Plosser thinks there is no jobs problem

So while we wait for the jobs plan that the president will announce later this week, the Fed published the minutes of the Federal Open Market Committee's (FOMC) meeting.  Three members, including Real Business Cycle (RBC) guru Charles Plosser, voted against maintaing interest rates close to zero until 2013. The three that voted against are afraid about core inflation, and signaling that rates will not increase if inflation accelerates.   Also, somebody believes that a slight increase in core inflation with the slightly lower unemployment (even though the lower unemployment is related to participation rates) implies that potential output is lower.  Not kidding.  Precise words in the minutes are:

"A couple of others, however, suggested that the juxtaposition of higher core inflation and somewhat lower unemployment could imply that the level of potential output was lower than had been thought."

The economy grew 0.7% in the first six months of the year, and we are still below the previous peak, but we're close to potential output?! My guess is that "the couple of others" includes Plosser.  In other words, this guy thinks that around 9 percent unemployment is close to the natural rate.  Nothing like believing that anything is full employment to convince yourself that markets actually produce optimal outcomes.

Alan Krueger to lead the CEA

The NYTimes reports that Alan Krueger will be the next chairman of the Council of Economic Advisors. A well respected, serious professor from Princeton, that almost everybody from Mankiw to Krugman will approve of. He is a labor economist, and yes that is a problem. My concern with labor economists, is that they tend to think in microeconomic terms when it comes to employment creation, and that is definitely not a solution for the current situation.

For example, the Times tells us that:

"Dr. Krueger was also one of the administration’s chief spokesmen for a payroll tax cut designed to encourage employers to hire, a policy that was in effect under the HIRE Act during 2010. The tax incentive, which was designed by Senators Chuck Schumer and Orrin Hatch after a raft of competing proposals floated through Washington, was criticized by some economists as being too small and ill-targeted to make much of a difference in hiring."

Don't get me wrong a reduction of payroll taxes, a regressive tax that burdens low income groups more heavily, is a good idea. But the reason is that it would stimulate consumption, not that it would reduce costs and lead to additional hiring. Why would a firm hire workers, because costs are lower, if they don't have demand for their products? Employment creation is NOT about incentives to the supply side, but about creating more demand!

Bernanke at Jackson Hole

Finally got around reading Bernanke's speech.  A bit underwhelmed to tell you the truth. Krugman seems to be happy with the fact that Bernanke acknowledged that the recovery is weak, at best. In terms of policy what he said is the following:

"In light of its current outlook, the Committee recently decided to provide more specific forward guidance about its expectations for the future path of the federal funds rate. In particular, in the statement following our meeting earlier this month, we indicated that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013."

In other words, short-term rates will remain low.  On long-term rates (i.e. quantitative easing) he said nothing.  Worse, his comments on fiscal policy were terrible.  He said:

"To achieve economic and financial stability, U.S. fiscal policy must be placed on a sustainable path that ensures that debt relative to national income is at least stable or, preferably, declining over time. As I have emphasized on previous occasions, without significant policy changes, the finances of the federal government will inevitably spiral out of control, risking severe economic and financial damage."

Can you imagine if in 1937-38 (the Roosevelt recession) the concern would have been with not allowing the debt-to-GDP ratio to grow.  Why? Does Bernanke know anything about a magical number above which the debt-to-GDP ratio has a negative impact on the economy?  Has he accepted the Rogoff-Reinhart view that beyond 90% we are doomed? The size of debt in domestic currency with respect to GDP is irrelevant, and shouldn't be a concern.

At any rate, it seems that between congressional Republicans and Obama fiscal stimulus is off the table (in fact, expect fiscal contraction), and monetary policy is wait and see with no radical measures.  So the economy will continue to stagnate.  As Christina Romer said we're "pretty darned f_cked!"

PS: I'll say more on Rogoff-Reinhart in another post.

Inequality monster

So Steve tells me I have competition in the art the department.  I think I lost.  Great graph by Jared Bernstein, ex-advisor to Joe Biden, and the only truly heterodox economist they had in the White House.  Sadly he is not there any more.

The only thing is that this graph shows only short term fluctuations in corporate profits. Pretty cool anyway.

C'mon, Paul, you can get there!

Professor Krugman seems to be undergoing an (structuralist?) epiphany. Or at least admitting it in public.

What am I talking about? My perception of his movement toward recognizing macro foundations as the driving force in reality and any model that presumes to approximate it.

Evidence?

This piece, in which he says "pah...all that micro trade theory doesn't have anything to do with reality." He doesn't really say that, I am imputing that. Here's what he did say "The case for free trade is about microeconomics, about raising efficiency. There’s no particular reason to think that trade liberalization is good for fixing problems of inadequate demand."

