Relevant and even prescient commentary on news, politics and the economy.

Why do recessions occur?… One answer points to Productivity

Noah Smith made a thought-provoking statement on twitter, “Sometimes I wonder what actually causes recessions.” He received a slew of responses.

While one could point to many causes, including tight money and the beats of butterfly wings, I look primarily to the dynamics of productivity. Here is a graph of year-over-year productivity growth…

prod 34

You will see that productivity has a tendency to accelerate through the recessions. Productivity has a natural tendency to increase due to innovation. So why are recessions part of that process to higher productivity?

  • On the supply side… Some firms continue with lower productivity processes. They have contracts. They have market presence. They do not replace equipment that is less productive. So there is a force to push these firms to either increase productivity or get out of the way.
  • On the demand side… Effective demand constrains productivity. In the process of a business cycle, productivity gets limited by demand. In the sense that demand wears thin for increased production. Before many recessions, effective demand will expand allowing productivity to increase.

Recessions are a normal part of the cyclical growth process to push through the demand and supply constraints upon productivity. In the graph above, you will see productivity growth spurts after the recessions. Those are times when more productive firms can establish themselves more securely in the economy.

In China… Productivity has increased greatly there, right? Well, maybe… Productivity has slowed down greatly in China, and one could make a case that productivity is the most important problem in China. (link to WSJ article)

Eventually the less productive firms feel the increasing pressure from more productive firms.  There is a battle for market share and profits. Labor share normally rises, Inflation will rise. The economy will overheat in this battle for productivity. Nominal interest rates may rise to try to cool it down, but eventually the more productive firms gain advantage through the reshuffling process in a recession as profit rates become too vulnerable for the less productive firms.

Some recessions are better at supporting the advance of more productive firms. After the crisis, productivity had a nice quick growth spurt but then fell flat as less productive firms were protected within accommodative policies, most specifically monetary… and the stagnation of real wages.

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In the ‘Be careful what you wish for’ category …

Is it just me, or did Joni Ernst just effectively announce that she wants to kill farm subsidies?  Of course, how effectively she announced it will depend on whether her opponent, Bruce Braley, picks up this ball and runs with it.

Although maybe she’s talking about something else she thinks is pork.

Be careful what you wish for, Iowa voters.

This is the perfect opening for Braley to inform the public about the really dramatic reduction in federal spending in the last few years–and what, exactly, the effects are.  (Tuition at public universities; medical research; etc.  Y’know; all the stuff that Obama should point out, but doesn’t trouble himself to.)

And, speaking of out-of-the-mouths-of-babes admissions, this one is downright-comically jaw-dropping—and presumably will be mentioned in the soon-to-be-filed “cert” petitions to the Supreme Court in the slew of voter-ID/voter-access cases that have made headlines in the last month.

I mean … seriously … how dumb is Chris Christi?  I do suspect that by now most people know they shouldn’t buy the deed to that bridge he’s selling.  But just in case they didn’t know before ….

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The result of taxpayers’ financial bailout of GMAC

Linda Beale announced her return to blogging after the death of her husband here.   (Dan here…Welcome back to blogging Linda.)

by Linda Beale

The result of taxpayers’ financial bailout of GMAC

GMAC, as most of you likely know, was General Motors’ financial group.  GMAC had originated as a means for the auto company to support the market for autos through its wholly owned lending group.  But as with most corporate enterprises, it outgrew its origin, reaching near-collapse after becoming heavily involved in the residential mortgage securitization business and subprime loans.  It was transferred to a hedge fund in 2006, and ultimately required rescue by the government’s bailout program in the 2008 financial crisis.  Why was GMAC bailed out when other mortgage lenders were not?  The government wanted to save the auto lending business, so “auto czar” Steven Rattner says, the rescue of GMAC was necessary in that “the governmant had to act quickly and there wasn’t enough time to untangle GMAC’s mortgage unit from the auto lending business.” U.S. Taxpayers Earn Profit on Ally, as Treasury Cuts Stake, Wall St. J., Oct. 21, 2014 at C4.

GM, of course, ultimately established a new financial arm related to its auto business, and that company has acquired some of the GMAC’s successor’s businesses around the globe.  See, e.g., GM Financial to Benefit from Wall Street Upgrade, Sept 24, 2014.

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About that “State and local governments are closer to the people” thing …

Indeed, they are; state and local governments are closer to the people.  It’s just that the people they’re closer to probably aren’t, well … you.

So, here’s a question: Why isn’t, say, Kay Hagan, who’s running against the North Carolina Senate Majority Leader, or Charlie Crist, who’s running against Florida governor Rick Scott, um, mentioning this in their campaigns?

Beats me, although it may actually be that they don’t know about this, since apparently the news media in these states and the other six that have enacted similar laws hasn’t bothered to report it.

It’s part of what I now think of as vacuum-packed politics, in which only the Republicans ever say anything, and in which for nearly six years now we’ve had a Democratic president who doesn’t trouble himself to respond to falsehoods about policy, or ever actually educate the public about, like, anything.

