Category: Equitablog

A new era of earnings-led consumption growth?

Posted on by Bridget Ansel

After the U.S. housing bubble burst in 2007, many economists and policymakers claimed that the United States could no longer depend upon credit growth to boost consumption and economic growth. Investment and earnings would have become the foundation for future increases in personal consumption. It seems that part of that recommendation may be coming true. Personal consumption appears to be now strongly linked to earnings growth, a relationship that could have important implications for the future pace and stability of economic growth.

Late last week, Bloomberg News reported on an analysis of consumption growth by Tom Porcelli, the chief U.S. economist for RBC Capital Markets. The analysis looked at the correlation between the growth in earnings, specifically total weekly payrolls, and consumption growth. Porcelli finds that correlation during the current economic expansion, from June 2009 to today, is 0.9, a very high correlation. Compare that to the correlation for the expansion from late 2001 to late 2007, which was just over 0.1. This weak relationship between consumption and earnings growth during this earlier period makes sense as this was when the housing bubble was inflating.

Porcelli’s results indicate that consumption and earnings growth are currently tightly linked. Looking at the growth in weekly payrolls over the past two expansions, the difference in the rate isn’t that large. For the expansion between November 2001 and December 2007, the growth rate in payrolls was 4.12 percent on an annual basis. For the most recent expansion, June 2009 to today, the average annual growth rate is 4.09 percent. Yet there’s a significant difference in the growth rate of consumption. For the previous expansion, the average annual growth rate in inflation-adjusted personal consumption expenditures, or PCE, was 2.8 percent. Yet, with roughly the same payroll growth, the average annual growth rate in PCE for this expansion now stands at 2.3 percent, a full half percentage point lower, though of course the current expansion has yet to run its full course.

A dig into the data shows that the decline in consumption powering economic growth is about the growth in the consumption of nondurable goods (food and clothing) and the consumption of services (healthcare and transportation). In the 2001-to-2007 expansion, consumption of nondurable goods grew at a 2.6 percent average annual rate and services grew by 2.5 percent. In the current expansion, the average rates are 1.9 percent and 1.8 percent, respectively. And as economists Atif Mian of Princeton University and Amir Sufi of the University of Chicago noted last year, nondurable and services PCE growth is historically weak during this business cycle.

Earnings growth over a recovery intuitively seems more connected to nondurable and services rather than durable goods. The reason: Durable goods (a car or a dishwasher) are often large essentials for a household whereas nondurable goods and services are more likely to be expenditures that are not critical for the maintenance of life. Households could hold back on these expenditures if earnings growth isn’t as strong.

Personal consumption is about 70 percent of the total U.S. economy, so understanding the changing determinants of consumption growth is critical. If consumption is more earnings-led and earnings growth picks up, then the result would be more sustainable and equitable growth. But if it doesn’t pick up then consumption growth may become permanently lower. So either consumption would become a lower share of total economic growth or total growth slow down. Any of the above scenarios would be a stark and important change for the U.S. economy.

 

 

Today’s Must-Must-Read: Robert Skidelsky: Messed-Up Macro

Posted on by Brad DeLong

Robert Skidelsky: Messed-Up Macro: “Until a few years ago, economists of all persuasions confidently proclaimed that the Great Depression would never recur. In a way, they were right…

…After the financial crisis of 2008 erupted, we got the Great Recession instead. Governments managed to limit the damage by pumping huge amounts of money into the global economy and slashing interest rates to near zero. But, having cut off the downward slide of 2008-2009, they ran out of intellectual and political ammunition. Economic advisers assured their bosses that recovery would be rapid…. But then it stalled in 2010…. It is now pretty much agreed that fiscal tightening has cost developed economies 5-10 percentage points of GDP growth since 2010. All of that output and income has been permanently lost… [and] made the task of reducing budget deficits and national debt as a share of GDP much more difficult…. That should have ended the argument. But it did not…

Evening Must Read: Mark Thoma: The Attack of the Anti-Keynesians

Posted on by Brad DeLong

Mark Thoma: The Attack of the Anti-Keynesians: “When the Great Recession hit the economy… mainstream macroeconomic models… in use… provided little insight…

…and… little guidance… [to] fiscal policy in particular. So we should not have been surprised when many people turned to a model that had been developed to address precisely these types of questions, the Keynesian model, for guidance. Was this guidance useful?… The insights and advice… turned out to be remarkably good…. Modern macroeconomic models were not up to the task when they were needed the most, and nobody should be faulted for turning to the ‘old fashioned’ Keynesian model… for guidance…

The Assumptions Behind the Federal Reserve’s Choice of 2% per Year Were Erroneous

Posted on by Brad DeLong

A question I will never ask any Federal Reserve policymakers— not in public, not in private. They do not need their elbows jiggled in this way:

The decision by the Federal Reserve in the mid-1990s to settle on a 2% per year target inflation rate depended on three facts — or, rather, on three things that were presumed to be facts back in the mid-1990s:

  1. That the long run Phillips curve was vertical even with an inflation rate averaging 2% per year, so that there was no production or employment cost of such a target.

