Inflation

More and more we are hearing experts worry about rising inflation. This worry is new for several reasons but the best one is the data. Since the recession ended in 2009, the inflation rate as measured by the percentage change in the consumer price index has averaged less than 2% per year. 

Some of you remember the extreme inflations of the 1970s but this recent bout of disinflation is extreme even in regards to recent decades. Inflation is clearly on a downward long term trend. And like a boxer on the canvas, we can't call inflation out until the count of 10. Economists for the first time in quite a while -- are wondering if inflation is ready to come back. 

And that's where the stories get interesting. Inflation is one of those household words that we interface with all the time. Fruit prices are up -- housing prices are up -- wages are climbing -- productivity is falling -- the money supply is increasing -- government is spending more -- the list goes on and on. The list of causal suspects is so large that it is overwhelming. What really explains or causes sustained or durable inflation? Is there no simple or more simple way to think about it? Why are some experts ready to see it rise and become worrisome again?

The main source of their concern comes from economic recovery. We have a simple theory that says that prices respond to imbalances between demand and supply. Too much supply and prices go down. Too much demand and prices go up. During a recession the inflation rate often falls because demand is insufficient to buy all the goods and services produced. Whether demand is low because people have meagre resources or is low because government limits what they can buy, the outcome is the same -- demand is low and so is inflation. 

It makes sense that if experts believe that Covid is going to improve and if experts believe that buyers will start buying more -- then they believe that an economic recovery could be in our near future. Firms seeing demand snapping back will be more optimistic and will have more confidence that higher prices will stick. Some experts point out that regulations that made it difficult to buy have caused households to save a lot -- and when the economy improves they will want to convert those savings into cars, clothing, and who knows what else. 

Makes sense to me. But there remains one big question. When I used to teach in a classroom, I would refer to the slope of the supply curve. When the demand curve shifts rightward along a given supply curve, what happens to output and prices depends on the slope of the supply curve. Or in more common language -- a flat supply curve translates higher demand into a lot more output and not much price change. But a very vertical supply curve translates more buying into price increases. 

Why would a supply curve be vertical? 

Vertical means that firms simply cannot or will not increase output when demand increases. Today, firms have plenty of workers and equipment laying around. So a deficiency of inputs is not the problem. The problem is expectations. Why hire a bunch of workers or light up your plant if you are not pretty sure that the increase in demand will keep up? Why go to all the trouble to meet an increase in demand if you don't think you will make profits doing so? It would be much easier to raise prices for a while to see how things pan out. 

Why would firms be worried about future demand and profits? Probably for many reasons. Perhaps they are skeptical about the longer term effects of very unique and  risky recent government policies. Huge government deficits and endless zero interest rates might be cause for concern. Politics of regulation might enter into the equation as well. Raising the minimum wage often affects the whole structure of wages as everyone gets a bump. Higher wages might sound good for spending but it raises costs and reduces profit incentives for suppliers. 

We don't need to repeat every policy the Biden administration is contemplating to reduce the supply of energy and bring on renewables.  And I think it goes without saying that whether it is healthcare or education -- the Biden administration's emphasis on equity is bound to lead to concerns about business costs and profitability. 

Is inflation going to worsen? Probably so. It seems to me that policy is tilting the nation's supply curve in a vertical direction. As policy incentivizes buying yet penalizes selling, the outcome is likely to be less in the way of increased output and employment and more along the lines of higher prices. 

We are living through quite an economic experiment. The ride should be interesting. 

Full Employment and Recessions

In the past week, we have heard over and over from several politicians that it is wasteful to not attack unemployment. Unemployment is not only bad for the usual and obvious reasons, but now we are learning that if we do not attack unemployment quickly, its negatives will ossify. Long term structural damage will be the result of moving too slowly. They argue that we must move quickly to full employment.

How can one argue with laxity when it comes to unemployment? You don't have to know someone enduring the hardships of unemployment to see how devastating that condition can be. Loss of income. Loss of pride. The list of negatives is too long to list here. 

One can argue how to best reduce unemployment. I have a friend recovering from surgery. I wish she could get rid of that cast and go dancing tonight. Even if we could remove the cast and go dancing in her kitchen (it is Covid you know), it wouldn't be a good idea. It is going to take time for her foot to heal. I am trying to learn to speak Spanish. I'd love to speak Spanish to others. But I am definitely not ready for that yet either. 

