Sound Fundamentals?

Strong Fundamentals? 

 

(1) It took almost four years for real disposable income per capita to return to its previous peak level of $36,679 (which it reached in Q2 2008).  It continued to grow throughout that year by the end of 2012 reaching a level that was just a hair over 3% more than its level in 2008. This growth abruptly ended as the payroll tax reduction was removed.  This was part of the agreement that President Obama and Congress reached to avoid the infamous “fiscal cliff” in early 2013. 

(2) A return to the Q2 2008 level of real disposable income per capita took considerably less time the second time around.  It returned to the level it was at six years earlier during the first quarter of 2014.  Real disposable income per capita however only reached the point it had achieved in late 2012 during the first quarter of 2015 (meaning at this time last year).  It has continued to grow over the last year. However it is important to note that as of the end of 2015 real disposable income per capita stands at $38,445 or $1,766 higher or 4.8% higher than where it was seven and a half years earlier.  This represents about two-thirds of a percentage point annual growth in the average American’s earnings after taxes since the Great Recession.   Compare this to an annual average rate of increase of 2% between the second quarter of 2001 and the second quarter of 2008! 

(3) Despite poor growth in real disposable income consumer spending has increased at a respectable clip.  If this growth cannot be attributed to growing earnings in general, then the question that should be asked is what should we credit this growth to?  There are potentially several things that have fostered growth in consumer spending despite slow growth in real after tax income per person.  None of these are sustainable over the longer term. 

First, between 2007 and 2014 there have been about 9.4 million non-business bankruptcies.  Rather than lowering consumer spending, by wiping the slate clean, bankruptcies can increase it.^*    In part because of bankruptcies^**, household debt per person in real terms has fallen by over 12% and so what can be called discretionary real income has risen accordingly at a much faster clip than real disposable income has.  Falling levels of debt when combined with lower interest rates have translated into a reduction in debt service equivalent to over $900 per person or, with a population at the end of this last year of over 322 million by the end of 2015,  an additional $290 billion of spending power in real terms.

* If one defines real discretionary income as real disposable income per family net of payments of interest and principal on outstanding debt or as: C= + mpc(Y-T-(i+g)*D)  where g=the percent of principal amortized over the year , D is equal to the real value of debt outstanding, and Y-T-(i+g)*D is equal to real discretionary income or real disposable income after payment of interest and principal on debt.  Given the mpc, a drop in D means that household spending grows despite little growth in earnings.  Of course, rising levels of debt service can also fuel growing consumer spending.  However, in this case, it is only if real disposable income grows at a faster clip.  It is perhaps instructive to compare the 2001 to 2008 period to what we have seen over the last seven years since the Great Recession began.  Real disposable income per person grew by over 15% 2001 to 2008 while real discretionary income grew by 14.81% with debt service per person increasing by $713 in real terms.  Real disposable income per person grew by less than 7% 2008 to 2015 while real discretionary income grew by a bit over 10% with debt service per person falling $706 in real terms. Borrowing fuels growth and default and lower interest rates (to the degree there is refinancing or variable rate debt) fuels continued growth in consumer spending despite lower growth in real disposable income. The former is much healthier obviously than the latter. 

**Twelve states (most notably California) have no recourse mortgages (1) where, when a mortgagee goes into default, the creditor can only recover the sale value of the property.   A debt of $x thousands of dollars is written off when the default occurs and the property is sold for X-Y thousands of dollars.  The amount y is absorbed by the creditor. Even in states without such arrangements the benefits of a strategic default have often been far higher than the costs.  These defaults have freed up funds previously used in servicing debt that then fuel higher consumer spending (2).  Add to this the exemptions on chapter 7 bankruptcies where many assets are protected (car, home, and such) one can see the boost to consumer spending afforded by no longer having to service as much outstanding debt.

