A quick note on the US and the Fed. Pressure for rate rises never really stopped, but lately it has intensified. Today I read on the FT that James Bullard, Saint Louis Fed head, urges Janet Yellen to raise rates as soon as possible, to avoid “devastating asset bubbles”. Just a few months ago we learned that QE was dangerous because, once again through asset price inflation, it led to increasing inequality. Not to mention the inflationistas (thanks PK for the great name!) who since 2009 have been predicting Weimar-type inflation because of irresponsible Fed behaviour (a very similar pattern can be found in the EMU). Let’s play the game, for the sake of argument. After all, asset price inflation, and distortions in general are not unlikely in the current environment. So let’s assume that the Fed suddenly were convinced by its critics, and turned its policy stance to restrictive (hopefully this is just a thought experiment). I have two related questions to rate-raisers (the same two questions apply to QE opponents in the EMU):
- Do they think that private expenditure is healthy enough to grow and to sustain economic activity without the oxygen tent of monetary policy?
- If not, would they be willing to accept that monetary restriction is accompanied by a fiscal expansion?
I am afraid we all know the answer, at least to the second of these questions. Just yesterday, on Italian daily Il Corriere della Sera, Alberto Alesina and Francesco Giavazzi called for public expenditure cuts, invoking the confidence fairy and expansionary austerity (yes, you have read well. Check for yourself if you understand Italian. And check the date, it is 2015, not 2007) What Fed (and ECB) bashers tend to forget, in conclusion, is that central bankers are at the center of the stage, reluctantly, because they have to fill the void left, for different reasons, by fiscal policy. Look at the fiscal stance for the US: Fiscal impulse, the discretionary stance of the US government, was positive only in 2008-2009, and has been restrictive since then. In other words, while the US were experiencing the worse crisis since the 1930s, while recovery was sluggish and jobless, the US government was pushing the brake. We all know why: political blockage and systematic boycott, by one side of Congress, of each and every one of the measures proposed by the administration (that was a bit too timid, if I may say so). Whatever the reasons, the fact remains that fiscal policy was of very limited help during the crisis. What do Fed bashers have to say about this? What would have happened if, faced with procyclical fiscal policy, the Fed had not stepped in with QE? I am afraid their answer would once again turn around confidence fairies… The EMU is pretty much in the same situation. The following figure shows the cumulative fiscal impulse since 2008 for a number of countries: The figure speaks for itself. With the exception of Japan (thanks Abenomics!) governments overall acted as brakes for the economy (Alesina and Giavazzi should look at the data for Italy, by the way). Central banks had to act in the thunderous silence of fiscal policy. So I repeat my question once again: who would be willing to exchange a normalization of monetary policy with a radical change in the fiscal stance? To conclude, yes, monetary policy has been very proactive (even Mario Draghi’s ECB); yes, this led us in unchartered lands, and we do not fully grasp what will be the long term effects of QEs and unconventional monetary policies; yes, some distortions are potentially dangerous. But central bankers had no choice. We are in a liquidity trap, and the main tool to be used should be fiscal policy. Monetary policy could and should be normalized, if only fiscal policy would finally take the witness, and the burden to lift the economy out of its woes; if fiscal policy finally tackled the increasing inequality that is choking the economy. If fiscal policy did its job, in other words.
I don’t know why, but I have the feeling that Janet Yellen and Mario Draghi would not completely disagree.
I am writing a paper on inequality and the crisis, for which I used Piketty and Saez ‘s World Top Income Database to try to understand whether the distributional effect changed over time. Unfortunately their data cover 2012 only for a handful of countries, among which are the United States; waiting for new data here is the evolution of income percentiles, including capital gains, from 2007 to 2009 (yellow bars), and from 2009 to 2012 (red bars):
The financial crisis of 2007-2008 mainly hit asset prices, thus having a major impact on the richest layers of the income distribution. In fact, the top 0.1% to 0.01% (a handful of people) lost more than 40% of their income in real terms, while average income of the bottom 90% dropped of around 10%. This was short-lasted, nevertheless, as the prolonged recession, and the jobless recovery that followed, quickly restored, and further deepened the distance between the rich on one side and the middle and lower classes on the other. Since 2009 average income of the bottom 95% stagnated (for the bottom 90% it kept decreasing). Nothing really new, here. The iAGS 2014 report, to which I (marginally) contributed, reaches similar conclusions. But I thought it would be interesting to share it.
