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In Which I Disagree with Paul Krugman and Brad DeLong

This is a rare event. Both Brad DeLong and Paul Krugman argue that a recent argument by Kevin Warsh and Michael Spence makes no theoretical sense. I disagree. I am sure Warsh and Spence are wrong, but I can make a simple theoretical argument for their conclusion.

The argument is that QE causes low non residential fixed capital investment. DeLong and Krugman noted that their is no anomaly to explain — non residential fixed capital investment is what one would expect given the sluggish growth of other components of GDP. In other words, the explanation of why it hasn’t bounced back this recovery is low housing investment and government purchases of goods and services. I am convinced by the evidence Brad presented (click the damn link).

But I am not convinced by his theoretical argument (and not just because it is a theoretical argument)

Krugman agrees with DeLong

QE reduces volatility in financial markets by making some of the risk tolerance that was otherwise soaked up bearing duration risk free to bear other kinds of risk. That is what it is supposed to do. With more risk tolerance available, more risky real activities will be undertaken

Krugman agreed

“Brad DeLong spends what may be too much time on the latest; it’s an argument that doesn’t make any sense, deployed to explain something that isn’t happening”

I think it is easy to make the argument (although I am do not find it convincing).

My comment on Krugman below (I am less polite to Brad — you can see my comment over at his blog if you click the link).

I think it is possible to write down a simple (not even obviously forced to reach the desired conclusion) economic model in which QE causes low nonresidential fixed investment. Here I define QE as purchases of 10 year Treasury notes & 30 year Treasury bonds (not RMBS).

The argument is that the duration risk in long term Treasuries is negatively correlated with the risk in fixed capital. I think this is clearly true. The risk of long term Treasuries is that future short term rates will be high. This can be because of high inflation or because the FED considers high real rates required to cool off an overheated economy. Both of these are correlated with high returns on fixed capital (someone somewhere keeps arguing that what the economy needs is higher inflation).

This means that a higher price for long term treasuries should make fixed capital less attractive — the cost of insuring against the risk in fixed capital is greater.

It is important that the assets bought via QE are nominal assets with extremely low default risk. The risk in corporate junk bonds is mainly the risk of default. Their returns are similar to the returns on fixed capital (and on stock). If the Fed were to (illegally) buy corporate default risk, it would increase incentives for corporations to invest.

None of this reasoning applies to Fed purchases of mortgage bonds. Also it has no influence on my actual beliefs (it is economic theory).

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Neo-Fisher Reflections

The Fisher Effect would say that steady and low nominal interests would bring down inflation as the real interest rises to its natural level at full employment. OK… nominal interest rates are steady and low and inflation is low. So is it really the Fisher Effect that is bringing down inflation?

Just yesterday I posted that last year my model of the Fisher Effect predicted that inflation would stay low. Now… did inflation stay low due to the Fisher Effect or some other force?

The Fisher Effect should kick in when monetary policy has its hands tied for a long time. Even though we have seen the Fed rate stuck at the zero lower bound for many years, monetary policy has still been tightening because the Fed first stopped QE, then lately they have been saying that they will raise the Fed rate by the end of the year. Expectations of tightening ensued which tightened monetary policy even though the Fed rate and monetary base had not changed.

What about supply and demand in the aggregate economy?

Low interest rates globally are encouraging production on the supply side.

Lower labor share in the US, China and other advanced countries is reducing the consumer demand side. There isn’t strong fiscal policy demand since many other countries are limiting their fiscal spending. China has a strong fiscal stimulus policy but their strong financial repression measures keep inflation low.

So when supply is being boosted and demand is being weakened, prices should want to come down.

The point here is that these dynamics of supply and demand are only indirectly related to the Fisher Effect. The low interest rate could generate inflation if consumer and fiscal demands were increased. But labor share is not rising much, and the US govt debt is falling as a share of GDP. Low labor share and fiscal restraint are not caused by low nominal interest rates. So the dynamics of supply and demand are only indirectly related to any Fisher Effect.

