Month: September 2015

Must-Read: Tim Duy: Why the Fed Is Likely to Stand Pat This Week

Posted on by Brad DeLong

Must-Read: Tim Duy: Why the Fed Is Likely to Stand Pat This Week: “The Federal Reserve is looking for a time with minimal downside risks…

…to raise interest rates. The wavering global economy is likely creating enough downside risk to defer that first hike to a later meeting. But the Fed still wants to begin normalizing policy, and it will signal that it remains committed to a rate hike this year. Regardless of the global situation and the inflation picture, I suspect it will feel increasingly compelled to do just that as the unemployment rate drifts below 5 percent.

The Arguments Being Put Forward for Raising Interest Rates Now Are Very Weak Indeed

Posted on by Brad DeLong

The arguments for raising interest rates right now are of appallingly low-quality.

Consider, for example, Bloomberg View:

Brad Brooks: Why the Fed Should Raise Rates Now: “Although the Fed hasn’t raised interest rates in almost 10 years…

…sympathetic pundits say it’s still too soon to raise them…. How did our financial system weaken to the point where a quarter of a percent increase in rates is more than it can handle?

Stop right there: it is not that “our financial system [is] weaken[ed] to the point where a quarter of a percent increase in rates is more than it can handle”. No interest-rate dove says it is. The reason interest-rate doves oppose rate increases right now is not that the financial system cannot handle them, but that they come with a cost–lower employment and slower growth–and no compensating gain in the form of an appropriate curbing of excess inflationary pressures, since there are no excess inflationary pressures visible either her and now or as far out as the horizon we can see.

The process started… when Alan Greenspan… lower[ed interest] rates to 1 percent… then… tighten[ed] policy… with agonizing slowness… set[ting] the table for the subprime housing debt mess…

Suppose, for the sake of argument, that Greenspan were to have pushed the short-term safe interest rate 200 basis points below its “proper” level–whatever that is–and kept it there for three years. By how much would that have boosted the amount that a subprime borrower could have paid for a house? The answer is simple: 2% x 3 = 6%. Even if you buy that Greenspan made an error in monetary policy in the mid-2000s, it accounts for only one-tenth of the runup in housing prices. And it accounts for a correspondingly-small share of the “subprime housing debt mess”. Greenspan’s policy errors were mighty–but they were all in the arena of lax supervision of lending standards and lending fraud. Bernanke’s policy errors were mighty–but they were all in the area of not cleaning up the supervision-and-fraud mess and not understanding the seriousness of the situation he was handed.

We’re likely to see a serious correction in the U.S. equity market… trigger[ed by]… hundreds of billions of dollars worth of bad debt in the energy sector… made to finance the fracking frenzy…. Perhaps the most disturbing statistic is that American corporations have announced dividends and share buybacks for this year that total more than a trillion dollars… at the expense of long-term capital investment…. Another area for concern is the burgeoning private market for investments, where companies are finding it relatively easy to raise capital…. The Fed has to finally take away the punch bowl. The economy may not be in top shape, but it’s strong enough to handle an equity correction of 20 percent to 25 percent…. Another mild recession would not be the end of the world…. Writedowns can be painful, but they instill a sense of responsibility…. Lift[ing] overnight rates back up to the 2.5 percent range years ago… would generate at least a trillion dollars annually, if not more, for [short-duration] fixed-income investors–and a possible boost of 6 percent to GDP…

Ummm… The purpose of raising interest rates is to shrink the economy, not grow it by “6 percent” or some other imaginary number pulled out of the air without any analysis. The extra trillion a year of income to short-duration fixed-income investors is offset by a ten-trillion loss to the portfolios of long-duration fixed income investors, plus an extra trillion dollars a year of payments by enterprising and consuming borrowers to rentiers.

So when Brooks writes:

So let’s end the era of the “Greenspan put” and Bernanke’s quantitative easing, and return to basics…

I, speaking as a Brad, find myself completely and totally humiliated by the low quality of these arguments.

