the logical outcome?

[phil_20686]

Ireland (the south) is in danger, but I think less than Greece. The rest of the UK is not in the Euro so has a different set of problems. Our government is not putting a stimulus in which is the opposite of the way the French are tackling this. Basically our problem is something like:

 

Under the Conservatives - owe 160 BN and increasing for a bit till the situation improves - pay 1.87% interest on it - the markets trust the strategy.

Under Labour use a stimulus, - owe 180 BN which will increase for a shorter time then come down faster as extra tax comes in if it works - pay 6% on it as the markets would have no confidence due to the mess the previous Labour administration made of it.

 

AHHHHH!.

 

Our interest rates are low because we borrow in our own currency and because there is a shortage of safe assets in the shadow banking system. If you think that low interest rates in teh UK reflect predictions for the economy, then God Help Us All. Since you can effectively buy a share of GDP growth by buying the FTSE all share, that means that we are expecting thirty year GDP growth rates of under two percent. Low interest rates are an indictment of central bank policy. Except their not, as the shadow banking is forced to buy them to grease repo transactions, and raise liquidity from teh ECB, so really the rates don't tell us anything. Germany is selling its bonds at zero coupon. Switzerland recently offered a two year bond with a negative coupon rate, and it had three times bid to cover. People are literally paying the swiss treasury for the privilege of holding their currency.

 

So, interest rates are low because either:

(1) The central banks have mot yet countered the monetary contraction caused by the collapse of the AAA rated securities market.

Or

(2) Because investors believed that the long term future of GDP is negative.

 

NEITHER OF THESE THINGS ARE POSITIVES.

 

Regarding Ireland. This is a structural problem. Every country in the eurozone periphery will follow spain. What happens is this, germany's productivity growth is higher than country A by x%. This means that the wage growth in germany and country A should be different by x%. However the bundesbank is allergic to inflation, and has demanded a one percent inflation target. Since inflation == rising wages, the most that wages can rise in Germany is one percent. Thus any country whose productivity growth is 1% or more lower than germany's is forced to cut their wages. But wages are downwardly rigid, so instead they become uncompetitive and have to lay of workers.

 

It is impossible for the eurozone to function unless the differences in productivity growth between the best and worst countries are less than the rate of inflation. Greece, then spain, then italy, then Ireland then france. Its a destructive cycle that will not end unless the ECB raises its inflation target above 3% long term, and to 5% in the short term, to help make up for past adjustments. Germany knows that if inflation rises, it will not rise symmetrical, instead German wages will rise while the periphery stay stationary. This will ruin their profitable export business, and force them to balance consumption and production. So it opposes it.

 

The fiscal policy of the eurozone goverments is irrelevant. If you want proof, look at the markets. They are the best way to process information. Everytime it looks like one of the world banks will engage in expansionary monetary policy, the stock markets soars, the implicit price of default drops, everything moves in the right direction. The markets know that a monetary solution is needed here. Every time the ECB talks about the need for price stability, and to stay the course, the markets collapse. These are predictions of the effects of ECB policy.

[luke warm]

The markets know that a monetary solution is needed here. Every time the ECB talks about the need for price stability, and to stay the course, the markets collapse. These are predictions of the effects of ECB policy.

if i understand your last few posts on this, you seem to be saying that the u.s.'s (for example) problems can all be solved by simply printing more money, lots more... there will either be inflation, in effect wiping out the debt, or not... if not (which seems impossible), the dollar stays high or goes higher, and there are more of them... unemployment would of necessity then drop

 

is that even close?

[phil_20686]

if i understand your last few posts on this, you seem to be saying that the u.s.'s (for example) problems can all be solved by simply printing more money, lots more... there will either be inflation, in effect wiping out the debt, or not... if not (which seems impossible), the dollar stays high or goes higher, and there are more of them... unemployment would of necessity then drop

 

is that even close?

 

 

The point of rising inflation, is that it will lower unemployment. In a demand side recession, there is nothing `wrong' with the economy, but for some reason prices have gone wrong, so we can no longer exchange the stuff we are producing for the stuff that we want. In theory we should simply be able to reset the prices. In reality wages and prices are downwards sticky. It is not easy to convince people to take a pay cut. Inflation makes it easier to give people effective pay cuts, as holding wages steady is a pay cut. So in a demand side recession there is a direct trade off between the rate of inflation and the unemployment rate. This is called the Philip's curve (google it).