And while we are at it, here are the ratios of average income of those at the very top, with respect to income of the bottom 90% (from the same dataset):
The top 0.1%-0.01%, the same handful of people as before, has an average income that is 120 times the average income of the bottom 90%. This is also barely breaking news…
Now, as we all know, the traditional view on income distribution states that factors of production are paid according to their contribution to the production process (their “marginal productivity”). Within this traditional view, the recent steep increase of inequality would be explained by skill-biased technical progress and increased competition in the globalized labor market: the entrance in the global labor market of low-skilled workers from emerging and developing economies lowered the average marginal productivity of labor, thus reducing its share of national income. Increasing inequality would then be an ineluctable process that policy is not supposed to address, if not at the price of reduced efficiency and growth. Is this a caricature? Not so much. in his recent Project Syndicate comment on Piketty, Kenneth Rogoff proposes once again the old tradeoff between inequality and growth that the crisis seemed to have buried once and for all (just look at the widely cited IMF discussion paper by Ostry et al). The traditional view is alive and kicking, and those who oppose it are dangerous liberal extremists! After all, Rogoff tells us, the tide raises all boats…
The bottom line is that if a top executive makes on average 120 times the wage of his or her employee, well, this means that he or she is 120 times more productive. Rent seeking and political capture play no role in explaining the difference in pay. Circulez, il n’y a rien à voir…
Nothing new under the sky, I guess. But it is important, from time to time, to send out reminders.
Update, March 20th: Speaking of ideological biases concerning inflation, Paul Krugman nails it, as usual.
On today’s Financial Times, Phillip Hildebrand gives yet another proof of unwarranted inflation terror. His argument is not new: In spite of the consensus on a weak recovery, the US economy may be close to its potential , so that further monetary stimulus would eventually be inflationary.
He then deflects (?) the objection that decreasing unemployment reflects decreasing labour force participation rather than new employment, by suggesting that it is hard to know how many of the 13 millions jobs missing are structural, i.e.not linked to the crisis. I think it is worth quoting him, because otherwise it would be hard to believe:
However, an increasingly vocal group of observers, including within the Fed, posits that more of the fall in the participation rate appears to have been structural than cyclical, and it was even predictable – the result of factors such as an ageing workforce and the effect of technology on jobs.
(the emphasis is mine). Now look at this figure, quickly produced from FRED data: Read more
Larry Summers’ IMF speech on secular stagnation partially shifted the attention from the crisis to the long run challenges facing advanced economies. I like to think of Summers’ point of as a conjectures that “in the long run we are all Keynesians”, as we face a permanent shortage of demand that may lead to a new normal made of hard choices between an unstable, debt-driven growth, and a quasi-depressed economy. A number of factors, from aging and demographics to slowing technical progress, may support the conjecture that globally we may be facing permanently higher levels of savings and lower levels of investment, leading to negative natural rates of interest. Surprisingly, another factor that had a major impact in the long-run compression of aggregate demand has been so far neglected: the steep and widespread increase of inequality. Reversing the trend towards increasing inequality would then become a crucial element in trying to escape secular stagnation.
A follow-up of the post on public investment. I had said that the resources available based on my calculation were to be seen as an upper bound, being among other things based on the Spring forecasts of the Commission (most likely too optimistic).
And here we are. On Friday the IMF published the result of its Article IV consultation with Italy, where growth for 2013 is revised downwards from -1.3% to -1.8%.
In terms of public finances, a crude back-of-the-envelop estimation yields a worsening of deficit of 0.25% (the elasticity is roughly 0.5). This means that in the calculation I made based on the Commission’s numbers, the 4.8 billions available for 2013 shrink to 1.5 once we take in the IMF numbers. It is worth reminding that besides Germany, Italy is the only large country who
can could benefit of the Commission’s new stance.