And this piece, (which I promise to find) in which he admits to becoming increasingly interested in macro somewhere in the 90's.

And he's almost there...,almost as in this piece, where he, among others, takes Barro to task for his ridiculous labeling of micro as "regular economics," implying that, well, read the piece.

So, Paul, keep going, you are on the road to the promised land. We're really happy that you got your Nobel for micro trade theory...that wonderful event appears to have freed you to follow the path of truth. Now just take the final step and follow Vernengo et al. into explaining microeconomics using macro foundations.

The meaning of structuralist macroeconomics

Semester started again.  Teaching Intermediate Macroeconomics, and trying to explain to students what is the meaning of structuralist macroeconomics.  The origins of the term are well known, and associated to the development of the theory of inflation by Juan Noyola Vázquez, and other economists at the Economic Commission for Latin America (ECLA). Development implies changes in the structure of production, with an increase of the industrial and service sectors, and a reduction of the agricultural sector, accompanied by significant increases in the levels of labor productivity in all sectors.

As the agricultural sector's size decreases, and its productivity increases, and workers migrate from rural to urban areas, the price of foodstuff goes up, and wage resistance by workers implies that costs increase in general.  In other words, inflation resulted from the transformation of the structure of production.  Hence, the term structuralism, that at the same time, in 1950s, was being popularized by Claude Levi Strauss. Structuralism in Latin America was, as a result, a response to Monetarist views of inflation, and seemed to be aligned with Keynesian economics.

However, there is a more profound meaning to structuralism.  Levi Strauss argued that science proceeds in two ways; it is reductionist when the object of analysis is simple, and it is structuralist when it deals with complex systems.  I tend to believe that a more productive understanding of social sciences should not distinguish between simple and complex phenomena, but emphasize the difference between methodological individualism and structuralism, that is, the presumption that one cannot understand social behavior unless one understands individual behavior, and the counter-argument that individual behavior is by definition constrained by social relations.

In that sense, classical authors (surplus approach), that emphasized the role of class as a central determinant of individual behavior, and Keynes, whose belief in the fallacy of composition implied that the whole is more than the aggregation of its parts, would be structuralists.  For example, it might seem reasonable to assume that an individual worker would accept to work for a lower wage in order to find a job, but if lower wages in the whole system lead to lower demand and a reduction in labor demand, the individual firm reducing wages, and the individual worker accepting it may not solve the problem. One has to understand the functioning of the system as whole first, in order to understand how the individual parts interact.  Or put it simply one needs macro-foundations for microeconomic behavior, not the other way round.

PS: The classic book on macroeconomic structuralism in the anglo-saxon world is Lance Taylor's one (image above).  A simple intro to structuralism in Spanish and Portuguese was the book by Carlos Lessa and Antônio Barros de Castro, the latter sadly passed away last Sunday.

One graph is worth...

The graph below shows the relation between the percentage change in hourly wages across all sectors of the economy in local currency adjusted for inflation and real GDP growth between 2003 and 2011 (last year is obviously a forecast), using data from the Economic Intelligence Unit (EIU, access is restricted).

Even if one does not completely trust the data on real wage growth in China and India, or the relevance of real wages (considering the size of informal markets) in developing countries when compared to the developed countries closer to the axis like France, Germany, Japan and the US. But clearly one way out of the crisis is to redistribute income, and promote a healthier increase of real wages and domestic demand.

Heinz Kurz on the state of the dismal science

Here is a very important paper, by Kurz, published in Investigación Económica (see previous post).  He shares a similar view of what it means to be a heterodox economist with this blogger, and argues that:

"Economics may be a dismal science or discipline, but its present dismal state applies not to the discipline as a whole or to all traditions of economic thought available. It applies to the neoclassical mainstream and especially to NCE [New Classical Economics]."

It is the notion of an economic system that automatically tends to full employment that makes ours a dismal science, but that is NOT a general, even if it is dominant, view in the profession.

Investigación Económica at 70

Investigación Económica, a journal that has become the most important in México, is turning 70, and Ignacio Perrotini, the editor, is organizing a very interesting conference (disclosure, I'm in the board, and will be at the conference). Jesús Silva Herzog was the founder, and while he cannot be considered a structuralist, it is clear that he was very open to publish the authors that would become central for that school of thought in Latin America, like Juan Noyola Vázquez, the father of the structuralist theory of inflation, Hans Singer, of Prebisch-Singer fame, and Celso Furtado, a central figure in early structuralism and the Economic Commission for Latin America (ECLA) when Prebisch was the Executive Secretary. IE published original and translated articles of the main heterodox economists over the years, and now that it is bilingual it has become a central outlet for high quality heterodox research.  So if you cannot go to the conference, you can check the various issues in the link above.