Secondly, after falling by less than a percentage point 2008-2010, real income for the top 20% of all households in the US grew in real terms by over 13% between 2008 and 2014.  This translates into an increase in overall inflation adjusted earnings of some $573 billion total or $23,000 per family.  This growth in earnings was 1.72 times faster than the middle fifth of the families and, even assuming a tendency to spend out of income of only 0.5 for the top quintile would account for about a third of the growth in consumer spending between 2008 and 2014.     The mean income of families in this top quintile in 2014 was $194,053 and the mean for the fourth quintile was $87,834.  Assuming a tendency on the part of both groups of 50%, the growth in earnings of the top 40 percent of the households in the US (far in excess of the growth in earnings for the bottom 60%) would combined account for 44% of the increase in consumer spending seen between 2008 and 2014.  When assuming an mpc of .7 for families in the fourth quintile the contribution of higher income Americans to the growth in consumer spending rises from 44% to nearly half. 

(4) This $290 billion gain in real discretionary earnings when combined with the effect of disproportionately faster growth in family incomes for the top 40% of American families in terms of income accounts for almost 80% of the growth in real consumer spending per capita since 2008.^***

*** If you assume an mpc out of real discretionary income for the falling debt service group of 0.9

(5)  Gross private domestic investment spending only returned to its peak level of 2773.83 billion (in the first quarter of 2006 or 10 years ago!) at the very end of 2014.  This of course then was just a little over  a year ago. As of last quarter it is only 68.2 billion higher than it was at the very start of 2006 or just 2.4% higher.  Technological advances come in the form of new investment and increasing amounts of net investment increases the hourly productivity of labor, even in the absence of technological change.  The fact that investment spending has not increased for over a decade is yet another source of concern.

(6) Employment hit its peak in the fourth quarter of 2007 at 146,271,000 and failed to return to this level until the 3^rd quarter of 2014 (when it reached 146,479,000).  Now (as of the end of 2015) employment stands at 149,523,000.  In short, within 8 years we have only seen job growth of 3.25 million or 2.2% overall.  And while 22% of the jobs lost during the crisis were low wage jobs 44% of the jobs created have been these sorts of jobs.³

(7) If government spending on goods and services at all levels of government (local, state, and federal) were to return to the level it was at per American and that we accepted as safe and prudent during the last year of President George W Bush’s tenure in office it would be over $300,000,000,000 higher than it is now (at the end of 2015). This translates into nearly $200 billion higher spending at the state and local level and over $100 billion at the federal level.  Instead state governments throughout the U.S. have continued to cut K-12 public school funding and spending on a variety of other vital activities.  The most striking statistic that I can refer to as far as school funding is concerned is that as the number of students enrolled in public schools K-12 has grown by over 800,000 since 2008 the number of teachers employed in our public school systems has fallen by almost 300,000.  The short-run impact of such job losses when combined with the longer-term costs of a potentially even less well-educated labor force than we have at present is very serious.  Cuts to not only education but to public health and infrastructural maintenance and development acts as drag on effective demand in the short-run but also create significant problems vis-à-vis our productive capacity over time.⁴

(8) While real GDP grew at an average annual rate below 2% a year during the first ten years of this century and has, 2011-2015 grown at a slightly faster clip of over 2% a year.  This, however, compares quite unfavorably to the decade-by-decade rates of growth each decade from 1950 to 2000. 

(9) The Fed’s efforts to stimulate the U.S. economy have been out of sync with the ECB’s efforts, the Bank of Japan’s efforts and so on.  In part because of this but regardless their efforts have been far more successful in stimulating the financial sector than it has been providing stimulus to the overall economy.  The impatience many have had expressed with the Fed, urging the FED to push interest rates closer to their “normal” or, worse still, “natural” level by raising the targeted fed funds rate above the 0 to .25% range to where it is now (in the .25% to .5% range) and beyond is confusing inasmuch as Aaa and Baa bond yields have been rising over the last year.  The increase in Baa yields has been more pronounced than the increase in Aaa yields increasing the spread between the two.

(10) The only more or less consistently positive factor in terms of effective demand has been real export spending.  After falling dramatically in 2009 it recovered quickly and continued to grow.  Real export spending is now 17.8% higher than it was in the second quarter of 2008.  However since the second quarter of 2010 the rate of growth has slowed down.   A very worrying sign is that there was negative growth in the fourth quarter of last year. 

