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Why you should be afraid: the next recession is likely to include wage deflation

by New Deal democrat

Why you should be afraid: the next recession is likely to include wage deflation

Beginning 3 years ago, I identified poor wage growth  as the shortfall in the economy that worries me the most. And it still worries me, even though there has been some modest improvement.

Why? Because unless there is enough of a cushion, the next recession, whenever it comes, there is a significant danger of outright wage deflation. And as we know from the Great Depression, outright wage deflation means that payments on previously contracted debts become, in real terms, higher. This can lead to a vicious spiral of debt-deflation, whereby more and more people fall behind on debt, leading to a further economic contraction, more unemployment, and even more wage deflation, and so the cycle repeats.

So why am I particularly concerned now?  Because a decline in wage growth is a feature of virtually all recessions.  And we may start the next recession from such a low level of wage growth that the decline in wage growth turns into an absolute decline.

Here’s the data.

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Clinton Finally Announces Her Message: Banality and Incoherence.

The much-ballyhooed announcement video offers little hint [of who, policy-wise, Clinton is].  For the first half-minute or so, you would be excused for thinking that it was some sort of detergent commercial, intended to air during the Olympics. Gay weddings! Babies being born! Moms going back to work! Clorox, this commercial seems to say, has finally gotten with the program.

But then the ad continues. Clearly, this is some sort of anthology drama, around the theme of getting ready for things. Possibly the next installment of “Love Actually.”

Call it “Hillary, Actually.” Women getting ready to start businesses! Brothers getting ready to start businesses! Moms getting ready to go back to work! Families getting ready for the addition of new members! Gay weddings! Tomatoes! Legendary tomatoes! School plays! “I’m gonna be in the school play and I’m gonna be in a fish costume,” says a child. This is actually a thing that happens in the commercial. Actually. “The little tiny fishes…” the child sings. It doesn’t stop there. Cats! Dogs! Hillary actually is all around us. All it was missing was an aging rocker, hoping for one last hit.

But instead, we have Hillary. “I’m getting ready to do something, too,” Hillary says at the end of the video, one-upping all these people with their businesses and prize tomato gardens. “I’m getting ready to run for president.” (That fish costume doesn’t sound so impressive now, does it?)

“Because it’s YOUR time and I hope you’ll join me on this journey,” she amends quickly, but not quickly enough.

‘Hillary, Actually’–Hillary Clinton actually is all around us, Alexandra Petri, Washington Post online, late yesterday afternoon

My late father (no less a politics junkie and frustrated liberal than is his daughter) and I had a longstanding joke dating back to the 1988 Michael Dukakis campaign.  The ad, a short one, 30 seconds, probably, shown late in the general-election campaign, began with the camera showing … something; I no longer recall what the video showed, but I think maybe it was just Dukakis speaking into the camera, and with Dukakis saying … something.  I don’t recall the specifics of what his first sentences were, other than that they were unspecific.  But the last three sentences were, if I remember right, “That’s not a Democratic concern.  That’s not a Republican concern.  That’s a father’s concern.”

Actually, I do remember, precisely, that final sentence, since it served as the punchline of our standing joke.  Which had to do with the fact that the ad gave no clue to what the “that” was.  The first time or two that you saw the ad, you thought you simply had missed what the “that” was.  But you had not missed what the “that” was.  Dukakis had missed including it.

I began to think about that ad again around the time last fall when most of the political reports about Clinton said she planned to run as a grandmother.  (“That’s a grandmother’s concern.”)

Then came news, early this year, that she was also going to get into substantive economic policy that would go beyond verifying yet again (and again and again) her support for an increase in the federal minimum wage, paid sick leave and vacation time, and affordable childcare and guaranteed preschool. She was, it was reported, speaking at length to economists.  Did this mean that she might discuss Keynesian vs. Laffer fiscal policy, and the actual effects of each?  Hope springs eternal.  So, maybe?