Things take time. And while our politicians might have good hearts when it comes to the unemployed, I wish they also had good brains too. Unemployment has always been referred to as a lagging indicator. Those words mean that the unemployment rate lags the economy. When the economy recovers, it takes a while before employment catches up. There are lots of reasons for that. But the primary one is uncertainty. 

Imagine going through a recession. Your firm had to cut back output and it had to lay off workers. Profits became losses. Not a good time for anyone. Then the economy starts to recover.  More people are buying your goods. Many firms react cautiously. Is the recession REALLY over? Let's wait and see before we start making big investments -- let's wait before we start hiring a lot of employees. If the recovery is a flash in the pan, you don't want to have to reverse all those decisions. For the time being we have plenty of inventories to satisfy the new demands. 

In a nutshell -- unemployment is a lagging indicator. 

In the 2008-9 recession, employment dropped from 137.7 million to 129.9. It took 5 years (2014) for employment to return to 137.7. 

Now let's look at the graph below. I won't discuss every recession (indicated by vertical bars)  but notice the lagging unemployment rate. You see the lag, but first notice the unemployment rate at the beginning of a recession. For example, before the 1975 recession the unemployment rate was around 5%. After rising considerably after that, it came down but never got back to 5% even by 1980. 

Before the 1990 recession the unemployment rate was around 5%. It took until well after 1995 to return to something near 5%. 

Again, before the 2007 recession the unemployment rate was around 5%. It was after 2015 before it got back to that range. 

Stand back and look at the map. Since 1972, how many times did the unemployment rate fall below 6%? 5%? Not many.

Is "full employment" a realistic target? 

Look at the chart another way. Look at those nice time periods in which we did get the unemployment rate down. How long did that phase last? And then what happened? 

Reminds me of dieting. It is one thing to have a sensible diet. It is another thing to try to fit into those jeans you wore in high school. So your diet works and you fit into them one more time and then what? Soon you are back to wearing that mumu.

In February 2020, employment was 152.4 million. It fell to 130.3 million. As of December, it rebounded to 142.6. It ain't back to 152.4 yet -- but it's only been one year!

Why and how do today's anxious politicians today think they are going to use a huge stimulus to move us quickly back to unemployment nirvana? Do they plan to continue raising the national debt and keeping interest rates at zero for years? If so, how many years? If they overdo the stimulus, then what? If my friend tries to walk too much on her healing foot, then what? I think we know the answer to both questions. 

NYT Silliness

The New York Times ran a lead article a couple weeks ago -- by David Leonard -- Why Has the US Economy fared so much better under Democratic presidents than Republicans?

https://mail.google.com/mail/u/0/?pli=1#inbox/FMfcgxwLsJzngqwGrpwmjTxfQWSXkmhV

What a piece of junk. I realize that the NYT has a job to support all liberal/progressive causes unflinchingly, but this article has to be the biggest pile of dogdo (no insult intended to dogs) that I have seen from a so-called respectable newspaper. 

I wish I had better skills to reproduce or copy the tables from the original source but alas I can't. So please stick with me. 

Background. Mr. Leonard wants to compare the economic records of Presidents. So he takes time periods with D presidents and compares them with those of R presidents. 

In his first table, he shows that during Democrat presidents, job growth averaged 2.8% per year but only 1% per year with R presidents. With respect to GDP growth, Rs could produce only 2.4% growth compared to D's 4.6%. Sounds pretty damning. 

Read on...

The second Leonard table is a bar chart showing average GDP growth by president -- starting with Roosevelt at the top (more than 8% per year) and going to Trump at the bottom (about 1%) The bars are arranged in order of GDP growth. 

The order of Presidents by size of GDP growth: Roosevelt, Kennedy, Johnson, Clinton, Reagan, Carter, Ford, Nixon, Eisenhower, Obama, GHW Bush, Truman, GW Bush, and Trump. 

14 presidents. First, point. Do we have enough observations to make a conclusion? I don't think so. So this is not good stats. 

Second point. We know that what a president can accomplish depends on the make-up of Congress. How did that factor into the results? 

We also know that what a president can accomplish depends on stuff going on at the time. Did he take over after a recession? Was he a president during a war? After a global pandemic? Apparently none of that matters to the NYT. According to the NYT the important thing that matters for unemployment and output is the party of the president. 

