of GDP, and there is good reason to believe they are substantial. China has done much to clean up its air and water in the last two decades, but many areas still have severe problems. Other things equal, more people consuming more energy and material items, means greater problems with pollution. This can be offset with increased efforts at containing pollution, but these efforts carry a substantial cost.
The problem of more people goes well beyond what we just think of as pollution. More people means more traffic congestion. People will have to live further from work, which means longer distance commutes. Public infrastructure will see more wear and tear and everything from parks and museums to beaches and sporting events will be more crowded. These costs are picked up at best imperfectly in GDP measures, and in many cases, not at all. This means that if China’s solution to its declining ratio of workers to retirees is to have more children, it may be making matters worse for its population a quarter-century into the future.
This brings up the final point, which everyone should have guessed by now. Children are also dependents. If our plan for reducing the ratio of workers to retirees is to have more children, that provides zero help at all for the next two decades, and only modest help in the following decade or so.
Meanwhile, the ratio of dependent children to workers will have risen substantially. It will take a very very long time for an increase in fertility rates to lead to a fall in overall dependency ratios.[1] In the case of the United States, the total dependency ratio (both young people and older people relative to the working-age population) was 0.681 in 1945, at end of World War II. Then we had the baby boom, which led to a sharp increase in the ratio of young dependents to working-age people.
We did not see the ratio of total dependents to working-age population fall back below its 1945 until after 2000, more than 55 years later. We know that China’s leaders are often praised for having a longer-term view, but in this case, we are not talking about planning for 2045, but rather 2075.
The long and short is that China does not face a demographic crisis, contrary to what you read in the paper, and encouraging people to have more children is not a good solution.
[1] We can argue about the resource needs of children relative to retirees. For purposes of this discussion, let’s just say they are close.
Both the Post and NYT had pieces today on how China is encouraging families to have more babies in order to counter an alleged demographic crisis. The basic story, which has been repeated many times in the U.S., is that China will be seeing a decline in the ratio of workers to retirees since families have had relatively few children over the last four decades. This is supposed to be really bad news, in fact, a crisis.
In response, China’s government is apparently taking steps to encourage families to have more children. This follows several decades in which it had the opposite policy in place, encouraging families to have just one child.
The crisis story is a bit hard to understand for those of us familiar with arithmetic. Every wealthy country has seen a sharp reduction in the ratio of working-age people to retirees. That is something that happens when better living standards and improved health care allow people to live longer. Also, when countries have gotten wealthier, people have chosen to have fewer children.
This rise in the ratio of retirees to the working-age population has not prevented both working-age people and retirees from enjoying higher living standards. This isn’t magic, productivity rises through time as technology improves and workers become better educated. This means that each worker can produce more output in the hours they work.
The graph below projects the number of effective working-age people per retiree under various productivity assumptions. The first bar shows the 2020 ratio in China of 3.74 working-age people to retiree (people over age 60 for this calculation). This ratio is projected to fall to 1.68 by 2045.
Source: Statistica and author’s calculations.
That only looks bad until we factor in productivity growth over the next 25 years. In an extremely pessimistic case, where productivity growth averages just 1.0 percent annually (the lowest sustained rate the U.S. has ever experienced), the ratio of 2020 equivalent workers per retiree would be 2.15. This would mean that the average worker would have to see a decline in their income relative to retiree’s income (i.e. a tax increase), to ensure that retirees have the same income in 2045 as in 2020. This doesn’t imply a decline in workers’ wages, as will be shown shortly.
The next bar assumes a 2.0 percent annual rate of productivity growth over the next 25 years. That is roughly the average in the United States over the post-World War II era. In this case, the decline in the ratio of 2020 equivalent workers is more modest, dropping to 2.76.
China has actually been seeing very rapid productivity growth over the last four decades. Its productivity growth averaged more than 6.0 percent annually between 2009 and 2019. The next two bars show the ratio of 2020 equivalent workers to retirees assuming alternatively 4.0 percent annual productivity growth over the next quarter-century and 6.0 percent annual productivity growth over this period.
In the former case, the ratio of 2020 equivalent workers to retirees would be 4.48. In the latter case, it would be 7.21. This means that if the goal is to ensure that retirees enjoy the same living standard in 2045 as they did in 2020, this can be easily done without any increase in taxes on the working population. In fact, if the goal is to just maintain retirees’ 2020 living standards, tax on workers can be reduced in these high productivity growth scenarios.
Output Per Person
If we’re looking at how demographics affect living standards, another way to evaluate the picture is to look at output per person. This calculation picks up directly the impact of a smaller segment of the population working. The graph below shows the story, with the same set of productivity assumptions in the earlier figure.
Source: Statistica and author’s calculations.
As can be seen, even in the very low productivity growth scenario, output per person would be slightly higher in 2045 than in 2020. That means that it should be possible to structure distribution so that everyone can see an improvement in living standards over this period, albeit a very small one.
If China’s productivity growth over the next quarter-century matches the U.S. post-World War II average, then incomes will be more than 30 percent higher in 2045 than they were in 2020. That would allow for substantial improvements in living standards for both workers and retirees.
In the 4.0 percent productivity growth scenario per-person income will be more than twice as high in 2045 as in 2020. And if China can sustain the 6.0 percent productivity growth of the last decade, per person income will be 3.4 times as high in 2045 as in 2020.
In short, even modest rates of productivity growth will easily offset the impact of a declining ratio of workers to retirees that China is expecting over the next quarter-century. If the country can sustain productivity growth rates anywhere near what it has been seeing, the impact of the drop in the ratio of workers to retirees will be trivial in comparison.
Four Factors that Make the Demographic Problem Less Serious
There are four major reasons why changing demographics pose even less of a problem than indicated in the discussion above. The first has to do with more accurately calculating the ratio of workers to retirees. I was deliberately sloppy about what we were measuring in using working-age people to retirees (people over age 60). Many people, generally women, between the ages of 20 and 60 are not in the paid labor force. If the share of women in the paid labor force increases over the next quarter-century, then the drop in the ratio of workers to retirees will be smaller than indicated in the calculations above.
