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

More on housing

(Dan here…Lifted from Bonddad blog by NewDealdemocrat):

More on housing

I’ve elaborated on my dissection of October housing permits and starts over at

Anecdotally, I know of three twenty-somethings, two of whom are single, who are blue collar workers in the construction or retail sectors, all of whom are in the process of moving out of apartments into existing homes. The story for all three is basically the same: compared with rents, the monthly payments on a house is a compelling bargain.

Whether or not the plural of anecdote is data, somehow I doubt these three people are the only ones to make that calculation — which supports the data I published a month ago pointing out that even though house prices are very high, the monthly payment is very reasonable compared with the last 30 years, and a bargain compared with soarding rents.

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There is still a Phillips Curve in the USA Too

Has the Phillips curve vanished ? There is widespread discussion of the possibility that the Phillips curve has become horizontal. I am old enough to remember when all serious economists agreed that, in the long run, it is vertical. The reason for the thought that it might be horizontal is that large important countries have unemployment lower than estimated non accelerating inflation rates, and yet still have low inflation (including low wage inflation).
I looked at the old Europe 15 (the countries which were in the European Union in 1997 so the European Commission has harmonized time series going back to the 1960s). The Phillips curve is still very clear in that data set. There is no sign that it has a lower slope in the 2st than in the late 20th century. So I wonder why people are convinced it has vanished. One possible explanation is that more attention is focused on the USA than on other countries (maybe than on all other countries put together). So I will look at the case of the Phillips curve in the USA (probably the most over studied topic in economics). It still slopes down. Even in the US I estimate, at most, a mild reduction of the slope. This makes the puzzle more puzzling.

Before going on, I should note that I just learned that Joe Gagnon has written a much better version of this post right here .He argues that there is no inflation puzzle.

I will present the US evidence after the jump.

I will puzzle over perceptions here.

I will puzzle over perceptions here.

I think one key issue is that inflation hawks must argue that the Phillips curve is steep — not just downward sloping. It is hard to argue that we must accept 6% unemployment because 4.1% might lead to inflation of 2.5% for a few years starting next year. This means that a gradual increase in inflation (consistent with data from the 20th century) is considered anomalous because it contradicts the inflation hawk and generally austerian ideology. I think this is an important factor, but I have trouble determining how important using objective evidence.

second, Policy makers, commentators and even academic economists discussing real time economic issues focus intensely on the past months or, at most, the past few years. Reality is stochastic and the Phillips curve is useful but crude. We can’t really expect to be able to forecast the change in inflation from one month to the next. But we do. This means that there are constantly puzzles which turn out to have no interesting explanation. Gagnon puts this very well

The unexpected drop in inflation in mid-2017 is not particularly large in historical context. The figure displays the location of the latest observation (2017Q3), which is well within the historical Phillips curve experience.[5] In February 2017, the unemployment rate was equal to the estimated natural rate of 4.7 percent. By October 2017, it had dropped to 4.1 percent, implying that overall employment was 0.6 percentage points above potential. Based on the [accelerationist] Phillips curve, we would expect inflation to rise by about half a percentage point over the next year. But historical experience suggests that inflation may end up anywhere from 1 percentage point lower to 3 percentage points higher. In other words, the Phillips curve remains an important fundamental driver of inflation, but we should not overstate the precision with which it operates.

Third, I think there is great faith, based on little evidence , that the non accelerating rate of inflation (NAIRU is known and fairly high — definitely higher than it used to be back in the good old days (note that Gagnon does not share this view 4.7% is about what the NAIRU was guessed to be when the term was coined) . I think a very large part of this is the conviction that unemployment can not stay far above the natural rate for years and years. This is, I think, an article of faith. If unemployment can’t be far above the natural rate for years, fact that unemployment is much lower than it was in recent years implies it must be far below the natural rate. Marco Fioramanti and I have written a lot about this. I just include a google search.

This is a good place to start . People who rely on bad estimates of the non accelerating rate of inflation will be surprised by observed inflation.

fourth, the Phillips curve curves. I think the habit of linearizing for convenience mislead people. The slope of the curve is low at high unemployment rates. This is true for approxmately all specifications with all data sets. But it surprises people again and again.

fifth, finally, and importantly, I think there is an odd attitude towards the expected inflation term in the Phillips curve. The relationship estimated since the 60s give wage inflation as expected price inflation plus a function of unemployment. The old approach was to include lagged price inflation as a variable and consider the coefficient to give expected inflation as a function of past inflation. This approach was refuted by a though experiment (that is it was not shown to fail empirically as an approximation to the behavior of the variables of interest). It was argued that constant high inflation must eventually be 100% expected. There are a number of responses, but the one chosen by practical people was to keep expected inflation a linear function of lags of inflation and impose the assumption that the sum of coefficients was one. Then, to make things simple by using only one lag. And so the accelerationist Phillips curve was born. In this equation the change of inflation is a function of unemployment.

