Greg Ip

Articles by The Economist’s U.S. Economics Editor

A less dovish Yellen, a more dovish Draghi

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Aug 23rd 2014, 4:14 by G.I. | JACKSON HOLE, WY.

The contradictory signals generated by American labour market data in the last year have provided grist for both hawks and doves at the Federal Reserve. For hawks, the rapid decline in the unemployment rate shows slack in the economy is disappearing so the Fed should tighten soon. For doves, the low rate of wage growth suggests there’s plenty of slack and tightening should wait.

Since becoming chair, Janet Yellen has usually been in the second camp, on balance interpreting the data as suggesting there wasn’t any urgency about raising rates. Her speech to the Kansas City Fed’s Economic Symposium on Friday in Jackson Hole, Wyoming struck a different tone. True, it covered both sides of the debate without coming down on either; Ian Shepherdson counted “1 coulds, 20 buts, 11 woulds, 7 mights, and a magnificent 56 ifs.” But she raised enough questions about the dovish case to suggest her own convictions are weakening. She was not telegraphing the case for raising rates soon. But it should be a wake-up call for investors who assume she would spin all the labour data that comes her way in a dovish direction. Read the rest of this entry »

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Written by gregip

August 23, 2014 at 9:00 am

How long will the expansion last?

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Weighing the evidence

Aug 16th 2014 | WASHINGTON, DC | From the print edition
NEWS that America’s economy grew at a brisk annualised rate of 4% in the second quarter was greeted with relief. After a puzzling first-quarter contraction, growth has returned, though the recovery remains the weakest since the second world war. As of June, the expansion is now five years old, longer than the post-war average of 58 months (see chart 1).

Recessions have become rarer in recent decades. The three expansions preceding the 2008 crisis lasted on average for 95 months. For that, economists credit structural factors such as companies’ better control of stocks, and modest inflation. The latter is especially important because as the late Rudi Dornbusch, an economist, once said, post-war expansions didn’t die in their beds; they were murdered by the Federal Reserve. The economy would run out of spare capacity, profits deteriorated, prices and wages rose and the Fed hiked interest rates, precipitating a recession.

If that pattern holds, the current expansion should have plenty of life left in it. Inflation is actually lower than the Fed’s target of 2%. The huge hit sustained during the crisis has a positive side: it has given the economy plenty of running room. JPMorgan reckons that adding a percentage point to the output gap at the start of an expansion adds two quarters to its lifespan. (The output gap is the difference between actual output and the maximum an economy can produce without sparking inflation.)
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Written by gregip

August 14, 2014 at 8:55 am

Posted in Uncategorized

How to stop the inversion perversion

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Restricting companies from moving abroad is no substitute for corporate-tax reform

 

Jul 26th 2014 | From the print edition

ECONOMIC refugees have traditionally lined up to get into America. Lately, they have been lining up to leave. In the past few months, half a dozen biggish companies have announced plans to merge with foreign partners and in the process move their corporate homes abroad. The motive is simple: corporate taxes are lower in Ireland, Britain and, for that matter, almost everywhere else than they are in America.

In Washington, DC, policymakers have reacted with indignation. Jack Lew, the treasury secretary, has questioned the companies’ patriotism and called on Congress to outlaw such transactions. His fellow Democrats are eager to oblige, and some Republicans are willing to listen.

The proposals are misguided. Tightening the rules on corporate “inversions”, as these moves are called, does nothing to deal with the reason why so many firms want to leave: America has the rich world’s most dysfunctional corporate-tax system. It needs fundamental reform, not new complications. Read the rest of this entry »

Written by gregip

July 26, 2014 at 9:23 am

America’s economy: Jobs are not enough

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New figures show that the speed at which America’s economy can grow without stoking inflation has fallen

Jul 19th 2014 | WASHINGTON, DC | From the print edition

AMERICAN workers have had no news this good for years. In June employers added 288,000 jobs, bringing the total for the year to 1.4m, the best six-month stretch since 2006. Unemployment has sunk to 6.1%, the lowest rate in almost six years. It could hit levels long regarded as “full employment” within a year. Help-wanted signs are proliferating, with vacancies up by 20% since January.

Such an ebullient labour market is usually the token of a booming economy. Not now. In the first quarter gross domestic product fell by 2.9% at an annual rate, the worst showing since the recession. This was a result in part of bad weather. Yet the second quarter will only be strong enough to make up the ground lost in the first. Economists had thought 2014 would be the best year since the recession; with growth in the first half of around zero, it is shaping up to be the worst.

