Slightly left of center economic commentary on news, politics and the economy.

Question for our readers…

I am watchng the video of Paul Krugman on Bill Moyers. Mr. Krugman is seeing things about inequality that he hadn’t seen before Piketty’s book. So he is now seeing that inequality is a huge problem now and into the future. Inequality is the one major problem in the economy.

Question…

How should monetary policy change if reducing inequality was seen as the most important priority?

And please do not say “Helicopter drops of money”. You must use the tools available to central banks. The one stipulation is that your answer must reduce inequality, irregardless of the side effects. Think like a doctor giving medicine for the main illness knowing that there may be unpleasant side effects, like losing hair in chemotherapy.

Write your answers in the comments below…

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Lane Kenworthy, Prosperity, and the Infinite Forms of “Redistribution”

I haven’t beaten the drum lately for Lane Kenworthy — perhaps the best researcher out there on the economic effects of income and wealth distribution. His years of careful, diligent (and voluminous) statistical and analytic work, tapping the best data sets available, and his cogent, coherent explanations of his findings, should get a lot more attention in the econoblogosphere. Lane Kenworthy rocks.

He’s especially good at trying to suss out causation, which he will be the first to acknowledge is always a difficult business in a discipline that’s inevitably dependent on retrospective data — where you can’t rerun the experiment, much less run it from the start with a randomized control group. (And natural experiments/control groups like the ones that Arindrajit Dube exploited to look at minimum-wage effects — adjacent counties across state lines with different minimum wages — aren’t thick on the ground.)

Nevertheless there are some excellent statistical techniques that can give a good indication of causation. Well-executed, they can really move your Bayesian priors. At the very least, they’re excellent at ruling out causation. Put simply, if there’s a significant negative correlation between presumed-cause A and presumed-effect B (or no correlation at all), you can feel fairly confident that A didn’t cause B. It’s difficult to prove causation with correlation; it’s much easier to disprove causation — to falsify a hypothesis.

But enough with the philosophical throat-clearing. Let’s look at one recent paper (PDF), a multi-country multi-regression analysis comparing rich countries, looking at income inequality and middle-class income growth. He finds that from the late 70s to the mid 2000s (all emphasis mine for easy scanning):

an increase of 1 percentage point in the top 1 percent’s share of pre-tax income reduced growth of income for the median household by about USD530. In the most extreme case-the United States-the top 1 percent’s pre-tax share increased by 8 percentage points between 1979 and 2004. According to this estimate, that may have reduced median household income growth by a little more than USD4,000. The actual rise in the United States during those years was USD8,000, so the estimated impact of rising income inequality is not trivial

In other words, if the 1%’s share of income had not grown by 8%, median household income would have grown by $12,000 instead of $8,000. This bears out Lane’s rather intuitive, common-sense assertion earlier in the paper:

Household income growth is not a zero-sum game because the pie tends to get larger over time. Disproportionately large gains at the top, however, are  likely to come at least partly at the expense of those in the middle.

Always careful, he adds:

At the same time, the data suggest that the income-reducing impact of a rise in top-heavy inequality has been overshadowed by the income-boosting impact of economic growth and of increases in net government transfers.…even after adjusting for these other influences, change in top-heavy inequality is not a very good predictor of growth in middle-class incomes.

So yes: income inequality in and of itself seems to have reduced middle-class income growth significantly. But obviously, of course, that’s not the only economic effect at play. (Only a wild-eyed, ideologically blinded, axe-grinding, bought-and-paid-for Republican would make that kind of foolish claim about some particular economic effect.)

Which brings me to another recent paper (prominently citing the previous one), that questions the Left’s rhetorical emphasis on (in)equality:

I fear the American left’s recent move to put income inequality reduction front and centre might be harmful rather than helpful. It may foster a conviction that the key to addressing America’s social, economic and political problems is to reduce the top 1 per cent’s share or the Gini coefficient. That could distract attention from more direct and effective efforts to address those problems.

Such efforts include fully universal health insurance; improvements in eligibility, duration and benefit level for various social-insurance and social-assistance programmes; wage insurance; early education; enhanced financial support for college; a minimum wage indexed to prices; an expanded earned-income tax credit indexed to average compensation; and monetary policy less tilted towards inflation avoidance. Policy changes like these would go a long way towards improving economic security, enhancing opportunity (and mobility) and ensuring shared prosperity in the US. Inequality of political influence could be lessened via direct reforms, such as reversal of the Citizens United decision, introduction of a strong transparency rule and public funding for congressional election campaigns.