And while we are at Italy, the table at page 63 of the EC Spring Forecasts (pdf) is striking. The comparison of 2012 with the annus horribilis 2009 shows that private demand is the real Italian problem. The contribution to growth of domestic demand was of -3.2% in 2009, and -4.7% in 2012! In part this is because of the reversed fiscal stimulus; but mostly because of the collapse of consumption (-4.2% in 2012, against -1.6% in 2009). Luckily, the rest of the world is recovering, and the contribution of net exports, went from -1.1% in 2009 to 3.0% in 2012. This explains the difference in GDP growth between the -5.5% of 2009 and the -2.4% of 2012.
Italian households feel crisis fatigue, and having depleted their buffers, they are today reducing consumption. I remain convinced that strong income redistribution is the only quick way to restart consumption. Looking at the issues currently debated in Italy, this could be attempted reshaping both VAT and property taxes so as to impact the rich and the very rich significantly more than the middle classes. The property tax base should be widened to include much more than just real estate, and an exemption should be introduced (currently in France it is 1.2 millions euro per household). Concerning VAT, a reduction of basic rates should be compensated by a significant increase in rates on luxury goods.
Chances that this will happen?
In the past weeks I have argued at length that the eurozone is in recession because of a strong contraction of aggregate demand; and that in spite of this fact the overall fiscal stance is restrictive.
I also argued that in the current situation the best that can be hoped for peripheral countries is a more gradual consolidation (ideally a neutral stance, but this is too much to ask). I do believe that a fiscal expansion, even in the periphery, would be sustainable and growth-enhancing. But at this stage this is just daydreaming. It won’t happen.
The fiscal stance of the eurozone will not become expansionary (as is sorely needed), if the core (and in particular Germany) does not implement robustly expansionary fiscal policies.
If their fiscal space is limited or non-existent, what can peripheral countries do, besides waiting for an improbable fiscal stimulus in Germany? A lot, actually. If public demand cannot be significantly increased (and will actually be further compressed, albeit at a slower pace), it is all the more important that the governments of Italy, Greece, Spain and so on, find ways to restart private demand.
There is a lot of discussion about structural reforms. They are not the answer. First, because they have an impact mostly on supply (and the problem, let me repeat it, is demand); second, because their benefits, if any, won’t materialize before a few years. And there is no time. The cumulate effect of five years of crisis is now threatening social cohesion in most peripheral countries.
A more straightforward policy, that could be implemented in the next few months with immediate effects, is a strong redistribution of the tax burden towards higher incomes. The increasing inequality of income of the past three decades is in my opinion one of the deep causes of the crisis; inequality has further increased since 2008. The squeeze of revenues for low incomes, coming from the combination of high unemployment and fiscal adjustment, is depressing both the capacity to spend and the morale of households. Increased inequality contributed to global imbalances in the past, and is recessionary in the current crisis.
In September, when the season of budget laws begins, governments in the periphery should propose to their parliaments revenue-neutral tax adjustments, lowering taxes on low income households and increasing them on the rich and very rich. This would be fair, and more importantly, effective to boost morale and consumption. I am talking about a substantial shift of the burden, large enough for its macroeconomic impact to be significant. This is all the more necessary if standard Keynesian deficit spending can not be implemented.
Paul Krugman hits hard on one of the most cherished american myths, the golden years of Reaganomics. He shows that using the middle class as a benchmark (the median family income of the economy), the Reagan decade saw a disappointing performance; this, not only if compared to the longest expansion in post war history, during the Clinton presidency, but also with respect to the much less glorious 1970s.
But, maybe, Krugman is telling a story of inequality, and not of sluggish growth. The fact that median income did not grow much during the Reagan years may not mean that growth was not satisfactory, but simply that somebody else grasped the fruits.
For curiosity, I completed his figure with average yearly growth rates for two other series: Income of the top 5% of the population, and the growth rate of the economy.
Well, it turns out that Reaganomics yielded increasing inequality and unsatisfactory growth. And well beyond that, median income consistently under-performed economic growth in the past forty years.
What seems extremely robust is the performance of the top 5% of the population. Their income increased significantly more than output over the past decades. It is striking in particular, how the very wealthy managed to cruise through the current crisis, when income of the middle class was slashed.
Nothing new, Ken Loach in 1993 said it beautifully: it is always raining stones on the working class. But I guess it does no harm to remind it from time to time…