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Whose Inflation Expectations ? *

Janet Yellen gave a speach which has received a lot of attention and not just because she is one of the most powerful people in the world. I agree with Lorcan Roche Kelly that the best parts are footnotes 28 and 26.

I got into a twitter debate with Andy Harless who was unconvinced by footnote 28

28. My interpretation of the historical evidence is that long-run inflation expectations become anchored at a particular level only after a central bank succeeds in keeping actual inflation near some target level for many years. For that reason, I am somewhat skeptical about the actual effectiveness of any monetary policy that relies primarily on the central bank’s theoretical ability to influence the public’s inflation expectations directly by simply announcing that it will pursue a different inflation goal in the future. Although such announcements might potentially persuade some financial market participants and professional forecasters to shift their expectations, other members of the public are probably much less likely to do so. Hence, actual inflation would probably be affected only after the central bank has had sufficient time to concretely demonstrate its sustained commitment and ability to generate a new norm for the average level of inflation and the behavior of monetary policy–a process that might take years, based on U.S. experience. Consistent with my assessment that announcements alone are not enough, Bernanke and others (1999) found no evidence across a number of countries that the initial disinflation which follows the adoption of inflation targeting is any less costly than disinflations carried out under alternative monetary regimes.

This is my view expressed by my snarky comments about the expected inflation imp. I didn’t know about Bernanke et al 1999 and just looked at the Volcker deflation (which is alleged to show the power of expecations management but doesn’t).

Harless disagreed, Brad DeLong retweeted his tweets, and I promised to write a blog post, so here it is.

Andy Harless ‏@AndyHarless Sep 25
Disagree with Yellen’s note 28. For inflation expectations to have an effect, you don’t need to convince the public, just the smart money.

I disagreed with Harless and will reproduce the tweet debate after the jump. What I should have written is that Yellen’s footnote 28 must be read in the context of footnote 26

26. Another complication is that we do not know whose expectations “matter” for determining inflation. Inflation expectations of professional forecasters (such as those collected in the Blue Chip Economic Indicators, the Survey of Professional Forecasters, or the Survey of Primary Dealers) or inflation expectations derived from asset prices probably capture the views of participants in financial markets but need not reflect the views of households and firms more broadly. As an empirical matter, the little information available on the longer-term inflation expectations of firms from the Atlanta Federal Reserve Business Inflation Expectations survey suggests that firms’ expectations more closely resemble expectations from the University of Michigan Surveys of Consumers than the expectations of professional forecasters. Similarly, preliminary data from a New Zealand study suggests that inflation forecasts of firms are much more similar to those of households than those of professional forecasters (see Coibion and Gorodnichenko, 2015).

The “other members of the public” mentioned in footnote 28 include the managers of firms. Assuming Yellen’s claims of fact are correct and the “smart money” consists of bond traders and professional forecasters but not ordinary people or managers of non-financial firms, how can the “smart money” affect aggregate demand ?

The Harless & Waldmann debate after the jump (but Waldmann gets almost all the pixels as he knows the Angrybear blogger password (or at least his hard disk does)).

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Where MMT Gets Its Accounting Wrong — And Right

Modern Monetary Theory has been revolutionary in economics, and its influence is — beneficially — ever-more pervasive. It has opened the eyes of a generation to a clear-eyed, accounting-based methodology that trumps dimensionless theory, and has brought a deep, nuts-and-bolts understanding of money, debt, and financial institutions to a discipline where that understanding has been inexcusably absent. Witness: a whole raft of papers from central-bank economists worldwide embracing MMT principles (though often not MMT by name), and eviscerating decades or centuries of facile and false explanations of monetary mechanisms. But MMT’s terminology and associated accounting constructs remain problematic and contentious, even among some MMT supporters like the splinter group, the Modern Monetary Realists. Some of this contention results from the usual resistance to new ideas and ways of thinking. But some arises, in my opinion, because MMT terms and accounting constructs are indeed problematic. (The terminological confusion even causes some to object correctly, but for the wrong reasons — and vice versa!) These difficulties are apparent when you consider one of MMT’s central and oft-repeated mantras and accounting identities, here in its simplified form for a closed economy ignoring Rest of World, courtesy of the redoubtable Stephanie Kelton:

Domestic Private Surplus = Government Deficit

This suggests an important truth, as far as it goes: public (monetarily sovereign federal government) deficit spending creates private assets out of thin air. The government spends new money, created ab nihilo, into private accounts. +Private Assets. No change to private liabilities. So: +Private Sector Net Worth.

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Inequality for All, the film

If you do not know, Prof Reich’s film is currently up on youtube.  I just watched it.  For most readers it is nothing new.  But for the masses this is a great film.  Plus, I did not know that he literally went over on the same boat as Bill Clinton when they were going to their Rhodes Scholarship.

Do share it as it may not be up for long.

