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Edward Lambert on Effective Demand, Labor Share, Capacity Utilization, and Growth

He’s only been blogging since March. His credentials? “Independent Researcher on the equation for Effective Demand.”

That may explain why, aside from a lonely Steve Randy Waldman link, I’ve seen no mention of his work out there. Just another internet econocrank?

I’m wildly unqualified to pass judgment, but Lambert’s built what strikes me as a very interesting, cogent, and coherent model of effective demand, labor share, unemployment, and capacity utilization in growing economies. And he’s extending it fast, including into optimal monetary policy. (Mark Sadowski has been challenging him on the model in comments here.)

I won’t try to summarize his modeling or poke holes — go look at it. I’ll just give you a picture and a few post titles to whet your appetite.

Here’s his UT (“Unused Total”) Index:

The regularity of its coincidence with recessions (especially the ends of recessions), at least, seems like it should raise eyebrows.

Here are some posts to peruse:

What is Effective Demand?

What Non-inclusive Growth Looks LIke

When Labor Share does not rise in the Growth Model

Effective Demand Monetary Policy: the z coefficient

AS-ED Model: Raising Labor Share of Income

Update on AS-ED model: The future has a problem

Given Scott Sumner’s recent reversion to labor share as the appropriate target for monetary policy, I’m thinking that Market Monetarists might find Lambert’s work as interesting as effective-demand-obsessed Keynesians will. MMTers and other Post-Keynesians? His results certainly comport with their political predilections.

Cross-posted at Asymptosis.

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Stock Market Valuation

Mark Thoma had a tweet asking if the stock market is  in a bubble.

I do not think so.

The market PE  on trailing operating earnings is 15.5 and my model says that based on the historic relationship to interest rates and inflation the market PE should be 21.5%.

Obviously, either the market does not believe rates will stay this low and are using a higher interest rate or they expect  long-run trend earnings to slip far below the long run trend of  7%   The market PE is an expression of the present value of expected long-run earnings growth.  The long term historic average for the market PE is 15, almost exactly where it is now.  Of course there is no central tendency for the market to converge on a PE of 15.  If you do a histogram of the market PE you will find that the probability of the PE being on any number between 10 and 20 is about the same.


Clipboard01 pe

Maybe we just need to look at the market from a simpler perspective.

Clipboard02 sp

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Should The Inflation Target be 4.3%?

I’m quite tongue-in-cheek in asking that question, but nevertheless: I present for your delectation what at first blush seems like a revealing bit of chart porn (hat tip: Zero Hedge):

You could flip this upside down and replace “Earning Yield” with “PE ratio.”

The data displays a remarkably regular relationship. Equity investors seem to be most optimistic about future economic (or at least earnings) growth when the inflation rate is 4.3%. (It would be interesting to see: did this relationship hold, albeit with the inevitable noise from smaller samples, in shorter sub-periods — and if so, which sub-periods? In particular curious: did it hold equally pre- and post-1971?)

Can we draw any conclusion from this? i.e.:

• Market conditions that are most conducive to economic growth are revealed by a 4.3% inflation rate.

• Equity investors display the most “irrational exuberance” when the inflation rate is 4.3%.

I’d love to hear whether Market Monetarists and MMTers think this has any useful import.

Cross-posted at Asymptosis.

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Patterns of buying food changing?

The cost of hand-to-mouth living – Financial Times:

A few weeks ago, when I was chatting with the head of one of America’s largest food and drink companies, he made a revealing comment about data flows. Like most consumer groups, this particular company is currently spending a lot of money to monitor its customers with big data. But it is not simply watching what they do or do not buy. These days it is increasingly scrutinizing the micro-level details of pay and benefit cycles in every district in America. The reason? Before 2007, this executive said, consumer spending on food and drink was fairly stable during the month in most US cities. But since 2007, spending patterns have become extremely volatile. More and more consumers appear to be living hand-to-mouth, buying goods only when their pay checks, food stamps or benefit money arrive. And this change has not simply occurred in the poorest areas: even middle-class districts are prone to these swings. Hence the need to study local pay and benefit cycles. “Consumers are living pay check by pay check, and they tend to spend accordingly. Then you have 50 million people on food stamps and that has cycles too. So for our business it has become critical to understand the cycle – when pay [and benefit] checks are arriving.”