It wasn’t ever respectable theory and it doesn’t fit data from the past 30 years well. It just became the conventional approach of practical people. It performed less well than more flexible models in the 20th century. It performs terribly in the 21st. This isn’t really a major change — I can’t find a specification so that the null that the relationship is the same in the 20th and 21st century is rejected. The accelerationist Phillips curve was always hard to detect, and it isn’t surprising that it doesn’t show up clearly in less than 17 years of data.

Oddly, one popular alternative to the accelerationist curve used by extremely practical people who don’t like fancy stuff like OLS is the orginal Phillips scatter of inflation and unempoyment. This is odd. No one (including Phillips) ever argued that there shouldn’t be any expected inflation term (expensive book warning).

that simple relationship has shifted. There was stagflation in the 70s and early 80s. This is not news to anyone. What is news to me at least, is that, when I drop the data from 1970-1984, the remaining points in the original Phillips scatter form a curve. This would occur if expectations which were anchored except during those 15 years. I can’t resist putting the graph right here.

Quartely data from FRED Winf is the annualized rate of change of the average hourly wage of production workers (AHEPTI). Unem is the ordinary headline unemployment rate (UNRATE). Data are quarterly from the late 60s (64-69 — oddly the FRED AHEPTI series start in 1964) or first quarter of 1985 on.

After the jump, I will show another scatter and a bunch of regressions. I don’t see strong evidence that the relationship between unemployment and wage inflation has changed recently even in the USA. There is strong evidence there (as in Europe) that the coefficient on lagged inflation is much lower than it was in the 70s and early 80s. This is consistent with anchoring of expectations. A quick simple story is that expectations were well anchored until the early 70s, then de-anchored until around 1985 and have been well anchored since. I, personally, can’t tell that story, because I insist that (some people’s) inflation expectations are not anchored based on TIPS breakevens ( evidence from bond markets ). I think the explanation might be that the expectations of employers and employees negotiating wages are anchored even if the expectations of bond traders aren’t.

In any case, the coefficient on unemployment is fairly stable. Various authors have noted that, in sophisticated state space/random coefficients models, the series of estimates isn’t flat, but there are not changes dramatic enough to refute the null of no change with old fashioned econometrics (a Chow test).

I think that the belief that the Phillips curve has vanished has two principle causes. Most importantly, people who look only at the last couple of years of data often see no particular pattern. Also insistence that the right specification of a Phillips curve must be accelerationist has kept people from seeing that the pattern described sixty years ago is still in the data.

Some very simple analysis of US data on unemployment and inflation (the most over analysed data in economics) after the jump.

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The Leprechaun Long Run

The more people think about the Republican proposal to cut corporate taxes the worse it looks. Most people dismiss the argument that the benefits will trickle down to workers. Supporters’ argument is that reduced taxes on profits will cause increased investment which causes higher production and wages. There are strong arguments that the tax cut won’t cause firms to invest more. But aside from that, increased investment wouln’t cause (all) of the promised increase in wages. In this post, I will, for the sake of argument, make many assumptions favorable to advocates of the tax cut.

As often, I am following Paul Krugman and thinking of tax incidence in an open economy. Among others including Jared Bernstein, he argues that advocates of the tax cut have neglected their assumption that the increased investment will require foreign funds & that foreigners don’t invest in the US as a charity and expect to be repaid. This means that, in the short run, advocates argue that foreigners will buy US assets (the US will have a capital account surplus) which means that the US will have an even larger current account deficit. The plan is to cause high trade deficits in the short run.

Krugman has a post on the dynamics of convergence which he correctly notes is insanely wonkish. I will write only about the long run — the new steady state. So the math will be relatively simple. But mostly he writes comprehensible about Leprechaun economics, which is what he names it, because the number one example of trying to grow by cutting corporate taxes is Ireland. The basic point is embarrassingly simple, since foreigners require a return on their investment, attracting it does not cause national income to increase as much as gross national product. With foreign direct investment, more would be produced in the US but a lot of the revenue would belong to the foreigners. He has written four posts on the topic (the first four hits in this search)

Another interest of his the Gravelle Geardown which discusses how Jennifer Gravelle explains why the effect of a corporate tax cut on wages would be lower than some have argued. The point of this post (if any) is that the two issues are linked — the effect on wages is reduced by the fact that the country which attracts foreign investment will have to pay foreigners returns on that investment in the new steady state. I tried to begin to argue this here (reading I see I didn’t get very far).