I think Lane’s right. I’ll say it again: if you talk about fairness and equality, Americans change the channel. (They’re only somewhat more open to hearing about “opportunity.”) They want to hear about prosperity — especially widespread prosperity. And the programs Lane points to have a decades-long history of delivering widespread prosperity. Expanding those programs (and funding them with a tax system that actually is progressive) would make us all more prosperous.

And that’s exactly what Lane’s first paper demonstrates. No: just reducing inequality through redistribution doesn’t make everything peachy. No duh. (Though in the current environment of concentrated wealth and income it does improve things a lot in and of itself.) If you really want to increase prosperity, you use methods of redistribution that increase prosperity – like the programs that Lane details above. (Plus publicly funded infrastructure, research, etc.)

So the two things aren’t mutually exclusive. You implement programs that deliver widespread prosperity in and of themselves, and distributive effects also deliver the prosperity benefits of reduced wealth and income concentration. It’s a virtuous cycle, rolling forward on a path to American prosperity. Rinse and repeat.

In brief, widespread prosperity both causes and is greater prosperity.

Cross-posted at Asymptosis.

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Repeat After Me: The American Tax System is Hardly Progressive at All

The latest numbers on 2014 taxes as share of income are out, and they’re saying pretty the same thing as last year:

Above about $80K a year in income, the American tax system is not really progressive. Like, at all:

The people making $100K a year pay about the same share of income at people making $10 million a year.

This is because — while federal income taxes are reasonably progressive — payroll, state, and local taxes are horribly regressive — particularly in (blush) my home state:

Screen shot 2014-04-19 at 9.32.10 AM

Read it and weep.

Cross-posted at Asymptosis.

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Comparing Sweden & Norway on inflation

Paul Krugman has a post talking about how tighter monetary policy caused Sweden to go into deflation. Here is the chart showing their deflation.

swed inf
OK… we can see the deflation there far to the right. Paul Krugman talked about Sweden raising the interest rate to battle bubbles. Let’s look at the interest rate in Sweden.

swed int

Yes, they certainly raised the interest rate. But didn’t Norway also raise their interest rate? Norway also has its own currency.
nor int

Norway actually raised their interest rate higher and longer than Sweden. So I guess we would see deflation in Norway, right?

nor inf

Hmmmm, Norway has an inflation rate of 2.6%. OK, Mr. Krugman, what am I missing here?  Your logic is not solid. Where is the answer?… I compare consumer spending in these two countries.

swed cons

Swedish consumer spending rose 13% since 2009. What about Norway?

nor cons

In Norway, consumer spending rose 17% since 2009. That would help inflation if people were spending more. Maybe inflation is stronger in Norway over Sweden due to more purchasing power of people, instead of what the central bank interest rate is.

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Steve Williamson, the Fisher Effect & Raising the nominal Fed rate

http://meetville.com/images/quotes/Quotation-Irving-Fisher-finance-interest-Meetville-Quotes-65760.jpg

I just watched the debate between Mark Thoma and Steve Williamson. (youtube video) As I see it, the main issue was the direction of causality in the Fisher equation. In the end, I agree with Mr. Williamson.

The basic Fisher equation is…

Real rate = nominal rate – expected inflation

As the real rate is said to be independent of monetary policy in the longer-run, the nominal rate and the expected inflation move together as time goes by.

So if the real rate wants to be -1% for instance, in the long run you would see either of these two outcomes…

-1% = 0% – 1%
-1% = 2% – 3%

In the second equation, expected inflation is higher. How did that happen? Was it because the nominal rate rose?

During the debate, the question came up whether to raise the nominal Fed rate or not. Mr. Williamson, who is in favor of raising the Fed rate like me, said that expected inflation will follow the nominal rate in the middle and long-run according to the Fisher effect. The basis of this idea is that the real rate is independent of monetary policy in the longer-run... such that the nominal rate will guide the expected inflation rate. The opposite direction of causality happens in the short-run.

Mr. Williamson implies that a higher nominal rate of 2% would guide a 3% expected inflation rate through time. The other implication is that the low nominal central bank rates we see around the world have led to low inflation rates by the same long-run guiding effect in the Fisher equation.

Mr. Williamson made a case that the short-run effects of monetary policy have worn off. And since we are now in the long-run of monetary policy, expected inflation is low because it seeks balance with the low nominal rates. I agree with him. And I also agree with him when he says that inflation will not rise as central bankers say it will.
I have been calling for tighter monetary policy for a different reason, because according to my research of effective demand, the output gap is much smaller than the CBO says. I see we are reaching the end of the business cycle. Some $100 billion more in real GDP and the spare capacity is all gone. This leads me to want tighter monetary policy. Yet, Mr. Williamson takes a different yet complementary approach to raising the Fed rate.