When I look at bank type lending (in real terms)…

bank lend

Lending dropped after the crisis and then started to pick up again in 2013. We can imagine a bubble of lending toward the end of the last business cycle, then lending came back down to a long-term trend in 2013, at which point it started to rise again.

From the interest rate rule that I use, the Fed rate started to fall below the curve in 2013. In effect, the Fed rate started to be lower than the prescribed rate for the economy. The Taylor rule is showing the same trend. Borrowing from the banks should increase under these conditions.

2013 trend

So we have a “depressed” economy. Labor share is low. Fiscal stimulus should could have been stronger. Nominal interest rates were too high after the crisis. Production came back stronger than consumer demand as capacity utilization rose much faster than unemployment fell according to past patterns. The effect was to suppress inflation. But now what, the Fed rate looks to be stimulating the economy. Bank type lending is increasing again. There is hope that this will feed into inflation…

But labor share is still not rising. Capital income may pull back its consumption as the stock markets wobble at the end of the business cycle. The demand side is staying weak. Inflation is weak.

So… is inflation weak from weak demand in the face of supported supply? or is inflation weak from the Fisher Effect where the Fed rate is stuck at the zero lower bound for years and looks like years to come?

I can more clearly see the mechanisms behind weak demand and supported supply, than the mechanisms behind the Fisher Effect. So I put the Fisher Effect up on a shelf until low inflation is no longer explained by weak labor share, weak fiscal stimulus and various types of financial repression vis-á-vis a supported supply side that seems to be in a position to feed itself first upon monetary efforts to stimulate inflation.

The govt should be borrowing and spending more. Labor should be sharing more in the record profits. The Fisher Effect does not explain weak demand. The Fisher Effect does not understand why this is happening.

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When Titans collide: UPS petitions the PRC to change USPS costing methodologies




(A North Carolina Retired Postmaster). First posted at Save The Post Office

The United Parcel Service is very concerned that you might be paying too much for a postage stamp.

If you’re wondering why UPS would be worried about something like that, it has to do with the way postal rates are set. According to the law, each USPS product is supposed to cover its share of the Postal Service’s operating costs, which includes costs attributable to that product as well as a share of total institutional costs.

UPS believes that market-dominant products — First Class mail, Standard mail, and periodicals — are covering more than their fair share of the Postal Service’s operating costs, while competitive products — Priority and most shipping services — are not paying enough. As a result, argues UPS, the average customer who buys a First-Class stamp is paying too much because part of the stamp’s price is being used to subsidize competitive products. UPS wants the cost allocation methodology changed so that competitive products pay a larger share of the Postal Service’s operating costs.

Then the Postal Service will to have to raise the prices of the products with which UPS competes, which will put UPS in a better competitive position and increase its profits. UPS doesn’t really care that some USPS customers are paying too much for postage. UPS cares about UPS.

The UPS petition

UPS has been complaining about the costing methodology for many years; but in recent weeks, it has intensified its efforts to get the Postal Regulatory Commission to do something about the problem. In a petition recently filed with the PRC, UPS argues that the costing methodology used by the Postal Service and PRC is seriously flawed. It recommends several changes that are intended to make the system fairer and bring it into compliance with the law. (The UPS filing is in PRC Docket NumberRM2016-2.).

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Inflation Expectations trending lower… predicted by Neo-Fisherian model

update inflation expectations

Link to graph

The graph shows that inflation expectations are still trending lower. This trend is consistent with the Neo-fisherian view that over time, as the Fed rate stays stuck at a low rate, the expected inflation will trend lower as the real rate seeks to rise to its natural level.

We have seen in the past month that the Fed is not able to raise the Fed rate. Thus the projected Fed rate at full-employment is expected to be lower. The result is that inflation expectations should go lower according to the dynamics of the Fisher Effect.

Below is a video that I made in November of last year. Using a dynamic model of the Fisher Effect, it explains why expected inflation is still dropping even with the Fed rate stuck at the zero lower bound. (The numbers in the video for expected inflation, the projected Fed rate at full-employment, estimated natural real rate are very applicable to today’s views.)