  2. That the safe real interest rate would be positive and significant, so that a 2% per year inflation target would not entail disturbingly low levels of nominal interest rates that might lead to instabilities in velocity.

  3. That shocks to the economy would be small, so that the Federal Reserve would never seek to compensate with an interest-rate reduction in the range of 5% or more.

We now know that all three of these were and are false.

The easiest way to fix this problem would be to revise the Federal Reserve Act — perhaps to add “healthy rate of nominal wage growth” to the list of Federal Reserve monetary policy objectives.

A Rant Against the Use of the Word “Bubble” in the Context of the Bond Market

Posted on by Brad DeLong

I was reading Duncan Weldon’s very interesting “A Policy Driven Bond Bubble” (see also “Is There a Bubble in Fear” plus “A Monetary Policy Which Is Cheap But Not Easy”), and I found myself thinking:

We should careful when we call things “bubbles”.

When we call something a “bubble” we attach a number of meaning-tags to it. Here are three:

  1. Bubbles are collective irrationality.

  2. Bubbles pop.

  3. Owning bubbly assets entails large long- and fat-tailed risks.

Safe bond prices are certainly elevated — more than elevated: absurd. The Federal Reserve has squeezed the term premium by shrinking the supply of long-term bonds and put the underlying fundamental future short rate to which the term previous applied on a very low path.

But does holding bonds entail accepting large long- and fat-tailed risks? Only if you must sell your bonds in the future. If you have the option to hold them to maturity, your risks are bounded and very small. What you are complaining about is not risk, but rather lousy expected return. And even if you cannot hold them to maturity, the fact that others can hold them to maturity provides a pool of demand that limits how far bond prices can crash.

Must bond prices undergo a sharp drop as interest rates spike? No. It might happen — and it might not. But with a bubble you know there is going to be a crash. With a bubble, the people holding the asset at any moment know that its fundamental value does not match its price. They hope that they will be able to sell their position to a greater fool at a higher price. But nobody in a bubble who understands what is going on thinks holding the asset to maturity or for the long run will end in less than tears.

And are bond prices collective irrationality? Are the traders and investors who are holding bonds making a large collective mistake? I certainly believe most of them should shrink their bond positions and invest in diversified equities instead. But many have: that is why the Shiller stock price to average earnings over the last decade stands at 27.85 — a cyclically-adjusted earnings yield of 4%/year:

EconWeekly

But if you are unwilling to accept the equity risk that you could lose 40% of your value in a year — as people did in 2008, 2001, 1974, 1945, 1937, 1929-1933, 1907, and 1904, and almost in 1970 and 1987 — should stock prices return next year to their long-term average earnings yields, your choices are limited. Cash and near-cash are not attractive to anyone save those unable to get the option to hold long Treasuries to maturity. What is “irrational” is not bond traders and investors, but rather the economy that has convinced the Federal Reserve that its current low-rates-forecast-forever policy path is the best it can do.

Thus I think clearer thought is obtained by eschewing applying the word “bubble” the bond market. Call them extremely richly-valued. Call them low return. Call them risky for those without the option to hold them to maturity. But if you have to use the word “bubble” apply it to other things.

I wouldn’t even say that the U.S. is currently in a monetary policy bubble. For that to be the case, it would have to be a small open economy borrowing heavily in foreign currency, or in some form of currency union with larger economic powers…

Things to Read on the Morning of March 24, 2015

Posted on by Brad DeLong

Must- and Should-Reads:

Might Like to Be Aware of:

Fixed: “A Significant Step Toward the Entrenchment of Abnormal Dynamics”: Focus

Posted on by Brad DeLong

Fixed: “Beginning the normalization of policy will be a significant step toward the restoration entrenchment of… normal abnormal dynamics

Stanley Fischer: Monetary Policy Lessons and the Way Ahead: “For over six years, the federal funds rate has, effectively, been zero…

…However it is widely expected that the rate will lift off before the end of this year, as the normalization of monetary policy gets underway. The approach of liftoff reflects the significant progress we have made toward our objectives of maximum employment and price stability. The extraordinary monetary policy accommodation that the Federal Reserve has undertaken in response to the crisis has contributed importantly to the economic recovery, though the recovery has taken longer than we expected. The unemployment rate, at 5.5 percent in February, is nearing estimates of its natural rate, and we expect that inflation will gradually rise toward the Fed’s target of 2 percent. Beginning the normalization of policy will be a significant step toward the restoration of the economy’s normal dynamics, allowing monetary policy to respond to shocks without recourse to unconventional tools…

Let me say this politely.

It will not.

Graph Employed full time Median usual weekly nominal earnings second quartile Wage and salary workers 16 years and over FRED St Louis Fed

A Federal Reserve that seeks to create and maintain a low-pressure economy does two things. First, it makes growth inequitable by ensuring that labor has little bargaining power, and thus that the fruits of economic growth Will flow in an ever more-concentrated way toward the rich. Second, it helps anchor inflation expectations at a low level by convincing everyone that the Federal Reserve has a very low tolerance for inflation.