There is a similar story on the over 60 part of the calculation. As the country gets richer and the workforce is better educated and healthier, a larger share of the population over age 60 is likely to continue working. This is both because jobs will be less physically demanding on average and also because better-educated people are more likely to have jobs they find inherently rewarding. In the United States in 2019, before the pandemic, 56.0 percent of the people between the ages of 60 and 64 were employed. Of people between the ages of 65 and 69, 33. 3 percent were employed on average. Insofar as a substantial segment of this older group is employed, it both raises the number of workers and reduces the number of retirees who need to be supported by the work of others.
The third issue is the pollution and crowding that would result from efforts to increase the population. These negatives are not picked up in measures of GDP, and there is good reason to believe they are substantial. China has done much to clean up its air and water in the last two decades, but many areas still have severe problems. Other things equal, more people consuming more energy and material items, means greater problems with pollution. This can be offset with increased efforts at containing pollution, but these efforts carry a substantial cost.
The problem of more people goes well beyond what we just think of as pollution. More people means more traffic congestion. People will have to live further from work, which means longer distance commutes. Public infrastructure will see more wear and tear and everything from parks and museums to beaches and sporting events will be more crowded. These costs are picked up at best imperfectly in GDP measures, and in many cases, not at all. This means that if China’s solution to its declining ratio of workers to retirees is to have more children, it may be making matters worse for its population a quarter-century into the future.
This brings up the final point, which everyone should have guessed by now. Children are also dependents. If our plan for reducing the ratio of workers to retirees is to have more children, that provides zero help at all for the next two decades, and only modest help in the following decade or so.
Meanwhile, the ratio of dependent children to workers will have risen substantially. It will take a very very long time for an increase in fertility rates to lead to a fall in overall dependency ratios.[1] In the case of the United States, the total dependency ratio (both young people and older people relative to the working-age population) was 0.681 in 1945, at end of World War II. Then we had the baby boom, which led to a sharp increase in the ratio of young dependents to working-age people.
We did not see the ratio of total dependents to working-age population fall back below its 1945 until after 2000, more than 55 years later. We know that China’s leaders are often praised for having a longer-term view, but in this case, we are not talking about planning for 2045, but rather 2075.
The long and short is that China does not face a demographic crisis, contrary to what you read in the paper, and encouraging people to have more children is not a good solution.
[1] We can argue about the resource needs of children relative to retirees. For purposes of this discussion, let’s just say they are close.
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• Economic Crisis and RecoveryCrisis económica y recuperación
Most of the data on the economy is looking very good these days. The number of weekly unemployment claims has fallen sharply. Levels are still high, but just over half the level we were seeing earlier this year. And, this is before all the moves by Republican governors to cut back benefits, so the decline reflects the availability of jobs, not more stringent eligibility.
Consumer spending has been rising rapidly, with the March and April levels both above where they were before the pandemic. Even restaurant sales have largely recovered. Adjusted for inflation, the April levels were just 2.7 percent below where they were in February 2020.
The housing market continues to be very strong, especially in lower-priced areas. The increase in the Federal Housing Finance Administration’s house price index from the first quarter of 2020 to the first quarter of 2021 was 16.0 percent in Wichita, KS, 15.8 percent in Buffalo, NY, 15.6 percent in Dayton, OH, 14.6 percent in Nashville, TN, and 13.8 percent in Gary, IN. By contrast, prices are up just 9.7 percent in the New York metro area and 6.5 percent in San Francisco.
It is too early to know if this is the start of a trend, where people take advantage of increased opportunities for remote work to live in lower-cost areas, or whether it is a one-time blip. However, if the opportunities for increased remote work stay in place after the pandemic is over, it is likely that more people will move to low-cost areas. This will both benefit those areas by bringing in new consumers and taxpayers, and also the high-cost areas, by relieving pressure on house prices.
Residential construction has also been very strong, running at close to 25 percent above the pre-pandemic pace. Starts did slow some in April, which is likely in part due to a shortage of materials, most importantly lumber. This should be alleviated in the months ahead.
Investment also is strong. New orders for capital goods are running more than 10 percent above the pre-pandemic level. This is noteworthy because it doesn’t appear that the prospect of higher corporate income taxes is doing much to discourage new investment.
With the rapid growth we are now seeing across most sectors in the economy, many have raised concerns about inflation. We did see high inflation numbers in April. There are two main factors here. First, much of this is a bounce-back effect, where the price of many items that plunged during the recession is now rebounding back to more normal levels. This is true in areas like hotels, airfares, and car insurance.
The other factor is that there are shortages in many areas as the economy is again getting up to steam. This is the case with lumber, where many mills shut down, anticipating a longer recession. It will take some time to get them up and running again. It is also the case with cars, where a shortage of semiconductors, due to a fire at a plant in Japan, has hampered production. New car prices rose 0.5 percent in April, while used car prices rose an incredible 10.0 percent in the month, adding almost 0.3 percentage points to the CPI.
Both of these effects will be temporary. If we are to see sustained inflation then we really need a story where wage growth is substantially outpacing productivity growth. There is not the case at present. Wage growth has at best accelerated modestly, with the average hourly wage rising at an annual rate of 3.1 percent, comparing the last three months (February, March, April) with the prior three months (November, December, January).
This would not be the basis for real concerns with inflation, even if productivity had stayed on its pre-pandemic pace of just over 1.0 percent annually. However, productivity growth has accelerated sharply in the last year, rising 4.1 percent from the first quarter of 2020 to the first quarter of 2021. With GDP growth projected at close to 10 percent for the second quarter, we will almost certainly add another strong quarter of productivity growth.
It is not plausible that we will sustain productivity growth of 4.0 percent, but if the pace falls back to 2.0 percent, instead of its pre-pandemic 1.0 percent rate, it is hard to see inflation becoming a problem. A 2.0 percent rate of productivity growth is consistent with 4.0 percent wage growth and 2.0 percent inflation.