 

So much for sound fundamentals.

 

 

Sequestration: My lord we are stupid.

The question of how much of an impact $85 billion worth of cuts between March and September of this year might have can be answered in a variety of ways.  To begin with, note that since we look at real GDP statistics in annualized terms (real income generated over a quarter times four basically) we should note that $85 billion over seven months is, on an annualized basis, equivalent to about $146 billion in cuts.  Next, inasmuch as our focus should be on the impact on total earnings adjusted for inflation (real GDP), assuming that prices remain at the level they were at the very end of 2012 this means spending cuts at the federal level in real terms of  about $126 billion (the GDP deflator for the fourth quarter was approximately 116).  Note too that the $85 billion is just for the rest of fiscal year 2013 with still more cuts in spending on the way! (1) (2)  

Last quarter real GDP was estimated to have been about $13.6 trillion (with an estimated total population of just a bit over 315 million this means real per capita income of about $43,175).  Assuming that there are no multiplier effects taking 126 billion of income generating spending out of the economy will, all else equal, lead to about a 1% drop in real income or PER PERSON a decline in real income of about $400.  With an expenditure multiplier of 2, double this figure for an average loss per American of about $800!  Estimates can vary of course.  One set of estimates I have -using data from the first quarter of 1995 to the third quarter of 2011- suggests that, controlling for increases in inflation-adjusted government spending at the state and local levels and increases in real economic investment,each billion cut to increases in real government spending at the federal level on average lowers absolute increases in real GDP by 0.016%.  This means, on an annualized basis, sequestration cuts  may, all else equal, shave as much as 2%  (.016*126) off whatever increases in real income we might otherwise manage to achieve.  Those who argue that the impact of such cuts are minimal have, as a matter of simple arithmetic, a challenge ahead of them unless they can argue either for a remarkably reliable and speedy supply-side adjustment to reduced demand or that households and businesses, so encouraged and relieved by decisive action by the federal government, set in motion a tremendous increase in private sector spending.

Absent such miracles the economy will suffer. And the fact is that regardless of the details, we are talking about averages and so, by definition, if there are some of us who may barely feel the effects of these cuts while others will feel their effects all the more acutely.  If, for example half of a population of 315 million souls (congressional representatives, stock brokers, and college  professors) emerge largely unscathed by these cuts and AVERAGE real income falls by $600 (I split the difference from the above numbers of $400 and $800 or in other words, assume an expenditure multiplier of 1.5) this means that the other half of the population suffers an average loss in real income of $1,200 a head!  Far too often, principally because those of us looking at these issues are not the ones who end up bearing the brunt of cuts, we pay too little attention to how unevenly and unfairly the burden of adjustment is carried.  It is far easier to focus on the potential long-run benefits of any action if one is not likely to bear much of the short-run costs.

Also note that what all this is based on the assumption that state and local spending will remain constant and that economic investment will do so as well.  This is, to say the least, questionable.  State and local government spending adjusted for inflation and measure per capita was, as of last quarter nearly 7.7% less than its most recent peak level of  $5,103 per person in the third quarter of 2009.  In short, in a time of economic distress state and local governments have cut their spending per person in real terms by over $480.  Again largely overlooked economic investment has been increasing nicely in the last year (arguably thanks to the Fed's Operation Twist).  While the coming cutbacks will free up resources that eventually could be used for still more private sector investment, is it sensible to assume that an entrepreneur  would seriously consider adding to retail space in areas where a large number of federal employees are now working four days out of every five or that she would be giving much thought to increasing or modernizing her fleet of trucks to travel over roads that are increasingly in need of repair? It is possible but not probable.