He acknowledges that there would be a short-term adverse reaction to raising the Fed rate, but then as that wore off, expected inflation would rise with the natural business cycle dynamics. Inflation is what economists like Mr. Thoma and Mr. Krugman want. But they want inflation to drive the real rate lower. But if the real rate is independent of monetary policy in the long-run, holding the Fed rate at the zero lower bound will not lower the real rate, but rather lower inflation, according to Mr. Williamson. The real rate edges higher. This is actually what we have been seeing.

There is a natural tendency for the real rate to rise during the expansion phase of the business cycle. So as the economy is now reaching the natural level of GDP, the real rate, which is negative, wants to rise to around 2%, where it would be naturally balanced. Keeping the nominal rates low means inflation will go lower as the real rate rises naturally. Yet,, inflation meets resistance as it goes toward 0%. So the real rate stays negative and can’t rise to its natural level. Outright deflation would allow the real rate to rise to its natural level.

Monetary policy is manufacturing an abnormally low real interest with the hopes of pushing GDP back to a higher level. It is an unnatural process. Mr. Williamson sees a higher Fed rate as a natural process, which would allow both inflation and the real rate to rise to their natural target levels in the long-run.

Mr. Thoma responds to this by giving the opposite direction of causality in the Fisher equation. He implies that expected inflation always drives the nominal rate, in the long-run and short-run. So Mr. Thoma says that inflation has to rise first as an overall general principle in order to raise the nominal rates, whether short or long-run. In such a case you have to generate demand first to generate inflation.

Mr. Thoma says that best way to increase demand is through tax incentives for investment. I do not like this approach because consumption demand by labor has to come first before business investment will pick up.

So, who is right? While Mr. Williamson says the direction of causality between nominal rates and expected inflation can go both ways depending on short or long-run. Mr. Thoma says the direction of causality goes only in one direction.

In the end, it is Mr. Williamson’s distinction between the short-run and longer-run equilibrium effects of the Fisher equation that wins out. Holding the central bank rates low for so long caused the low inflation problem. The way to get the benefits of higher inflation and a natural real rate is to raise the nominal Fed rate, accepting a temporary period of economic contraction in the short-run.

Related post:

Williamson, Stephen. Phillips Curves and Fisher Relations. Stephen Williamson: New Monetarist Economics. December 15, 2013.

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The Global “Capital” Glut

No, I’m not talking about Piketty hitting the Times bestseller list. And it’s not just wild-eyed lefty Frenchman who are expressing concern about the state of world capital these days. Mitt Romney’s shop was beating this drum loudly more than a year ago.

One of the central takeaways from Piketty’s Capital in the 21st Century is the U-shaped long-term trend in the capital-to-income ratio, especially in rich countries. He uses “capital” synonymously with “wealth.” Here are the latest numbers for the U.S. from his compatriots Saez and Zucman (source PDF):

Screen shot 2014-04-17 at 12.46.35 PM

The economic relationship between wealth (or net worth, financial assets minus liabilities) and real capital  is a sticky one, even if you’re only considering “fixed capital” — structures, equipment (hardware), and software. It’s even more so if you consider  human skills, knowledge (i.e. patents), organizational capital, etc. (The line between organizational capital and “software” is getting especially blurry these days; what would Vanguard’s, much less Google’s, value be without their web presence?) And more so again if you consider natural capital like land and what’s on/under it.

But “Wealth in the 21st Century” wouldn’t have had quite the same ring to it, so let’s just go with it, with the knowledge that we’re talking about wealth (“financial capital”), and wealth has some indeterminate but somewhat representative relationship to real assets/capital. We can at least say, loosely, that financial assets are claims on real assets, or on the production that’s enabled by those assets.

So what about Bain Capital, Romney’s shop? Here from their December 10, 2012 report (PDF; hat tip to the always-remarkable Izabella Kaminska, and to Climateer Investing).

World awash in nearly one quadrillion of cheap capital by end of decade, according to new Bain & Company report

Their takeaways include:

The capital glut will be accompanied by persistently low real interest rates, high volatility and thin real rates of return.

Sound like secular stagnation to you?