There has been some evidence that wages are increasing more rapidly in the lowest paying sectors, like hotels and restaurants. This is good news for these workers and it is not especially inflationary. The average weekly earnings at the cutoff for the bottom decile is less than $500. Suppose this rises by $50. This would come to $2,500 a year. With 15 million workers in the bottom decile, that comes to less than $40 billion annually, less than 0.2 percent of GDP.
That would not be the sort of thing that is likely to set off an inflationary spiral, and we are also not likely to see wages for the bottom decile rise by 10 percent in the immediate future.
What About the Debt?
With the release of President Biden’s new budget, there were a slew of news stories warning about the large deficit and projected debt. The usual story about high levels of debt is that they will cause bond markets to panic and interest rates to soar.
Back in the Clinton and Obama years, we were regularly regaled with stories about how the bond market vigilantes would send interest rates soaring if we didn’t rein in the deficit. And of course, they would reward us with low-interest rates if we were good boys and girls and got deficits down, usually by cutting spending.
It turns out that we didn’t have as much to fear from higher interest rates as advertised. Ever since the Great Recession, long-term interest rates have consistently run well below the projections from the Congressional Budget Office and most other forecasters. The interest rate on 10-year Treasury bonds was hovering near 2.7 percent just before the pandemic hit, in spite of the large tax cut induced deficits of the Trump years. That compares to rates that were typically well over 5.0 percent when we were running budget surpluses in the Clinton years.
Rates plunged after the pandemic hit and the Fed stepped in with its rescue package. Even now, with the large deficits resulting from the CARES Act and President Biden’s recovery package, the rate remains near 1.6 percent.
But the deficit hawks tell us this is all a temporary story. Soon the bond market vigilantes will get back on the job and send interest rates soaring. Perhaps this will happen at some point in the future, but there does not seem to be much evidence for it. The graph below shows the ratio of debt-to-GDP for most wealthy countries, compared with the interest rate on 10-year government bonds.
Source: International Monetary Fund and Financial Times.
As can be seen, there is essentially no relationship between the two. Many countries with much larger debt-to-GDP ratios have far lower interest rates on their long-term bond. Japan takes the prize here with a debt-to-GDP ratio of more than 170 percent and an interest rate on its long-term bonds of less than 0.1 percent. However, many other countries with far higher debt-to-GDP ratios than the United States, including France, Belgium, and Greece, have much lower interest rates on their government debt.
In short, it doesn’t seem like the deficit hawks have much of a case. To be clear, there is a real concern that the boost to the economy from the Biden recovery package may go too far and lead to problems with inflation. I have argued before that I think this risk is limited, and one well worth taking given the political obstacles Biden will face in getting future packages approved by Congress.
But this issue is very different from the concern that excessive debt will cause a flight from U.S. government bonds and send interest rates soaring. This one seems more like a scare story designed to fool children rather than serious economic analysis.
Most of the data on the economy is looking very good these days. The number of weekly unemployment claims has fallen sharply. Levels are still high, but just over half the level we were seeing earlier this year. And, this is before all the moves by Republican governors to cut back benefits, so the decline reflects the availability of jobs, not more stringent eligibility.
Consumer spending has been rising rapidly, with the March and April levels both above where they were before the pandemic. Even restaurant sales have largely recovered. Adjusted for inflation, the April levels were just 2.7 percent below where they were in February 2020.
The housing market continues to be very strong, especially in lower-priced areas. The increase in the Federal Housing Finance Administration’s house price index from the first quarter of 2020 to the first quarter of 2021 was 16.0 percent in Wichita, KS, 15.8 percent in Buffalo, NY, 15.6 percent in Dayton, OH, 14.6 percent in Nashville, TN, and 13.8 percent in Gary, IN. By contrast, prices are up just 9.7 percent in the New York metro area and 6.5 percent in San Francisco.
It is too early to know if this is the start of a trend, where people take advantage of increased opportunities for remote work to live in lower-cost areas, or whether it is a one-time blip. However, if the opportunities for increased remote work stay in place after the pandemic is over, it is likely that more people will move to low-cost areas. This will both benefit those areas by bringing in new consumers and taxpayers, and also the high-cost areas, by relieving pressure on house prices.
Residential construction has also been very strong, running at close to 25 percent above the pre-pandemic pace. Starts did slow some in April, which is likely in part due to a shortage of materials, most importantly lumber. This should be alleviated in the months ahead.
Investment also is strong. New orders for capital goods are running more than 10 percent above the pre-pandemic level. This is noteworthy because it doesn’t appear that the prospect of higher corporate income taxes is doing much to discourage new investment.
With the rapid growth we are now seeing across most sectors in the economy, many have raised concerns about inflation. We did see high inflation numbers in April. There are two main factors here. First, much of this is a bounce-back effect, where the price of many items that plunged during the recession is now rebounding back to more normal levels. This is true in areas like hotels, airfares, and car insurance.
The other factor is that there are shortages in many areas as the economy is again getting up to steam. This is the case with lumber, where many mills shut down, anticipating a longer recession. It will take some time to get them up and running again. It is also the case with cars, where a shortage of semiconductors, due to a fire at a plant in Japan, has hampered production. New car prices rose 0.5 percent in April, while used car prices rose an incredible 10.0 percent in the month, adding almost 0.3 percentage points to the CPI.
Both of these effects will be temporary. If we are to see sustained inflation then we really need a story where wage growth is substantially outpacing productivity growth. There is not the case at present. Wage growth has at best accelerated modestly, with the average hourly wage rising at an annual rate of 3.1 percent, comparing the last three months (February, March, April) with the prior three months (November, December, January).
This would not be the basis for real concerns with inflation, even if productivity had stayed on its pre-pandemic pace of just over 1.0 percent annually. However, productivity growth has accelerated sharply in the last year, rising 4.1 percent from the first quarter of 2020 to the first quarter of 2021. With GDP growth projected at close to 10 percent for the second quarter, we will almost certainly add another strong quarter of productivity growth.