What else to say?

If Ds are so good then why are Truman and Obama in the bottom 5 of 14. 

If the Rs were so bad, then why were Reagan, Ford, Nixon, and Eisenhower in the top half? 

What else was going to on to color the economy? Maybe Carter had strong growth -- but do you recall stagflation? Would you characterize his years as president as a great economic success? I doubt many people think of him as a great president. 

When Reagan had to stomp out inflation fires after Carter, isn't it amazing that he managed such strong growth during his time in office?

Is there something weird about the fact that the highest economic growth rates came from Presidents who were in office more than half a century ago? Maybe it wasn't so much the party of the President -- but the times they were in office?

Deciding how presidential party affects the economy is not a simple thing. The NYT owes it to its readers to not print rubbish. Of course, I guess rubbish is okay so long as it supports their causes. 

I don't subscribe to the NYT so I was not privy to the full article. But I did find this juicy NYT quote which apparently explains it all - Ds are smart and caring and Rs are not. 

I quote, "Democrats have been more willing to heed economic and historical lessons about what policies actually strengthen the economy, while Republicans have often clung to theories that they want to believe — like the supposedly magical power of tax cuts and deregulation." Democrats, in short, have been more pragmatic."

So there we have it. I am so glad we have a D for president for the next four years -- life will be splendid. We will have mature people running our government. No clinging to stupid theories. We won't have any silly tax cuts or deregulation of industry. 

There is a mature and technical literature around this topic. One good example of a real approach to this difficult question can be found at https://www.princeton.edu/~mwatson/papers/Presidents_Blinder_Watson_Nov2013.pdf

My wonderful colleagues, Fratianni and von Hagen, and I wrote our piece on this topic a while back.  "Testing for Political Business Cycles," Journal of Policy Modeling,  (spring, 1990).  pp. 35-59. 

The NYT apparently doesn't bother researching real work on their topics. 

Staying the Course

In a recent Wall Street Journal piece*, Jason Furman strongly advised President Biden and his economic team to “Stay the Course.”

Staying the course usually means sticking to a policy. If you decided to start a diet with no barbecue ribs – staying the course means you don’t eat any barbecue ribs. I am not sure what it means for Biden to stay the course. He has only been in office for a short time. He has no course. Should he continue Trump’s policies? Should he continue Obama’s? Or should he continue FDR’s course?

Anyway, Furman doesn’t really mean stay the course. What he means is that Biden should not stay any particular course. When it rains, Biden should wear a rain suit. When it snows, he should don his best parka and winter boots. When the sun shines, he should wear cool aviator’s sunglasses.

This sounds logical and easy and cool. Especially the sunglasses part. But wait, we learned in econ the difference between ex ante and ex post. Ex post we know if it is raining, or snowing, or sunny. But ex ante is where it is all at. Suppose you don’t trust the weather lady and you have to decide what to wear before you actually know for sure what the weather will be?

Now, all of a sudden, this is no longer a trivial decision. What do you wear if you are not sure of the weather?

What’s this got to do with Furman? Furman says Biden should keep the stimulus accelerator down as long as the economy needs it. Then when the economy clearly does not need the stimulus, take his foot off the gas pedal. Sounds cool.

But wait. Our problem/challenge is not about the economy in the past. It is about the future. Today's policy can't change the past. Policy always takes time to have impacts. You put in a policy today to ward off the evils of tomorrow. Just like farmers who plant in the spring, you don’t harvest until later. 

If the future is easily knowable, this is all trivial and meaningless. But farmers don’t know how cold and rainy the coming spring will be. And Biden does not know how weak or strong the economy will be in the next six months. Maybe the last zillion dollars of stimulus will kick in. Maybe it won't. 

We don’t know the course of the future economy? No … we don’t! Would Jason Furman please show me the models he uses that predict the future of the US economy?

Will he also look into history and show me that similar stimulus programs did not backfire? I think he is old enough to have experienced or at least learned what happened to the US economy in 1969 and then again in 1979.

Larry. Silly boy. That was so long ago! This same thing has happened since but these two examples are too beautiful to forget. These two examples defined a new term – Stagflation. Stagflation was a terrible time period in which both unemployment and inflation soared.

You do not want to live through time periods when inflation makes goods too expensive to buy and unemployment prevents you from finding work and income. No government would ever purposely visit its people with stagflation!