Also:

The ever-present danger of asset inflation will contribute to an overall steepening of the investment risk curve… companies will need to strengthen their bubble-detection capabilities

In short, there’s a huge amount of money floating around out there relative to income and production. (In Steve World, all financial assets embody money, and the money stock is the total value of financial assets — including dollar bills, deeds, or other formal financial claims — regardless of how currency-like those things are. Equating currency and currency-like things with money is conceptually incoherent.)

With so much money around, is it any surprise that people are lending it cheap?

As usual I have much more to say on this but instead I’ll hand it off to Jesse Livermore, who recently wrote one of the clearest and most cogent posts I’ve seen in years on financial asset values, hence wealth. I’ve been meaning to link to it. Read the whole thing.

The Single Greatest Predictor of Future Stock Market Returns

Hint: it’s about what the herd does with all that money.

Cross-posted at Asymptosis.

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Now That the Supreme Court Has Expressly Found a Right to Vote in the First Amendment, Are State Laws Denying the Vote to Convicted Felons Unconstitutional? You Betcha.

“There is no right more basic in our democracy than the right to participate in electing our political leaders.”  That’s how Roberts began the opinion.

So I guess we can now assume that the Court will strike down all those voter-ID laws that so clearly impact that most basic of rights, and will do so by unanimous vote of the justices.

– The REAL News From the McCutcheon v. FCC Opinion, me, Apr. 3

Actually, I had thought the most basic right in our democracy was the right of states to violate individuals’ constitutional rights as they chose, courtesy of the fundamental constitutional principle of states’ equal sovereignty.  So my post and its title were intended as facetious.  But then AB reader Alex Bollinger reminded me in a comment to my post that Antonin Scalia had written in his concurrence in Bush v. Gore that the Constitution contains no generic guarantee to the right to vote.

I mean, sure, the Fifteenth Amendment says:

Section 1. The right of citizens of the United States to vote shall not be denied or abridged by the United States or by any State on account of race, color, or previous condition of servitude.

Section 2. The Congress shall have power to enforce this article by appropriate legislation.

But those Reconstructionist types who drafted and ratified that Amendment hadn’t checked with James Madison before presuming that there was a right of citizens of the United States to vote.  And, more important, they hadn’t checked with Roger Taney.

In any event, Scalia, by joining Roberts’ opinion in McCutcheon, now agrees that the Constitution indeed guarantees a right to vote.  It does so in the First Amendment, which James Madison participated in drafting!  And which Roger Taney probably approved of.  (Whew!)

While that first sentence in McCutcheon doesn’t directly identify the First Amendment as the source of the right to participate in electing our political leaders, elsewhere in McCutcheon the First Amendment is expressly credited as guaranteeing that right.

I realized that this morning when I read Linda Greenhouse’s op-ed in today’s New York Times in which she pretty much sums up John Roberts along with McCutcheon.  She writes:

It wasn’t until the Roberts court’s Citizens United decision in 2010 that the court shrank the definition of corruption to quid pro quo bribery. To assess the implications of that shift, it’s important to remember what Citizens United was about: not direct contributions, which remain prohibited to corporations, but independent spending. In the Buckley decision and since, the court has accorded greater First Amendment protection to independent expenditures than to direct contributions, which it has viewed as more tightly linked to the anti-corruption rationale and thus properly subject to tighter regulation. To say that only quid pro quo corruption can justify a limit on independent expenditures was not to similarly limit the rationale for regulating direct contributions, the subject of the McCutcheon case.

But in his McCutcheon opinion, Chief Justice Roberts collapsed the distinction between the two, extending Citizens United’s narrow definition of corruption to direct contributions. The government “has a strong interest,” he wrote, “in combatting corruption and its appearance. We have, however, held that this interest must be limited to a specific kind of corruption — quid pro quo corruption — in order to ensure that the government’s efforts do not have the effect of restricting the First Amendment right of citizens to choose who shall govern them.” Justice Stephen G. Breyer’s dissenting opinion called the chief justice out on this maneuver, but in vain.

Indeed.

Greenhouse’s main focus in that op-ed is Roberts’ ridiculously transparent pretenses to judicial minimalism, in McCutcheon and in his opinion last year striking down the key section of the Voting Rights Act case on the fundamental constitutional principle of states’ equal sovereignty introduced in 1885 by Chief Justice Taney in Dred Scott v. Sanford, and dormant since the Civil War began in 1861 until last year.  What Roberts actually is doing, as I wrote here in a series of posts, and as Greenhouse makes clear, is effectively rewriting the standard for judicial review of federal and state laws so that it’s now simply a game of sophistic, sleights-of-hand analogies and of redefinitions of common words and phrases.