It is not plausible that we will sustain productivity growth of 4.0 percent, but if the pace falls back to 2.0 percent, instead of its pre-pandemic 1.0 percent rate, it is hard to see inflation becoming a problem. A 2.0 percent rate of productivity growth is consistent with 4.0 percent wage growth and 2.0 percent inflation.
There has been some evidence that wages are increasing more rapidly in the lowest paying sectors, like hotels and restaurants. This is good news for these workers and it is not especially inflationary. The average weekly earnings at the cutoff for the bottom decile is less than $500. Suppose this rises by $50. This would come to $2,500 a year. With 15 million workers in the bottom decile, that comes to less than $40 billion annually, less than 0.2 percent of GDP.
That would not be the sort of thing that is likely to set off an inflationary spiral, and we are also not likely to see wages for the bottom decile rise by 10 percent in the immediate future.
What About the Debt?
With the release of President Biden’s new budget, there were a slew of news stories warning about the large deficit and projected debt. The usual story about high levels of debt is that they will cause bond markets to panic and interest rates to soar.
Back in the Clinton and Obama years, we were regularly regaled with stories about how the bond market vigilantes would send interest rates soaring if we didn’t rein in the deficit. And of course, they would reward us with low-interest rates if we were good boys and girls and got deficits down, usually by cutting spending.
It turns out that we didn’t have as much to fear from higher interest rates as advertised. Ever since the Great Recession, long-term interest rates have consistently run well below the projections from the Congressional Budget Office and most other forecasters. The interest rate on 10-year Treasury bonds was hovering near 2.7 percent just before the pandemic hit, in spite of the large tax cut induced deficits of the Trump years. That compares to rates that were typically well over 5.0 percent when we were running budget surpluses in the Clinton years.
Rates plunged after the pandemic hit and the Fed stepped in with its rescue package. Even now, with the large deficits resulting from the CARES Act and President Biden’s recovery package, the rate remains near 1.6 percent.
But the deficit hawks tell us this is all a temporary story. Soon the bond market vigilantes will get back on the job and send interest rates soaring. Perhaps this will happen at some point in the future, but there does not seem to be much evidence for it. The graph below shows the ratio of debt-to-GDP for most wealthy countries, compared with the interest rate on 10-year government bonds.
Source: International Monetary Fund and Financial Times.
As can be seen, there is essentially no relationship between the two. Many countries with much larger debt-to-GDP ratios have far lower interest rates on their long-term bond. Japan takes the prize here with a debt-to-GDP ratio of more than 170 percent and an interest rate on its long-term bonds of less than 0.1 percent. However, many other countries with far higher debt-to-GDP ratios than the United States, including France, Belgium, and Greece, have much lower interest rates on their government debt.
In short, it doesn’t seem like the deficit hawks have much of a case. To be clear, there is a real concern that the boost to the economy from the Biden recovery package may go too far and lead to problems with inflation. I have argued before that I think this risk is limited, and one well worth taking given the political obstacles Biden will face in getting future packages approved by Congress.
But this issue is very different from the concern that excessive debt will cause a flight from U.S. government bonds and send interest rates soaring. This one seems more like a scare story designed to fool children rather than serious economic analysis.
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• Economic Crisis and RecoveryCrisis económica y recuperación
Here’s a pro tip for reporters: employers’ complaints about getting workers are not always honest. This one may have been helpful for a piece about employers at summer beach locations who are having a hard time finding workers. The piece discusses the difficulty several employers face in finding workers. At one point it recounts the story of a restaurant owner:
“He attributed the lack of workers to unemployment benefits. A worker in New Jersey could receive up to $1,000 a week with the $300 federal bonus, according to state data.”
While some workers in New Jersey can get close to $1,000 a week, with the $300 federal supplement (the state has a maximum payment of $681 a week), this is not likely relevant for restaurant workers. The piece reports that the minimum wage in New Jersey for seasonal employees is $10.10 an hour or $404 for a forty-hour week. Most restaurant workers likely earn close to this minimum. Also, many do not work a forty-hour week. (The average for the country as a whole is 25 hours.)
If we use the $404 as a rough average, a worker could be getting $242 from their regular benefit, which would translate into $542 with the federal supplement. The benefit would somewhat higher if they had a higher wage history, but almost certainly nowhere near $1,000 a week for people considering restaurant work.
Here’s a pro tip for reporters: employers’ complaints about getting workers are not always honest. This one may have been helpful for a piece about employers at summer beach locations who are having a hard time finding workers. The piece discusses the difficulty several employers face in finding workers. At one point it recounts the story of a restaurant owner:
“He attributed the lack of workers to unemployment benefits. A worker in New Jersey could receive up to $1,000 a week with the $300 federal bonus, according to state data.”
While some workers in New Jersey can get close to $1,000 a week, with the $300 federal supplement (the state has a maximum payment of $681 a week), this is not likely relevant for restaurant workers. The piece reports that the minimum wage in New Jersey for seasonal employees is $10.10 an hour or $404 for a forty-hour week. Most restaurant workers likely earn close to this minimum. Also, many do not work a forty-hour week. (The average for the country as a whole is 25 hours.)
If we use the $404 as a rough average, a worker could be getting $242 from their regular benefit, which would translate into $542 with the federal supplement. The benefit would somewhat higher if they had a higher wage history, but almost certainly nowhere near $1,000 a week for people considering restaurant work.
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A New York Times article on efforts to create a cooperative for an Uber-like service reported without comment the claim by Uber that its drivers in the city have a median wage of $37.44 an hour. It is important to note that this is a gross figure. It does not subtract expenses like gas, insurance, and depreciation on the driver’s car.
If we assume that these expenses average 60 cents a mile (roughly the federal government figure) and that a driver covers 20 miles in an hour, they would average $12 an hour. That would make the net pay $25.44 an hour. (Uber does have the mileage data, but apparently did not choose to release it.) It is also not clear if Uber’s calculation is based on the time drivers actually spend driving with a passenger or the time where they have their app activated. If it is the former, then their true hourly pay would be considerably less.