(hat tip rjs)

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Scott Sumner Goes Marxist, Proposes Targeting Labor’s Share of Income

I’m joking of course. He’s still grinding the supply-side axe (though judiciously here, IMO). But you gotta admire a fellow when he follows the logic of the data where his own logic requires him to go. He’s just done three posts about Germany’s growth and unemployment rates through the great recession:

Annualized change, Q1 2006 – Q4 2012:

RGDP: 1.3%
NGDP: 2.4%

But the unemployment rate fell from about 12% to 5.4%.

Lackluster GDP growth coupled with a damned impressive drop in unemployment. How do you account for that in Scott’s long-argued model, where NGDP growth drives employment growth?

As he says, he buries the lede in his first post. Here it is, from the end of the post (I’m reversing these two paras to make it flow even better; emphasis mine, correction his):

Recessions are not caused by less spending; they are caused by less income going to workers.  Usually the two go hand-in-hand, but the German miracle tells us that when they diverge, it is employer employee income that matters most.

When I started blogging I assumed wage targeting would be politically impossible, and knew that NGDP targeting was already a well-regarded concept.  So I latched on to NGDP targeting.  But in retrospect I wish I’d latched on to aggregate employee income.  Call it “income targeting.”

Did I mention admirable? Speaking of the very argument he’s been making doggedly and insistently for years, he says:

I took some shortcuts, instead of staying true to the “musical chairs model.”  In the past I’ve often argued that a fall in NGDP causes unemployment because there is less income to pay workers, and yet hourly wages are sticky.  Some workers end up sitting on the floor.  The logic of that model suggests that the real problem is not unstable NGDP, but rather instability in a component of NGDP, namely total wages and salaries.

And speaking of the school of economics based on that thinking, a school that he’s been primarily responsible for creating and popularizing, he says:

Now that market monetarism riding high, I figured it was time for a vicious internecine struggle for the soul of market monetarism.  Consider this the first shot. 

The fruit doesn’t fall far from the tree, of course; in his second post he attributes the “miracle” largely to “structural”/supply-side factors:

Germany did lots of labor market reforms, which I’ve discussed in previous posts, and this opened up lots of low wage jobs.

The basic idea: the Hartz reforms beginning in 2003 resulted in more jobs, though often with shorter hours and/or lower wages, all netting out to a larger share of GDP going to employee compensation.

This is not crazy. But it’s incomplete. And he even acknowledges that in a nod to his commenters:

Many commenters pointed to various job sharing programs, or subsidies to keep workers employed during the recession. Libetaer used the metaphor of putting 2 workers in one chair.  The one chair reflects relatively meager growth in NGDP, and the two workers represent job sharing.

The key problem I find in his thinking is his glossing over a key word in the preceding: subsidies. He only discusses job sharing, which fits neatly in his musical-chairs analogy. (How about musical benches instead? When the music “stops” — national income is weak — workers squeeze in more tightly.)

But the Hartz reforms did more than make it easier for firms to hire cheap (create more chairs/bench space); they increased subsidies for low-wage and part-time jobs. This 1) makes it easier for employers to hire lower-productivity workers for low wages, 2) gives those lower-productivity workers sufficient incentive to take those jobs, and 3) increases the share of national income going to lower-income workers.

And since those workers have a high propensity to spend their income, all things being equal that distributional shift should mean there’s a higher average velocity of money, aggregate demand, NGDP, etc., all in a virtuous cycle. (See JW Mason here and me here.)

Scott says much the same thing from a different direction:

The welfare loss to a society from a 5% RGDP shock is much greater if 5% of workers lose their jobs, as compared to all workers staying employed, but working 5% less hard.

This is a statement about absolute utility, but (hence, because spending is driven by the desire for utility) it’s also a statement about different policies’ distributional effects on spending and aggregate demand. Because subsistence has (very!) high utility, cutting some subsistence incomes (which would surely be re-spent) results in a bigger hit to aggregate demand than cutting many marginal incomes (which are less likely to get re-spent). It’s straightforward Marginal Propensity to Spend out of income thinking.

I’m here to suggest that the same logic, rather inevitably, applies to subsidies for low-wage jobs (paid for by better-off taxpayers). We redirect disposable income at the margin from higher-income folks, and flow it into the hands of lower-income folks who will spend it on. Got velocity?

