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

Oscar Landerretche on Inequality

Oscar Landerretche is an awesome economist from Chile. Below is an excerpt of his participation in a video forum with Brad DeLong on the Politics of Inequality in 2012. Since then he has become the President of the Board of Directors for Codelco, the largest copper producer in Chile. He is currently dealing with the problems in the copper industry. His views help us understand the growing inequality in the US.

Oscar Landerretche on inequality. (48 minute point of video)

“The context of this is that Chile has always been a very unequal society, which is a striking difference with the United States which has had historical periods of relative equality. So, let’s say that somebody came up with a magical policy formula and actually managed to improve our Gini coefficient by 15 points or something like that… which is what we would need to become something like a European country… the structure of the economy would be very very different, in every single sense… it would be extremely different from what we have today. You would have to have other economic sectors that do not exist right now. You would have to have a different political structure. You would have to have a different labor structure… “

Keep in mind that the Gini coefficient in the US has moved toward Chile’s. The structures of our politics and economy have become more like Chile’s. We have lost economic sectors.

“So it’s very hard to promise someone… “you know what?, We’re going to do these things that are going to make dramatic changes in our economy and you’re going to come up a winner.” It’s very hard to make that promise, because a lot of things we have to do is really answer questions. Like, What else are we going to produce besides commodities, food stuffs and copper?… and depending on what sectors are going to come up first, the structure of society and the economy are going to be very different.”

People begin to lose sight of the work they can do for their local community, because local demand for goods and services dries up. As well, economic development concentrates in the hands of fewer people. Grassroots’ endeavors fade away.

“On the hand, the losers are very clear. Chile is a very small country. It’s markets are very concentrated. It’s basically controlled by just a handful of very large family conglomerates. And they are going to lose.”

As inequality concentrates wealth and income, it also concentrates the markets of production. Fewer labor hours are needed to serve the demand of those with the concentrated wealth. Just as we see in the US, underemployment increases with more inequality.

If you were to spread income more evenly throughout society, you would see a broader demand base. Each community would be able to develop more work opportunities.

“It’s easier for the losers to coordinate their strategies to defend what they have. than the winners. The winners don’t really know who they are. It’s very theoretical. It’s sort of an abstract notion. These abstract notions usually get defeated in politics unfortunately…”

Oscar Landerretche is describing the present and future of the US.

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High slack or Low slack?

One has to be crazy to disagree with Brad DeLong. Then, I must be crazy. He said…

“After being wrong for eight straight years, critics of expansionary macro policies in a high-slack low-inflation economy–” Link

It is true that if we look across America, we will see lots of slack and underemployment. Labor force participation is low. Labor hours are at the same level as 15 years ago. (link) Part-time work is higher than in the past.

So why do I disagree with Brad?

Monetary policy is coordinated with the hope that the high-slack will eventually be utilized. In the words of my daughter, “Not gonna happen”. Much of the labor force is simply not going to be needed for the equilibrium economy. Much of labor has been cut out (marginalized) from the equilibrium economy.

The reason is growing inequality…

more concentrated wealth and income = more concentrated consumption demand = more concentrated production

We need fewer labor hours to serve those with the concentrated wealth. The equilibrium level of labor is lower. So we will now always see slack and more underemployment, because the labor force is being concentrated due to income inequality.

The hope of low interest rates is for lower-level businesses to hire the marginalized labor and tighten the labor market so that inflation will return. But the larger marginalized labor force sitting outside the equilibrium economy helps keep wages down. So inflation will stay weak. The low Fed rate is in a delusional attempt. The Fed rate will stay low for a long time until it recognizes that a significant portion of the high-slack is simply gone causing inflation to remain weak.

The Two Groups within Slack

When you look at the high-slack, a relatively smaller portion of it currently will be utilized to bring the economy into an “equilibrium” state of full-employment. The slack that we see is comprised of two groups.

  1. Those who will be utilized.
  2. Those who will not be utilized… the marginalized.

The “true slack” only corresponds to the first group. It is an error to put both groups into the potential slack to be utilized, because as the second group grows relative to the first, you drive down the Fed rate unwisely… unless you see institutions and policies reversing inequality. But inequality in the US is not reversing.

It is like expecting 100 people to come to a party, so you make enough food for 100 people. But then, really only 50 people have any chance of getting to the party. It was an inefficient error expecting 100 people. Too much food will be prepared. Too many people will be hired to prepare the food. Yet, businesses are smart. They know to hire enough labor to prepare food for only 50 people. That is what the “true demand” is.