The “basics” are that the Federal Reserve (i) engages in prudential regulation to curb the growth of systemic risk and reduce fraud, and (ii) sets interest rates so that planned investment is equal to desired savings at full employment and there are neither unanticipated inflationary or deflationary pressures on the economy. Labor-market indicators are confusing: the unemployment rate suggests that deflationary pressures are now gone, while the prime-age labor-force participation rate suggests deflationary pressures are still here. Inflation indicators are not confusing: inflationary pressures aren’t here, and aren’t expected to emerge in the near future. Financial asset prices suggest an overheated economy if the Federal Reserve is about to embark on a full tightening cycle, but are justifiably high if the new normal is one of Summers’s “secular stagnation” or Bernanke’s global savings glut. High financial asset prices do indeed raise the risks from lax macroprudential supervision. But why isn’t the appropriate policy response to make sure that macroprudential supervision is not lax?

Comments on proposed U.S. overtime regulation

Posted on by Nick Bunker
Photo of clock by A. Strakey, flickr, cc

In the Notice of Proposed Rulemaking (NPRM) RIN 1235-A111, DOL proposes to increase and automatically update the salary threshold for exemptions from overtime protections under the The Fair Labor Standards Act (FLSA). I observe in the comments below that DOL understates the economic benefits of the proposed threshold and that the proposed level is consistent with the historical growth in prices and economic output.

In its analysis of the effect of the proposed rule on hours worked, DOL understates the benefits to the workforce by failing to account for employers’ tendency to hire additional workers and to schedule non-overtime work in response to the rule change. Footnote 120 of the NPRM acknowledges that the substitution of overtime hours to non-overtime hours is a possibility, and that DOL understandably “did not have credible evidence to support an estimation of the number of hours transferred to other workers.” Yet it should be noted that this possibility is actually an implication of the fixed-wage model that partially underlies DOL’s analysis.

Ignoring this consequence of the economic model underlying DOL’s analysis causes the NPRM to overestimate the total reduction in economy-wide hours due to the proposed rule, at least in the short run. In particular, when the overtime premia threshold is raised, employers will substitute away from overtime hours and either hire additional workers or schedule additional hours for workers below the 40-hour threshold. Indeed, the fact that there is a spike of 40 hours in the distribution of weekly hours is consistent with the idea that firms substitute away from overtime hours. Moreover, private-sector analyses such as those by the National Retail Federation (2015) and Goldman Sachs (2015) predict increases in employment as employers hire additional workers to work non-overtime hours. This substitution toward non-overtime hours is necessarily implied by the fixed-wage model when output is constant, say in the very short run or in an economy with a large degree of excess capacity. Any offsetting increase in non-overtime hours will be smaller over the medium- to long-term, when both output and capital adjust more easily.

The possibility that some individuals will see increased employment through the extensive or intensive margins has important welfare considerations ignored by the NPRM. Based on empirical evidence describing the extent of overwork in the United States, the NPRM correctly concludes that the proposed rule may improve welfare because it “may result in increased time off for a group of workers who may prefer such an outcome.” At the same time, although many workers in the United States are overworked, a sizable portion of the labor force does not work as many hours as desired (Golden and Gebreselassie 2007; Jacobs and Gerson 2005). Footnote 135 of the NPRM states that the lack of existing scholarly studies precludes quantifying any increase in employment or hours due to the rule, but DOL should make clear that under certain conditions the fixed-wage model underlying their analysis implies that some workers will see an increase in hours. If these workers are under-employed, the shift in the composition of those hours from over-worked to under-worked employees will be a welfare-improving consequence of the proposed rule.

In its calculation of the monetary benefits of reducing hours, the NPRM fails to account for significant externalities associated with high levels of hours worked. The NPRM approximates the benefit an affected worker receives for an hour of additional leisure by the average hourly wage, but this approximation understates the social benefits when the social and private costs of work differ. Some empirical work calculates that longer work hours entail greater energy consumption and consequentially more environmental damage (Rosnick and Weisbrot 2006). And economic theory suggests that long work hours may be detrimental both within and outside of the household (Gersbach and Haller 2005; Folbre, Gornick, Connolly, and Muzni 2013). In a separate section on health benefits of the proposed rule, the NPRM also effectively acknowledges the existence of these externalities cited above, stating that the rule will not only benefit the worker’s welfare through its positive health effects but also “their family’s welfare, and society since fewer resources would need to be spent on health.” Although the NPRM states that its wage-based approximation may overestimate the social benefits of fewer hours worked because not all workers will prefer to reduce their hours, the exclusion of important externalities causes the NPRM to underestimate some benefits of reducing hours.