A New York Times article on efforts to create a cooperative for an Uber-like service reported without comment the claim by Uber that its drivers in the city have a median wage of $37.44 an hour. It is important to note that this is a gross figure. It does not subtract expenses like gas, insurance, and depreciation on the driver’s car.
If we assume that these expenses average 60 cents a mile (roughly the federal government figure) and that a driver covers 20 miles in an hour, they would average $12 an hour. That would make the net pay $25.44 an hour. (Uber does have the mileage data, but apparently did not choose to release it.) It is also not clear if Uber’s calculation is based on the time drivers actually spend driving with a passenger or the time where they have their app activated. If it is the former, then their true hourly pay would be considerably less.
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• Economic Crisis and RecoveryCrisis económica y recuperación
There have been a number of reports that people are getting increasingly concerned about inflation. That could be due to the fact that they are seeing the prices of the things they buy go up rapidly. Or, it could be because they hear from the media that prices are soaring.
The Washington Post looks to be making that latter case. A piece on its homepage was headlined:
“Even in the face of surging grocery prices, retail beef and pork prices cause sticker shock.”
Well, that sounds pretty bad. Fortunately, the first full paragraph contradicts the headline.
“Overall food prices rose 0.4 percent from March, and are up 1 percent from a year ago, according to data released by the Bureau of Economic Analysis on Friday. The price of pork soared 2.6 percent in the month of April and 4.8 percent from a year ago, adjusting for seasonality. And while beef and veal prices stayed fairly flat for the month, they are up 3.3 percent from a year ago.”
A 1.0 percent year-over-year rise in food prices (actually, it’s 1.2 percent) would hardly count as “surging” in most people’s minds. It’s considerably less than the overall rate of inflation and down from a 4.0 percent increase going from April 2019 to April 2020.
But what about the price of beef and pork creating sticker shock? Well, inflation fans know that the price of these items are highly erratic. It is easy to go back over the last two decades and find many occasions where there were far larger increases.
For example, in the case of beef, the price went up 24.6 percent in the year from June 2019 to June 2020. It rose by 19.0 percent in the year from January 2014 to January 2015, and by 23.5 percent in the year from December 2002 to December 2003.
There is a similar story with pork prices. They rose by 12.4 percent from May 2013 to May 2014 and by 13.0 percent from November 2009 to November 2010.
The long and short of it is that there is zero real story here of soaring food prices. The price rises in beef and pork that are allegedly causing sticker shock are much smaller than price increases we have seen in these products in the recent past.
Maybe the Post should just stick to reporting the inflation that actually exists and not try to invent some on its own.
There have been a number of reports that people are getting increasingly concerned about inflation. That could be due to the fact that they are seeing the prices of the things they buy go up rapidly. Or, it could be because they hear from the media that prices are soaring.
The Washington Post looks to be making that latter case. A piece on its homepage was headlined:
“Even in the face of surging grocery prices, retail beef and pork prices cause sticker shock.”
Well, that sounds pretty bad. Fortunately, the first full paragraph contradicts the headline.
“Overall food prices rose 0.4 percent from March, and are up 1 percent from a year ago, according to data released by the Bureau of Economic Analysis on Friday. The price of pork soared 2.6 percent in the month of April and 4.8 percent from a year ago, adjusting for seasonality. And while beef and veal prices stayed fairly flat for the month, they are up 3.3 percent from a year ago.”
A 1.0 percent year-over-year rise in food prices (actually, it’s 1.2 percent) would hardly count as “surging” in most people’s minds. It’s considerably less than the overall rate of inflation and down from a 4.0 percent increase going from April 2019 to April 2020.
But what about the price of beef and pork creating sticker shock? Well, inflation fans know that the price of these items are highly erratic. It is easy to go back over the last two decades and find many occasions where there were far larger increases.
For example, in the case of beef, the price went up 24.6 percent in the year from June 2019 to June 2020. It rose by 19.0 percent in the year from January 2014 to January 2015, and by 23.5 percent in the year from December 2002 to December 2003.
There is a similar story with pork prices. They rose by 12.4 percent from May 2013 to May 2014 and by 13.0 percent from November 2009 to November 2010.
The long and short of it is that there is zero real story here of soaring food prices. The price rises in beef and pork that are allegedly causing sticker shock are much smaller than price increases we have seen in these products in the recent past.
Maybe the Post should just stick to reporting the inflation that actually exists and not try to invent some on its own.
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• Economic Crisis and RecoveryCrisis económica y recuperación
Sometimes budget battles can get confusing, which is why it is important to keep your eye on the ball. That’s good advice for readers of the Washington Post’s article on President Biden’s proposed budget for 2022. The short piece deals with various aspects of the budget and then gets to Biden’s proposed tax increases:
“Conservatives also warn that the administration’s tax plans could slow growth. The administration has proposed increasing the corporate tax rate from 21 percent to 28 percent, while also imposing dramatically higher taxes on multinational corporations operating abroad. The White House has denied those plans will slow the growth rate, though Biden has said he’s willing to negotiate with Republicans on other solutions.”
The reason that Biden is proposing tax increases is to offset additional spending. The spending adds to demand and boosts growth. This can lead to concerns about inflation, which are discussed in this piece. The tax increases pull money out of the economy, which means that people will have less money to spend, thereby slowing growth, so as to relieve inflationary pressures. Slower growth is not an unfortunate side effect of the tax increases, it is the point.
There is an issue that the proposed tax increases, which largely undo Trump’s 2017 tax cut, could lead to less investment. This could have the effect of reducing growth in the longer term since less investment would mean slower productivity growth and therefore slower GDP growth.
However, there is zero evidence that Trump’s tax cut led to any noticeable uptick in investment, and therefore no reason to believe that reversing the tax cut would slow investment. Furthermore, orders for new capital goods, the largest component of investment, have been very strong. This indicates the fear of higher taxes is not discouraging companies from investing in new equipment.