 

Lowering unemployment should be the first goal in a recession, as putting people back to work will raise national output, and is generally a good thing. Also, it is difficult for inflation to rise much when the output is increasing, as the money supply has to rise faster than the output in order to cause inflation. What happens in reality, is that the central bank attempts to cause inflation by printing money, this puts people back to work, and the rate of inflation starts to rise only after unemployment is close to its natural rate, at which point the trade off becomes less. When you are at the natural rate, no amount of inflation will achieve a reduction in unemployment.

 

It appears, that central bankers believe that `price stability' is a more important goal that reducing unemployment. This is bananas.

 

However, there is a second argument sometimes advanced by left wing commentators, e.g. Krugman, that we need fiscal policy (i.e. government spending) in order to reduce unemployment. The believe that monetary policy is ineffective when interest rates are zero, since the traditional way for a central bank to expand the money supply is by buying treasuries, but zero coupon treasuries are identical to hard cash, so this becomes less effective at low interest rates. This is called, variously, the zero bound, the liquidity trap, ZIRP, and other things, but basically the thrust of their argument is that the central bank cannot, under these circumstances, cause inflation. This is also bananas. For one thing, if it is true, the central bank could buy up every US treasury and give them back to the US government, and say "look, don't bother paying us back, theres no need, we can print this money for free anyhow". Krugman seems to believe that doing this would not cause any inflation, and would therefore not achieve anything. If this were the case, the central bank could buy up every piece of personal, private or government bond or debt with newly minted cash, and retire them, for free. So it should clearly do that.

 

On the other hand, if like me, you believe that the central bank can cause inflation even at the lower bound, then we are back to reducing unemployment. They should clearly engage in monetary stimulus to lower unemployment back to the natural rate (5-6% for the US). Central banks are choosing high unemployment and recession.

 

My understanding is that they misunderstand the distinction between supply side and demand side problems, and therefore do not believe that raising inflation would lower unemployment. This is what happened in the 1970's. in that case they tried to lower unemployment by raising inflation, but that did not work,because supply side problems are `real' problems, and cannot be fixed or alleviated by fiddling with monetary policy. Supply side problems are easy to understand in principle: Suppose that an asteroid destroyed half of the united states, and half of its productive capacity (eg factories) but you managed to save all of the people by evacuating them. In this case it is clearly absurd to believe that causing inflation will lead to rapid return of unemployment to 5%. In truth we would need to rebuild all of the factories, farms, cities, etc. This is what happened in the 1970's, except there was a rapidly expanding population (faster than you could build factories), coupled with a restricted supply of commodities, (which caused their prices, especially oil, to rise).

 

The pessimistic reading is that they do understand perfectly well, they just would rather protect the rich than lower unemployment. I never assume malice where stupidity is sufficient, but there we go.

[blackshoe]

Printing more money certainly worked well for the Weimar Republic.

[luke warm]

My understanding is that they misunderstand the distinction between supply side and demand side problems, and therefore do not believe that raising inflation would lower unemployment. This is what happened in the 1970's. in that case they tried to lower unemployment by raising inflation, but that did not work,because supply side problems are `real' problems, and cannot be fixed or alleviated by fiddling with monetary policy. Supply side problems are easy to understand in principle: Suppose that an asteroid destroyed half of the united states, and half of its productive capacity (eg factories) but you managed to save all of the people by evacuating them. In this case it is clearly absurd to believe that causing inflation will lead to rapid return of unemployment to 5%. In truth we would need to rebuild all of the factories, farms, cities, etc. This is what happened in the 1970's, except there was a rapidly expanding population (faster than you could build factories), coupled with a restricted supply of commodities, (which caused their prices, especially oil, to rise).

then, because this is a demand vs. supply issue, what i wrote is an accurate reflection of what you are saying?

 

Printing more money certainly worked well for the Weimar Republic.

that's what i was thinking

[PassedOut]

Printing more money certainly worked well for the Weimar Republic.

Is it your view that the Weimar Republic had a demand-side problem? Otherwise your observation here seems misdirected.

[barmar]

Note 4: Oddly enough, there are many tax benefits/loopholes/dodges that can only be effectively used if you have a lot of money to spare. I can't imagine why, given that one of the things that gets a massive tax benefit is political contributions. If you can afford a good tax accountant, you can probably afford to play the games that get you these tax benefits that "everybody" has access to (but only people in your income range can actually use). This is a spin-off effect of Notes 2 and 3, of course.