Some assumptions
1a) The economy is not in a liquidity trap so unemployment (and spare capacity) are at the levels targetting by the Federal Reserve Board. In practice this is like assuming that there is full employment. This means that additional investment has to crowd out something: consumption, government consumption and investment, or net exports.

1b) Consumption is not measurably affected by interest rates. This corresponds to the evidence. This is the reason supply siders have had to appeal to the open economy and foreign investment.

1c) we are talking about tax cuts without government spending cuts.

This implies that the increased investment corresponds to reduced net exports — to a larger trade deficit.

2a) firms invest until the marginal product of capital is equal to the return demanded by investors, so that return is critically important (in the real world interest rates have small effects on investment by firms & mainly affect residential investment).

2b) the production function is smooth and allows substitution of capital and labor. In fact I assume a Cobb-Douglas production function. This means that the concept of “spare capacity” doesn’t apply to the model (and vice versa the model doesn’t apply to the real world).

These are key (implausible) assumptions made by advocates for the tax cut.

3a) Capital and labor are paid their marginal products. This means that the wage measured as a quantity of domestically produced goods depends on the capital labor ratio.

3a) foreigners demand a fixed after tax real return on their investments r* which is not affected by the policy. This is the assumption that the US economy is small. Again a concession for the sake of argument to tax cut advocates.

4) for both US consumption and US investment domestically produced and imported goods are not perfect substitutes. Instead they appear in a utility function (for consumption) or what is called an aggregator for investment. I did algebra (which I won’t inflict on anyone) assuming both have the form (foreign goods)^beta(domestic goods)^(1-beta). I assumed this so the share of spending on foreign goods is fixed. This means that the ratio of quantities demanded is the inverse of the ratio of relative prices. This is, honestly, just a convenient assumption which simplifies algebra. It means that there is a valid price index — utility is the same if dollar spent divided by the price index is fixed, capital is the same if dollar investment divided by the price index is the same and production is the same if capital and labor are the same. The price index is (price of foreign goods)^beta(price of domestic goods)^(1-beta) [oh how convenient]

5) someting similar is happening outside the USA (over here) so the share of foreign spending on US exports is constant. Also, the US is small, so total foreign spending is constant. This means that the value (in terms of foreign goods) of US exports is fixed.

OK that’s about it. I might use some horrible notation. I will use e to refer to the real exchange rate, the price in US goods of a unit of foreign made goods. This means that an increase in e is a real depreciation of the dollar. I will set current e to 1, so e will always refer to the depreciation casused by the policy. I will also set the price of US made goods to 1. This means that the price index is e^beta.

OK the story.
As the economy converges to the new steady stat, the US will run trade deficits summing to the increase in US located capital due to the tax cut. This means that the US will have to run a trade surplus to pay the returns on to the foreigners. This means that, in the long run, the policy will cause a real depreciation of the dollar. e (real exchange rate) will rise.

This has two important effects. First workers are less well off for a given capital labor ratio. The capitol labor ratio determines the wage measured as an amount of domestic goods. The price index relevant for workers as consumers is e^beta times the price of domestic goods. The real depreciation makes workers poorer.

Second the product of capital is also an amount of domestically produced goods. But the cost of a unit of capital is also e^beta>1. This means that, for a given capital labor ratio, the rate of return is lower. So this means that the real depreciation implies a lower capital labor ratio is required to pay the foreigners their required rate of return.

Given the assumption of the same shares beta and 1-beta is spent on domestic and foreign goods both for consumption and investmnet, the two effects have the same magnitude for small changes in K. Both hurt US workers.

To solve for the depreciation required to finance the returns on the additional capital, I have to make some assumption about exports. I think assumption 5) makes sense. It implies that the share of foreign spending on US goods is constant, so the amount of goods exported is proportional to e (I almost wrote exports measured in units of domestically produced goods, but hey the exports *are* domestically produced goods).

This makes the closed form solution pretty simple (although not simple enough to type in plain ascii). Indeed the effect on wages of a cut in the tax on profits is reduced.

This Gravelle gear ratio is a bigger deal if a large share of spending is on imported goods (high beta) and if the share of capital is large. I’m pretty sure the closed form solution and those two statement depend a lot on Cobb-Douglas assumptions made for convnenience.