Finally, there is the question of need.  At the federal level, real spending per American hit a peak of $3518.90 in the third quarter of 2010 and, last quarter, continued the  steady DOWNWARD trend it has been on since then to end up about $331 lower.  While this helps to explain a certain part of the drop in the federal government's budget deficit, most of the decline of some 343.8 billion in real terms since 2009 is thanks to economic growth.  (One figure in support of this is that federal receipts in real terms have increased -despite lower tax RATES- by over $200 billion  between 2009 and 2012) If the budget deficit were to continue to fall, largely through economic growth, by as much as it did last year (some 200 billion) over the next two years it would "only" be some $100 billion higher than  it was in 2008; a time when few of those now so concerned  with its size seemed terribly worried about it.

Why businesses aren't hiring as much as they could be.

My two cents on an interview Scott Simon had with two top executives  Christopher M. Gorman (president of Key Corporate Bank and CEO of KeyBank in Cleveland.) and Lynn Ann Casey (the CEO of Arc Aspicio, headquartered in Arlington, Virginia) about weak job growth on Weekend Edition Saturday, July 7th . 

repeal child labor laws

Thinking about the merits of regulation and trying to understand those advocating less regulation as a solution to our current economic malaise I came up with this essay.

a lie repeated often enough becomes the truth

One hears or reads the claim that the uncertainty created by high budget deficits and excessive regulation has so frightened businesses that they are afraid to spend and hire. Undoubtedly over the next twelve months this will be repeated more often still. The claim, however, is nonsense. I explain why in this essay.

"Failed" stimulus, businesses strangled by the noose of regulation, and no jobs. Is any of this true?

We are told the 2009 stimulus plan has failed, that the U.S. economy is stagnant, that both monetary and fiscal stimulus have failed to create jobs, and that because of high budget deficits and the current administration's increased enforcement of existing regulations and imposition of a host of new ones businesses are afraid to spend or hire. As I point out in the following, the fact is there has not been -in total- all that much fiscal stimulus applied to the economy, there has been net job growth, and over the course of last year, business investment recovered quite rapidly. I have spent last couple of weeks putting the following together: Several facts, a simple projection, and a few opinions. My plan is to fill this out with more detail and references, as time permits, over the next few weeks. The point remains, coming up with what I have so far was by no means all that tough. Anyone reporting on these important issues or making the sort of claims that are often being made should do no less than what I have done here.

fiscal responsibility

As the debate continues in Washington, I put the following together to see if I could better understand the magnitude of the "problem" we currently face. As the link indicates I am more than bit inclined to argue, as Dean Baker, co-director of the Center for Economic and Policy Research has repeatedly argued, that in terms of real priorities we have really got it all wrong. Fiscal "Responsibility".