I always get a laugh when I hear about the big companies with an "army of tax lawyers" finding tax loopholes for them. How much does it cost to employ an army of lawyers, so what's the net savings when you include all their salaries, benefits, and overhead costs?

 

On the other hand, maybe I'd rather see that money going to hiring than the government.

[ArtK78]

I always get a laugh when I hear about the big companies with an "army of tax lawyers" finding tax loopholes for them. How much does it cost to employ an army of lawyers, so what's the net savings when you include all their salaries, benefits, and overhead costs?

 

On the other hand, maybe I'd rather see that money going to hiring than the government.

Political contributions are not deductible and get no tax benefits. Now, if you want to say that political contributions lead to other benefits....

[blackshoe]

It's my view that radically increasing the money supply is likely to cause more problems than it fixes.

[PassedOut]

It's my view that radically increasing the money supply is likely to cause more problems than it fixes.

Okay. I had thought you were addressing Phil's argument.

[phil_20686]

It's my view that radically increasing the money supply is likely to cause more problems than it fixes.

 

If this turns out to be the case, the central bank can always decrease the money supply again.

 

Anyway, this is a non argument. The fed controls the money supply. It must choose a path for it, the question is only which monetary indicator should it target. The main purpose of targeting inflation, its primary virtue, is that it makes saving fairly attractive, by preserving the value of past claims on future consumption. A perfectly reasonably thing to do when the economy is doing well. When its doing badly, your first job is to return it to doing well. If your economy is making less stuff, everyone is a loser.

 

Besides, linking the money supply with inflation is an error anyway. What matters is how much money gets spent. I.e. NGDP. Those central banks that have implicit NGDP targets seldom have to take any action to achieve them, as their is a profit motive in front running their action, so what happens is if it looks like NGDP will overshoot/undershoot, the markets self adjust. Of course, in severe cases like the financial crises, the central banks need to step in, but the better run central banks have mostly reduced their balance sheets to pre-crises level.

[squealydan]

I always get a laugh when I hear about the big companies with an "army of tax lawyers" finding tax loopholes for them. How much does it cost to employ an army of lawyers, so what's the net savings when you include all their salaries, benefits, and overhead costs?

 

On the other hand, maybe I'd rather see that money going to hiring than the government.

 

I bing-ed "tax lawyer salary" and on the first page I got :

 

"Tax lawyers are usually between the highest paid lawyers in legal professions. " quote from thelawyersalary.blogspot.co.nz

 

"Tax attorneys are generally among the highest-paid lawyers in the legal profession." quote from eHow.com

 

"The median expected salary for a typical Tax Attorney IV in the United States is $169,441. This basic market pricing report was prepared using our Certified Compensation Professionals' analysis of survey data collected from thousands of HR departments at employers of all sizes, industries and geographies." quote from salary.com

 

From the same site :

"Job Description for Tax Attorney IV

Acts as organization's representation in dealing with local, state, and federal taxing agencies. Responsible for developing tax saving plans and preparing legal documents involving liabilities."

 

If they aren't saving their employers vast amounts of money in reduced or deferred tax payments, why are tax attorneys are the highest paid lawyers in the legal profession, and why do corporations tend to employ large numbers of them?

 

From thinkprogress.org : "U.S. corporate taxes that were actually paid (the effective rate) fell to a 40 year low of 12.1 percent in fiscal year 2011, despite corporate profits rebounding to their pre-Great Recession heights."

[WellSpyder]

This is called the Philip's curve.

I like your appropriation of the "Philip's" curve - for those who haven't come across it before, it is not named after Phil, but after an engineer/economist called Bill Phillips.

 

I think, though, that you might want to think a bit more about the "inflation-augmented" Phillips curve. If I understand it correctly, you are arguing that the central bank should allow (or create) more inflation, to solve a shortage of demand. The problem that has been noted in the past, however, is that it is only really unexpected inflation that stimulates demand. Once people come to expect a certain rate of inflation, you have to create more inflation above that rate to get any impact, and then people come to expect a higher rate of inflation ratcheting the effect up further, and so on...

 

This is the fundamental reason for inflation targeting, and I think it is only because this has been fairly successful in anchoring inflation expectations that it appears possible to exploit those expectations to generate unexpected inflation. Once you destroy the credibility of low inflation expectations then the whole round of higher expectations generating higher inflation in a never-ending spiral starts again.