When I posted this video last year, I predicted…

“The video at the very end shows the case for what many of us are projecting now… That the Fed rate will not be able rise next year, nor even 2016.” (link)

From the graph above, we are seeing that inflation expectations are still trending lower.

Link to video

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Federal Deficit by President

If you look at the federal deficit as a share of GDP by presidential administration an interesting pattern emerges.

Every Republican administration left office with a larger deficit than they inherited.

Every Democratic administration left office with a smaller deficit than they inherited.

fed deficits

Why should we pay any attention to anything any Republican says about the deficit.

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New study finds state subsidies go overwhelmingly to large companies

Good Jobs First has just issued a new report analyzing state investment incentive programs open to small and large businesses alike. With the financial support of the Surdna Foundation and the Ewing Marion Kauffman Foundation, Shortchanging Small Business: How Big Businesses Dominate State Economic Development Incentives finds that 70% of the awards and 90% of the money goes to large companies. This is a big deal: The justification for many major incentive programs is that they benefit small business. This study is the first in a planned series of reports which show that this claim does not stand up.

If subsidy programs disproportionately benefit large businesses, they reduce market competition and thereby make the economy less efficient. As I discussed in Competing for Capital, subsidies to capital exacerbate income inequality (post-tax, post-subsidy). This effect will be magnified if the incentives are flowing primarily to large firms rather than smaller ones, as this new study suggests to be the case. The report’s findings are relevant to the European Commission’s ruling last week on Starbucks and Fiat, that subsidies created by tax havens harm the ability of small- and medium-sized enterprises (SMEs) to compete.

Shortchanging Small Business looks at 15 incentive programs in 13 states that are well-documented in Good Jobs First’s Subsidy Tracker database, plus one Missouri program that is highly transparent online (and will soon be included in Subsidy Tracker), for a total of 16 programs in 14 states. Overall, these programs account for 4228 individual awards allocating over $3.2 billion.

Note that these are not one-off deals for a large company: For example, as I showed in my special report on North Carolina incentive packages, the deal Google received from the state in 2007 was worth $140.6 million at present value to the company. This dwarfs the $26.4 million over six years given by the One NC Fund, included in this Good Jobs First report, and is only one of a number of megadeals in North Carolina.

Moreover, neither are they apparently open programs with criteria that in fact rule out small companies through the use of large job creation or investment requirements. No, the 16 programs considered in this report are all genuinely available to large and small firms alike; that is what makes this such an important study. This report excludes programs directed solely to small businesses, but Good Jobs First has promised a separate analysis of those generally poorly funded measures.

What, then, is a small company? For the purposes of this study, it has to have fewer than 100 employees, it has to be an independently owned local firm, and it must have fewer than 10 establishments. If a company does not meet all three criteria, it is classified as a large company. Note that this cutoff is considerably below that of the U.S. Small Business Administration, which for most industries is 500 employees. On the other hand it is larger than the European Union definition of a small enterprise (50 workers) but smaller than the EU definition of a medium-sized enterprise (250 workers).

Despite the fact that small companies are theoretically eligible for the 16 programs analyzed, they receive only 30% of the awards and 10% of the money available through them. As I pointed out earlier, combined with one-off megadeals, programs that only appear to be open to small firms, and tiny programs specifically for small business, this adds up to a large bias in favor of big business, with all the consequences noted above.

What should be done? The report notes that many small businesses cannot benefit from the tax credit or tax abatement involved in the programs analyzed and, in a separate survey, many small business leaders said they would benefit more from public goods like job training, education, and transportation. Therefore, Good Jobs First proposes a reduction in incentive spending going to large companies, to be effected by using hard caps on each program’s spending, on cost per job, and on the total amount any one company can receive under a given subsidy policy. While such caps are unusual in the United States, they are the main basis for the European Union’s successful control over incentive spending there, elaborated further to have higher caps in poorer regions and a cap of 0 in the richest EU regions. In addition, the caps proposed by Good Jobs First could be augmented by using an EU metric known as aid intensity, which is simply the subsidy divided by the investment. While a cost per job cap is useful at resisting excessive capital intensity, an aid intensity cap is a valuable metric when substantial jobs are created but the government is paying for virtually the entire cost of the project (for example, Electrolux in Memphis).