Economic growth over the business cycle is driven mostly by swings in demand, and in recent years demand has been held back: households have been repaying their debts; the government has restrained its spending and raised taxes; and interest rates, having reached zero, are unable to fall further. Over the long run, however, a country’s potential growth depends on supply: how many workers it has and how productive they are. The recent divergence between America’s employment and output suggests the country faces not just deficient demand but also enfeebled supply, as more people working without more output means lower productivity. That is bad news for all Americans since their standard of living depends on productivity. It is also a headache for the Federal Reserve, since inflation emerges more quickly when economic capacity is expanding more slowly. Thus it could mean interest rates rising sooner than might otherwise be expected. If so, though, it would also mean they might not rise that high; in a slower-growing economy, there is less demand for capital.

In the 1990s America boasted one of the rich world’s highest potential growth rates, of more than 3%, thanks to a labour force that was expanding by more than 1% a year and productivity, fuelled by the spread of information technology, growing at around 3% a year (see chart 1). By 2007 the Congressional Budget Office (CBO) had trimmed its estimate of potential growth to a still respectable 2.6%. It now thinks it may be just 2.1% (see chart 2). The Fed has lowered its projections of long-term growth by almost as much.

Even that may be optimistic. The recent spell of strong jobs growth and feeble output means that productivity declined by 0.4% over the past year, JPMorgan calculates. The labour force did not grow at all. Economic theory holds that unemployment declines when the economy grows faster than its potential on the upswing of the business cycle. If the slow growth of the past year was above the long-term potential, as the rapid drop in unemployment suggests, it would seem to imply that the long-term potential was actually negative. Things are almost certainly not that bad. Still, JPMorgan reckons America’s potential growth is just 1.75%—about half the rate it enjoyed from 1947 to 2007.

Measuring potential growth is notoriously difficult. Productivity is volatile, making underlying trends hard to discern. Disentangling short-term demand from long-term supply is complicated by the fact that the former has a direct effect on the latter. When the economy is booming, businesses invest and innovate more, which raises productivity, and people who might have stayed at home, retired or remained in school join the labour force. That is what happened in the 1990s: as the economic boom continued with no uptick in inflation, economists concluded that potential growth had risen.

The great reversion

The optimistic way to read the current situation is as the same thing happening in reverse: potential growth may be being depressed by the hangover of weak demand from the Great Recession, rather than by underlying structural forces. For example, the labour force has grown by just 0.3% per year so far this decade, compared with 0.8% in the previous decade, and the participation rate—the share of the working-age population either working or looking for work—has fallen from 65.9% at the end of 2007 to 62.8%. Some of that is structural: of particular note is the fact that the first baby boomers qualified for Social Security (the public pension) in 2008. Some is cyclical: those who have not found work since the recession are quitting the jobs market. But which effect is bigger?

A new report by Barack Obama’s Council of Economic Advisers reckons 1.6 percentage points of the 3.1-point decline in participation can be explained by ageing alone. It reckons another half point is clearly cyclical. That leaves a gap of roughly one percentage point requiring explanation. One factor is that 16- to 24-year-olds are staying in education longer, and are less likely to work while learning. But participation among those aged from 25 and 54, the biggest and most active portion of the workforce, has also fallen—and it was doing so before the recession hit.

This fall has been most striking for those with less education: participation has dropped by four percentage points for those with only a high-school diploma, according to Judd Cramer, a doctoral student at Princeton University. These are the workers most likely to be displaced by technology or foreign competition. But this long-standing trend was made worse by the recession; participation in states hit harder by the recession fell more than it did in those less afflicted, according to Christopher Erceg and Andrew Levin of the International Monetary Fund.

In theory, a hotter economy should draw some of these workers back into the labour market. In practice, the impact is likely to be small. Many dropouts have retired or begun collecting disability benefits, a decision that is “more or less permanent”, according to Shigeru Fujita of the Federal Reserve Bank of Philadelphia. And the structural problem will get worse; the baby-boomers will continue to retire, even as the supply of new workers shrivels. The Census Bureau reckons America’s working-age population will grow by just 0.3% a year from 2010 to 2030, less than a third of the rate of the past two decades. Ageing is not the only reason: falling fertility rates and declining immigration also play a role.