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Two Powerful Women Losing Power

Two Powerful Women Losing Power

That would be respective Angela Merkel and Janet Yellen, both reported to have lost a lot of power in today’s Washington Post.  During at least the last year, if not the last four, they have been probably the two most powerful women on the planet.

In the case of Merkel, what has happened is that she has failed to form a coalition government after last month’s election, which put her and her party in the lead, but not enough so to allow her to push through to a coalition government, with the hard right Alternative for Democracy (AfD) getting the Bundestag.  She had been trying to form a “Jamaica” coalition with the Greens and the Free Democrats, but the latter withdrew from the negotiations for reasons the WaPo story did not clarify (quality of reporting at WaPo has been declining steadily for some time).  Apparently she then made a last gasp effort to negotiate another “grand coalition” with the Social Democrats, but having lost a lot of support due to having been in such an arrangement prior to the last election, they refused.

It looks like she will call for another round of elections in January, and the AfD is crowing with delight for an apparent triumph on their part.  I guess we shall see.  In the meantime, aside from her personal embarrassment, EU-Brexit negotiations are now reportedly in a stall pattern as nobody wants to sign on to anything without a definitely in-place government in Germany to approve or disapprove of it.   Merkel may yet regain her power if the January elections go more firmly her way, although she may well be forced to step aside as Kanzler der Bundes Deutsches Republik and more completely and thoroughly lose power. Many fear the results of the latter, although if it were to be due to a government led by the SocDems, many hear might cheer.

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Productivity and wages

Another article from Jared Bernstein Washington Post:

There’s an interesting sort of argument going on between Stansbury/Summers (SS) and Mishel/Bivens (MB). My name has been invoked as well, so I’ll weigh in. It’s a “sort-of” argument because there’s less disagreement than first appears.

It all revolves around this chart, which plots to the real compensation of mid-wage workers against the growth in productivity. For years they grew together, then they grow apart. The levels of both variables almost double, 1948-73, but since then, productivity has outpaced the real comp of blue-collar, non-managerial workers (mid-wage workers) by a factor of 6.

Figure 1

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Trade deficits, offshoring jobs, Republican tax plan

Via Washington Post, Jared Bernstein writes:

The Republican tax cut plan has been justly criticized for worsening both income inequality and the national debt, but the plan has another big problem: It’s likely to lead to more outsourcing of U.S. jobs and a larger trade deficit. That’s obviously a negative for factory jobs and net exports, but it’s also precisely the opposite of what Trump continues to promise to many of his working-class supporters.

First, the tax plan moves to what’s called a territorial system of international taxation, which means the U.S. tax rate on the overseas earnings of U.S. foreign affiliates would become zero. While it’s true these firms can defer taxes on these earnings for as long as they like, they cannot “repatriate” them tax-free to invest domestically or to pay dividends to their shareholders (instead, they invest them in financial markets).

Would not the lower corporate rate proposed by the GOP’s tax plan — 20 percent — preclude this incentive? Unfortunately not, because our multinationals have perfected the art of “transfer pricing:” booking, if not producing, their overseas profits in tax havens with single-digit tax rates, while booking deductible expenses in high-tax countries. Under the new regime, they’d be able to keep up this tax avoidance with the added bonus of sending earnings back home tax free. As international tax expert Ed Klienbard puts it: “Territorial tax systems … reward successful transfer pricing gamers as “instant winners” by enabling the successful U.S. firm to recycle immediately its offshore profits as tax-exempt dividends paid to the U.S. parent.”

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Venezuela and the Next Debt Crisis

by Joseph Joyce

Venezuela and the Next Debt Crisis

The markets for the bonds of emerging markets have been rattled by developments in Venezuela. On November 13,Standard & Poor’s declared Venezuela to be in default after that country missed interest payments of $200 million on two government bonds. Venezuelan President Nicolás Maduro had pledged to restructure and refinance his country’s $60 billion debt, but there were no concrete proposals offered at a meeting with bondholders. By the end of the week, however, support from Russia and China had allowed the country to make the late payments.

Whether or not Venezuela’s situation can be resolved, the outlook for the sovereign debt of emerging markets and developing economies is worrisome. The incentive to purchase the debt is clear: their recent yields of about 5% and total returns of over 10% have surpassed the returns on similar debt in the advanced economies. The security of those returns seem to be based on strong fundamental condtions: the IMF in its most recent World Economic Outlook has forecast growth rates for emerging market and developing economies of 4.6% in 2017, 4.9% next year and 5% over the medium term.