The NPRM also understates benefits by excluding the possibility that an updated salary threshold will improve pay for hourly workers who are not paid overtime, even when they should be. Rohwedder and Wenger (2015) find that 19 percent of hourly workers are not paid a premium for working overtime hours. While it is unclear if all of these workers are legally required to receive overtime payments (due to occupational exemptions), many of them are not receiving pay promised under the FLSA. The proposed, transparent update to the salary threshold will provide employers an opportunity to revisit whether their employees are paid according to the law.

Finally, the proposed threshold for the overtime weekly salary exemption appears to be consistent with a range of economically appropriate levels. The NPRM proposes raising this threshold to approximately $921, or the 40th percentile of the weekly earnings distribution of salaried employees working full-time. This level is appropriate because it is similar to the exemption threshold that already applied in 1975, after adjusting for inflation ($250 in 1975 dollars, or approximately $1,000 per week in 2014 dollars.). Yet if the labor market’s capacity to bear this regulation is determined by productivity, then this threshold is almost certainly too low. Since 1975, real productivity has grown by more than 72 percent, suggesting an overtime weekly salary threshold of at least $1,720, well exceeding the proposed rule.

 

Ben Zipperer

Research Economist

Washington Center for Equitable Growth

1333 H St., NW

Washington, DC  20005

 

References

Folbre, Nancy, Janet Gornick, Helen Connolly, and Teresa Munzi. 2013. “Women’s Employment, Unpaid Work, and Economic Inequality,” in Janet Gornick and Markus Janti, editors, Income Inequality: Economic Disparities and the Middle Class in Affluent Countries, Redwood City CA: Stanford University Press.

Golden, Lonnie and Tesfayi Gebreselassie. 2007. “Overemployment mismatches: the preference for fewer work hours.” Monthly Labor Review. April.

Gersbach, Hans and Hans Haller. 2005. “Beware of Workaholics: Household Preferences and Individual Equilibrium Utility.” IZA Discussion Paper. February. http://ftp.iza.org/dp1502.pdf

Goldman Sachs Global Macro Research. 2015. “The New Federal Overtime Rules: A Greater Effect on Payrolls than Pay.” July 7.

Jacobs, Jerry, and Kathleen Gerson. 2005. The Time Divide: Work, Family, and Gender Inequality. Cambridge MA: Harvard University Press.

National Retail Federation. 2015. “Rethinking Overtime.” https://nrf.com/sites/default/files/Documents/Rethinking_Overtime.pdf

Rohwedder, Susann and Jeffrey B. Wenger. 2015. “The Fair Labor Standards Act: Worker Misclassification and the Hours and Earnings Effects of Expanded Coverage.” http://www.rand.org/content/dam/rand/pubs/working_papers/WR1100/WR1114/RAND_WR1114.pdf

Rosnick, David and Mark Weisbrot. 2006. “Are Shorter Hours Good for the Environment? A Comparison of U.S. & European Energy Consumption.” Center for Economic and Policy Research. December. http://www.cepr.net/documents/publications/energy_2006_12.pdf

Keep an eye on changes to U.S. corporate income tax proposals

Posted on by Nick Bunker

The current U.S. presidential election process not surprisingly features a number of tax reform idea, some well thought out and others not so much. More concrete ideas about overhauling the U.S. tax system are drawing attention, as the recent conversation around former Florida Governor Jeb Bush’s plan shows. The focus is often on the individual tax system, however, with more detailed proposed changes to the corporate tax system often overshadowed.

There are two big areas in the debate about the U.S. corporate tax system: the rate and the coverage. When it comes to the rate, there’s an important distinction to be made. You’ll hear some claim that the United States has the highest corporate income tax among developed economies. That’s statement is strictly true. The statutory corporate income tax, or the rate that’s on the books, 39.1 percent, is the highest among the developed and leading developing economies in the Organisation for Economic Co-operation and Development.