Ricardian equivalence

Ricardian equivalence: A mere day before second quarter spending stats were released in late July of this year, the Hoover Institute’s John Taylor was a guest on PBS’s News Hour. He argued that the reason the U.S. recovery was weaker than some might have hoped for was due to less rapid growth in investment spending. Taylor argued that this drop in growth was due in turn to worries about high budget deficits: “And now the slowdown is because investment has slowed down, and people are getting nervous about the increased debt that has partly resulted from the stimulus.” (A very small part due to President Obama's stimulus package. According to the Heritage Foundation's Brian Riedl’s only 6% of it. His paper is available online). This argument that the impact of government spending on overall macroeconomic equilibrium is relatively weak because of the effects of budget deficits on expectations is referred to as Ricardian equivalence. With Ricardian equivalence higher deficits now create the fear that taxes will eventually increase. This lowers the net expected return to investment. It lowers expected real disposable income of consumers as well. According to this, bond financed increases in government spending provide no more stimulus than tax financed ones would because we are smart enough to realize that –at some point in the future- the piper must be paid. The day following Taylor’s appearance on PBS’s News Hour Q2 2010 (the second quarter of 2010) spending stats (real GDP figures) were released. They indicated a year over year increase in investment spending of 23%. So much for weakened investment spending. The stupidity of Ricardian equivalence: If one stops to consider what we must assume when we try to apply this general idea to the real world all sorts of logical problems present themselves. Will there not be a range of opinions about exactly when budget deficits will have become too burdensome to tolerate? Given this, will there not also be a range of opinions about when leaders who have the commitment and power to push through higher taxes will appear to save the day and put our financial house in order? Furthermore, won’t the confidence with which these opinions are held also differ widely? Finally, there is question of how much weight will be attached to any of this. Say that I am the owner of a profitable business who plans to retire soon. I plan to sell the business to someone else. I believe –perhaps with good reason- that the bulk of potential buyers are oblivious to the threat of higher future taxes and lower net income. I also do not care about the financial fate of future generations. I could care less about what impact the choices the government makes now might have on my descendants. My indifference towards those who follow is exemplified by the fact that I can’t help but roll my eyes when someone says that we do not inherit the planet from our ancestors we are borrowing from those who come after. All this said, I attach relatively little weight to the long distant prospect of higher taxes. It would seem that the question of how to interpret the impact of the increased spending from added road repair and the added amount left after taxes in my pay check from current tax cuts (or the reverse of these, spending cuts and tax increases now) would be much easier than trying to figure out than the following : (1) If we don’t get deficits under control by date x, what the consequences will be. (2) If the leadership needed to chart a course through such politically dangerous waters of tax increases and spending cuts will ever appear. (3) Whether I am the only one to be concerned about such things, whether or not those of us who are worried about such things are correct in our assessment of how bad the situation will become by date x and whether politically we will be able to do anything about it . (4) What the likely consequences of failure might be. (5) The question of whether balance or surpluses might be achieved not via raising taxes –which would affect me directly- but instead via cuts in spending. If I have faith in the self-correcting tendencies of the market would have at most an indirect and very temporary affect on my situation. Besides all of this there is something else that is key and is missing from the discussion. This is the question centers on the issue of how what the composition of increased spending and the mix of tax cuts. If the deficits that have emerged are the result of governments simply continuing to do what they need to (vis-à-vis things such as primary and secondary education, police and fire protection, road repairs and so on) in the face of temporarily lower revenues should I be that concerned? Why are we not considering what I would like to call the Rohatyn effect? Rohatyn in his 2009 book Bold Endeavors: How Our Government Built America, and Why It Must Rebuild Now argues that much of the prosperity of the U.S. economy is based on private sector investment made far more productive and profitable in the wake of government investment in things like education, infrastructure, and overall economy stability. Add to the list of complicating factors that a more nuanced view of Ricardian equivalence demands then one more item in honor of Mr. Rohatyn and his book. Increased government spending and tax cuts, if directed at areas that increase the long-run productive capacity of the country, while they may lead to larger deficits now, via growth in capacity and earnings (assuming that the effective demand is there), over the long-run will lead to lower deficits, balanced budgets or possibly even generate surpluses. As summarized in his survey of work done on Ricardian equivalence North Carolina State’s John Seater notes: Finite horizons, nonaltruistic or inoperative bequest motives, childless couples, liquidity constraints, and uncertainty all can lead to failure of Ricardian equivalence, and it seems virtually certain that some of these sources of nonequivalence are operative. It appears likely that the world is not Ricardian. (p. 155 – 156) Stupid or not, it seems to fit the facts?: Despite this, Seater goes on to argue that as implausible an explanation as Ricardian equivalence might be, that it somehow or the other fits the facts reasonably well. In short, the evidence that Seater has examined would suggest that fiscal stimulus has been relatively