 

So to support the policy you are advocating you need to be confident that the benefits of a short-term demand stimulus are so high in current circumstances that it is worth throwing away the inflation anchor that has been achieved by credible inflation targeting.

[phil_20686]

I like your appropriation of the "Philip's" curve - for those who haven't come across it before, it is not named after Phil, but after an engineer/economist called Bill Phillips.

 

I think, though, that you might want to think a bit more about the "inflation-augmented" Phillips curve. If I understand it correctly, you are arguing that the central bank should allow (or create) more inflation, to solve a shortage of demand. The problem that has been noted in the past, however, is that it is only really unexpected inflation that stimulates demand. Once people come to expect a certain rate of inflation, you have to create more inflation above that rate to get any impact, and then people come to expect a higher rate of inflation ratcheting the effect up further, and so on...

 

Its not so much "unexpected" as "changing the inflation rate". In the long run money is neutral, and employment will settle into its natural rate regardless of the rate of inflation, provided that it is stable, (and that its not so high as to be distorionary). It should be underlined that the philips curve in all its forms is just an empirical relationship. Its not quantitatively founded, and it is different at different times and situations. Theory strongly suggests that in demand side recessions the Philips curve is steep, whereas in supply side recessions its quite shallow (so in demand side recessions raising inflation works better than in supply side recessions). Qualitatively this reasons are pretty clear I think. A central bank generates inflation by printing money and then buying stuff. In a demand side recession that leads to the putting to work of idle resources. In a supply side recession it is (by definition) impossible/very hard for the economy to produce extra stuff, so when you purchase stuff you are increasing demand but not supply, and so prices rise. This is the root of stagflation: that the economy cannot produce more stuff regardless of how much stimulus is provided.

 

 

 

So to support the policy you are advocating you need to be confident that the benefits of a short-term demand stimulus are so high in current circumstances that it is worth throwing away the inflation anchor that has been achieved by credible inflation targeting.

 

 

Your argument is basically an argument in favour of counter cyclical inflation targeting. I think most people broadly agree that its right to let inflation run high during high unemployment, and reign it in when the economy is booming (to prevent it from overheating). Somce central bank mandates (like australia) are explicit: They target two percent average inflation over the cycle, not on a month to month basis. Nominal GDP targeting does the same. Since NGDP = real GDP + inflation, then during recession inflation rises. To de anchor inflation expectations, the markets/people have to believe that the bank will continue to increase the rate of inflation when it is having no effect, or that the central bank will never lower it again.

 

So in short, I do not believe that temporary rises in the rate of inflation, to moderate totals, will act to de-anchor inflation exectations, provided the central bank is transparent about its policy goals. Afterall, several countries, most notably australia and canada, seem to have explicit NGDP targets, and it has not de-anchored inflation expectations.

This is the fundamental reason for inflation targeting, and I think it is only because this has been fairly successful in anchoring inflation expectations that it appears possible to exploit those expectations to generate unexpected inflation. Once you destroy the credibility of low inflation expectations then the whole round of higher expectations generating higher inflation in a never-ending spiral starts again.

This is not correct. The fundamental reason that monetary policy works at all, is that prices/wages are sticky. This means that changing the rate of inflation gives you a short term boost until wages adjust. In the long run money is neutral. The existance of a neverending spiral basically implies that you do not think that raising the inflation rate will lower unemployment. If it does successfully lower unemployment, then you can lower the rate of inflation again. What happened in the 1970's, is that due to supply side problems, the philips curve had a different shape, and so raising inflation did not have the expected effect on unemployment. Because they failed to appreciate that it was supply side problems, they ended up raising the inflation rate extremely high, because they were worried that lowering it would lead to high unemployment. It was Volker who realised that the philips curve would be shallow, and so he lowered the inflation rate by raising interest rates (contracting the money supply) and this had only a very moderate effect on the unemployment rates, which only confirmed that the philips curve was shallow.

 

Moreover, I really think this should not concern us at all: recall the central bank will be expanding its balance sheet by buying assets in order to expand the money supply, so it can always contract it at will by selling those assets again. Finally, I leave you with the thought, that those countries who allowed inflation to run high through the financial crisis, managed to avoid high unemployment without de-anchoring their inflation expectations. Even iceland who let inflation peak near to 15%, has had no trouble bringing it back down:

 

http://www.tradingeconomics.com/chart.png?s=iccpiyoy&d1=19900101&d2=20120831

 

Does that look like a wage spiral to you?<br class="Apple-interchange-newline">

 

 

 

 

[mycroft]

Political contributions are not deductible and get no tax benefits. Now, if you want to say that political contributions lead to other benefits...