PS: A partial list of the conference participants includes Amitava Dutt, Anthony Thirlwall, Carlo Panico, Guadalupe Mántey, Tom Palley and Jaime Ros among others.

More fiscal stimulus or an Infrastructure bank?

In a recent LATimes op-ed Jamie Galbraith says that:

Federal budget deficits in this situation are like IV-bags in an emergency room: they stabilize things. IV's are definitely linked to sickness, and no one would use them if they weren't necessary. But very few doctors propose to cut back on saline while the patient is still sick. Today, however, the official economists and their followers in Congress, the White House and the media are divided between those who would remove the IV's slowly, whether the patient recovers or not, and those who'd like to charge through the wards, yanking needles from arms. The debt deal enacted earlier this month put the first group in charge, but that's pretty cold comfort.

The solution is not another "stimulus" — a term that stinks of needles and quick fixes. The solution has to be a long-term strategy: both a new direction for economic activity and new institutions to provide the money. The proposed national infrastructure bank — a permanent institution — is the right sort of thing and would be a good place to start.

Both the IV analogy, and the need for a radical departure from conventional solutions are right on the money.  I would add, however, that we do not need to wait for the infrastructure bank, since the Fed can and should do it.  As Jerry Epstein (2006) has shown, in the past central banks have provided subsidized credit for industrial activities, and have acted as agents of development.  So rather than wait for institutional innovation, current institutions can be put to work immediately.

On investment and taxes

To follow up on Matias' last post, with all of this talk about taxes and job creators, it is worth thinking through the effects of taxes on the decision by firm to invest in new plant and equipment (thus creating jobs). Thinking through the baseline scenario, it is not immediately obvious why a capital gains tax (or even a profits tax) would discourage investment. The investor (firm) only gets taxed on gains (profit) so unless the tax is 100 per cent, they still make money. It would be hard to find a successful businessman who chooses not to make money! Of course, other costs may imply that the world is a little more complicated.

In addition, it is well known in the empirical literature on investment that the decision by to firms to expand productive capacity is quite insensitive to the cost of capital and quite sensitive to current and expected demand for the firm's output. Taxes, along with interest rates, the price of equipment, and other items form the total cost of capital. Thus, taxes are a (small) component of a group of costs that really don't matter!

Not only that, but if the taxes are on capital gains, they matter even less! In general, firms finance investment out of retained earnings first, loans second, and issuing new equity third. That is, the stock market is the last resort in paying for new plant and equipment. This is because issuing new shares may dilute the value of existing shares, and may signal to markets that the firm doesn't have the ability to finance investment out of profits and can't get a loan. So firms are particularly insensitive to stock markets! This suggests the very often, the stock market is but a sides show - a very large casino that has little to do with productive investment.

Finally, if it is the case that investment is pretty I insensitive to taxes (particularly those on capital gains) and the tax revenues are spent on the output firms (perhaps via unemployment insurance or welfare payments), we may have a large "balanced budget multiplier." In other words, we end up taking savers and transferring it to spenders, thus encouraging economic expansion. It is then likely the case that taxing the "job creators" actually creates jobs!

Warren Buffett on job creators

According to the GOP, and their economists, you cannot tax the rich (sorry job creators), because that would have a negative impact on employment.  Warren Buffett (a very job creating guy) thinks differently.  He says:

"Back in the 1980s and 1990s, tax rates for the rich were far higher, and my percentage rate was in the middle of the pack. According to a theory I sometimes hear, I should have thrown a fit and refused to invest because of the elevated tax rates on capital gains and dividends.

I didn’t refuse, nor did others. I have worked with investors for 60 years and I have yet to see anyone — not even when capital gains rates were 39.9 percent in 1976-77 — shy away from a sensible investment because of the tax rate on the potential gain. People invest to make money, and potential taxes have never scared them off. And to those who argue that higher rates hurt job creation, I would note that a net of nearly 40 million jobs were added between 1980 and 2000. You know what’s happened since then: lower tax rates and far lower job creation."

Of course this involves actual evidence, which is irrelevant for the discussion about economic policy with Republicans these days.  In their view, Warren Buffett is a job creation denier.

Krugman believes the US economy is wage-led

This is one thing that Krugman got right, and several heterodox economists did not.  In his critique of the myth of an economic miracle in Texas, he notes that:

"at a national level lower wages would almost certainly lead to fewer jobs — because they would leave working Americans even less able to cope with the overhang of debt left behind by the housing bubble, an overhang that is at the heart of our economic problem."

Which by the way, also means that soaking the rich, because they are job creators, makes a lot of economic sense.  It should be no surprise that jobless recoveries became common in the period in which real wages have stagnated!