Like labour, productivity is growing more slowly, averaging a little over 1% since the recovery began, about half the average of 2.3% from 1947 to 2007. This might be partly cyclical: weak sales and financial crises have discouraged investment in recent years. But productivity growth had begun to slow even before the recession, from around 2005. John Fernald of the Federal Reserve Bank of San Francisco attributes this to the waning of the IT revolution. Led by the likes of Walmart, a fiercely efficient retailer, businesses began using IT in the late 1990s to better manage supply chains, deploy workers and design products. By 2005 they had reaped most of the benefits, the theory runs, and the pace of innovation in semiconductors had slowed.

The spread of social media which allow new forms of working, of automation which increases an individual’s output and of many other technological innovations which, like those of the previous wave, are taking their time to show up in the productivity figures may yet improve the outlook. But such a pay-off could be many years away. As Michael Feroli of JPMorgan notes, the share of GDP devoted to investments in IT plunged during the recession and has continued to fall, even as investment of other sorts has recovered. The Bank Credit Analyst, an investment journal, notes that lower potential growth means business needs less capital to meet future sales. That would explain why investment, at 12% of GDP, remains below its pre-recession peak.

Even if potential growth picks up a bit, America will increasingly resemble the ageing slow-growth economies on which it used to look down. To improve potential growth policymakers can take various steps, such as raising the age at which the elderly receive government benefits, lowering the top corporate-tax rate and reforming support for the disabled. But such steps would take years to bear fruit. In the meantime the Fed has held interest rates at zero out of a belief that the economy is loaded with spare capacity which is holding down inflation.

Recent data have prompted a reappraisal. Not only has unemployment fallen rapidly, broader measures of underemployment which include the unemployed who have given up looking for work have fallen even further. Yet participation has not risen. Meanwhile, employers are having more trouble filling jobs: in May 3.2% of all jobs went vacant, close to a seven-year high, suggesting the jobless lack the skills that employers are looking for.

All this indicates that the economy is closer to full employment than the Fed had expected just a year ago. Given how quiescent wages and prices remain, rate rises seem still at least a year away. But as Janet Yellen, the Fed chair, noted on July 15th, that date will come sooner if unemployment keeps falling so quickly.

The original article is linked here.

Written by gregip

July 18, 2014 at 8:54 am

Posted in Uncategorized

Red tape blues: Small businesses fret less about taxes than over-regulation

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Jul 5th 2014 | WASHINGTON, DC | From the print edition
IAN TONER, an architect in Philadelphia, recently went to city offices for a permit to build a stoop for a client’s home. The city, he learned, had just imposed new requirements: he would have to get maps from gas, electric, water and other utilities to ensure the stoop would not disturb their underground lines and then resubmit his application. A process he thought would take a day took more than two weeks.

That’s not all. Other new rules require that he prove that his builder has general liability, workers’ compensation and car insurance, and has paid all his taxes. Four times a year he must set aside a half day to ensure he is paying the state’s and city’s myriad taxes correctly. Mr Toner doesn’t question the need for rules and taxes; what galls him is the time and hassle involved in complying with them. “The information exists all over the place and the burden is on me not just to gather it but [to] interpret it. I’m not going to leave here because of this, but they’re all things that could turn a person off of coming here.”

America’s states and cities have traditionally tried to attract businesses by offering them tax breaks and other cash incentives. Yet there may be a more effective way, and one which puts no strain on stretched budgets: make life simpler. Read the rest of this entry »

Written by gregip

July 3, 2014 at 5:21 pm

Posted in Uncategorized

Optimal crises

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Jul 2nd 2014, 20:32 by G.I. | WASHINGTON, D.C.

Janet Yellen, the Federal Reserve chair, has long said there might be times when monetary policy could be used to counteract financial instability. But in a speech before the International Monetary Fund today, she erected such a high bar to its use that is seems unlikely ever to happen: the “potential cost … is likely to be too great … at least most of the time.”
The unstated logical conclusion is that there is some optimal exposure to crisis. Read the rest of this entry »

Written by gregip

July 2, 2014 at 5:23 pm

Posted in Uncategorized

The spontaneous combustion theory of inflation

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Jun 26th 2014, 15:42 by G.I. | WASHINGTON, D.C.

