Time to Whip Up a Little Voodoo?

Last week I mentioned supply-side economics as one solution to the tradeoff between inflation and unemployment. I promised to say more about supply-side policy this week.

If your memory is as bad as mine, it won't hurt either of us to review a bit here. Thanks to a guy named John Maynard Keynes and a Paul Krugman band of Keynesians, the dominant view of the economy focuses on spending or what we often refer to as demand for goods and services. The essence of demand-side macroeconomics is that policymakers can attack only one problem at a time. 

If they want to reduce the unemployment rate, they use demand-side (AD) policy to ramp up spending. If they want to reduce the inflation rate, they do the opposite. Last week I lamented the situation when both inflation and unemployment are too high. What can the policymaker do then? Attacking inflation with AD policy makes inflation worse. Trying to reduce unemployment makes inflation worse.  

What a dilemma! Talk about being between a rock and a hard place. Last week I offered supply-side (AS) economic policy as a way out of this dilemma. Today I have to back up and explain my point. 

Let's start with the criticism of supply-side economics. Famous economists labelled it "Voodoo Economics". You have to admit, that's pretty bad. Can you imagine the President telling the voters that he is going to use Voodoo Economics to solve our problems? 

Why call it Voodoo? Maybe snake oil would be better? No matter what you call it, the communication is that there is no theory or no history to support the notion of a policy that radically differs from the usual AD policy. If it ain't D it ain't nothing. We know D. It might not be perfect but we know it.

So what's the big difference? The difference stems from an understanding of basic economics. Basic economics posits that we can explain price and quantity sold with a simple model that focuses on supply and demand. Think of two very different situations.

    If everyone wants more candy and we express that by going to stores and buying more candy, this is the kind of situation that could lead to a shortage and eventually a rise in prices and output. 

    If instead the key change is that firms decide that this March is a wonderful time to supply more candy to stores, then we might have a glut of candy and an ensuing drop in price and increase in quantity sold. 

Clearly, economics says that a rise in supply has effects that are very different from a rise in demand. 

Back to macro. From the beginning of macroeconomic thinking we thought of AD as the driver of the economy. Then someone came along and started talking about AS. Wow. Crazy. But why not? If we can speak about supply in microeconomic markets, why can't we use the same ideas in macro?

There's not a lot more to say. If the current situation of the economy is high inflation AND high unemployment, AD policy is not ideal. The tradeoffs can be very painful. Why not try AS policy? Why not have a policy designed to encourage and motivate firms to produce more? If that policy works, then we will observe firms bringing more output of goods and services to the marketplace. The glut should heal the rising inflation rate while simultaneously reducing unemployment. No tradeoff there!

How do we do this magic? We focus on the AS curve. Two basic forces will increase AS -- lower business costs and higher business productivity. With that logical basis we focus our policy tools away from trying to get people to spend more and instead focus on ways to use policy tools to limit business costs and raise business productivity. 

What are business costs? Easy -- the wage rate, taxes on labor, the cost of capital which include prices of plant and equipment, costs imposed by government regulations, and other costs incurred by companies.

What is business productivity? Business productivity rises when a firm does anything that makes it possible to produce more output with the same amount of inputs. Giving workers better machines could do that. So could better training.  Better business practices would have the same effects.  

Notice the stark difference between AD and AS policy. AS policy might be less well known but in times when AD policy is hampered by tradeoffs, it might not be a bad time to whip up a little Voodoo. 

Recession or Inflation?

On Match 15 I was doing my usual thing. I was reading the Wall Street Journal online and perusing the New York Times free online summary. No, I will not pay for a full subscription to the NYT. That would be like me ordering Bananas Foster when I am allergic to bananas. 

Anyway, I loved the stark contrast. While I could not read Paul Krugman's whole article in the NYT, its title was enough to send the message  -- "We can avoid a Putin recession in the U.S. — if the Federal Reserve doesn't overreact to rising oil prices." Got it? The Fed should not be worried about rising oil prices. It should not cause a recession. It should not tighten monetary policy.

Meanwhile, the WSJ was writing the opposite. "Let's Start Raising Interest Rates" was the title their article. I was able to read that article. 

It is worth writing about this here since this is a classic battle between left and right macroeconomics. The right wants to put out inflation flames. The left worries more about a recession. 