But hope began to fade (it wasn’t eternal, after all) a few weeks ago, when every three or four days, or so it seemed, there was another report about another one or two or three new communications hires—um, should she decide to run.  The solely political hires seemed fine, if very numerous.  But then there were the ones from Madison Avenue, including the one most recently from Madison Avenue and, before that, Michelle Obama’s staff.  (She’s credited as the one who suggested that Michelle do a dance on some daytime TV show, or something, which apparently was a big success in the effort to “humanize” Michelle for the then-upcoming reelection campaign.)

On the heels of those reports came the ones, repeated again and again in the past two weeks, that Clinton would forego, at least for the first few months, the traditional large rallies and speeches to large audiences, and would instead speak with people in small, somewhat intimate settings.  I thought that sounded great; I detest those idolatry political rallies and the like, and Clinton, it was clear from her 2007-08 effort, was particularly bad at this type of thing.  And I assumed that Clinton would use these small-setting meetings, in part, to discuss specifics of economic policy.  After all, this campaign, high-level people inside it made a point of indicating, will not be focused on her—her political ambitions; her desire to be the first female president—and will instead be focused on economic policy addressing middle-class fears and aspirations.

And even when the campaign insiders said she planned to meet with ordinary people in order just to listen to them and learn what’s on their minds, I figured that that didn’t preclude something more than soundbites and clichés from her during these discussions.  Her answers could involve, maybe, three or four sentences of substantive background and explanations.  Theoretically, anyway.  Her husband did that, at times.  Maybe she could, too.  So I held out hope for a campaign of genuine substance about economic policy.

And we all were assured, and assured and assured, that her long-awaited announcement wouldn’t be like her announcement last time, which was, “I’m in.  And I’m in to win.” Weren’t we?

But instead, it turned out, it would be: “I’m in.  And I’ll use a Super Bowl-style commercial that, for its first three-fourths, gives no hint of tie-in to the product being pushed, and then closes with a few words or maybe two sentences generically identifying the brand, the product, the slogan, and, finally, the intended message of the very long lead-in.”

Which, in this case, is that Clinton, like other Americans who are preparing for something new and major in their lives, is getting ready to do something, too!  In her case, it’s running for president.

But something had to be said about, y’know, policy.  Or something hinting at it.  And so, in perfect Super Bowl-ad style, she said, “Americans have fought their way back from tough economic times, but the deck is still stacked in favor of those at the top.”  And, in perfect Super Bowl-ad style, that was it for a tie-in to, well, anything.

Okay, well, almost it for a tie-in.  She did add, “Everyday Americans need a champion, and I want to be that champion so you can do more than just get by.” So she’s “hitting the road to earn your vote, because it’s your time.” And “I hope you’ll join me on this journey.”

Which I will, of course.  Bush, Walker, Rubio and Paul don’t appeal to me, partly because Laffer doesn’t.  And on my way home from the voting booth I’ll stop in at a grocery store and buy a bottle of Clorox.  Or maybe buy that Chrysler advertised during the Super Bowl.  It might be my time for one of those, anyway.  I mean, who knows.


Appended to add the following exchange between reader CaffeinatedOne and me in the Ccomments thread:


April 13, 2015 3:59 pm

Yes, Presidents are expected to do substantive policy things, but campaigns are a lot more than that. All this was intended to be was a feel-good kickoff announcement and some broad framing of themes. Given where we are in the campaign cycle, doing much more than that hardly necessary and likely counterproductive,

Anything solid that she proposes at this point just becomes a target for the republicans in the clown car, and the media and doesn’t really help her much. Once republicans have a nominee and (somewhat) coherent set of policy proposals, then we’ll (hopefully) get to the meat of things.

Yes, it’s cruddy that campaigns aren’t policy focused affairs, but tactically it makes a lot of sense for her to focus on framing and positioning at this stage and wait for an opponent to form up.

Beverly Mann

April 13, 2015 6:19 pm

“Americans have fought their way back from tough economic times, but the deck is still stacked in favor of those at the top.” And, “Everyday Americans need a champion, and I want to be that champion so you can do more than just get by.” And she’s “hitting the road to earn your vote, because it’s your time.” And “I hope you’ll join me on this journey.”