I’m looking forward to further extensions of this research, and you should, too.

Cross-posted from Middle Class Political Economist.

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Looks Like It’s All Over But the Shouting.*

The New York Times’ report today by Maggie Haberman and Jonathan Martin on Clinton’s, Sanders’s and O’Malley’s speeches last night at the annual Iowa Democratic Party Jefferson-Jackson Dinner includes this:

“I’ve been told to stop shouting to end gun violence,” [Clinton] said, repeating a line she has begun using since Mr. Sanders said in the debate that “all the shouting in the world” would not keep guns out of the wrong hands. “I haven’t been shouting, but sometimes when a woman speaks out, some people think it’s shouting.”

I guess she’ll keep this up until Sanders or the mainstream media asks whether Clinton actually can’t recognize figurative speech and can’t distinguish between a statement to her about only her and one about groups of people that include members of both sexes.

Sanders’s comment was clear.  If she misunderstood it, that doesn’t speak well for her level of skill in understanding statements by people that presidents need to communicate with.  If instead she understood Sanders perfectly well but thinks the public has forgotten, and won’t be reminded of, what Sanders actually said, she’s mistaken.

The NYT article also mentions that by the time Clinton spoke, many of Sanders’s supporters already had left the hall in order to catch chartered buses or to party (or both).  That’s too bad, because I doubt that had they remained and heard that comment they would not have cared much for it.  In any event, I don’t see how this helps a candidate whose Achilles heel is a perception that she is somewhat dishonest by nature.

I don’t want to beat a dead horse, but I don’t think this horse is even nearly dead.  Sanders needs to recognize that apparently Clinton plans throughout the campaign to misrepresent his statements by selecting a clause or phrase and misrepresenting its context.  Sleights of hand will be a primary tool in her campaign.  He needs to respond to these quickly.



Sanders on Sunday laughed at her suggestion that his remarks were about gender.

“All that I can say is I am very proud of my record on women’s issues. I certainly do not have a problem with women speaking out — and I think what the secretary is doing there is taking words and misapplying them,” Sanders told [CNN’s Jake] Tapper. [Boldface added.]

“What I would say is if we are going to make some progress in dealing with these horrific massacres that we’re seeing, is that people have got to start all over this country talking to each other,” he said. “It’s not Hillary Clinton. You have some people who are shouting at other people all across this country. You know that. This nation is divided on this issue.”

Indeed. I think Clinton will find that this type of campaign tactic is very much out of tune with large swaths of Democratic voters right now.

Updated 10/25 at 12:22 p.m.


SECOND UPDATE: The New York Times’s Thomas Kaplan wrote on the Times’ political blog First Draft:

Hillary Rodham Clinton has seized on remarks Senator Bernie Sanders made in the first Democratic debate that “all the shouting in the world” would not keep guns out of the wrong hands, suggesting that Mr. Sanders used those words because of Mrs. Clinton’s gender.

“I haven’t been shouting, but sometimes when a woman speaks out, some people think it’s shouting,” she said at the Jefferson­-Jackson dinner in Des Moines, Iowa, on Saturday.

But Mr. Sanders’s past comments about gun control suggest that his “shouting” line is just that – a favored turn of phrase that he has used regularly in the past few months, long before Mrs. Clinton released her plan to address gun violence.

In July, Mr. Sanders, senator of Vermont, said that people needed to “stop shouting at each other” on the issue of guns. In August, he said that “people shouting at each other” about gun control “is not doing anybody any good.” And on Oct. 1, reacting to the mass shooting at a community college in Oregon, he said that the nation needed to “get beyond the shouting” on the issue.

Mrs. Clinton, the former secretary of state, announced her proposals to curb gun violence on Oct. 5, and in recent weeks she has been particularly vocal on the issue of gun control, a subject on which Mr. Sanders has a mixed.