So why did they do that? Not because they planned it. They did it because, just like Furman, they cannot forecast the future. They don’t know when the economy no longer needs stimulus and thus, they don’t know when to back off the accelerator. Waiting too long to remove the stimulus is like waiting too long to tend to a broken leg. You have to do it in a timely fashion or you create an even bigger problem.

Waiting too long to remove stimulus causes inflation and unemployment to rise. That is called a No-Win situation. Why? Because once you have twin problems in the economy, the traditional macro tools no longer work. If you attack high unemployment you make inflation worse. If you attack high inflation, you make unemployment worse. 

So Mr. Furman,  Ms Yellen, and Mr. Biden. Please do not try to fine-tune the economy like you would fine-tune your radio. Your dials might move you from one station to the next -- but there are no dials for the economy. Pretending that there are will get you nothing but static. I lived through the 1970s once. Please don't put us through that again. I especially didn't like the leisure suits and bell-bottom jeans. Great advice: Don't wear a bell bottom if you have one!

Real GDP 2020

Two weeks ago, we looked at changes in employment by sector in 2020. This week we continue looking at sectoral change, this time using GDP statistics. Real Gross Domestic Product measures output. GDP starts with sales figures and then the price change is statistically removed so that what is left is output.

The numbers found in the table below show dollars of output. For example, real GDP went from $19.1 trillion* in Q3 2019 to $18.6 trillion in Q3 2020. This $545 billion reduction is independent of whatever price changes might have occurred*. It reflects only the quantity of goods and services produced. In Q3 2020 we got a smaller pile of goods and services than we got in Q3 of 2019. We say output fell.   

It is traditional to present real GDP figures in terms of the destination of the goods -- the buyers. Most students taking macroeconomics courses learn the equation for real GDP:

            

            Real GDP = C + I + G+ NX 

Where C represents Personal consumption expenditures (PCE) -- the output of goods and services that mostly went to consumers; I is Gross Private Domestic Investment (GPDI) which mostly goes to business firms for capital goods and to people who buy new houses; G is government purchases of goods and services; and NX measures the difference between goods and services exports and imports to foreign countries. 

The top of the table shows these summary categories. The parts of the table below the top break each of the main categories into output changes for very specific segments of each of the main categories. Since these breakdowns differ from the sectors presented last week for employment, we learn a little more about recent sectoral impacts this week.  

Let's start with the broader categories to describe most of 2020. The top line reports that real GDP fell by 2.8% from Q3 2019 to Q3 2020. Of the major categories, only 1 showed an increase in output over that year -- the government bought 3.6% more goods and services during that year. You see a 7.2% increase for net exports but that plus sign is misleading. I will say more about that below. Outputs bought by consumers and firms, in contrast, declined. GPDI fell by 3.4% and PCE by 2.8%. A quick summary would be to say that private (not government) domestic purchases declined in 2020. 

The PCE story is interesting. Overall it fell by 2.8% but notice that consumers kept on buying goods (+$347.2 billion) while they quit buying services (-$622 billion). All but one of the categories of goods, from motor vehicles (+7.3%) to food and beverages (+6.4%), increased. Gasoline and Other energy goods was the only main category of goods spending to show a decline (-9.9%).  PCE fell because of a reduction in the purchases of services. Recreation services (-34.3%) and Transportation Services (-24.1%) led the sectors downward. 

Gross Private Domestic Investment has three key parts: Non-residential investment, residential investment and inventory change. Thus we explain the $116 billion reduction in GPDI by those three categories. Of those three, Non-residential investment was the main negative component -- falling by about $125 billion. That was driven by reduced business spending on structures, equipment, and transportation equipment. Businesses did buy more information processing equipment (+$65.3 billion). 

The main positive part of GPDI in 2020 was residential construction -- or the building of new houses. That rose by almost $44 billion or 7.2% in 2020. 

The negative almost $48 billion showed that inventories fell in 2020. That negative number, therefore, is a positive sign that sales were higher than input. But since those were goods produced in an earlier time period, those sales actually subtract from output in 2020.

That leaves us with net exports -- a measure of international trade. While the US exported $950 billion of goods and services to the world during 2020, we also imported a little more than $1 trillion from the world. Thus we say we had a trade deficit in goods and services. Notice that both exports and imports declined in 2020. So we say that trade was lower. But since exports fell more than imports -- the trade deficit got bigger -- the negative number became even more negative. 