Brad DeLong should know that inequality marginalizes portions of the labor force. He works in an organization that deals with inequality. And he sponsored a forum on inequality with Oscar Landerretche (economist from Chile who speaks against inequality) Youtube video link. In the video link Oscar Landerretche seeks to articulate his direct experience and deep insights of inequality.

Inequality produces higher levels of underemployment within the effective demand limits. I wonder if Brad DeLong has any measure of an effective demand limit upon an economy as Keynes tried to describe it. (link)


As the Fed rate rises, the marginalized workers will become more visible as to what they really are… marginalized. The marginalized workers really are unusable, unprofitable and unneeded slack. “True” slack in the economy is actually low. The unemployment rate would most likely rise as the Fed rate normalizes trimming out the weakly-incorporated marginalized.
At some point though, the Fed rate will have to let go of these marginalized workers as dead weight on the equilibrium economy so that it can normalize… Otherwise a way has to be found to reverse the trend of inequality.

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Catching up to the Natural Real Rate

This is a comment on an article that came out yesterday called The equilibrium real funds rate: Past, present and future by James D. Hamilton, Ethan Harris, Jan Hatzius and Kenneth D. West. They talk about how difficult it is to determine an equilibrium real interest rate which is the real rate at full employment or the natural level of real GDP.

Yes, it would be difficult to estimate the natural real rate when one does not have an estimate of an effective demand limit for a business cycle. One has a vague idea what the output gap could be. It is like a blind person groping not knowing where a wall is.

My way to determine the effective demand limit may not be the best way, but it is the only way so far. No one else talks about one. So far the economy is following my theories. I hope to be opening some insights that economics has not seen before.

The authors of the referenced article say that the equilibrium real rate is somewhere between 0% and 2%. The wide range is based on uncertainty surrounding many factors. Based on the effective demand limit which sets the natural level of real GDP, I say the equilibrium real rate is in the upper range of their estimate, between 1.5% and 2.0%.

projected fed path1

In the graph, I determine the natural real rate by first estimating potential real GDP with relation to an effective demand limit. (see this link) Then I take a 2-year, 3-year and 4-year annual growth rates of that potential real GDP. Then I average these 3 rates.

My sense though is that the authors agree with a natural real rate at least above 1.5% because they show a graph where the Fed rate normalizes a bit above 3.5%. This is based on an inflation target of 2.0% plus a natural real rate of 1.5%. It seems they expect the natural real rate to revert towards its mean.

projected fed path

However, this graph implies that the Fed rate could rise from 0.5% to 2.5% through 2016. In order to do this, the Fed rate would have to rise at least 0.5% every quarter after sitting at the ZLB since 2009. The markets would be shocked. The Fed seems too far behind the curve. Such a fast rate rise would be hard for the markets to stomach. But since the Fed does not see an effective demand limit, they estimate more available capacity than I and others do.

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Low Inflation Pressures at Zero Output Gap due to rising Inequality

Menzie Chinn wrote about various ways to estimate potential GDP. It becomes perplexing when an estimation shows that the output gap could be zero. Why? Because there are such weak inflation pressures…

“That seems implausible to me, but then, so too does a nearly zero gap, given the lagging inflation rate.” – Menzie Chinn

The gap can be closed with weak inflation pressures.

Just hold down labor power, spread underemployment among more people, reduce labor share by 5%, mute investment and increase inequality. You weaken consumer power for more people.
Now the real problem in understanding low inflation at a zero gap is thinking there is still much more spare capacity with so much underemployment. That is not good thinking. Underemployment does not necessarily imply spare capacity. It could also imply economically marginalized people working in underemployed jobs, which holds down wage inflation.

The economy has a balance for the number of labor hours needed for the concentrations of consumer wealth in an economy. The higher concentrations of wealth that we see now imply fewer labor hours in balance. We have seen labor hours peak at the same level for two decades now. The result is that many people will be cut out (marginalized) from the economy because they are not needed in the balance.

So what appears as spare capacity is really unneeded capacity that will never be utilized.

How many people have been cut out of the economy by rising inequality? We will eventually know as the Fed rate seeks normalization.

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Dow’s Attractor Level over the past year

Since December of 2014, I have been tweeting that the Dow will orbit around an attractor level around 17,300…

Here is what the Dow has done since then until just a moment ago…

1 year dow

The red line shows the attractor level that I have been seeing. Why did I see this? The economy hit the effective demand limit in the 3rd quarter of 2014. I knew the market could not go much above that level due to a profit limit. I sensed that the economy would slide along the effective demand limit. I sensed that the economy would at least hold onto that level. And I knew that monetary policy would stay accommodative. I knew there would be a correction at some point, but that the market would rise back to the attractor.