There was a complete disconnect between “the deck is still stacked in favor of those at the top” and “Everyday Americans need a champion, and I want to be that champion so you can do more than just get by,” and the stories of the people in that video. There was no one in the video, best as I recall, who sounded like he or she was just getting by. The child who sang the fish song, maybe?

They all were upbeat and excited about the upcoming big change or big event in their lives. Just like Hillary’s all excited about running for president. But the things that these people were excited about are basic parts of their lives. Expecting a new baby. Finishing college. Moving. Major home repairs to that young couple’s new home. A woman looking forward to her imminent retirement and thinking of what she will become involved in then. None of these people looked as though they were just getting by, or, if they were, expected that it would last much longer. The deck may still be stacked in favor of those at the top, but it wasn’t hurting the people appearing in that video. It may be their time, but they didn’t seem to need a champion.

This was a deeply incoherent message, surely the result of a compromise between the Madison Avenue messaging folks and the political people who wrote a coherent passionate message for her give and then saw three lines of it appended disjointedly to the Super Bowl ad.

Clinton doesn’t really care very much about policy, other than the traditional women’s movement policy issues. She wants this particular glass ceiling broken and she wants to be the one to do it. That’s why she flits from one persona to another, convinced that what matters for her electability is her persona and nothing more. I was surprised at how really bad that video was, in my opinion. I’m pretty sure it was really bad.

Not fatal, of course. She will, after all, be running against a Republican. But more than a day after I watched that thing, I still can’t shake a feeling of incredulity.

Added 4/13 at 6:37 p.m.

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A thought on GE’s opting out of the Finance Business

Paul Krugman writes about GE’s announcement to get out of the finance business. Why are they getting out? Financial reform from the Dodd-Frank legislation that includes “greater oversight, higher capital and liquidity requirements, etc.”

Paul Krugman says…

“And sure enough, what GE is in effect saying is that if we have to compete on a level playing field, if we can’t play the moral hazard game, it’s not worth being in this business. That’s a clear demonstration that reform is having a real effect.”

Standards are tightening in the financial business to prevent moral hazard. Higher liquidity and capital requirements will go hand-in-hand with the Fed’s intent to raise interest rates. So I see a positive side to normalizing interest rates in that some socially risky shadow banks will opt out.

Less shadow banks could translate into an easier time for normalizing the Fed rate. We wouldn’t have these shadow banks doing arbitrage and such with their moral hazard to put downward pressure on interest rates.

What do the readers of Angry Bear think? Does financial reform make normalizing interest rates easier? Does the lack of financial reform cause the Fed rate to seem stuck at the zero lower bound? Can the Fed rate rise without good financial reform? How important is financial reform to the normalizing of the Fed rate?

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Good Jobs First reveals top federal subsidy recipients: Subsidy Tracker 3.0

Slow to be getting to this, but I have to come back to such a major development. Good Jobs First, a national non-profit best known for its work on state and local subsidies to business, unveiled in March its Subsidy Tracker 3.0. This work differs from previous publications on federal subsidies by being project-based/firm-based, rather than program-based. This lets us know which companies have received the most federal subsidies over the years.

“Uncle Sam’s Favorite Corporations” finds that the federal government has awarded $68 billion in “grants and special tax credits” in the last 15 years. 2/3 of this has gone to large corporations. This is on top of hundreds of billions of dollars given to the banking sector during the financial crisis. One advantage of using Subsidy Tracker 3.0 is that it incorporates previous work by Good Jobs First tracking parent/subsidiary relationships.

One substantial finding is that:

Six parent companies have received more than $1 billion in grants and allocated tax credits (those awarded to specific companies), 21 have received $500 million or more, and 98 have received $100 million or more. Just 582 large companies account for 67% of the $68 billion total.