Normally, I would expect the president to, for example, inform the public that, as the New York Times puts it in an editorial today, complaining about the self-defeating cowardice of most of the Democratic Senate candidates in “red” or “purple” states, that the reason he has not imposed a ban on travel to this country from “African countries with Ebola cases [is that] most public­health experts say such a ban would be ineffective and could make the situation worse.  But I don’t expect that, because this president just plain doesn’t do explanation to the public.  It’s pretty difficult for a senator or Senate candidate to educate the public about something of this sort, but it would be very easy for the president to do that.

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Jim Bruce on Future Fed policy… Fed rate not rising next year

By way of the show Boom-Bust, we have an interview with Jim Bruce on the future of Fed Policy. (interview starts at 14:40) He does not see the Fed rate lifting off next year. He does not see easy Fed policy avoiding an economic downturn. He says Fed has been unable to generate inflation at the CPI level.

I agree with everything he had to say.

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Fisher Effect in Econoblogosphere again

Interest in money growth

John Cochrane is developing a model for the Fisher Effect to explain that raising the nominal central bank rate could lead to higher inflation, not lower inflation as many say. Nick Rowe complements the model with a simpler “model”. And Steve Williamson has been an ever-present force for the Fisher Effect. I too have written about this before (link).

I also wrote in June (link) that the extra loosening of monetary policy by the ECB in Europe would be a test of the Fisher effect. Since June, we have seen inflation expectations continue to fall, which supports the Fisher Effect.

Once you realize that firms hedge against extra funding costs by raising prices as I see, and that a rise in the nominal rate is a rise in the money growth rate as Nick Rowe explains, and that coordinated fiscal-monetary policy produces the Fisher Effect as John Cochrane sees… then you see why nominal rates should not fall but rise in order to raise inflation.

Raising the nominal rates by central banks would also increase consumption. John Cochrane and Nick Rowe talk about this.

  • John Cochrane…”In the meantime the higher real interest rates (green) induce a little boom in consumption. So, raising rates not only raises inflation, it gives you a little output boost along the way! “
  • Nick Rowe… “Now remember the relationship between consumption and real interest rates from the standard New Keynesian Euler equation. There is a positive relationship between the level of the real interest rate and the growth rate of consumption.

I presented a video one year ago here on Angry Bear in response to a post from Nick Rowe that talked about how consumption would increase from a rise in nominal rates. The video gave a model of a bifurcated money market between labor and capital where lower interest rates were causing bond prices to rise, inflation to fall and GDP to fall. The bifurcated money market is due to the divergence in money supply between labor and capital income after the crisis. The model supports what Cochrane and Rowe say about a boost in consumption from raising interest rates.

We have had an environment that greatly favors the Fisher Effect to raise inflation and consumption by raising nominal rates… but I think time is running out has run out on this option.

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Increasing productivity by cleaning out low-productivity firms

In the Solow Growth Model, productivity is a powerful factor for raising income per person in a country. So it is important to maintain productivity growth if a country would like to have economic growth.

I have written recently that there are ways to discipline the market in order to achieve greater productivity and thus greater net social benefits. We could raise the minimum wage or raise the Fed rate. What would the result be? Low productivity firms get cleaned out leaving high productivity firms still in business.

There is a post at the Growth Economics Blog on this very issue. The post refers to a paper titled, Reallocation in the Great Recession: cleansing or not? The paper says that low productivity firms normally get cleaned out during a recession, which allows productivity to increase after a recession. But that didn’t happen after our recent crisis. So there is evidence that low-productivity firms are still in business.

So why didn’t low-productivity firms get cleaned out this time? As the Growth Economics Blog’s post says…

“The authors don’t offer an explanation, as their paper is just about documenting these changes.”

Well, some of the answers to this question are simple. If you keep real wages low, low-productivity firms have a better chance to survive.

prod real comp

This graph uses show real compensation (blue) and productivity (red). From the graph, we see that this is the only business cycle so far where real compensation has not risen. You can also see a correlation between productivity and real compensation. By the way, productivity rose greatly back in the 50′s and 60′s, and look how steadily real compensation grew through the recessions back then.

Then we can look at the Fed rate.

fed rate fred

This is the only business cycle where the Fed rate has not risen to challenge low-productivity firms. Productivity has a delayed response to an increase in the Fed rate due to a subsequent process of cleaning out low-productivity firms, usually in a recession.

One would think that if the Fed rate was truly tight for market conditions, we would have seen more low-productivity firms get cleaned out. But the continued existence of relatively more low-productivity firms supports the view that the Fed rate has not been tight and therefore not disciplining low-productivity firms.

Also the banks want low-productivity firms to stay alive because the banks are protecting their own capital ratios.

So these two processes of challenging low-productivity firms, higher real wages and a rising Fed rate, have been excessively weak so far in this business cycle. The result is a weaker economy.