Yet the statutory rate is quite different from the effective tax rate, or the rate corporations actually pay. The difference is due to the variety of deductions and loopholes present in the current system. Estimates of the effective rate differ, but according to the U.S. Congressional Budget Office the effective rate averaged 25.4 percent from 1987 to 2008, or about the current average of 24.8 percent for the other 33 economies in the OECD.

What’s more, there is some evidence that points to a much lower effective tax rate. Research by economist Patrick Driessen at Bloomberg Government points out that models used by the Congressional Budget Office and others calculate the effective tax rate by looking at how the capital gains tax that individuals paid on realized capital gains from investments in corporations. This method ends up missing the significant amount of earnings held by U.S. corporations abroad. Driessen pegs that number at about $400 billion. After accounting for these deferred foreign earnings, Drissen gets a much lower effective rate: about 14 percent,

These foreign earnings bring up the second area of discussion when it comes to the corporate income tax. The U.S. corporate income tax system is currently a worldwide system, where theoretically the profits of a U.S. corporation earned anywhere are taxed at the U.S. rate. But if profits earned elsewhere are kept outside of the United States, then they remain untaxed by the federal and states government. This large stash of profits kept overseas and untaxed is one of the trends highlighted by economist Gabriel Zucman at the London School of Economics in his book, “The Hidden Wealth of Nations.”

Some politicians and economists propose that the United States should deal with these untaxed offshore profits by switching to a “territorial” system, where only profits earned in the United States would be taxed. But there remains the possibility that corporations would figure out how to make profits earned in the United States looks like they were earned elsewhere, as they do now under the current corporate tax system.

Which is all to say that the complexities of the U.S. corporate income tax system are one reason why it often receives less attention than the more-well understood individual tax system, with which citizens have a more visceral relationship. Given the amount of money at stake and the distributional effects of reform, let’s hope the current election cycle sparks a serious debate about the current system.

Must-Read: Mike Konczal: Student Loan Distress Goes Beyond Default

Posted on by Brad DeLong

**Must-Read: I do not think it is an accident that “student debt activists… put forward people defrauded by the for-profit industry, the media prefers to talk about poetry majors with outrageous debt balances…” The Graham family conglomerate, remember, included both The Washington Post and Stanley Kaplan University–the second-worst for-profit student-loan grifter–before its break-up. I think that mattered…

Mike Konczal: Student Loan Distress Goes Beyond Defaults: “Adam Looney and… Constantine Yannelis… [say] that there is no…

…general student loan default crisis. Instead there is a serious, though limited, problem concentrated in for-profit schools and, to a lesser extent, community colleges… made far worse by the Great Recession…. I agree…. Student loans defaults from for-profit schools are a genuine problem, and the media often fails to recognize this. As Astra Taylor notes, when student debt activists in the wake of Occupy put forward people defrauded by the for-profit industry, the media prefers to talk about poetry majors with outrageous debt balances….

For-profits were allowed to expand rapidly in the 2000s, and they’ve done a remarkable job in maximizing their profits…. The yearly net tuition increase for students attending a community college is up around $950 a year between 2000 and 2010. If the public policy is to shift costs from states to individual students, we shouldn’t be surprised when it goes perfectly to plan…. Poor communities have very large debt balances relative to income, forcing such distress that the results are large default rates. But there’s another issue, and that’s the life effects of student debt. And default rates won’t catch this…

Must-Read: Martin Sandbu: The Importance of Corbynomics

Posted on by Brad DeLong

Must-Read: Martin Sandbu**: The Importance of Corbynomics: “A good place to start is by the two competing letters from economists…

…for and against Corbynomics. One, in the Guardian, insisted that Mr Corbyn’s opposition to fiscal austerity was mainstream economics. The other, in the Financial Times, argued that nationalising industries and printing money to fund investment was not. If this is a war of letters, it is a phoney kind of war, since both can be true at the same time (as Simon Wren-Lewis has pointed out.) But together, the two letters make up as good a list as any of the main traits of the economic policy that Mr Corbyn has suggested he wants to pursue.