All six of the billion-recipients are in the energy sector: Spanish company Iberdrola tops the list with $2.2 billion, followed by NextEra Energy, NRG Energy, Southern Company, Summit Power, and SCS Energy. And five companies were on all three of the top 50 federal subsidy recipients list, the top 50 bailout list, and the top 50 state & local subsidy list: Boeing, Ford, General Electric, General Motors, and JPMorgan Chase.

It’s important to recognize that project-based and program-based subsidy databases serve two functions that that do not reduce to each other. If you want to know the total amount of money governments give in incentives, you need program-based reporting. This is because many subsidy programs provide benefits automatically to all investors meeting certain criteria and they rarely list all the automatic recipients. In that case, you need to know what the program as a whole is spending. This is the approach I have taken in my subsidy estimates in Competing for Capital and Investment Incentives and the Global Competition for Capital, and Louise Story took in the New York Times program database (“State Money Flow”) in its December 2012 series “The United States of Subsidies.” To understand the overall scope of the problem, you need program-based reporting.

Of course, program-based reporting can have its flaws. A number of think-tanks with widely varying ideologies have produced these reports over the years, and they appear to give dramatically different answers. In fact, as I showed in Competing for Capital (pp. 152-158), the answers are all highly consistent, as they are based on a handful of federal studies (the Joint Committee on Taxation’s Tax Expenditures reports, the Congressional Budget Office’s Reducing the Deficit: Spending and Revenue Options, and the CBO’s occasional publication, Federal Financial Support of Business). The differences, even when they are seemingly vast, stem from clear ideological choices by think-tank researchers.

To take the most obvious example, when the Cato Institute estimates “corporate welfare,” it does not include the value of subsidies which take the form of tax expenditures. This give a much smaller number than estimates that follow the JCT/CBO methodologies closely, since tax expenditures easily total 2/3 of federal subsidies (and often 90% of state and local subsidies). In Cato’s 2012 estimate of federal corporate welfare, author Tad DeHaven admits (p. 12) that tax expenditure are a “form” of corporate welfare, but he does not include them in his claimed total of $98 billion in federal “corporate welfare” annually. On the flip side, for any federal agency Cato wants to see privatized, it counts the entire budget as “corporate welfare.” This inflates the Cato estimates relative to those which stick closer to the JCT/CBO methodologies, such as Citizens for Tax Justice.

Project-based reporting, like Good Jobs First does with Subsidy Tracker and Megadeals, can find large individual recipients and projects, but it does not get you anywhere near the total amount of subsidies given by an individual government. As mentioned above, many programs with automatic tax breaks for investors do not give individualized listings of their recipients. (Hopefully this will change when the Government Accounting Standards Board releases its final tax incentive rules.) But because you can document every single individual award, you can derive an absolute baseline which is irrefutable.

The inauguration of Subsidy Tracker 3.0 is a great addition to the transparency tools brought to us by Good Jobs First.

Cross-posted from Middle Class Political Economist.

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Avoiding the “New Mediocre” – Christine Lagarde

Today the IMF published a short video with Christine Lagarde about avoiding the “New Mediocre”.

My view is that carefully raising interest rates in the US will help raise the standard for productivity getting us eventually out of this “New Mediocre”. What do the readers of Angry Bear suggest is the answer? Leave ideas in comments below.

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A Third Reason to raise Interest Rates?

I read Paul Krugman, Ben Bernanke and others. They mention two reasons why some people are calling for interest rates to rise…

  1. Possibility of Inflation
  2. Possibility of Financial instability

Now I would like interest rates to rise, but I have never seen any inflation coming. In fact, it seems that inflation will stay low when interest rates stay low in our present economic conditions. I have written about that before in relation to the Fisher effect here on Angry Bear.

As far as financial instability, my concern is more inequality which is subduing effective demand.

But there is a third reason that these economists don’t ever seem to mention… The economic inefficiency of low interest rates.