Which brings me back to the axe that I’m forever grinding: the best and most feasible structural labor-policy change we could make in the U.S. to improve long-term macroeconomic performance would be to greatly expand the Earned Income Tax Credit (while streamlining its tortured administration and — to increase its “salience” — delivering the credit on weekly paychecks as we do with payroll tax deductions).

If these subsidies were sufficient to make low-wage work/workers attractive for both employers and workers (and perhaps if they subsidized hourly compensation rather than annual family income), we might even be able to do what the Germans, with their generous low-wage subsidies, have been able to do: do without minimum-wage laws.

I bet Scott would like that.

And we still haven’t talked about national compensation/income targeting by the Fed, which promises to be a very lively discussion indeed. (I can just see Ben Bernanke slapping his forehead and looking heavenward.)

Cross-posted at Asymptosis.

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Trans-Pacific Partnership and US European Union free trade

Via Naked Capitalism comes more comment on two major global trade agreements also discussed here at Angry Bear. I keep wondering when our national conversation will get around to acknowledging ‘pro-business’ as having a second question to answer: which businesses mostly benefit and which lose out? And a third: what are the rules of free trade this time?

It’s a sign of the times that a reputable economist, Dean Baker, can use the word “corruption” in the headline of an article describing two major trade deals under negotiation and no one bats an eye.

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The Lessons of the North Atlantic Crisis for Economic Theory and Policy

Re-thinking macro policy:

Joseph Stiglits, Davis Romer, Oliver Blanchard at  Columbia University, New York, and co-host of the Conference on Rethinking Macro Policy II: First Steps and Early Lessons.

The Lessons of the North Atlantic Crisis for Economic Theory and Policy

Posted on May 3, 2013 by iMFdirect

Quantcastpost by: Joseph E. Stiglitz

In analyzing the most recent financial crisis, we can benefit somewhat from the misfortune of recent decades. The approximately 100 crises that have occurred during the last 30 years—as liberalization policies became dominant—have given us a wealth of experience and mountains of data. If we look over a 150 year period, we have an even richer data set.

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No: Less Consumption Does Not Cause More Investment

At risk of stating the obvious, in this post I’d like to highlight a pernicious misunderstanding that I find to be widespread out there in the world.

This is not new thinking. You’ll find a more sophisticated historical account, stated very clearly though in somewhat different terms, in the first few pages of this PDF. Still, despite decades of debunking, this misconception remains ubiquitous. I’d like to explain it in the simplest and clearest terms I can.

Start here:

GDP = Consumption Spending + Investment Spending

Consumption Spending = Spending on goods that will be consumed within the period.

Investment Spending = Spending on goods that will endure beyond the period.

Looking back at a period, from an accounting perspective, it’s obvious that if there’s less consumption spending, there’s more investment spending. This must be true, because that’s how we tally things up, once they’ve happened. There are two types of spending; every dollar spent last year must be one or the other. If there’s less of one, there’s more of the other.

But people conclude: if there is less consumption spending, there will be more investment spending. (So we’ll increase our stock of real stuff, and we’ll all be richer!)

They’re confusing (and confuting) a backward-looking, historical, accounting statement with a forward-looking, causal, predictive statement. Because looking back, GDP is fixed. It has to be; it’s already happened! But in that very instant of thought, people abandon that fixed, historical perspective and think: if one component is smaller, the other will be larger.

This makes no sense at all. Think about it: If people spend more on consumption goods next year, that will cause more production — including production of long-lived goods to increase production capacity. Investment won’t go down because people spend more on consumption. GDP will go up. Next year’s GDP (obviously) isn’t fixed.

Likewise, people tend to think that less consumption spending means there will be a higher proportion of investment spending (so, relatively, more real-wealth production). Wrong again. The backward-looking Y = C + I accounting identity tells us exactly nothing about why people will make their spending decisions — what causes them to choose consumption vs. investment spending. They might choose to increase or decrease either or both, for myriad reasons. One doesn’t cause the other in some kind of simple arithmetic manner.

This seems very obvious. But if you hold this firmly in your head as you peruse people’s statements out there in the world, I think that you will find that many of them do not have it fixed very firmly in their heads.

Cross-posted at Asymptosis.


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