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Anyone got a number? For ‘Real Debt Service of Public Debt as % of GDP’

And this is an honest question, one that I have been poking around in but maybe don’t have the chops to answer.

Lets take three measures of Public Debt:
One nominal. Public Debt as of the 16th was $17.899 trillion. And rising.
Two as percentage of GDP. And BTW the preferred measure of deficit fetishists prior to the blowup in R-R, but still active enough. Well depending on whether you take Total Public Debt or its major component Debt Held by the Public this ratio is either close to 100 or 70 depending (top of head, please insert real number.
Three when measured as debt service as share of GDP.

Now I would argue that this last measure is the right one for measuring ‘sustainability’ of debt. For one thing it is generally the measure used my most households and corporations because it directly effects cash flow, and for most people Cash is King. Take the following thought experiment:

I have borrowed a billion dollars at zero percent interest on an interest only loan with no term. Is that borrowed money actually to be considered ‘debt’ if it costs nothing to hold it and never has to be paid back? Well lets just say that it is an odd kind of debt. Now obviously no one is going to loan me a billion on those terms but increasingly people are effectively offering something close to that to Uncle Sam. That is the real rate on the 10 year is at or even below the zero bound, in effect people are paying the U.S. to hold their money for them. On the other hand there are still older issues of the 10 year and longer notes and bonds that are carrying higher yields and so there is actual debt service. But how much of that is real? And what is the percentage of federal revenues and/or GDP going to that? Because this is a harder number to come up with than you might think for a couple reasons.

One, most debt service on the Intragovernmental Holdings component of Total Public Debt is not financed in real terms, instead it is just credited to various Trust Funds and shows up as an increase in Debt. But mostly not as an expenditure.
Two, a good deal of debt service on the Debt Held by the Public component of Total Public Debt is being paid/credited to the Federal Reserve. Which in turn returns any ‘profits’ to the Treasury. To me it is an open question as to whether debt service actually paid to the Fed should count as ‘Real Debt Service’ at all. Which is why I posed all this as a question.

Has anyone actually taken the ‘Interest on the Public Debt’ figure and related it to the actual budget line items for ‘Debt Service’ and then adjusted THAT for such debt service actually paid to governmental and quasi-governmental institutions? I have been meaning to make an attempt at doing this myself but have run into problems of time and expertise. But the question still remains: in real terms how close is the U.S. Treasury to being in the same position as my theoretical borrower with a no term billion dollar zero interest rate interest only loan? Not all that close maybe but the answer is far far away from most people’s assumption of what it means to carry $17.9 trillion in debt.

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U.S. median wealth up from 27th to 25th

Yesterday Credit Suisse released its Global Wealth Databook 2014 to go along with the Global Wealth Report issued Monday. Global wealth hit another new record of $263 trillion as of mid-2014, up 8.3% from mid-2013 (Report, p. 3). Rich people are doing well, but how about the middle class? One measure of this is median wealth per adult, the exact midpoint of the wealth distribution.

In the United States, mean wealth per adult reached $347,845, and median wealth per adult hit $53,352 (Databook, Table 2-4). This represents an increase in median wealth of 18.8% over 2013, enough to move the U.S. up two places to 25th in the world.

Before we congratulate ourselves too much, we need to remember that $53,352 is not all that much money, especially for retirement (don’t forget that figure includes home equity). With 49% of Americans in the private sector having no retirement plan at all, and only 20% having a defined-benefit pension, a retirement crisis is looming for younger baby boomers and all later middle-class retirees. Meanwhile, if Republicans take control of the Senate in this year’s elections, we are likely to hear increasing demands for cuts to Social Security, when what we actually need is to raise Social Security benefits.

The relatively low median wealth also points to persistent inequality in the United States. While only 25th in median wealth per adult, the U.S. ranks 5th in mean wealth per adult. With a ratio between mean and median wealth per adult of 6.5:1, this is higher than any of the other top 25 countries. Number one Australia has a ratio of less than 2:1. Without further ado, here is the list of all countries with median wealth per adult above $50,000.


Median wealth per adult, mid-2014


1. Australia                  225,337

2. Belgium                   172,947

3. Iceland                    164,193

4. Luxembourg            156,267

5. Italy                         142,296

6. France                     140,638

7. United Kingdom     130,590

8. Japan                       112,998

9. Singapore                109.250

10. Switzerland           106,887

11. Canada                    98,756

12. Netherlands             93,116

13. Finland                    88,130

14. Norway                   86,953

15. New Zealand          82,610

16. Ireland                     79,346

17. Spain                       66,752

18. Taiwan                    65,375

19. Austria                    63,741

20. Sweden                   63,376

21. Malta                       63,271

22. Qatar                       56,969

23. Germany                 54,090

24. Greece                     53,375

25. United States          53,352

26. Israel                       51,346

27. Slovenia                  50,329

Source: Credit Suisse Global Wealth Databook 2014, Table 2-4


Cross-posted from Middle Class Political Economist.

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