Sometimes budget battles can get confusing, which is why it is important to keep your eye on the ball. That’s good advice for readers of the Washington Post’s article on President Biden’s proposed budget for 2022. The short piece deals with various aspects of the budget and then gets to Biden’s proposed tax increases:
“Conservatives also warn that the administration’s tax plans could slow growth. The administration has proposed increasing the corporate tax rate from 21 percent to 28 percent, while also imposing dramatically higher taxes on multinational corporations operating abroad. The White House has denied those plans will slow the growth rate, though Biden has said he’s willing to negotiate with Republicans on other solutions.”
The reason that Biden is proposing tax increases is to offset additional spending. The spending adds to demand and boosts growth. This can lead to concerns about inflation, which are discussed in this piece. The tax increases pull money out of the economy, which means that people will have less money to spend, thereby slowing growth, so as to relieve inflationary pressures. Slower growth is not an unfortunate side effect of the tax increases, it is the point.
There is an issue that the proposed tax increases, which largely undo Trump’s 2017 tax cut, could lead to less investment. This could have the effect of reducing growth in the longer term since less investment would mean slower productivity growth and therefore slower GDP growth.
However, there is zero evidence that Trump’s tax cut led to any noticeable uptick in investment, and therefore no reason to believe that reversing the tax cut would slow investment. Furthermore, orders for new capital goods, the largest component of investment, have been very strong. This indicates the fear of higher taxes is not discouraging companies from investing in new equipment.
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Yes, it is spring. The flowers are blooming, the birds are singing, and the deficit hawks are whining. The proximate cause is President Biden’s new budget, which will push the ratio of government debt to GDP to its highest level ever.
The question is whether this should bother anyone who has a life? The projections show that the debt to GDP ratio will rise to 117 percent of GDP in 2031. If that sounds scary, consider that Greece’s debt to GDP ratio is over 180 percent. And, the bond vigilantes don’t seem to be too bothered by this. The interest rate on long-term Greek debt is 0.8 percent, compared to the 1.6 percent on U.S. Treasury bonds.
Of course, if we really want to go big we can look at Japan, where the debt to GDP ratio is approaching 250 percent of GDP. It is paying 0.08 percent interest on its long-term debt.
But let’s get to the issue at hand, how patent monopolies are like government debt. At the most basic level, we have to understand that patent (and copyright) monopolies are a way the government pays for things it wants. Instead of using government funds to pay drug companies to develop new drugs and vaccines, we reward them with a patent monopoly. (Actually, in some cases, like Moderna, we do both. We pay them and give them a patent monopoly.)
In the government’s accounting, we treat patent monopolies and spending very differently. The grant of a patent monopoly does not appear in the government’s budget, so we can award these monopolies as an alternative to direct spending if we want the deficit to appear smaller.
We sometimes have literally gone this route of using a patent monopoly, or an equivalent grant of exclusivity, as a substitute to direct spending. In the case of prescription drugs, in order to get drug companies to do pediatric trials, the government will award a company a six-month period of exclusivity, beyond any patent duration, in order to pay for the trial.
The government could just pay the money directly for the pediatric trial, but this would be a direct expenditure that adds to the deficit. If instead it adds six months to a patent, the company is paid by being able to charge higher drug prices for this period. In effect, the government is allowing the company to tax patients to cover the cost of the trial.
This is the same story with outstanding patents raising the cost of prescription drugs far above the free market level. By my calculations, we will pay roughly $400 billion (1.8 percent of GDP) more this year for prescription drugs because of government-granted patent monopolies and related protections. If we add in all rents from patents and copyrights the annual amount could easily top $1 trillion.
Anyone who is really concerned about the burden that government debt places on our children must also include the rents that companies will collect from patent and copyright monopolies. These rents are in effect privately imposed taxes that the government allows companies to collect.
The idea of selling the ability to tax is not new. Centuries ago, it was common for governments to do tax farming, which effectively meant that it sold the right to impose a certain tax for a set period of time.
Suppose the government sold off the right to collect the estate tax for the next two decades for $1 trillion. The deficit hawks could all be very happy because our debt would now be $1 trillion lower, but anyone capable of logical thought would see that this has not relieved the burden of the debt on our children one iota.
It is the same story with patent rents. The annual payments that our children will make in the form of higher prices, on everything from prescription drugs and medical equipment to software and video games, dwarfs the interest burden on the debt. But for some totally inexplicable reason, the deficit hawks only focus on the government debt and never mention patent rents.
I leave the explanation for that one to greater minds than mine.
Yes, it is spring. The flowers are blooming, the birds are singing, and the deficit hawks are whining. The proximate cause is President Biden’s new budget, which will push the ratio of government debt to GDP to its highest level ever.
The question is whether this should bother anyone who has a life? The projections show that the debt to GDP ratio will rise to 117 percent of GDP in 2031. If that sounds scary, consider that Greece’s debt to GDP ratio is over 180 percent. And, the bond vigilantes don’t seem to be too bothered by this. The interest rate on long-term Greek debt is 0.8 percent, compared to the 1.6 percent on U.S. Treasury bonds.
Of course, if we really want to go big we can look at Japan, where the debt to GDP ratio is approaching 250 percent of GDP. It is paying 0.08 percent interest on its long-term debt.
But let’s get to the issue at hand, how patent monopolies are like government debt. At the most basic level, we have to understand that patent (and copyright) monopolies are a way the government pays for things it wants. Instead of using government funds to pay drug companies to develop new drugs and vaccines, we reward them with a patent monopoly. (Actually, in some cases, like Moderna, we do both. We pay them and give them a patent monopoly.)
In the government’s accounting, we treat patent monopolies and spending very differently. The grant of a patent monopoly does not appear in the government’s budget, so we can award these monopolies as an alternative to direct spending if we want the deficit to appear smaller.