If you know me at all, you know that I side with the righties. I think history is on my side but let's go through this one more time. Krugman is right on one score. Monetary or macro policy is not effective against rising  prices of one or even a few commodities. Macroeconomics teaches the difference between problems that start from microeconomic sources and those that are macro. 

If prices of cigars rise, this is because there is an imbalance between the supply and demand for cigars. We don't bother monetary policy about that. Using monetary policy to attack the price increases of cigars or energy, might be effective but it is overkill. 

So Krugman is right when he says monetary policy is not the best tool to fight energy prices. But as usual, Paul Krugman can be right about one thing but wrong about the right thing. Krugman's past reveals that his real passion is about unemployment rising in a recession. He loves using inflation as his cover, but that's just a game. Ask Paul Krugman. He is more concerned about unemployment. That's his goal. 

But that is exactly the problem. How can one argue about reducing the misery caused by high and rising unemployment? Anyone who ever had a heart (isn't that the words to a song?) has to care and do something about unemployment. No argument there. 

The issue is what to do about a recession and rising unemployment -- especially during a time period when inflation is rising. Yikes -- two problems -- rising inflation AND rising unemployment! 

That's the quagmire. Its a deep quagmire because the usual tools of macroeconomic policy will improve one at the expense of the other. Krugman wants lower unemployment. Good man! But wait -- if we use monetary or fiscal policy to expand spending in the economy that will raise output and employment. Case closed. Nope. 

If there is already high and/or rising inflation and you use policy to expand spending even more, then it will make inflation go higher. Cool. Employment is higher and the cost you pay is higher inflation. 

That's bad enough since no one loves paying higher prices, but the story doesn't end there. Higher inflation and higher expected future inflation drive up wages and many other costs paid by companies. In other words, higher inflation will lead to conditions of lower profits and firms will cut back. They will cut back on output and employment because conditions are poor for earning profits. Got it? Fighting unemployment means unemployment goes down and then it goes back up. Yikes. It's a policy boomerang. 

What did Krugman say about the boomerang in his recent article? Nada. He wants to help folks by expanding the economy and jobs. But what he doesn't say is that doing that in inflationary times just won't work. I won't bore you with the 1970s stagflations -- but history is there for you, me, and Paul to read. 

What do we do when inflation and unemployment are increasing at the same time? First, realize that the idiots running our national policy never should have got us into that place to begin with. Second, fight the inflation, tolerate rising unemployment, and then watch as both problems improve. Third, use something called supply-side policy. I am at my word limit so I won't open up the supply-side can of worms today. 

The Age of Information

Information, like technology and fried chicken, is loveable on the surface. When we read that we are in an age of information, we feel good and we feel proud. We feel modern and advanced and we feel smart. Information is valuable. Like the fried chicken, a big tub of information makes us feel like we have more command over our surroundings. It makes us smarter than our parents. It makes us more productive than those without so much information. 

I could go on. But my point today is that, like friend chicken, you can have too much of a good thing. And that includes too much information. I don't know about you but I shy away from picking up a newspaper, reading an online news source, listening to a radio news telecast or watching the TV news. Why? Because it is boring. It is boring not because of the color of the show or the beauty of the news purveyor. And the truth is that the stories are important. 

So what's the rub? The problem is that they don't know when the story is covered.  And they seem to want to drag out the same story for days if not months at a time. It's as if the press decided to cover a basketball game minute by minute. Imagine them writing a story on Monday that had the Seattle Superconics ahead 2-0 on a layup. And then they wrote an article on Tuesday when they went ahead by 4 points. Boring!

Think about the coverage you have seen lately. It doesn't matter if the topic was Covid or Russia or a missile launched by North Korea. Count the number of articles/stories that came out in the last two weeks about Russia and Ukraine. Could you really even count them? How many of those stories were identical? The first article might have been interesting and informative. But after thousands of similar articles,  I feel beat up by the process. 

I give them a break. I assume that the subsequent articles have something new or interesting or important. So I get sucked in. Read another one. But eventually I see that the story never changes. It is the same points and facts made over and over and over. What has really changed in the last weeks? Putin invaded Ukraine. Ukraine is a sovereign nation. People are dying in Ukraine. The world is unhappy and wants to do something about it. The same story over and over and over. 

