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

The reality of spare capacity… say, How fast can we taper? 3x fast

How much spare capacity remains in the economy in terms of labor and capital? This question is an incredibly important one… and economists such as Krugman, Bernstein and Baker are deluded by past grandeur…

You will hear Paul Krugman say that the Fed rate must stay at the zero lower bound in spite of the financial risks, because there is still so much spare capacity… such that the benefits of pushing the economy towards that spare capacity outweighs the costs of QE and the ZLB Fed rate. Yet, spare capacity is not so great…

I measure spare capacity by a variable that I call the TFUR, total factor utilization rate. The employment rate is multiplied by the capital utilization rate… like this…

TFUR = labor utilization x capital utilization

Labor utilization is just (1 – unemployment rate). Using current data we get…

TFUR = 92.7% x 78.1% = 72.4%

How does this value compare to historical data since 1967?

tfur since 1967

We would still be considered in a recession according to past data, but we should not live in the past. We need to understand the present.

The top limit of the TFUR held fairly constant from the late 70’s to the late 90’s. Then it dropped before the crisis. And if you look at the most recent data, the line is trending to even a lower limit. The implication is that there is actually little spare capacity left.

There must be an explanation of why the line looks to be capping off below 74%.

My work points to the fall in labor share which has weakened relative demand for production. The top limits in the graph follow the fall of labor share. The following graph super-imposes the effective labor share (the labor share index * 0.762) onto the TFUR.

tfur w els

The pattern becomes visible. The mechanism though is escaping top economists like Paul Krugman. They continue to say that there is a lot of spare capacity out there. Even Jared Bernstein and Dean Baker just came out saying that unemployment can go down to 4%.

“Our work suggests that 4 percent — the average unemployment rate for 2000, the last time we were at full employment — is a reasonable target, one worth shooting for.”

A 4% unemployment rate was accompanied by a roughly 82% capacity utilization back in 2000… which put the TFUR around 78%. By the pattern in the graph above that number is not going to happen. The utilization of labor and capital is slowing down to a lower limit… and there isn’t any past precedent that says it will speed back up.

Mr. Bernstein and Mr. Baker are looking at the past, and not current dynamics. They look to be deluded by a former grandeur. They do not see the new reality forming in front of their eyes. Mr. Krugman and many others are in the same boat.

These are dark days when the supposedly enlightened economists don’t see critical mechanisms. and Why is this critical? Because lots of spare capacity is the justification for QE and aggressive monetary policy.

Just imagine what will happen when the spare capacity caps off at a lower level, and the Fed is sitting there with QE and the zero lower bound… Can you say… How fast can we taper? … 3 times fast

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Is Abenomics Working ?

Recently Paul Krugman wrote a typically diplomatic post entitles “What to do when You’re Wrong” . I thought of that while advising Alessio Marchetti’s undergraduate thesis. He argues at some length that the Abe/Kuroda efforts stimulate an economy at the lower bound with monetary policy have been successful.

Of course I had vaguely noticed this. The problem is that he finds strong evidence that the effects were not achieved only through the exchange rate — there is a very significant partial correlateion between the break even inflation rate and the number of building permits issued.

worst of all he interprets the results as showing that words count more than actions — the explanation of the huge effect in Japan and the tiny effects of announcements in the USA (before the tapering fiasco) seems to him (and I admit me) to show that massive actions combined with the reassurance that they are moderate and influenced by concern about over stimulating the economy just don’t work.

I’d like to claim that I didn’t make predictions about Abenomics, but I foolishly googled myself an found this

Gloating in the comments thread is allowed, but I don’t have the guts to read the comments.

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The elephant in the room of secular stagnation

Secular stagnation involves the idea that Central bank interest rates will be at the zero lower bound (ZLB) for a long… long… time.

And they will be because of falling labor share around the world. Yet, other economists are not even including labor share as a factor. Paul Krugman and Simon Wren-Lewis for examples. Labor share is like the elephant in the room of secular stagnation that no one is seeing. Yet, labor share has fallen from Japan, to the US, to Germany and beyond. Of course China is the King of low labor share.

Falling labor share of national income is keeping the Central bank’s interest rate at the 0% (ZLB). How? The utilization of labor and capital are both constrained to lower levels by insufficient effective demand. The CB rate then goes lower in a vain attempt to raise them back up, but they won’t go back up because low labor share is constraining them. The CBs are fighting a losing battle. Labor share has not just fallen, it has actually anchored into a new lower normal after the 2001 and 2008 recessions.

There is pressure on countries to continue pushing down labor share in order to increase national savings in an attempt to raise exports. Lowering labor share so broadly is bringing down the global economy, and more specifically the workable range of the Central bank rates.
My view to resuscitate the CB rates is to either raise labor share, or shift the Central bank policy to lower expectations for the utilization of labor and capital. If the CBs acknowledge the constraining effect of low labor share on the utilization of labor and capital, they would realize their hopes for success with the ZLB are futile. They would realize that the costs outweigh the benefits of the ZLB since there is not as much spare capacity as they think.