We sometimes have literally gone this route of using a patent monopoly, or an equivalent grant of exclusivity, as a substitute to direct spending. In the case of prescription drugs, in order to get drug companies to do pediatric trials, the government will award a company a six-month period of exclusivity, beyond any patent duration, in order to pay for the trial.
The government could just pay the money directly for the pediatric trial, but this would be a direct expenditure that adds to the deficit. If instead it adds six months to a patent, the company is paid by being able to charge higher drug prices for this period. In effect, the government is allowing the company to tax patients to cover the cost of the trial.
This is the same story with outstanding patents raising the cost of prescription drugs far above the free market level. By my calculations, we will pay roughly $400 billion (1.8 percent of GDP) more this year for prescription drugs because of government-granted patent monopolies and related protections. If we add in all rents from patents and copyrights the annual amount could easily top $1 trillion.
Anyone who is really concerned about the burden that government debt places on our children must also include the rents that companies will collect from patent and copyright monopolies. These rents are in effect privately imposed taxes that the government allows companies to collect.
The idea of selling the ability to tax is not new. Centuries ago, it was common for governments to do tax farming, which effectively meant that it sold the right to impose a certain tax for a set period of time.
Suppose the government sold off the right to collect the estate tax for the next two decades for $1 trillion. The deficit hawks could all be very happy because our debt would now be $1 trillion lower, but anyone capable of logical thought would see that this has not relieved the burden of the debt on our children one iota.
It is the same story with patent rents. The annual payments that our children will make in the form of higher prices, on everything from prescription drugs and medical equipment to software and video games, dwarfs the interest burden on the debt. But for some totally inexplicable reason, the deficit hawks only focus on the government debt and never mention patent rents.
I leave the explanation for that one to greater minds than mine.
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This is the implication of its analysis of likely Covid deaths and infections in India. Its central estimate assumes a case fatality rate of 0.3. This means that for every thousand people who get infected, three will die.
There have been roughly 600,000 reported deaths from Covid since the pandemic began. If this is 0.3 percent of the people who contracted the disease, then 200,000,000 people in the United States have been infected.
This is the implication of its analysis of likely Covid deaths and infections in India. Its central estimate assumes a case fatality rate of 0.3. This means that for every thousand people who get infected, three will die.
There have been roughly 600,000 reported deaths from Covid since the pandemic began. If this is 0.3 percent of the people who contracted the disease, then 200,000,000 people in the United States have been infected.
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• Economic Crisis and RecoveryCrisis económica y recuperación
Larry Summers has a column in the Washington Post warning about inflationary risks to the economy, due to what he considers an excessively large recovery package from the Biden administration. Summers notes the extraordinarily high rate of inflation in the first quarter and warns us that worse is ahead if corrective measures are not taken soon.
Starting with the inflation that we have seen to date, it is important to remember that this follows the very low rate of inflation we saw in the pandemic. Much of this is just catch up.
The overall Consumer Price Index (CPI) jumped 0.8 percent in April. That sounds scary, but it is up just 3.1 percent since February of 2020, which translates into a 2.6 percent annual rate of growth. The core index, which excludes food and energy prices, is up just 2.5 percent since before the pandemic started, translating into a 2.2 percent annual rate of increase.
We can see a similar story in many of the sectors that were hard hit by the pandemic. Hotel prices jumped 8.8 percent in April, but are still almost 6.0 percent below the level of February 2020. Airfares rose 10.2 percent in April, but are 17.7 percent below their pre-pandemic level.
Everyone knew these big price jumps were coming, so they really should not be cause for panic. We did get an unexpected hit with a 0.5 percent jump in new car prices and an extraordinary 10.0 percent jump in used car prices. (The latter added 0.3 percentage points to the CPI inflation rate for April.)
But these rises were not due to an excessively large stimulus package, they were the result of a shortage of semi-conductors caused by a fire in a plant in Japan. As we are able to produce more semi-conductors later this year, or early in 2022, new car prices will come back down. Used car prices may fall earlier if many people take advantage of high current prices to sell their old cars.
We will have to see how prices move in the months ahead, but Summers is apparently worried that we have to act quickly to stem inflation. He tells us:
“It is possible that the Fed could contain inflationary pressures by raising interest rates without damaging the economy . . . The history here is not encouraging. Every time the Fed has hit the brakes hard enough to slow growth meaningfully, the economy has gone into recession.”
Hmmm, that’s not the history I know. The Fed raised the federal funds rate from 3.0 percent in February of 1994 to 6.0 percent in March of 1995. We didn’t get a recession until March of 2001. It raised rates from 2.0 percent in December of 2004 to 5.25 in July of 2006. We did get a recession a year and a half later at the end of 2007, but this was more obvious due to the collapse of the housing bubble than the Fed’s rate hikes.
More recently, the Fed raised rates from 0.0 in December of 2015 to 2.2 percent in December of 2018. We did get a recession more than a year later, but this seemed to have more to do with the pandemic than the Fed’s rate hikes.
In short, the history doesn’t look quite like Summer’s claims. The Fed has frequently raised rates, with the stated goal and effect of slowing the economy, without bringing on recessions. There is no obvious reason that it can’t do so again if the evidence indicates that inflation is becoming a serious problem.
While we know the data is quirky right now due to pandemic and the bounce back as the economy restarts, as a first approximation, inflation is going to be equal to the rate of wage growth minus the rate of productivity growth. Wage growth has been healthy through the recession, but wages have not risen rapidly enough to give much grounds for concern about inflation.
In the period from February of 2020 to April of this year, the average hourly wage has risen 5.8 percent, which translates into a 5.0 percent annual rate. That sounds fast, but this number is skewed upward by the loss of many low-paying jobs in restaurants and other areas. Taking the average of the last three months (February, March, April) with the prior three months (November, December, January), wages have risen at just a 3.1 percent annual rate.
The Employment Cost Index (ECI) gives us a better measure since it holds the mix of jobs constant and also includes the cost of benefits, such as health care and pensions. This rose 2.6 percent from the first quarter of 2020 to the first quarter of 2021.