ineffective. Almost two years ago I tried to untangled the equally twisted knot of Barro’s objections to ARRA: that the evidence suggested that increased government spending was ineffective. Barro pointed spending multipliers for 1941-42, 1942-1943, and 1943-1944 that were either below or just barely above one. I again come back to the same point that I raised in my posting in response to this from almost two years ago: that as the federal government applies stimulus to the overall economy the effectiveness of this is weakened considerably if –at the same time- state and local governments are doing the opposite. They did in this period that Barro refers to and they certainly are now. As the federal government has increased spending and cut taxes, state and local governments have been increasing taxes and cutting spending to balance their budgets. According to the National Organization of State Budget Officers (NABSO), despite projected increases in state level spending and revenues over the course of fiscal year (FY) 2011 both will still be well below their 2008 levels. Not even adjusting for inflation, state spending will be 7.6% lower in FY 2011 than it was in 2008. In real terms, it would of course be lower still. In the case of revenues, NASBO estimates that they will still be 7.8% lower in nominal terms in 2011 when compared to 2008. Not only have state and local governments been a drag on recovery but it is also true that a fairly high fraction of the production being generated to satisfy growing spending on both investment goods (23%) and exports (14%) in the fourth quarter was being covered via increased imports. Over the same period that both investment spending and export spending grew so rapidly in real terms (from Q209 to Q210) import spending grew in real terms 17.2%. Christian Weller notes this in his piece “Recovery Continues Amid Worrisome Trade Deficit”: The story of U.S. imports is not all that complicated, and it is directly related to struggles in the manufacturing sector. U.S. businesses are now operating in an expanding economy where other businesses and consumers demand more of their products. Domestic businesses thus need to ramp up production to meet that demand. They need more inputs for this added production, and they often turn to overseas suppliers for these. Imports of industrial supplies, for instance, increased by 20.2 percent in the second quarter, and imports of capital goods such as aircrafts and computers rose by 51.7 percent. The lack of domestic manufacturing capacity to supply these goods thus lowers the momentum for economic growth. (emphasis added). Finally, the over 6.5% growth in hourly productivity of labor since the crisis began might also have something to do with what we are seeing in terms of employment, especially when couple with the drag import spending growth, state and local government tax increases, and cuts in state and local government spending. Putting so much faith in others’ rationality, why would economists continue to offer an explanation that it implausible simply because it would appear to fit the facts as some argue Ricardian equivalence does? Why especially when there are other, more straightforward explanations to offer? The dangers of Ricardian equivalence: For those who wish to dress others in the sack-cloth and ashes of austerity Ricardian equivalence does offer an explanation of why “fiscal responsibility” can’t wait and austerity is needed now even if an economy could be counted on to pop right back on its own. In honor of Ed Prescott, what I refer to as the “pop back” theory is the neoclassical argument that if only wages and other resource costs were to move down along with the general level of prices to a sufficient degree the economy would self-correct. “Fiscal responsibility” means simply balancing government budgets when deficits emerge. Even though in 2007 the federal government was running a budget deficit, in 2007 - according to the NASBO report already cited above- state budgets were overall in balance. Their budget woes emerged as their economies moved into recession and were largely due to the natural decline in tax revenues that followed from economic weakness. Budgets that might have been in balance when state economies were stronger and unemployment lower moved toward deficit. Shouldn’t such economies if they are left alone –if they do indeed adjusts or pop right back- see their revenue picture improve considerably once recovery has been achieved. In fact, all else being equal, budgets should be back in balance again once long-run full-employment equilibrium is restored. In such a situation, to argue for austerity in the midst of a crisis would seem unnecessary. It is tantamount to saying that you think that even more pressure should be placed on labor and other resource suppliers to adjust than they would have to anyway. Ricardian equivalence provides a very dangerous answer to this question. Given increased deficits and its negative impact on private spending, whether governments cut spending , raise taxes, or carry out some combination of the two now or do so later, spending at the present time will be depressed. Labor and other resource supplies will be asked to carry the heavy burden of adjustment no matter what. The heavy burden of adjustment might be due directly to austerity measures put into place now. Lacking the political moxie to do something now, given Ricardian equivalence, the burden will be no lighter anyway as private households and businesses, seeing that the future will bring with it higher taxes unless something is done, cut their own spending in anticipation. God forbid that you live in an economy whose political leaders are so foolish to add even further to current and future budget deficits via expansionary fiscal policy such as we have. Households and businesses will only see still higher taxes in their future and cut back even more in order to get themselves ready. Waiting means that the final day of reckoning is further delayed and an even higher toll would have to be later than has to be paid now. This would be all well and good if true but it's not. Austerity is attacking the symptoms and not getting at the causes of our present difficulties. In economics we have a situation akin to modern medicine (with all its strengths and limitations) being practiced alongside bloodletting and humorism. It's too bad.