Paul Krugman makes this case that a low interest rate is needed because the spare capacity is so great. He says the potential benefits outweigh the costs from the ZLB. However, once you realize that low labor share has lowered the available capacity, then you realize that his reasoning will ultimately fail. The costs will outweigh the benefits in the end. Look at Latin American countries. The utilization of labor and capital is much lower in Latin America, but the rates from their central banks can go from 3% to 8%. Even with such low utilization rates, which would warrant a permanent ZLB in the US, the Latin American countries know the limits of their labor and capital. Their CBs set rates appropriately. In the US, economists do not know yet that the utilization of labor and capital has shifted to a lower range.

Central banks must fit their rate policy to the new lower range of labor and capital utilization. By surrendering to this sub-optimal truth, CBs would be obliged to raise their rates. The new sub-optimal reality would start to function correctly with less financial risk, albeit with more marginalized workers. Then attempts can be made to restore the former reality of a higher labor share. But that would require coordination on a global scale.

As for now, CBs are drowning in the delusions that they are still in the former reality.

The truth is hard to accept, especially this truth of secular stagnation.

Related posts:

Lambert, Edward. Monetary Policy of Effective Demand. Effective Demand blog. 5/18/2013.

Lambert, Edward. Equation for the z coefficient of monetary policy. Effective Demand blog. 5/28/2013

Lambert, Edward. Monetary Policy, take some air out of the tires. Effective Demand blog. 6/5/2013.

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FATCA Agreement with France

by Linda Beale

FATCA Agreement with France

On November 14, the US Treasury Department announced that it had signed an agreement with France relating to the implementation of the 2010 Foreign Account Tax Compliance Act (FATCA) law.  That makes the 10th such agreement signed between the US and other countries to date, and helps move the law towards smoother implementation.

The purpose of FATCA is to cut tax avoidance by increasing transparency–especially in the case of offshore bank accounts that have, in the past, served as key mechanisms for avoiding taxation.

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Recent decisions show China will not raise wages enough

I have written lately about the how the cultural economics of China will fail to raise wages of labor and thus fail to re-balance their domestic demand. A video interview with Minqi Li by The Real News Network notes that recent decisions by the Chinese government are meant to raise income for the owners of capital and not for labor.

This comes as no surprise. China may talk about raising wages for labor, but in the end they will push forward to make the rich richer. The same is happening in the West, but in China there is even less respect for labor. Eventually their economy will have severe troubles.

Watch around the 4 minute and 5:30 points for a discussion of labor issues.

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Free market economics and Manchester University

Via the Guardian, Orthodox economists failed market test

After all, the large majority of economists who predicted the crisis rejected the dominant neoclassical thinking: from Dean Baker and Steve Keen to Ann Pettifor, Paul Krugman and David Harvey. Whether Keynesians, post-Keynesians or Marxists, none accepted the neoliberal ideology that had held sway for 30 years; and all understood that, contrary to orthodoxy, deregulated markets don’t tend towards equilibrium but deepen the economy’s tendency to systemic crisis.

Alan Greenspan, the former chairman of the US Federal Reserve and high priest of deregulation, at least had the honesty to admit his view of the world had been proved “not right”. The same cannot be said for others. Eugene Fama, architect of the “efficient markets hypothesis” underpinning financial deregulation, concedes he doesn’t know what “causes recessions” – but insists his theory has been vindicated anyway. Most mainstream economists have carried on as if nothing had happened.

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Frances Coppola on repressing domestic demand… globally

The one thing I love about Frances Coppola, who is an economist from the United Kingdom, is that she is a perfect blend of someone inside the box and yet outside the box. I truly appreciate how she balances the two with an open and creative, yet grounded mind.

She wrote a terrific article, The Intergalactic Trade Frontier. She writes about trade balances, focusing on the trade surplus of Germany.

She writes…

“Trade moralists are fundamentally illogical and dangerously plausible. The idea of exporting your way to recovery is seductive. But it simply is not possible for all countries to export their way to recovery. Someone, somewhere has to have a trade deficit.”

She is absolutely correct and wise to understand the seduction of something that is ultimately not workable. We are witnessing a huge market failure on a global scale. What is at the core of this market failure? Cutting wages to raise national savings and raise exports originally by a few countries and now by many more.

“Everyone, it seems, is “making reforms” to repress domestic demand and promote exports. This is not encouraging. If everyone tries to increase exports and cut imports by repressing domestic demand, the result will not be a global export-led recovery. It will be a global depression.”

I recommend reading the whole article.

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Secular Stagnation and Fiscal Policy

The latest thing is discussing the possibility that the economy might be in a liquidity trap for a long long time or might repeatedly fall into one.

So I ask what about some permanent fiscal stimulus to deal with secular stagnation. Now this question is an offence against Keynes and, much more, against new Keynesian economics. Keynesians have spent decades insisting that Keynesian theory does not imply higher government spending on average but rather higher spending during recessions and lower spending during expansions. Uh so what happens if the economy is stuck in a depressed steady state?

OK a very simple but new Keynesian type model follows.

The conslusion is that permanent fiscal stimulus works fine with a multiplier greater than one.

The standard result that stimulus should end is due to the standard assumption that the economy exits the liquidity trap as it is assumed that the unemployment rate returns to the natural rate.

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