Well, colour me foreign-blind. My apologies.

 

You see, up where I live, political contributions *do* give a massive tax benefit; it's capped at a reasonable level, but you get $650 back on at least $1275 of donations federally ($300 of the first $400, going down from there). Every Province Is Different, but mine gives you $1000 back on $2300+ of donations.

 

But in my favour, I note that with sufficient lawyerly assistance, 501©(3) tax-exempt charities can be set up that look from the outside like political lobbying and advertising agencies, and do rather effective "charity". It's possible, because they exist.

 

And yes, I *will* argue that it leads to other benefits, straight up :-)

 

But that point, straight up and at least in the US, I am wrong on. Sorry.

[WellSpyder]

The fundamental reason that monetary policy works at all, is that prices/wages are sticky. This means that changing the rate of inflation gives you a short term boost until wages adjust. In the long run money is neutral. The existance of a neverending spiral basically implies that you do not think that raising the inflation rate will lower unemployment. If it does successfully lower unemployment, then you can lower the rate of inflation again.

I don't really want to pick up on all the points in your post, and I agree with quite a bit of what you say, but I suspect the fundamental reason why we don't necessarily agree on the appropriate policy response lies in the final sentence in your para above. How do you propose to lower the inflation rate again?? Do you think this will simply happen by the central bank reducing the rate of monetary expansion in the economy, with no consequences for the real economy?? Or is it more likely to require an increase in interest rates to reduce demand, and put downward pressure on inflation by increasing unemployment again, in order to reduce inflationary expectations again?

[phil_20686]

I don't really want to pick up on all the points in your post, and I agree with quite a bit of what you say, but I suspect the fundamental reason why we don't necessarily agree on the appropriate policy response lies in the final sentence in your para above. How do you propose to lower the inflation rate again?? Do you think this will simply happen by the central bank reducing the rate of monetary expansion in the economy, with no consequences for the real economy?? Or is it more likely to require an increase in interest rates to reduce demand, and put downward pressure on inflation by increasing unemployment again, in order to reduce inflationary expectations again?

 

The point is that the philips curve is not the same shape at full employment as it is during a recession, so these procedures are not symmetrical. Near full employment it is shallower, so reducing inflation by one percent near full employment will have less of an effect on employment than one percent now, where we are on the steep part of the curve.

 

Moreover, even if they were symmetric, you can lower it more slowly, so that you stay at full employment, and get an overall increase in net jobs. Its really just a variation on the fiscal policy argument: fiscal policy raises demand a lot now, and reduces it a little over a long period in the future, through consumption smoothing, and so stimulus during a recession does lead to a net increase in jobs. Of course, that must be true, as fiscal and monetary stimulus are essentially identical.

 

We can also see this through a less abstract lens: at full employment, there is a demand for labor, and generally the economy wants more workers than it has available, so small negative shifts at full employment are easily absorbed.

 

On final point, if inflation expectations in the long term are 2%, returning to the expected does not have any effect. What you say above is something which is true by degree. If we moved inflation expectations by having higher inflation for several decades, then lower inflation would be contractionary, but in reality a few years of higher than 2% inflation is unlikely to move the expectation.

 

Okay really final point here. If you are worried about longterm inflation expectations, you should be worried that expectations of inflation are already disachnchored. FOr decades the us 30 year treasuries have had an implied inflation rate between 2 and 2.5 %. But now we are seeing significant volatitility, check it out here. In late 2010, for example, implied inflation expectation for the US was down to 1%. Which is mental. The market no longer knows whether to believe that the Fed is actually targeting a 2% inflation, and the result is unprecedented volatility in long term expecations. We have already dis-anchored expectations, to the downside, which, by your own admission, is contractionary. :) The Fed, by having lower than expected inflation, is engaging in contractionary monetary policy, despite the high unemployment. This is a scandal.

[phil_20686]

I don't really want to pick up on all the points in your post, and I agree with quite a bit of what you say, but I suspect the fundamental reason why we don't necessarily agree on the appropriate policy response lies in the final sentence in your para above. How do you propose to lower the inflation rate again?? Do you think this will simply happen by the central bank reducing the rate of monetary expansion in the economy, with no consequences for the real economy?? Or is it more likely to require an increase in interest rates to reduce demand, and put downward pressure on inflation by increasing unemployment again, in order to reduce inflationary expectations again?