What am I trying to change here? Do I want the government to throttle the press? Do I want the press to act responsibly and only print what is new? I don't think so. The marketplace ought to be able to handle this problem if other people feel as strongly as I do. A market can't know how to react responsibly to garbage information unless we start talking about it. Do other people feel the same way as me? 

It's not only that we are getting useless redundant information, Some news is being left out or crowded out by Russia and Covid. The press seems happy relaying another story about Russia or Putin or global warming when they could be writing more articles about the weather, low-rise jeans, suburban crime, Octogenarian sex, and the latest diet crazes. 

Inflation Ain't so Bad?

Happy Tuesday.

I try not to think about inflation too much. While it is painful to pay higher prices for many things at the store, we exaggerate the impacts when we read the announcements of the national figures. The Consumer Price Index* recently rose at a rate of 0.6% in the month of January 2022. If you measure the change over a whole year,  from January of 2021 to January of 2022, the inflation rate of the CPI was 7.5%. The rate was 6% over the year measured by the PCE deflator* which has smaller weights for highly volatile food and energy prices. 

The national inflation measures apply to a large random sample of people and what they are buying. If your buying habits are different from that group, then your personal inflation rate differs from the published one. If you are a smart, savvy shopper, you might do much better than the published indices. Energy and prices at the pump are clearly alarming. But do I really need to ride around alone in my large gas-hog SUV when I could trade it in on something that makes more sense when a gallon of gas costs as much as a gallon of Jack Daniels?   

Another thing is that you buy some things whose prices are not changing. For example, if you have a fixed rate mortgage, your mortgage payment does not go up when interest rates or housing prices rise. If you buy other things on a long-term contract, those prices don't rise either. That's another way of saying that your CPI doesn't rise as much as the nation's.

Finally, is the issue of dollars and cents. Suppose you spend $3,000 per month on things whose prices rise. At 2% inflation, prices go up by $60. At 6% inflation, prices go up by $180. The difference of $120 might seem high but maybe not. It is not welcome but it won't exactly crush you. 

One mitigating factor is how your income or your wages react to inflation. If you are able to negotiate a higher wage or if some of your income is automatically indexed to inflation, then the impact of the price change alone is less. If your income rises by 3% when prices are rising by 6%, your purchasing power falls by 3%. That's not appreciated, but a 3% reduction beats the 6% decline. 

That's my story about inflation. Inflation isn't nice but maybe it is not as horrible as it seems.

*The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. An alternative measure of national prices is the deflator for personal consumption expenditures. 

Inflation Scares

We have all heard that inflation is getting worse. The number being quoted measures changes in the CPI during 2022 -- from December of 2020 to December of 2021 the rate of change of prices was about 7.5%. That number makes heads spin. 

It has been decades since we have had inflation so high. In the year before -- 2019 to 2020 -- the inflation rate was 1.4%. Clearly in 2021 something was going on.

Most of the analysis I have seen is not very curious about these increases. My first notion was that maybe it all happened in one month. And it is true that the annualized inflation rate in one month was 10.1%. But that wasn't enough to make the whole year's rate of inflation go from 1.4% one year to 7.5% the next. 

So I was curious. If it had to do with Covid then maybe we had high inflation in most months. So I decided to look at all the months of 2021 to see what the data had to say.

    Jan/Feb averaged 5.8%

    March to June averaged 9.8%

    July to September was 3.8%

    October to December 6.5%

The highest months were March, April, May, June, and October. They ranged from 9% to 11%.

The rest of the months the inflation rate ranged from a low of 2.5% to a high of 6.6%. 

These numbers have already been adjusted for regular seasonal patterns. So we can't blame the differences on regular seasonal patterns. 

But it does make us wonder about 2021 and the future. The worst inflation of 2021 came from March to June. But that was followed by a quarter of much lower inflation. Inflation then increased in the final quarter of 2021 but did not reach previous highs. 

Maybe the worse is over. Maybe not. 

While this kind of analysis is not perfect and it proves nothing -- I enjoy doing it because the press and the government are so bad at breaking down the news. They would rather scare us with screaming about the worse inflation in decades than take a honest look at what the data says.