When the Dow was around 16,700 on September 17th, I tweeted…

A month later…

With the Fed signalling a rate rise in December. I am now re-assessing the attractor level. The important factor is how consistent the Fed will be over time lifting the Fed rate.

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The Futility of low interest rates to save the already Marginalized

One who makes comments on Angry Bear, William Ryan, said…

“Besides I thought we have been in a slump since 2008 haven’t we?( I guess it depends on what sector of the economy we are talking about)”

What sector has been in a slump? Middle and low incomes. Wages have been barely rising. Under-employment is rampant with high levels of part-time workers and long-term unemployment.

How low interest rates are a Futile Attempt to save the Already Marginalized from High Inequality

Labor share has really been dropping since 2003. Inequality is rising. Corporations are making record profits while labor becomes marginalized. What does it mean to be marginalized?

If you go to any Latin American country, you will see large sectors of the populations marginalized. They just do not participate in the economy to any great extent. I have lived in Mexico, Guatemala and Chile and  passed through other countries.

Why are large sectors marginalized? … It is simple, Inequality. Money gets concentrated at the top and flows very slowly among the bottom of society. The rivers are full at the top, but the rivers run dry and slow at the bottom. It is a liquidity thing. It is the reason that Reagan and others were so wrong about “Trickle-down economics”. When you create an economy for the top incomes, hoping that it will trickle-down to the rest, you are in the realm of being evil. It is one of the greatest lies.

I never liked Reagan, even before 1980. I was not happy when he became president. I knew things would not turn out well over time. He started the political process to create inequality.

Ok, enough on Reagan… back to low interest rates trying to cover-up the evils of inequality.

When you look at a society, you will see sectors of labor marginalized, cut off from the economy. You may see millions upon millions in the country-side of China, or millions in India. You may see millions becoming marginalized in the United States.

In Chile, the marginalized are called, “Marginados o marginalizados”. It is a common term. Marginalized communities are extremely easy to spot and describe. They really have no place or hope to become part of the real economy and improve their condition. If the central bank of Chile wanted to incorporate these Marginados into the real economy, they would have to drop their interest rate down to zero for a long time and push businesses into less profitable ventures that could employ these people.

If you leave the marginalized labor outside the economy, you only have to set interest rates for a smaller tighter economy. Interest rates will go up because there will be less slack capacity of labor and capital. But the moment that you look to the marginalized sectors and say, “We have to get them into the economy”, then you all of sudden see unused capacity and start to drop interest rates in order to expand production and drive down societal unemployment rates.

You may want to bring the marginalized workers in because it is the right thing to do, or because you see large reserves of cheap labor to take advantage of. Either way, you bring down interest rates to motivate business to employ more people who are more likely to be unskilled and unproductive.

China has kept interest rates low as part of their financial repression policies. But those policies are slowly being reversed. The key though is if inequality can come down in China. That is a lot to ask, especially for China where people ferociously protect their wealth.

But by lowering interest rates, you bring in workers that are not part of the “real” economy which has been downsized from inequality. These extra workers will take more part-time jobs and lower pay. These jobs are less productive. As the marginalized sectors get incorporated, inflation is weakened due to lower pay and overextended business development, which in the long-run can only be profitable if there is a strong consumer base. So eventually inequality has to be reversed.

Context and the Future

Business development has been the fever for a few decades. Large amounts of marginalized labor, land and capital had to be developed. Interest rates have been falling steadily for decades. Business has overextended in China and as we see now in Europe too where banks have growing amounts of non-performing loans. The context of low interest rates started out as a plan to help businesses develop marginalized sectors worldwide. Now low interest rates are trying to salvage the businesses with non-performing loans.

What is the future? There will have to be a general pullback from low interest rates. Keeping the interest rates low will create deeper and deeper levels of non-performing loans that will have to be dealt with in the future.

Realize this… High inequality has already marginalized many workers. These workers are being employed but they have no hope of improving their condition. These employed workers are destined to be what they really are… marginalized.

It is delusional to think that we are helping them with low interest rates. It is like a patient that has no hope of living, and as doctors, we are telling them that they will live a normal life. It is a lie that will create massive bitterness in the future.

The rich feed upon low interest rates and get stronger. Inequality is not reversed with low interest rates.