 

Came across this the other day, I think it shows clearly why its important to understand the differences between when policy is demand side and supply side:

 

http://ingrimayne.com/econ/Labor/Figure13.8.gif

 

 

I will try to find subsequent data back to the great depression and forward to now

[PassedOut]

The point is that the philips curve is not the same shape at full employment as it is during a recession, so these procedures are not symmetrical. Near full employment it is shallower, so reducing inflation by one percent near full employment will have less of an effect on employment than one percent now, where we are on the steep part of the curve.

 

Moreover, even if they were symmetric, you can lower it more slowly, so that you stay at full employment, and get an overall increase in net jobs. Its really just a variation on the fiscal policy argument: fiscal policy raises demand a lot now, and reduces it a little over a long period in the future, through consumption smoothing, and so stimulus during a recession does lead to a net increase in jobs. Of course, that must be true, as fiscal and monetary stimulus are essentially identical.

Phil, thanks much for a great sequence of posts, especially this last clarification. The problem of reversing the effects of inflation later had always been a (perhaps irrational) problem for me.

 

Any inflation erodes the value of the nest egg of retired people. If inflation stays at a predictable 2% or so, folks can plan accordingly. But if it spikes above the normal amount for an extended period, it hurts those folks immensely. I saw that happen in the 1970s. Perhaps one should plan for a somewhat higher than normal inflation to account for the need to pump it up on occasion.

 

It would be good to know the exact strategy of the central banks (and, of course, that the strategy is sound).

[phil_20686]

Ok note quite as good, but I think this will make my point:

 

http://research.stlouisfed.org/fred2/graph/fredgraph.png?&id=CPIAUCSL,UNRATE&scale=Left,Left&range=Max,Max&cosd=1947-01-01,1948-01-01&coed=2012-06-01,2012-07-01&line_color=%230000ff,%23006600&link_values=false,false&line_style=Solid,Solid&mark_type=NONE,NONE&mw=4,4&lw=1,1&ost=-99999,-99999&oet=99999,99999&mma=0,0&fml=a,a&fq=Monthly,Monthly&fam=avg,avg&fgst=lin,lin&transformation=pc1,lin&vintage_date=2012-08-14,2012-08-14&revision_date=2012-08-14,2012-08-14

 

 

The philips curve suggests that during a recession unemployment rises, and inflation falls, We see this clearly, following each recession (shaded bar) pre 1970, unemployment rises, while inflation falls. Moreover, generally inflation remains depressed until unemployment has returned to its natural rate. See the 1960 to 1967 period. Expansionary policy leads first to falling unemployment, and then to rising inflation.

 

In the 1970's we see something different. Now inflation and unemployment move together. This is indicates that the philips curve is very steep. The explanation of this lies in supply constraint. Inflation was high because demand for stuff was outstripping the rate at which the economy could expand production, due to a combination of rising working age population (the entry of women into the work force raised labour participation rates rapidly), rising competition for commodities.

 

Supply side issues ended in the eighties, as we got better at making more with less (productivity gains), and we returned to the business as usual of demand side recessions. Then look what happened. five years ago we had the biggest recession visible on this graph, and the FOMC has allowed inflation, and inflation expectations, to languish below trend.

 

Now my preferred measure of whether policy is stimulative or not is Nominal GDP, which is basically a measure of aggregate demand. Its also clear that a central bank can necessarily raise nominal GDP, (although not necessarily RGDP).

 

http://research.stlouisfed.org/fred2/graph/fredgraph.png?&id=CPIAUCSL,UNRATE,NGDPPOT&scale=Left,Left,Left&range=Max,Max,Max&cosd=1947-01-01,1948-01-01,1949-01-01&coed=2012-06-01,2012-07-01,2022-10-01&line_color=%230000ff,%23ff0000,%236400c8&link_values=false,false,false&line_style=Solid,Solid,Solid&mark_type=NONE,NONE,NONE&mw=4,4,4&lw=1,1,1&ost=-99999,-99999,-99999&oet=99999,99999,99999&mma=0,0,0&fml=a,a,a&fq=Monthly,Monthly,Quarterly&fam=avg,avg,avg&fgst=lin,lin,lin&transformation=pc1,lin,pc1&vintage_date=2012-08-14,2012-08-14,2012-08-14&revision_date=2012-08-14,2012-08-14,2012-08-14

 

 