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More on Weak Productivity & Labor Share of Income

There is a post by Dietz Vollrath, Labor’s Share, Profits, and the Productivity Slowdown.

D. Vollrath has some math there for how a decline in labor share along with a rise in aggregate mark-ups can show that productivity growth is slowing. Mark-ups are the price over marginal cost. Normally in perfect competition, price is equal to marginal cost, but D. Vollrath questions true competition in the economy. He puts forward that price is above marginal cost.

In the end of his post, he calls for lower mark-ups.

“Measured productivity growth tells us how efficiently we use inputs to produce GDP, so anything that makes measured productivity go up – better technology ({A}) or lower markups – is good for us in terms of producing GDP.”

Higher mark-ups and profit rates can rely on lower labor share.

So the solution is to break up market power of companies. Well… Labor also needs more power. We may as well raise labor share too.

My work in effective demand seeks to show that productivity is limited by labor share… such that if labor share falls, productivity becomes even more limited. Also near the end of a business cycle, there is incentive to lower unemployment to maintain profits (mark-ups) while holding capital utilization steady.

In June, 2014, I had a post about labor share,  productivity and profit rates. Profit rates tie to mark-ups. I gave some equations and some analysis…

Profit rate = (1 – labor share)*productivity * labor hours/Capital

Profit rate = (1 – unit labor costs/inflation)*productivity * labor hours/Capital

“Considering 4 things…

  1. Profit rates have peaked
  2. Labor share has bottomed out
  3. Productivity has stalled
  4. Capacity utilization is low

… increases in capital will not be made profitable by lower labor share as they have in the past. So, the key to profit rates now is to raise labor hours holding all else fairly constant. Thus firms have an incentive to hire in an atmosphere of controlled unit labor costs, stable inflation and constrained productivity. Unemployment is coming down but unit labor costs are being strictly controlled and productive capital investment is moderate.”

The forecast proved true over the year. Profit rates stayed steady. Labor share and unit labor costs have risen mildly since then. Capacity utilization stayed low. Inflation has been low and stable. Investment in productive capital has been moderate. Unemployment has come down as the best means to maintain profit rates.

The constraints of the profit rate equation above are being tested more and more as time goes on.

The conclusion of my post from last year still stands…

“Profit rates just simply went too high and labor share went too low. Bringing these back into a sustainable balance will trigger an unstable financial situation, which would likely produce a recession.”

The economy continues to walk the tight rope keeping a balance between high profit rates and low labor share. Giving labor power would just upset the balance right? It might trigger a recession… or maybe stock values might collapse. Oh wait, they already have and labor share is still low.

The economy is far from a healthy balance.

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People who are published in newspapers who don’t make proper use of published data

“Pundits are regularly outpredicted by people you’ve never heard of. Here’s how to change that.”
is a very interesting article at the monkey cage by Sam Winter-Levy and Jacob Trefethen.
(h/t @MarkThoma)

They note a study of people you’ve never heard of vs intelligence analysts (not pundits) and write

accountability. While many pundits may not see themselves as being in the business of making forecasts, implicit predictions underpin much of what they write. It seems strange then that we know more about the accuracy of the predictions of Bill Flack, a superforecaster and retired irrigation specialist from Nebraska, than we do about the predictions of Paul Krugman or Bret Stephens.

I don’t know who Bret Stephens is, but note that Winter-Levy and Jacob Trefethen decided to type “Paul Krugman” without mentioning any forecast made by Paul Krugman. They don’t discuss evaluation of the accuracy of Paul Krugman’s forecasts. I assert with great confidencethat they didn’t google Paul Krugman forecast accuracy. I am also sure that they didn’t google Paul Krubman forecast accuracy (as I did — I don’t type so good)

My comment

It may be true that we know more about the accuracy of Bill Flack’s forecasts than of Krugman’s but Krugman’s ability to forecast has been graded. The sample was small, forecasts made on TV, but Krugman didn’t make any incorrect forecasts.

This is publicly available information. google Krugman forecast accuracy and find
or if you don’t want to bother with a pdf the second hit

I think that you really must note this scrap of data in an article about evaluating forecast accuracy in which you chose to name Krugman. Are you aware of the study ? If so, why didn’t you mention it. If not what does that tell us about your ability to handle publicly available data ?

I think your article shows us something about the ability to deal with publicly available data of people who are published in newspapers (including yourselves) and people no one has heard of (including me).

I mean really, would it have been too hard to google ?

Interestingly, this isn’t yesterday’s only post at The Monkey Cage which includes the words Paul and Krugman. Nor is it one which suggests the most ignorance.

I think the staff of The Monkey Cage (including the editor equivalent if there is one) have to have a talk about the proper use of the word “Krugman” which includes two principles

1) watch out for Brad DeLong and his friends (or in other words Krugman’s acolytes and his acolytes’ acolytes)
2) Paul Krugman is right surprisingly often.

I am not joking at all.

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