The Quarterly Review of the Bank for International Settlements last September reviewed the government debt of 23 emerging markets, worth $11.7 trillion. The BIS economists found that much of this debt was denominated in the domestic currency, had maturities comparable to those of the advanced economies, and carried fixed rates. These trends, the BIS economists reported, “..should help strengthen public finance sustainability by reducing currency mismatches and rollover risks.”

It was not surprising, then when earlier this year the Institute for International Finance announced that total debt in developing countries had risen by $3 trillion in the first quarter. But surging markets invariably attract borrowers with less promising prospects. A FT article reported more recent data from Dealogic, which tracks developments in these markets, that shows that governments with junk-bond ratings raised $75 billion in syndicated bonds this calendar year. These bonds represented 40% of the new debt issued in emerging markets. Examples of such debt include the $3 billion bond issue of Bahrain, Tajikistan’s $500 million issue and the $3 billion raised by Ukraine. These bonds offer even higher yields, in part to compensate bondholders for their relative illiquidity.

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Tax Cuts Pay for themselves nonsense

by Hale Stewart (originally published at Bonddad blog)

John Hinderaker Renews His “Tax Cuts Pay For Themselves With Growth” Nonsense

It’s been awhile since John “Everything I wrote about economics for an entire year was wrong” Hinderaker has written about economics.  The respite has been glorious.  But now that Republicans in the House have passed a tax bill, ol’ John has to tell us that they will lead to glorious growth.

I have one word for him: KANSAS.  Sam Brownback tried this over the last 5 years in his state and it failed.  Miserably.  For more on this, please see Menzie Chen’s writing over at Econbrowser.

But more to the point, the whole “tax cuts made the 80s the most amazing economic growth miracle since the beginning of time pure trope.  Let’s look at the overall pace of growth:

Above is a chart from the FRED database (which John still can’t seem to locate) that shows the Y/Y percentage change in real GDP.  On the really funny side, notice that the pace of growth under Carter was higher on a Y/Y pace than Reagan.  John never seems to mention that.  And yes, growth in the 1980s was good.  But after the initial acceleration (which is more a function of statistics than actual numbers) growth occurred at/near/around its historical trend.

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No, We Won’t See a Torrent of Investment From the Tax Bill

No, We Won’t See a Torrent of Investment From the Tax Bill

One of the arguments that Republicans are using to support their tax bill is that it will unleash investment.  The data says otherwise.  Currently, most US economic sectors are operating far below maximum capacity utilization.

Let’s start with manufacturing:

Figure 1

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ARAMCO CEO Is Delusional

ARAMCO CEO Is Delusional

Financial Times reported yesterday that Amin Nasser, the CEO of the Arabian American Oil Company (ARAMCO, currently 100% owned by the Saudi government, although originally founded by four former US oil company majors), has declared that investors should feel pleased that Crown Prince Muhammed bin Salman has arrested and purged over 200 Saudi princes, government officials, and private businessmen.  This is because this was strictly an anti-corruption move, and foreign investors can be assured that there will now be no corruption in the Kingdom. Really, he said this.

Now I declared in my post title that Nasser is delusional, but I doubt it.  I suspect that he is a very smart guy. The question is whether he can convince any potential buyers of the upcoming possibly $2 trillion Initial Public Offering of 5% of ARAMCO stock that indeed this purge sends a good signal to them about buying ARAMCO stock.  Wow, the nation will now be rid of corruption, and, no, future investor, you need have no fear of being arbitrarily arrested or having your assets seized by MbS, none whatsoever, not that you were worrying about those things previously, but now you really do not need to worry about them at all.

Of course on the very same page of the FT there was another article about how MbS’s purge has rattled world oil markets, with oil prices now sharply falling after sharply rising after he made his purge.  Nobody knows what the implications are or what the heck is going on, but, hey, no problem, no need to worry, Inshallah bukra maalesh (God willing tomorrow no problem, a fave line in KSA).  In any case, Nasser’s public statement will undoubtedly completely reassure everybody, and all will become extremely calm before we know it.

Oh, there is also the matter of where this IPO will happen, touted to be the largest in history.  New York and London stock exchanges have actually been competing with each other to host it, but in fact in the end this may not be such a good idea and they may not be in the running for real anyway.  According to the FT the Saudis are also considering Hong Kong and Tokyo, but at the end of the article it was floated what I have all along expected and predicted: that the IPO will be handled out of Riyadh’s own exchange with specially targeted sales to specially targeted individuals, with a lot of them being local big money Saudis.  So maybe Nasser’s speech was not for all the foolish foreigners, but for the well-off locals: buy when we tell you to or else you can join the officially designated-to-be-corrupt 200 plus..

Barkley Rosser

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