In the first quarter of the year, the ECI did rise at a somewhat faster 0.9 percent rate, which translates into a 3.6 percent annual rate of growth. That doesn’t sound too scary since much of this is catch-up following rises of 0.5 percent and 0.7 percent in the prior two quarters.
But to translate this rate of increase in wages into inflation, we need to know that rate of productivity growth. That had averaged just 1.0 percent from the fourth quarter of 2009 to the fourth quarter of 2019. However, in the last four quarters productivity growth has accelerated sharply.
Productivity increased by 4.1 percent from the first quarter of 2020 to the first quarter of 2021. Productivity data are notoriously erratic, but if the economy can sustain just a 2.0 percent rate of productivity growth going forward, that would mean that wages could grow at a 4.0 percent annual rate and still hit the Fed’s inflation target of 2.0 percent.
Our ability to predict productivity growth is not good, but it doesn’t seem implausible that the pandemic has forced businesses to make changes that have led to increases in productivity. So, the idea we could be on a faster productivity path for at least the next several years should not seem far-fetched.
In fact, I recall just reading somewhere about a speed-up in productivity growth. Oh yeah, the first paragraph of Summer’s piece concludes with the sentence: “Wages and productivity growth are increasing.”
Larry Summers has a column in the Washington Post warning about inflationary risks to the economy, due to what he considers an excessively large recovery package from the Biden administration. Summers notes the extraordinarily high rate of inflation in the first quarter and warns us that worse is ahead if corrective measures are not taken soon.
Starting with the inflation that we have seen to date, it is important to remember that this follows the very low rate of inflation we saw in the pandemic. Much of this is just catch up.
The overall Consumer Price Index (CPI) jumped 0.8 percent in April. That sounds scary, but it is up just 3.1 percent since February of 2020, which translates into a 2.6 percent annual rate of growth. The core index, which excludes food and energy prices, is up just 2.5 percent since before the pandemic started, translating into a 2.2 percent annual rate of increase.
We can see a similar story in many of the sectors that were hard hit by the pandemic. Hotel prices jumped 8.8 percent in April, but are still almost 6.0 percent below the level of February 2020. Airfares rose 10.2 percent in April, but are 17.7 percent below their pre-pandemic level.
Everyone knew these big price jumps were coming, so they really should not be cause for panic. We did get an unexpected hit with a 0.5 percent jump in new car prices and an extraordinary 10.0 percent jump in used car prices. (The latter added 0.3 percentage points to the CPI inflation rate for April.)
But these rises were not due to an excessively large stimulus package, they were the result of a shortage of semi-conductors caused by a fire in a plant in Japan. As we are able to produce more semi-conductors later this year, or early in 2022, new car prices will come back down. Used car prices may fall earlier if many people take advantage of high current prices to sell their old cars.
We will have to see how prices move in the months ahead, but Summers is apparently worried that we have to act quickly to stem inflation. He tells us:
“It is possible that the Fed could contain inflationary pressures by raising interest rates without damaging the economy . . . The history here is not encouraging. Every time the Fed has hit the brakes hard enough to slow growth meaningfully, the economy has gone into recession.”
Hmmm, that’s not the history I know. The Fed raised the federal funds rate from 3.0 percent in February of 1994 to 6.0 percent in March of 1995. We didn’t get a recession until March of 2001. It raised rates from 2.0 percent in December of 2004 to 5.25 in July of 2006. We did get a recession a year and a half later at the end of 2007, but this was more obvious due to the collapse of the housing bubble than the Fed’s rate hikes.
More recently, the Fed raised rates from 0.0 in December of 2015 to 2.2 percent in December of 2018. We did get a recession more than a year later, but this seemed to have more to do with the pandemic than the Fed’s rate hikes.
In short, the history doesn’t look quite like Summer’s claims. The Fed has frequently raised rates, with the stated goal and effect of slowing the economy, without bringing on recessions. There is no obvious reason that it can’t do so again if the evidence indicates that inflation is becoming a serious problem.
While we know the data is quirky right now due to pandemic and the bounce back as the economy restarts, as a first approximation, inflation is going to be equal to the rate of wage growth minus the rate of productivity growth. Wage growth has been healthy through the recession, but wages have not risen rapidly enough to give much grounds for concern about inflation.
In the period from February of 2020 to April of this year, the average hourly wage has risen 5.8 percent, which translates into a 5.0 percent annual rate. That sounds fast, but this number is skewed upward by the loss of many low-paying jobs in restaurants and other areas. Taking the average of the last three months (February, March, April) with the prior three months (November, December, January), wages have risen at just a 3.1 percent annual rate.
The Employment Cost Index (ECI) gives us a better measure since it holds the mix of jobs constant and also includes the cost of benefits, such as health care and pensions. This rose 2.6 percent from the first quarter of 2020 to the first quarter of 2021.
In the first quarter of the year, the ECI did rise at a somewhat faster 0.9 percent rate, which translates into a 3.6 percent annual rate of growth. That doesn’t sound too scary since much of this is catch-up following rises of 0.5 percent and 0.7 percent in the prior two quarters.
But to translate this rate of increase in wages into inflation, we need to know that rate of productivity growth. That had averaged just 1.0 percent from the fourth quarter of 2009 to the fourth quarter of 2019. However, in the last four quarters productivity growth has accelerated sharply.
Productivity increased by 4.1 percent from the first quarter of 2020 to the first quarter of 2021. Productivity data are notoriously erratic, but if the economy can sustain just a 2.0 percent rate of productivity growth going forward, that would mean that wages could grow at a 4.0 percent annual rate and still hit the Fed’s inflation target of 2.0 percent.
Our ability to predict productivity growth is not good, but it doesn’t seem implausible that the pandemic has forced businesses to make changes that have led to increases in productivity. So, the idea we could be on a faster productivity path for at least the next several years should not seem far-fetched.
In fact, I recall just reading somewhere about a speed-up in productivity growth. Oh yeah, the first paragraph of Summer’s piece concludes with the sentence: “Wages and productivity growth are increasing.”
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