Must-Read: Paul Krugman: Labour’s Dead Center

Posted on by Brad DeLong

Must-Read: Paul Krugman: Labour’s Dead Center: “One crucial piece of background to the Corbyn surge…

…the implosion of Labour’s moderates…. Every candidate other than Mr. Corbyn essentially supported the Conservative government’s austerity policies…. accepted the bogus justification… pleading guilty to policy crimes that Labour did not, in fact, commit….

Was the last Labour government fiscally irresponsible?… On the eve of the economic crisis of 2008… debt was lower, as a share of G.D.P., than it had been when Labour took office a decade earlier, and was lower than in any other major advanced economy except Canada…. There has never been any hint that investors, as opposed to politicians, were worried about Britain’s solvency: interest rates on British debt have stayed very low…. There was never any need for a sharp turn to austerity…. The whole narrative about Labour’s culpability for the economic crisis and the urgency of austerity is nonsense… consistently reported by British media as fact.

And all of Mr. Corbyn’s rivals for Labour leadership bought fully into [it]… accepting the Conservative case that their party did a terrible job…. Why Labour’s moderates have been so hapless. Consider the contrast with the United States…. Part of the answer is that the U.S. news media haven’t been as committed to fiscal fantasies, although that just pushes the question back a step. Beyond that, however, Labour’s political establishment seems to lack all conviction…

Must-Read: Ray Fair (2010): Convergence in Macroeconomics: Hoisted from Ray Fair’s Archives

Posted on by Brad DeLong

Must-Read: Bluntly, your macroeconomic model–whatever it is–needs to mimic a Simsian VAR in-sample. If it does not, it has no claim on our attention: it is imposing assumptions that are neither the true structure nor even useful epicycle-like forecasting hypotheses. And if it cannot fit the data we have, it has no ability to claim to provide useful policy multipliers.

The Lucas critique remains true: a model can mimic a VAR and still not be useful for the purpose of providing policy multipliers. But the anti-Lucas critique–that a model that does not mimic a VAR has no claim to our attention for any purpose whatsoever–is much truer:

Ray Fair (2010): Convergence in Macroeconomics: Hoisted from Ray Fair’s Archives: “There have been a number of recent papers arguing…

…that there has been considerable convergence in macro research and to the good. Blanchard (2009, p. 2)… Woodford (2009, pp. 267, 269)… Chari et al. (2009, p. 242) state: “Viewed from a distance, modern macroeconomists… are all alike.”… Galí and Gertler (2007, p. 26)… state: “Overall, the progress has been remarkable. A decade ago it would have been unimaginable that a tightly structured macroeconometric model would have much hope of capturing real-world data, let alone of being of any use in the monetary policy process.”… There has been convergence… [to what] I will call ‘macro 2’, [which] dominates… refereed journals….

My non-macro friends often ask why macroeconomists cannot just compare models in terms of how well they fit the data and choose the model that fits best?… It is not, however, common…. The only case I am away of is in Fair (2007, Table 1), where a DSGE model in Del Negro et al. (2007) is compared to the US model in Fair (2004)…. The four-quarter-ahead RMSE for real GDP for the DSGE model is 2.62%, which compares to 1.33% for the US model in which autoregressive equations are specified for the exogenous variables…. The eight-quarter-ahead RMSE for the DSGE model is 6.05%, which compares to 1.84% for the US model. The DSGE model is thus not accurate. This is, of course, only one example, and in future work more comparisons like this should be done…

I am with Ray fair here: Whenever somebody shows up with a DSGE model that they attempt to use for any purpose, my first question is: how does this fail to mimic a VAR? My second question is: how much do the factors in the model that caused it to fail to mimic a var–the factors that we know are wrong–corrupt your answers to the question of interest right now? My third question is: what validation can you present that this is in fact a useful linear approximation to the emergent properties generated by the true microfoundations–which true microfoundations your model definitely lacks?