Look at China. They have over-invested clearly. They have over-capacity in production. Their financial repression with low interest rates has led to over-investment. What do they do now? They roll over debts, keep interest rates low and try to keep these unnecessary firms active. In the US, firms still have debt. They pay interest costs. These low-productivity firms would most likely cut back production, hiring and may even go out of business if interest rates rise. So in order to keep these weak firms active, interest rates must stay low.

Low interest rates make the existence of these marginally weak firms much more possible. Of course, we do not want run-away inflation, nor even financial instability. However do we want these debtor weak firms which weaken the economy?

If we do not want them, we have some options.

  1. We can write off debts, which could include mortgage debts of households.
  2. We can raise taxes on corporations and the rich.
  3. We can close loopholes that allow profits to be hidden overseas.
  4. We can raise interest rates.

A combination of all four options would eventually strengthen our economy.

Imagine a football team that has some weak players. The team is not replacing these weak players.  The team is mediocre from year to year. Then the team starts setting higher standards for its players. It starts cutting weaker players and investing in better players to meet that higher standard. The result will be a better team with better profit potential because they will win more.

If the economy started weeding out weak firms with higher interest rates, they would be replaced with newer-technology firms without old debts from before the crisis. Do you see where I am going with this? Eventually the firms within our economy improve on average. Productivity will increase. Wages have a better chance to rise… and so on.

So arguing that interest rates should stay low because inflation is not likely and bubbles of financial instability should not be popped misses another reason to raise interest rates… to maintain the standard of excellence in the economy in line with medium-run potential. That means raising the Fed rate along an appropriate path so that the short-term real rate rises toward its medium-run natural real rate. Then it is just a matter of how much slack you see for setting that path.

Janet Yellen and the Fed seem to be focused on the slack more than anything. They feel the time is coming to start raising the Fed rate. They recognize that economic growth will slow down some as marginal businesses are tested with a higher interest-rate standard. They may even feel that is a good thing.

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A Fractal Case for Big Government

Brad DeLong made a case for big government and higher deficits. Paul Krugman wrote an exagerated pun of praise.

The part he liked was the appeal to myopia and paternalistic proposal “The problem is that as we move into the twenty-first century, the commodities we will be producing are becoming … more subject to myopia and other behavioral-psychological market failures.” I think that any hint of paternalism is rhetorical poison — even Brad doesn’t quite say that he thinks the government knows best whether, say, kids should stay in school. School attendence in mandatory, but we don’t talk about it much. Here my only contribution is to note a paradox of freedom. if people have time inconsistent preferences, they will choose to precommit. This means that people freely choose to reduce their future freedom. One example would be to introduce a payroll tax used to fund pensions. Notably that is a very very popular policy.

But I focused on something else.

1890. Since then, over any extended time period for major North Atlantic industrial economies, g > r without fail. That is now 125 years.


That fact strongly suggests that North Atlantic economies throughout the entire 20th Century suffered from a form of dynamic inefficiency, in that there was excessive accumulation of societal wealth in the form of net government capital—in other words, government debt was too low. Given the debt secured by government-held social wealth ought to be a close substitute in investors portfolios with debt secured by private capital formation, it is very difficult to understand how economies can be dynamically efficient with respect to private capital and dynamically inefficient with respect to government-held societal wealth in the absence of truly mammoth financial market failures.

Like Brad I follow John Quiggin in believing that the low return on public debt compared to corporate equities is a truly mamoth financial market failure. In other contexts, this view has caused Brad to advocate bond financed public purchases of stock, that is a sovereign wealth fund. This would be a huge expansion of the government and the public debt (public assets aren’t counted). I think risky assets are worth more to the US Federal Government than to any other entity, because it has the deepest pockets and is so big that if it fails, the world economy fails with it. The gigantic profits the US government made while saving the US financial sector are strong evidence of this.