The difference between NGDP and inflation is RGDP. You can see that mostly RGDP growth has been fairly robust, so NGDP tracks inflation. Every large decline in unemployment visible on this graph, has been accompanied by NGDP growth above five percent (which is roughly the stable trend at full employment). Not only is the fed not engaging in stimulus, it is allowing NGDP to be below trend, which is contractionary, and its own estimates suggest that NGDP will not be above 5% through 2020. Moreover, the apparent decline in the unemployment rate is flattering, it is mostly caused by people dropping out of the labour force, having been unable to find a job. Particularly for those in teh fifties, it often makes sense to start claiming your pension early, even though its not your first choice, rather than having no money. Once you do that, you are no longer unemployed.

[phil_20686]

Phil, thanks much for a great sequence of posts, especially this last clarification. The problem of reversing the effects of inflation later had always been a (perhaps irrational) problem for me.

 

Any inflation erodes the value of the nest egg of retired people. If inflation stays at a predictable 2% or so, folks can plan accordingly. But if it spikes above the normal amount for an extended period, it hurts those folks immensely. I saw that happen in the 1970s. Perhaps one should plan for a somewhat higher than normal inflation to account for the need to pump it up on occasion.

 

No problem:

 

Also, above average inflation shouldn't hurt you, what does hurt you is if you retire during below average inflation, or alternatively, if inflation rises after you retire. I realise that is counter intuitive, but basically it the argument goes like this suppose that you hold part of your retirement portfolio in bonds. Consider that you hold one year bonds in year one, and buy them at an interest rate of 8%, intending to roll them over upon maturity into more bonds. The next year, inflation expectations fall, so yields fall. This increases the capital value of your original bonds, but decreases the yield, so rolling over the capital always gives you exactly the same coupon payment that you started with. Thus, its actually best to buy bonds when inflation expectations are high, because if inflation expectations fall you benefit. So those people who saved their portfolio's in bonds through the 1970's, have made a killing as decreased inflation expectations have lowered yields. Anyway, my point is this: the yield for risk free assets should oscillate around the expected level of inflation, plus a small premium for bearing the risk of higher than expected inflation. The entire reason that yields have been higher in the past, was pretty much because the inflation expectations in thirty year bonds take a while to reset, and people had high expectations by the end of the 1970's:

 

http://research.stlouisfed.org/fred2/graph/fredgraph.png?&id=GS10,MICH&scale=Left,Left&range=Max,Max&cosd=1953-04-01,1978-01-01&coed=2012-07-01,2012-06-01&line_color=%230000ff,%23ff0000&link_values=false,false&line_style=Solid,Solid&mark_type=NONE,NONE&mw=4,4&lw=1,1&ost=-99999,-99999&oet=99999,99999&mma=0,0&fml=a,a&fq=Semiannual,Annual&fam=avg,avg&fgst=lin,lin&transformation=lin,lin&vintage_date=2012-08-14,2012-08-14&revision_date=2012-08-14,2012-08-14

 

 

So the people who really get hurt are those who are retiring right now, because the way pension funds are set up as annuities essentially forces you to move all of your assets from equities into bonds (although tihs all happens behind a curtain as it were), and yields are currently low, and its the yield on the day your annuity is taken out that matters, as that has that days inflation expectation built into it. But this is the central banks fault. If should have moved aggressively to stimulate NGDP, if it had, bond yields would not have fallen below the four percent they were yielding pre crises, which was pretty much their historical floor. Barring this crisis, they would have stabilised at around four percent. No one buys safe assets at a loss unless they have to :).

 

Of course, this is not a popular view. Obviously, in some sense, inflation `always' hurts you when you have an annuity, as people don't think "two percent of my yield is my inflation expectation, I should reinvest that in more bonds to protect myself from inflation", but that is how an economist thinks. :)

 

So the only losers here will be the people who retired 2008-now. But what can you do.

[WellSpyder]

Came across this the other day, I think it shows clearly why its important to understand the differences between when policy is demand side and supply side:

A useful chart, thanks - but I think what it really illustrates is the importance of inflation expectations, not whether the economy is demand or supply constrained.

 

Any inflation erodes the value of the nest egg of retired people. If inflation stays at a predictable 2% or so, folks can plan accordingly. But if it spikes above the normal amount for an extended period, it hurts those folks immensely. I saw that happen in the 1970s. Perhaps one should plan for a somewhat higher than normal inflation to account for the need to pump it up on occasion.