Inequality created marginalized workers and trying to make up for this fact with low interest rates is futile. As long as we have higher levels of inequality, we will have to accept higher levels of marginalized workers. Interest rates will go lower and lower trying to deny this reality.

But one day, interest rates will have to rise in order to optimize the economy at a smaller level that is functional with high levels of inequality.

We will set interest rates for a socially optimal level of workers that can work for the rich. Interest rates will have to abandon those who are marginalized. Interest rates will have to rise. In that moment, the reality and evil promise of inequality will be manifested. Large sectors of society will become as they were intended under higher levels of inequality… marginalized and infected with humiliation.

The United States and Europe will become as Latin American countries. You will have smaller neighborhoods of very rich. You will have larger neighborhoods of poor marginalized people. There can be no other outcome from high inequality. And low interest rates can try to hide or postpone this fact, but eventually the reality manifests, and most likely the hard way.

The only solution is to significantly raise labor’s share of income around the world. Inequality has to come down. The result will be that the rivers of liquidity at the bottom of society will start to flow better. Marginalized workers will stop being exploited and start being a real and viable part of the economy. They will create their own grassroots business development. Inflation will be supported throughout society.  There will then be good reasons to raise interest rates to normalized levels, because the marginalized workers are no longer marginalized. A place has been prepared for them at the table.


High inequality creates large sectors of marginalized people. Interest rates come down in an eventually futile attempt to keep them in the economy. But they are already destined to be marginalized. So interest rates go lower and lower to hide this reality.

The only way to return to normal interest rate levels is to reverse inequality.

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Labor Hours decreased in 3rd Quarter… It is noteworthy

From what I read, nobody has pointed out the drop in Nonfarm Business Sector: Hours of All Persons in the 3rd quarter. (seasonally adjusted) The index of hours decreased from 110.66 to 110.53. This is actually noteworthy…

Nonfarm Business Sector: Hours of All Persons since 1967. (link to graph)

hours down

You can see that hours increase through a business cycle. Looking closely at the numbers, hours really do continually increase through the business cycle. There are very few exceptions when hours decrease during an expansion of a business cycle.

But when hours do tick downward, normally a recession starts within 3 quarters. That has been the pattern since 1967… There has only been a few exceptions where hours ticked downward with no recession.

That is why the decrease in hours during the 3rd quarter is interesting. Are hours peaking?

If hours decrease again in the 4th quarter, history says to watch for a slump.


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Will the Fed be optimistic, pessimistic or surprised?

The Fed rate… What is going on with the Fed rate? The Fed say they would like to raise it in December. Others say they should wait.

Using an Effective Demand Version of the IS-LM curve

In a normal IS-LM model, the interest rate is on the y-axis and output on the x-axis. The following model will keep the interest rate on the y-axis, but put a measure for the utilization of labor and capital for output on the x-axis. The measure is TFUR which multiplies the capacity utilization rate by (1 – unemployment rate). This version of the IS-LM model makes it easier to compare business cycles.

path analysis 1

The model shows that the Fed rate would normally rise as the business cycle expands and more labor and capital are utilized. Eventually the Fed rate will normalize at an interest rate equal to the inflation target + the natural real rate. According to this model, the normalization of the Fed rate will take place at the effective demand limit.

In the above model, the vertical dashed green line is the effective demand limit based upon an effective labor share of 80%. The effective demand limit is the projected labor share at full employment. (Labor share is calculated by labor share index: non-farm business * 0.762) The effective demand limit is the limit that the TFUR utilization of labor and capital will reach at full employment.

The Model before the Crisis

This graph adds actual data from 1stQ 2002 to the present.

path analysis 2

As the expansion ensued after the 2001 recession, labor share was around 80%. The curving red arrow shows how the Fed rate was moving along a path associated with an 80% effective labor share, 2% inflation target and an estimated natural real rate of 2.3%.

The Fed rate was heading toward normalization at 4.3%. But then something unusual happened during the expansion. Labor share fell quickly to 77.3%. Effective labor share had never fallen to that level before. The up-sloping path shifted left.

path analysis 3

All of a sudden, the Fed rate was too low according to the prescribed path. Was the Fed surprised by the changes it began to see in the economy? I think so… The Fed rate appeared to rise faster toward the new green dot of normalization but really utilization of labor capital were slowing down. Imbalances in core inflation and bubbles were developing. Ultimately, the Fed rate rose above the normalization rate of 4.3% to control inflation pressures and bubble imbalances.

The economy went into recession for many reasons, but one reason is that the Fed rate probably went a bit too high. The Fed rate should have stayed near 4% during 2007 in my opinion.