More often than not, presenters give little evidence of having thought about any of these three questions before…

Must-Read: Paul Krugman: Poland vs. Greece

Posted on by Brad DeLong

Must-Read: There are a lot of instructive comparisons that can be made around the European periphery–Finland, Latvia, Greece, Spain, Portugal, Ireland, Iceland. They pretty much all lead to the conclusion that given the Austere way the euro has been implemented, it has been a huge mistake for everybody except Germany and Holland–for whom the lower currency value and thus greater export competitiveness produced by the eurozone has been an enormous benefit–a benefit that should make them very eager to pay the fiscal union transfers needed in the eurozone’s current situation.

Paul Krugman**: Poland Versus Greece: “Yannis Ioannides and Christopher Pissarides… talk about the ways lack of structural reform…

…hurts Greek productivity and competitiveness…. It’s very, very wrong to point to factors limiting Greek productivity and claim that these factors are the ‘cause’ of the Greek crisis. Low productivity exacts a price from any economy; it does not normally, or need not, create financial crisis and a huge deflationary depression. Consider… Greece and Poland…. Poland has not had a Greek-style crisis, or indeed any crisis at all. Instead, it has powered through the turmoil…. By adopting the euro Greece first brought on massive capital inflows, then found itself in a trap, unable to achieve the needed real devaluation without incredibly costly deflation. Every time someone asserts that the Greek problem is really on the supply side, you should ask… why this should lead to collapse. Greece… should have real wages only about 60 percent as high as Germany’s. It should not have 25 percent unemployment.

Why Don’t Commercial Bankers Understand the Interests of Their Class Fraction?

Posted on by Brad DeLong

Commercial bankers, you see, are not rentiers. Rather, they are intermediaries. And they are intermediaries who find an economy in which interest rates are likely to kiss the zero lower bound a very difficult environment in which to operate.

Thus if I were a commercial banker working for or advising the Federal Reserve, I would think like this:

The interest rate on relatively safe loans is going to bounce around with the state of the business cycle, as the Federal Reserve leans one way or another and as speculators expect the Federal Reserve to keep leaning or to normalize. But there is a fixed point of reference: The average around which the interest rate on relatively safe loans will bounce around will be equal to the rate of real profit, minus the yield discount for relative safety, plus the expected inflation rate.

Commercial banks need a wedge of about 300 basis points between their cost of funds and the returns on the loans they make. They need this wedge in order to operate their networks of ATMs, keep open their branches, and pay for their administrative processes. Commercial banks cannot pay negative interest on deposits. And commercial banks really do not want to sock their depositors with unexpected fees: that is a way for a bank to become a much smaller bank relatively quickly.

That means that:

  • either there has to be a wedge of at least 300 basis points between the nominal interest rate on the loan banks make and zero
  • or the commercial banking business model does not work.

If the average interest rate is below zero, then banks banks have to reach for yield. They must thus get into the business of making risky loans–loans that they are not equipped to judge well, and are made into situations rife with adverse selection and moral hazard.

Thus Commercial banks have a hard time making their business model work when the Federal Reserve target and the market expected inflation rate is, say, 2% per year. They would have a much easier time making their business model work when the Federal Reserve target and the market expected inflation rate were 4% per year.

Now combine this insight with the mechanics of maintaining an inflation target: When the actual inflation rate is less than 4% per year, the Federal Reserve should–slightly paradoxically–lower interest rates in order to boost spending and so get the inflation rate back up. And conclude that the commercial bankers and their allies in the Federal Reserve–the 36 Class “A” banker directors of the regional Federal Reserve Banks, the 36 Class “B” non-banker directors of the regional Federal Reserve Banks who are chosen by member banks to “represent” labor, agriculture, consumers, etc., but who do so mostly in the breach, and the regional Federal Reserve Bank Presidents who come out of the banking sector–ought to be among the strongest advocates of not raising interest rates now, and the strongest advocates of raising the 2% per year inflation target to 4% per year.

They are not.

Why not? Perhaps it is just that they do not believe in the Fisher Effect–do not believe that the average level of nominal interest rates would be 200 basis points higher under a 4% per year inflation target than under a 2% per year target.

Any other candidate explanations?