In the last few weeks, ominous warnings of inflation’s imminent resurgence have multiplied, prompted by recent upside surprises on core inflation and the cavalier dismissal by Janet Yellen, the Fed chair, of those reports as “noise. “
On factual, theoretical and strategic grounds, I find the panic over inflation perplexing.
First, factual. Yes, core CPI inflation has rebounded to 2% from 1.6% in February and today we learned that core PCE inflation has risen to 1.5% from 1.1%. What should we infer from this? Nothing. In the short run inflation oscillates because of idiosyncratic movements in various components, such as rent, health care and imported commodities, but over longer periods, it is remarkably inertial: the best forecast of inflation over the next five years is inflation over the past five years. The nearby chart illustrates this;

core inflation fell below 1% in 2010 and rose above 2% in 2012; neither marked the start of a new trend. There is no reason to think the recent run of high monthly readings is a new trend, either. The Fed, to its credit, didn’t freak out when core inflation was scraping 1% earlier this year; it predicted that as the downward pressure from imported goods inflation and health care faded, overall inflation would move toward its 2% target, and it has. Yes, it has done so slightly faster than expected but this is no more cause for concern than learning a patient will be discharged from the intensive care unit in six weeks instead of eight. Second, theoretical.  If you have a forecast of higher inflation, it helps to have a theory of the inflation determination process behind it. Inflation is a continuous rise in the price level; the obersvation that the price level has risen recently is not a theory any more than a patient’s high temperature is a theory of infectious disease. Many critics think the prolonged period of low real rates and the large size of the Fed’s balance sheet are in and of themselves inflationary, but this is divorced from any consideration for why real rates are negative and the Fed’s balance sheet so large in the first place. Charlie Evans, president of the Federal Reserve Bank of Chicago, calls this “the spontaneous combustion theory of inflation… Households and businesses simply wake up one day and expect higher inflation is coming without any further improvement in economic fundamentals.”
There are many competing theories for the inflation determination process. What do they tell us?  The New Keynesian theory, to which the Fed subscribes, considers inflation a function of slack and expectations. The evidence is pretty persuasive that while slack has shrunk in the last five years (and perhaps faster than expected because of diminished potential), it remains ample. Expectations, likewise, have oscillated but shown no trend up or down.
You may dismiss this model because slack is hard to measure and expectations are a lagging indicator. Perhaps you prefer to look at costs (as a mechanical price mark-up model does). Labour is the main component of costs, and as the nearby chart shows,

unit labour costs are up just 1.2% in the last year. This, too, is a noisy series, as it is driven by both wages and output per hour; but it’s hard to see a worrisome trend. Wages have barely kept up with prices since the recovery began which means the benefits of productivity growth (meager though they are) have gone predominantly to profit margins, which touched a new high of 12.7% in the fourth quarter. They dipped in the first quarter, but they’ll probably bounce back after GDP reverses its drop. So profit margins could accommodate some acceleration in labour costs and remain comfortably wide. What if you consider inflation always and everywhere a monetary phenomenon? I consider the money supply pretty useless for forecasting anything, but even if were a monetarist, I wouldn’t be worried. Quantitative easing has significantly expanded the monetary base, but that expansion will end once QE stops later this year. Meanwhile, this has not fueled broader measures of money and credit: M2 is up just 6.5% in the last year, slightly faster than last year but still well below rates of growth recorded in 2011 and 2012 (which, you’ll recall, did not signal an inflation breakout).

Third, strategic. I recently attended a conference at the Hoover Institution on central banking where many of the presenting scholars were deeply concerned the Federal Reserve’s unorthodox policies would lead to an eruption of inflation before long. Many cited the 1970s when the Fed kept real interest rates too low for too long in the mistaken belief the economy was operating below potential. What these analyses ignore is the asymmetry of risks facing the economy. Of course, the Fed might wait too long to tighten and inflation could eventually rise above the 2% target. But, leaving aside how costly such a deviation would be, the Fed has demonstrated it knows how to get inflation back down, even if the process can be costly. By contrast, recent history shows how few effective tools central banks have for reversing inflation that falls too far, or turns to deflation. Either outcome raises the prospect of real interest rates that are too high and unemployment above its natural rate for years to come. Given this asymmetry, overshooting inflation is clearly a lesser evil than undershooting inflation. This, more than anything else, is why the panic over inflation is misplaced.

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Written by gregip

June 26, 2014 at 5:25 pm

Posted in Blog posts