The participations in the Federal Reserve Open Market Committee all believe that given currency policy the “longer run” “range or target level for the federal funds rate” is lower than 4.5%. The median estimate is 3.75%.

Www federalreserve gov monetarypolicy files fomcprojtabl20150318 pdf

Eight times in the past fifty years–once every six years–the Federal Reserve has wished to drop the federal funds rate by more than 3.75% as part of its management of monetary policy.

Graph 3 Month Treasury Bill Secondary Market Rate FRED St Louis Fed

A policy that aims at a longer-run federal funds rate of 3.75% is a policy that seeks a return to the zero lower bound by 2021.

And that assumes that the liftoff is successfully accomplished, and not quickly reversed.

Morning Must-Read: Dan Davies: How Secular Stagnation Came to Smurf Village

Posted on by Brad DeLong

Dan Davies: How Secular Stagnation Came to Smurf Village: “The real lesson of the Smurf village model is that secular stagnation isn’t really about growth slowing down…

…It’s about investment slowing down, and none of the normal policy levers being able to speed it up again. What all six of the Smurfs’ explanations have in common is that investment capital, instead of circulating round the economy, gets stuck and starts to pile up somewhere, despite price signals telling it that it ought to be chasing new investments. So any policy response to secular stagnation needs to come up with new ways of persuading investors to invest, ways which aren’t (at least, not in the conventional sense,) price signals.

Looking inside the data-making factory

Posted on by Nick Bunker

Accessing economic data these days can be almost deceptively easy. A few clicks on the U.S. Bureau of Labor Statistics’ website or a simple search on the St. Louis Federal Reserve’s FRED site reveals thousands of datasets that anyone interested in economics can grab. Such quick-and-easy access to data has helped drive the “credibility revolution” in empirical economics research. Yet this multitude of data sets does not burst forth into the world fully formed. Rather, the creation of data can be a messy process, especially when considering the version that the U.S. public and researchers may eventually see.

Here’s one such mess—a new paper presented at last week’s Brooking Panel on Economic Activity warns that procedures used to protect privacy might be distorting many of the data sets that researchers use. Large data sets can be incredibly powerful in the amount of information they capture about individuals, but they also present a risk to those individuals’ privacy. Take the Current Population Survey, which is maintained by the U.S. Bureau of Labor Statistics and the U.S. Census Bureau. The survey contains information about a person’s family status, their income, their location, and quite a few more variables. If these data were made available to the public unaltered, then someone could look into the data and conceivably identify a respondent.

To avoid identification through these means, both private and public sector data providers mask the identity through a number of statistical processes. In the new Brookings paper, John M. Abowd of Cornell University and Ian M. Schmutte of the University of Georgia detail the ways that statistical disclosure limitations, or SDL—the catch-all name for these processes—can affect economic analyses. The authors single out one form of SDL that is particularly nefarious: swapping. In this process, the statistical agency or company will swap certain attributes of respondents. The location of individuals, for example, might be switched in order to protect their identities, but that could corrupt the economic analysis a researcher is running.

What the authors call for is a certain amount of disclosure from the organization creating these limited datasets. Abowd and Schmutte don’t want the raw, unaltered data, but rather better disclosure of how exactly the organization changed the data. If the agencies or companies let researchers know about certain aspects of the process that anonymized the data, then the researchers could account for these distortions in their analysis.

Of course, the agencies could just make more of the raw data available. But as participants at the Brookings panel noted, there are severe consequences for the employees of these agencies if someone is identified in the data. The punishment could include a fine of several thousand dollars or jail time. That potential punishment makes agency staff quite averse to disclosing data.

These statistical disclosure limitation processes right now are almost exclusively used on survey data, which makes some economists sanguine about the future of data. Microeconomists have increasingly turned to administrative data, which is taken directly from government sources and includes things like tax receipts, and away from survey data. But one participant warned that these SDL processes will almost certainly make their way to administrative data.

Abowd and Schmutte’s paper is an important reminder that we all need to pay attention to the sources and presentation of economic data. The old joke about economic analysis is that it’s like looking for a set of lost keys only where the streetlight illuminates the pavement. The least we can do is to make sure the light shines as bright and as wide as possible.

Nighttime Must-Read: Adam Ozimek: Dirty Energy Taxes and Clean Energy Innovation

Posted on by Brad DeLong

Adam Ozimek: Dirty Energy Taxes and Clean Energy Innovation: “I have a concern that not enough attention is being paid to the innovation function for clean energy….

…For clean energy to become globally dominant faster it’s better for the U.S. to just subsidize solar innovation and let the untaxed U.S. market price of dirty energy stand as a strong incentive for solar to drive costs lower…. Taxing dirty energy and using all the money for subsidies of clean tech innovation is really more efficient than subsidies without taxes…. The money for subsidies will need to come from somewhere…. [And perhaps] economies of scale and learning by doing are extremely important in this industry…. The downward march of solar energy costs is perhaps the most important factor determining how successful we will be at mitigating global warming, and I think policy should really be almost entirely about how do we keep this going and how do we accelerate it…