Finally is government spending on goods and services. Here we see vividly the impact of the power to print money. We see that a recession prevents state and local governments from spending more while the Federal government finds it possible to spend without increased tax revenues. The latter is not constrained legally from having gaping budgetary holes. And they can fund those holes by creating money. In the past year we saw state and local government spending falling by $35 billion while Federal government spending increased by almost $47 billion. 

* We can value output in terms of dollars and cents by using the prices that existed before the output changes. Thus the dollars and cents number only reflects the changes in output and NOT changes in prices. 

 

Source: bea.gov	2019	2020	$	%
Table	Q3	Q3	CHG	CHG
Part 1. Summary	billions	billions	billions
Gross domestic product (GDP)	19,141.7	18,596.5	-545.2	-2.8
Personal consumption expen.	13,301.3	12,924.7	-376.6	-2.8
Gross private domestic investment	3,445.7	3,329.6	-116.1	-3.4
Federal government spending	1,288.5	1,335.1	46.6	3.6
State and local government spending	2,028.3	1,993.1	-35.2	-1.7
Net Exports	-950.2	-1,019.0	-68.8	7.2
Part 2. Details
Personal consumption expen.	13,301.3	12,924.7	-376.6	-2.8
Goods	4,805.2	5,152.4	347.2	7.2
Durable goods	1,797.8	2,028.2	230.4	12.8
Motor vehicles and parts	535.1	574.1	39.0	7.3
Furnishings and durable household equipment	414.4	460.9	46.5	11.2
Recreational goods and vehicles	605.9	748.5	142.6	23.5
Other durable goods	263.5	284.0	20.5	7.8
Nondurable goods	3,023.9	3,154.5	130.6	4.3
Food and beverages purchased for off-premises consumption	991.6	1,055.0	63.4	6.4
Clothing and footwear	412.2	412.5	0.3	0.1
Gasoline and other energy goods	444.8	400.7	-44.1	-9.9
Other nondurable goods	1,156.5	1,249.5	93.0	8.0
Services	8,541.5	7,919.6	-621.9	-7.3
Household consumption expenditures (for services)	8,188.4	7,525.1	-663.3	-8.1
Housing and utilities	2,199.5	2,224.5	25.0	1.1
Health care	2,234.0	2,095.2	-138.8	-6.2
Transportation services	447.4	339.8	-107.6	-24.1
Recreation services	502.6	330.3	-172.3	-34.3
Food services and accommodations	847.1	680.1	-167.0	-19.7
Financial services and insurance	858.2	871.8	13.6	1.6
Other services	1,118.2	967.4	-150.8	-13.5
Gross private domestic investment	3,445.7	3,329.6	-116.1	-3.4
Fixed investment	3,378.9	3,314.7	-64.2	-1.9
Nonresidential	2,783.9	2,659.0	-124.9	-4.5
Structures	552.6	464.7	-87.9	-15.9
Equipment	1,263.3	1,230.1	-33.2	-2.6
Information processing equipment	494.3	559.6	65.3	13.2
Industrial equipment	251.4	236.1	-15.3	-6.1
Transportation equipment	277.1	220.2	-56.9	-20.5
Other equipment	252.2	247.0	-5.2	-2.1
Intellectual property products	974.0	981.1	7.1	0.7
Software	452.9	476.4	23.5	5.2
Research and development	442.7	439.5	-3.2	-0.7
Entertainment, literary, and artistic originals	83.9	74.5	-9.4	-11.2
Residential	601.9	645.5	43.6	7.2
Change in private inventories	44.0	-3.7	-47.7	-108.4
Net exports of goods and services	-950.2	-1,019.0	-68.8	7.2
Exports	2,536.6	2,166.5	-370.1	-14.6
Goods	1,775.8	1,610.5	-165.3	-9.3
Services	764.4	581.3	-183.1	-24.0
Imports	3,486.8	3,185.5	-301.3	-8.6
Goods	2,944.4	2,827.3	-117.1	-4.0
Services	545.2	393.3	-151.9	-27.9
Government consumption expenditures and gross investment	3,317.7	3,327.2	9.5	0.3
Federal	1,288.5	1,335.1	46.6	3.6
State and local	2,028.3	1,993.1	-35.2	-1.7

*These quarterly numbers have bee annualized.