This is exactly my problem with Phil's inflation-inducing strategy. Sure, you can plan for average inflation somewhat above normal, to allow for the occasional policy-induced extra inflation. But now the policy will only work if it pumps inflation up even higher. It is only if policy-makers can exceed inflationary expectations that such a policy will work, but that means savers have lost out again. And it also means that investors will be more wary of lending to governments in the future. Any policy that is "time inconsistent" (ie wouldn't work if people had known in advance that that was going to be your policy) is unlikely to be sutainable in the long run.

[phil_20686]

This is exactly my problem with Phil's inflation-inducing strategy. Sure, you can plan for average inflation somewhat above normal, to allow for the occasional policy-induced extra inflation. But now the policy will only work if it pumps inflation up even higher. It is only if policy-makers can exceed inflationary expectations that such a policy will work, but that means savers have lost out again. And it also means that investors will be more wary of lending to governments in the future. Any policy that is "time inconsistent" (ie wouldn't work if people had known in advance that that was going to be your policy) is unlikely to be sutainable in the long run.

 

From what I understand, the fundamental difference in our thinking, is that you think raising the inflation rate now will necessarily change inflation expectations. I don't think that this follows. If you can promise to balance inflation to two percent over the cycle, like australia attempts to do, and still allow it to run high now. If that is the case the policy is sustainable, as you can have quite a lot of above expected inflation without changing the long term inflation much at all. Of course, this is all about time horizons, but the `inflation expectation' people talk about seems to be roughly on a ten year horizon.

 

It does not seem to follow that having two or three years of 5% inflation should necessarily move the ten year expectation much at all. I can show you graphs of countries, like Australia, where the implied inflation in the bond market didn't move much at all, despite a short period of high inflation. Or in the UK, where we had a short period of high inflation (although in this case not because of the central bank).

[Cthulhu D]

If they aren't saving their employers vast amounts of money in reduced or deferred tax payments, why are tax attorneys are the highest paid lawyers in the legal profession, and why do corporations tend to employ large numbers of them?

 

From thinkprogress.org : "U.S. corporate taxes that were actually paid (the effective rate) fell to a 40 year low of 12.1 percent in fiscal year 2011, despite corporate profits rebounding to their pre-Great Recession heights."

 

The single best corporate tax evasion scheme is Ikea. Ikea is a charity dedicated to the advancement of furniture design (I'm not joking at all), and is run as a not for profit corporation. The profits are extracted via a licensing fee charged by an off-shore corporation in Bermuda.

 

It is the best thing.

[phil_20686]

From thinkprogress.org : "U.S. corporate taxes that were actually paid (the effective rate) fell to a 40 year low of 12.1 percent in fiscal year 2011, despite corporate profits rebounding to their pre-Great Recession heights."

 

This is one of those annoying `small truths' that isn't exactly false but paints a completely false picture.

 

The fundamental reason this number is falling is that co-corporations are earning more of their money abroad. If you are a co-orporation, you should be paying US corporation tax only on those profits relating to operations in the US.

 

Instead, you require corporation to be paid on foreign earnings, so US subsidiaries operating in England, will pay UK corporation tax, but if they pay their profits back to the US parent company they are expected to pay a second round of corporation tax on repatriated earnings.

 

However, the US allows earnings deferral, so the parent company does not have to pay corporation tax on its foreign earnings if they are held abroad, and never returned to the US. The result is that companies hold much of their profits abroad indefinitely until they are ready to invest somewhere abroad.

 

By contrast, the UK always avoids double taxation, and taxes foreign profits only if they were not taxes in the host country, or if they were taxed at a lower rate in the host country, we make up the difference. Since corporation tax rates are similar in most of Europe, there is no great benefit to going through the hassle of deferring.

 

These figures are created by taking at the declared world wide earnings of corporations, and then looking at US taxes paid. Which is obviously a ridiculous thing to do. Why should the US government be entitled to tax profits made by (say) British workers, working in British factories, using British infrastructure to transfer their goods to British consumers, just because their parent company happens to be incorporated in the US, rather than (almost) any other country in the developed world :).

 

 

PS: I actually think corporation tax should be zero. Economy is made up of people consuming things. So tax people, when they are paid, and when they consume. Taxing corporations, rather than the people they employ and the people they pay the money to, is weird, and it mostly happens because people don't know who is being taxed when you tax a faceless corporation, and so they don't know who is paying, and that always makes it politically feasible to have high corportation taxes.