Looks like this controversy is all over but the shouting.  Or is about to be.  And like her ‘Denmark’ sleight of hand, it’s not a plus for Clinton.

I think it’s a concern for Democrats that Clinton, who remains the party’s frontrunner, has an apparent compulsion to campaign in this way.  In this instance, she managed to trivialize sexism by claiming it so obviously falsely—the woman who cried wolf—and cheapen the very process of campaigning.  Why does she keep doing this kind of thing?


*The original title of this post was “Update to: “Hillary Clinton Says the NRA’s Leadership is Comprised Entirely of Women.  Seriously.”

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Hillary Clinton Says the NRA’s Leadership is Comprised Entirely of Women. Seriously.

Former Secretary of State Hillary Clinton called out Sen. Bernie Sanders (I-Vermont) on Friday over his request that politicians “stop shouting” about gun control.

During a speech at the Democratic National Committee’s Women’s Leadership Conference, Clinton implied that Sanders’ comments may even have had a sexist tinge.

“I’ve been told to, and I quote, ‘stop shouting’ about gun violence. First of all I’m not shouting. It’s just sometimes when women talk people think we’re shouting,” Clinton said, as the audience applauded.

“And second, I will not be silent, because we will not be silenced. Not by the gun lobby, not by the size of this challenge, not by any of it. Stopping gun violence is worth fighting for.”

Despite Sanders’ fiery rhetoric on a number of campaign issues, the senator has a more moderate record on gun control relative to many Democrats. He was pressed to defend that record at the first Democratic debate last week.

“All the shouting in the world is not going to do what all of us want and that is keep guns out of the hands of people who should not have those guns,” Sanders responded. “What we need to do is bring our people together to stop the shouting, to pass sensible gun control legislation.”

As Sanders has continued to gain steam on the left, his Democratic rivals have frequently pointed out his spotty record on gun control.

Hillary Clinton just took another swipe at Bernie Sanders, Maxwell Tani, Business Insider, yesterday

Well, props to Mr. Tani for pointing out that Sanders’s actual comment was directed not just at Clinton but to politicians on both sides of the gun-control divide, who, like Clinton, shout figuratively, not literally, about the issue.  Maybe that’s because, unlike other news organizations’ reporters and their online video editors, Tani actually quoted Sanders’s entire comment at the debate.

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Are low Fed rates a Price Floor or a Price Ceiling?

Brad DeLong talks about how other economists view Fed interest rate policies as “price controls”. Then he makes a comparison to the present situation with on an example of a “price floor” in agricultural products. But are low interest rates a price floor or a price ceiling?

If you think that interest rates need to go lower to efficiently clear the market than the zero lower bound would be a price floor. In effect, you cannot lower the price of money. This is how Brad DeLong views the current interest rate policy.

If you think that interest rates need to go higher to clear the market than the zero lower bound would be a price ceiling. In effect, the price of money is being pushed low.  This is not how Brad DeLong would see current interest rate policy. Yet this is how the others are seeing it.

Compare this Biz cycle to the last

What do we know about a price ceiling? In a price ceiling, suppliers are less willing to supply the good or service. Is that why bank lending is down so low this business cycle? (link to graph)

bank lend

Or is bank lending down due to deleveraging?

Also in a price ceiling, there is demand to raise the price. There is demand for the good or service. So is there demand for money? Well, corporate bond liabilities are up high in this business cycle which would imply that there is a higher demand for money. (link to graph)

bank lend bonds

Yes, there is demand for money through selling bonds, but not through borrowing from the banks.

In this business cycle compared to the last, it would seem that banks might be reluctant to lend with the price of money so low. Banks would prefer a higher price to sell the money. So banks limit their supply of loanable funds. Yet corporations that want money have gone to selling bonds to investors who are reaching for some yield. So it seems that the marketing clearing price might be higher which upon a first approximation says that low interest rates are a price ceiling, not a price floor.

Comments? Reactions?

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