After the Crisis

The economy is confusing after the crisis. There are large differences in estimating potential output. There are large differences in estimating the natural real rate. So this graph shows two views of the economy.

path analysis 5

The blue line shows a more optimistic view than the yellow line. The blue line is based on a higher utilization of labor and capital at full employment (82%), yellow (80%). The blue line is also based on a higher natural real rate (1.5%), yellow (-1.0%).

The blue line sees normalization eventually at 3.5%, yellow 1.0%. These points are shown by the green dots.

The red dot along the zero lower bound shows us where the economy was in the 3rd quarter. We can see that the Fed rate is lower at the same TFUR than before the crisis. It has actually never been this low at a TFUR of 74% since at least the 1960s.

If one agrees more with the blue line, they see the Fed rate getting ready to liftoff. If one, like Larry Summers and others, agrees more with the yellow line, then they would say that the Fed rate is far from liftoff.

Note: According to the model, as the effective labor share rises, the vertical dashed green line slides right leading to a higher Fed rate at normalization. The current effective labor share is lower now than before the crisis at 75%. So far the utilization of labor and capital is meeting up with resistance at 75% on the x-axi. If the effective demand limit at 75% holds, the Fed rate will have no space to rise and will stay at the ZLB. The Fed would end up being surprised by the unseen limit.

Which line would you agree with? How might you change the line to your own views? Would you change the slope of the line?

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Labor Share vs. Fiscal and Monetary Policy

Yes, demand is high for safe assets and this is in part driving down interest rates.

Labor share is the key to solving the issue.


Labor share is fallen in the US and other advanced countries, including China. Inequality of income has widened. The excess money at the top is driving the demand for safe assets over its supply, and this is pushing interests rates down.
No matter what stimulus you throw into the economy, monetary or fiscal, the money still circulates with the same labor share ratio. Money still concentrates at the top. Then the increased money at the top maintains demand for safe assets over supply and this further holds down interest rates.

The economy is at its level of output according to the labor share ratio. We are in a new normal.

Now if you want to go back to the old normal, then, labor share has to rise. Until such time, current monetary and fiscal policies will not work in a beneficial way.

New Labor share data came out today. It is still low. Here is the updated FRED graph.

update FRED labor share

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Output is Normally Determined by Effective Demand

An article came out today by Ricardo Caballero, Emmanuel Farhi and Pierre-Olivier Gourinchas, called On the global ZLB economy, where they talk about how a liquidity trap scenario can spread globally.They see a high demand for safe assets over their supply.

“The growing global shortage of safe assets imparted a strong downward secular trend to world real (safe) interest rates for more than two decades. Capital flows acted as the propagating mechanism by which the asset-scarce regions dragged asset-rich regions’ interest rates down.”

This is a consequence of growing income inequality in the advanced countries, combined with the extreme inequality of China becoming more influential in global economic flows. High concentrated wealth and income lead to a higher demand of safe assets and less consumption demand.

They do not see any change in this situation coming soon. The correcting mechanisms are being blocked.

I wrote yesterday about why I use labor share as the over-riding factor in determining the limit on output according to Keynes. Labor share is the best approximation of current income for consumption from current output.

They say in their article that global output is determined by demand, once demand for financial assets exceeds their supply.

“Given the nominal rigidities, output is aggregate-demand determined as soon as the global demand for financial assets exceeds their supply, at the ZLB.”

From my research, the limit on output is always demand determined by the effective demand limit.

They recognize that part of the re-balancing of the situation is for incomes to come down.

“In our model, once real interest rates cannot play their equilibrium role any longer, global output becomes the active margin: lower global output – by reducing income and therefore asset demand more than asset supply – rebalances global asset markets. In this world, liquidity traps emerge naturally and countries drag each other into them.”

But the the problem is that inequality is not decreasing, so high incomes are increasing relative to lower incomes which fuels more demand for safe assets, which keeps the interest rates low and keeps them from normalizing and re-balancing.

So in the end, the drop in labor share seen since 2000 was the signal that the global liquidity trap was bound to happen. And especially the precipitous drop in labor share after the crisis was an extremely important indicator to warn of a persistent liquidity trap. Economists are only understanding this now. Yet, I saw this and wrote about it over two years ago as I began my research of effective demand. (link) In that post, I predicted…

“If labor share of income does not rise, the Fed rate will stay dead no matter what they try to do.”

So the article on the global ZLB is revealing what I have been saying for a couple of years. But more will be discovered in time about how effective demand operates.

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