Nothing new yet, but now I want to argue that the advantages of gigantic risk bearing capacity affects optimal public sector employment and public provision of private goods. The Medicare advantage experiment provides evidence that the public sector CMS is more efficient than health insurance companies. Part of this is the high required return on equity, some of the extra cost of Medicare advantage goes to health insurance company profits. Importantly profits are not theft. Insurance companies must have equity and investors demand high returns on equity. However, it is also a fact that public sector bureaucrats are paid much less than private sector managers (even counting the more generous benefits). It is also true, as passionate bureaucracy hater James Q Wilson taught me long ago, that they tend to be, if anything, more qualified on paper. Here I think people are willing to accept much lower incomes for much higher job security.

Now, it is generally believed that the low salaries correspond to extremely low work effort and that the job security leads to extreme moral hazard due to shirking. I am sure this can be a gigantic issue (I work in the Italian public sector — but not very hard). But I’m not convinced that it outweighs the advantages of public employment in many other countries including the USA.

So if offering job security is efficient, why can’t a profit seeking corporation achieve higher profits by offering job security ? One issue is, again, deep pockets. A corporation just can’t guarantee lifetime employment — if demand for its product falls it will go bankrupt. GM offered only lifetime health insurance and ended up bankrupt. Civil service job security corresponds to the US Treasury bearing risk. This can be efficient given its unique risk bearing capacity.

But another issue is dynamic consistency again. As noted by Schliefer and Summers, the possibility of corporate takeovers can be costly to shareholders, because it makes it impossible for shareholders to precommit to an implicit contract with workers by hiring a manager who really wants to keep her word. Managers can’t promise workers that they will stick to an agreement even if, in the event, it would be better for shareholders for the firm to renege. The shareholders can and do toss the managers.

Interestingly Summers (and DeLong) worked for the Clinton administration which had a project to reinvent government by replacing public provision of services with vouchers so they would be provided by the efficient private sector. I don’t think this has worked out very well (say Blackwater 10 times before commenting if you disagree). I think part of the problem is the risk bearing issue I discussed above.

But I think a much larger part of the problem is the nature of typical government failure. I think that the largest losses for citizens occur at the edge of the state, where lowly paid civil servants negotiate with highly paid managers as both stand near the revolving door. If so, this would mean that the cost is proportional not the volume of government but to the surface area of government. Outsourcing tasks reduces government employment, but it increases the number and dollar value of contracts negotiated by agents with extremely asymmetric incentives. I honestly think that the least efficient approach is the mixed approach where money collected with taxes is used to pay profit seeking firms to provide services.

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A thought on Economic Inefficiencies & Low Interest Rates

There is discourse in the econoblogosphere currently about why interest rates are low and may stay low for a long time. Larry Summers says that we may even have a negative natural real rate at full employment, even though Ben Bernanke sees that as somewhat impossible.

It is fairly common knowledge that excess debt and leveraging built up before the crisis. That is economic inefficiency. So we now have a situation where debt is actually growing again internationally. China has accumulated economic inefficiencies in its surge of investment. The effect is to subdue borrowing for global investment which leads to lower interest rates internationally.

So how do we cure the past economic inefficiencies that seem to still be with us? Do we keep interest rates low so that firms and people with debt on the margin won’t go bankrupt? Or do we raise interest rates to start cleaning them out?

If we keep interest rates low, marginal debt will continue and the global economy will LIMP along for who knows how long. And would the economic inefficiencies indirectly fade away through renewed growth as we approach full employment? Maybe, maybe not. Mark Thoma has said, and I agree, that wages will not rise due to globalization, technology and slack/weakness in the labor’s power to ask for higher wages… even at full employment. Thus, inflation would stay low even at full employment. As well, aggregate demand will stay low from weak wage growth.

If we raise interest rates in the US, the economy will slow down some as Janet Yellen has said. A rise in interest rates will hinder firms and people on the margin. Some of them may even go bankrupt. Also, the dollar will rise stressing marginal foreign firms that have borrowed in US dollars. Economic inefficiencies will be directly forced out through higher interest rates.

There exist economic inefficiencies that weaken the global economy. We can get rid of them in an indirect way that may not work even at US full employment or a direct way with some discomfort.


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