Earlier this week, in what I thought would be my final post on that subject, I suggested that liberals should plan to pick up that Supreme-Court-can-now-casually-repeal-statutes-it-doesn’t-like ball and run with it, once they regain a 5-4 majority on the Court.  I said that there were several statutes that I could think of offhand that would be good candidates for this, including some that actually are unconstitutional, not necessarily as written but as the current Court majority has interpreted them, and as an example I cited the Federal Arbitration Act, which as it happens, is the law at issue in another article in the New York Times today: This one. (H/T Dan Crawford.)

And aren’t some of those anti-labor-union sections of Taft-Hartley unconstitutional?

But more immediately–and deadly seriously–I see no even-remotely logical ground upon which the state statutes that remove the franchise from convicted felons can survive McCutcheon’s statement that even corruption, other than that of the direct, explicit quid pro quo variety, cannot be limited, because we must ensure that the government’s efforts do not have the effect of restricting the First Amendment right of citizens to choose who shall govern them.  Remember: This prohibition is in election-law statutes, not in criminal-sentencing statutes, which shouldn’t, but could, make a difference.  I hope challenges to those state laws begin soon.

Greenhouse points in her op-ed to a passage in McCutcheon in which Roberts justifies the de facto overruling of a part of Buckley v. Valeo, the first post-Watergate Supreme Court opinion that addressed campaign-finance law, by saying that, well, Buckley concerned another federal statute, not McCain-Feingold, which was enacted in 2002–and since Buckley, the Court’s conservative majority has partnered aggressively with usual-suspect Conservative Legal Movement lawyers and groups to rewrite First Amendment jurisprudence as a deregulation juggernaut.  Regulatory statutes that crowd doesn’t like but can’t repeal through the legislative process can be struck down as violations of the First Amendment!  Call it playing the First Amendment card.

Which of course could butt up against the fundamental constitutional principle of states’ equal sovereignty.  But which, in light of McCutcheon, would look like pure partisanship, concerning state election laws that deny the vote to convicted felons. Which may not matter.

As I suggested in another post this week, liberals and libertarians can play the McCutcheon First Amendment card in another respect: pushing for legislation (or an SEC rule) that would prohibit publicly-traded corporations to from making political expenditures–and, eventually, direct campaign contributions–unless the corporation first gets approval from a majority of shareholders.  As I pointed out in that earlier post, a passage from McCutcheon itself seems to imply that the First Amendment right of citizens to choose who shall govern them is a right of personal choice that, Citizens United notwithstanding, cannot be co-opted derivatively without intentional delegation.

I ended that post by saying that the conservative majority’s petards can hoist only so much before shrapnel lands so visibly in unintended places that it becomes impossible to hide it.  And, who knows? Maybe I’m right.

—-

*Cross-posted at The Law of the Jungle.

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Inflation Expectations in the USA

In case anyone is interested, I put together a lot of stuff I have been doing with inflation expectations into a soft of manuscript here (warning 19 poorly written pages)

The conclusions

Inflation expectations are not anchored. A simple regression model fits both the median Livingston Survey respondent’s expected CPI inflation and five year TIPS break evens quite well, and fits 20 year breakevens fairly well. There is no sign of some widely alleged credibility effects in the Livingston forecasts. The Livingston forecasts add some useful information not in lagged inflation, but this useful role is strongly concentrated in the period of the oil shocks. They are very poor forecasts. A simple regression model estimated using data from June 1973 and before (so before the oil shocks) fits inflation post December 1989 better than the median Livingston forecast.

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Do you understand the VALUE of water?

David Zetland at Aguanomics mentions a very local proposition by yours truly as part of a question posed on UN world water day March 22. Purely anecdotal and personal, but I found people willing to chart water use but not to go downstairs and turn off the water as a thought experiment. It was an annoying task for me as well.

Do you understand the VALUE of water? by David Zetland

There are lots of footprint calculators, statistics on use and conservation devices available, but some people still fail to understand (or feel they do not understand) the value of water.
I appreciate the value after many stays in many places where there was zero water or water of unhealthy quality.
DC suggests this approach to helping people understand the value of water to them:

Instead of writing down flushes and glasses of water I “challenged” people to turn off their water at say 10 PM, turn it on in the morning for early ablutions and off again, etc., using water to do things but then turn off again for the next 24 hours. (My guess maybe on/off five six times).
Even interested parties would rather keep track of flushes, brushes, and washes. Just to notice use, but the going downstairs was too annoying…

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