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June 18, 2009

Economist's View - 6 new articles

One Third of the Prices within the CPI Fell Last Month

Is Greg Mankiw correct to say that deflation worries are overstated? Here's Laurel Graefe of the Atlanta Fed:

CPI: The left and the right of it, macroblog: We got a good reading of May's inflation numbers this week. On both the producer and the consumer sides, price measures for the month came in well short of market expectations. The prospect of deflation has been getting a good deal of coverage in the blogosphere; see Andy Harless' blog, Economist's View, and Paul Krugman's column.

Greg Mankiw, however, points out that a trimmed mean estimate of the consumer price index (CPI), which removes the large relative price changes in each month, makes the deflation story seem a bit, uh, exaggerated.

"As every grade school student learns when the teacher reports results of the latest test, the average of any data set can be thrown off by a few extreme outliers; the median is a more robust statistic to estimate the central tendency in the data. "Right now, the two measures of inflation are diverging substantially. The standard CPI shows deflation over the past year, but that average is due to a few anomalous sectors, such as energy. If you look at the median CPI, which shows what a more typical price is doing, the inflation rate does not look very unusual."

While the median is certainly a valuable way to look at inflation, there is also some interesting information that can be gleaned from breaking down the whole distribution of prices.

The chart below (hat tip to Brent Meyer at the Cleveland Fed) shows another interesting feature of yesterday's CPI release. Notice the clear downward shift in the distribution of CPI component price changes. Over half of the prices within the CPI market basket posted declines at or below 1 percent last month, up from an average of 29 percent in 2008, with a whopping one-third of the price index posting declines in May.


Of course, one month does not a trend make, but the month's price numbers were nonetheless noteworthy.

A Lasting Recovery?

Olivier Blanchard argues that global imbalances must be resolved in order to put the world economy on a sustainable path to recovery:

What is needed for a lasting recovery, by Olivier Blanchard, Commentary, Financial Times: In 2007, worried about the growing size of current account imbalances, the IMF organised multilateral consultations to see what should be done about it. There was wide agreement that the solution was conceptually straightforward. To caricature: get US consumers to spend less. Get Chinese consumers to spend more. This would be good for the US, good for China, and good for the world. ...

It was an impressive piece of global macroeconomic planning. But, at least until the crisis, not much happened. ... And, since the beginning of the crisis, dealing with global imbalances has gone down the priority list. ... As the crisis evolves, however,... the issue of global imbalances is likely to return to the fore. Again, a central role will have to be played by the US and by China.

Half of the adjustment ... is coming into play: US consumers are, at last, cutting their spending. ... And ... they have learnt a more general lesson. The world is more risky than they thought. ...

The main unknown is about the other half of the adjustment. In response to the crisis, China has embarked on a major fiscal expansion, with a focus on investment rather than on consumption. This was the right policy given the need to increase spending quickly... The question is whether, as time passes, China will allow an increase in consumption. If it does, the 2007 master plan may come into being. ... The world recovery can proceed and we can emerge with a more balanced world economy.

Will this scenario naturally play out? Maybe, maybe not. China has announced ambitious healthcare reform, which goes in the right direction. But the export-led model that China has so successfully followed will not be abandoned overnight. And ... the crisis may have convinced many countries to accumulate even more reserves, thus running even larger current account surpluses. These countries will not be eager to appreciate against the dollar, and so allow for larger US net exports.

What if there is no rebalancing? Without ... higher net exports, the US recovery may weaken once the fiscal stimulus is phased out. In normal times, monetary policy could help, by lowering interest rates...; these are not normal times and rates can fall no further. Thus, there will be heavy pressure on the US government to maintain a strong fiscal stimulus for as long as private demand is weak... While strong fiscal stimulus was and still is needed to fight the crisis, it cannot go on forever; at some stage, debt dynamics become unsustainable...

Sustained recovery requires decreased domestic US spending and increased domestic spending in China and much of the rest of the world, together with adjustments in exchange rates. ...

"The Army's Development Delusions"

Bill Easterly is worried that the Army's "utopian dreams" for conquered societies will lead to the "excessive use of military force, which kills real human beings":

J'accuse: the US Army's Development Delusions, by Bill Easterly: A wise economist that I met recently tipped me off that I would find the latest Army field manual interesting reading. He was more than right about that. The 2009 US ARMY STABILITY OPERATIONS FIELD MANUAL (available in a University of Michigan paperback as well as an earlier version online ) is remarkably full of utopian dreams of transforming other societies into oases of prosperity, peace, and democracy through the coordinated use of military force, foreign aid, and expert knowledge.

My usual MO is to ridicule such documents. But my wells of satire are starting to run dry after years of deployment against utopians like Jeffrey Sachs and Paul Collier. More in sorrow than in anger, I see the utopian social engineering craze might affect actions of people with guns. I am sad for Iraqis and Afghans that the U.S. Army is operating in their countries guided by such misguided ideas.

To document a little of what seems utopian, the foreword by Lieutentant General William B. Caldwell IV, Commander, US Army Combined Arms Center, says:

we will …defeat insurgency, assist fragile states, and provide vital humanitarian aid to the suffering. …. to promote participation in government, spur economic development, and address the root causes of conflict among the disenfranchised populations of the world….{with} a comprehensive approach to stability operations that integrates the tools of statecraft with our military forces, international partners, humanitarian organizations, and the private sector.

The Manual, with a foreword by Under Secretary of Defense for Policy Michèle Flournoy, says the US Army will be

leveraging the coercive…force to establish a safe and secure environment; …establish political, legal, social, and ….economic institutions; and help transition responsibility to a legitimate civil authority {my emphasis} operating under the rule of law…. toward long-term developmental activities where military forces support broader efforts in pursuit of national and international objectives.

The definition of a legitimate civil authority is then given:

Respects freedom of religion, conscience, speech, assembly, association, and press. Submits to the will of the people, especially when people vote to change their government. Maintains order within its own borders, protects independent and impartial systems of justice, punishes crime, embraces the rule of law, and resists corruption. Protects the institutions of civil society, including the family, religious communities, voluntary associations, private property, independent businesses, and a market economy.

Even in the most dysfunctional societies ("fragile states"):

national strategy aims to—Promote freedom, justice, and human dignity while working to end tyranny, to promote effective democracies, and to extend prosperity through free trade and wise development policies.

Who is going to do all this? The US Army is going to be assisted by other US government agencies, intergovernmental organizations, nongovernmental organizations, international and region organizations and the private sector, i.e people who have different approaches, different objectives, different incentives, and answer to different bosses, with no credible mechanism for coordination (the Manual suggests a "Civil-Military Operations Center")

The danger is that, if put into practice, such delusions create excessive ambition, which creates excessive use of military force, which kills real human beings, Afghans and Iraqis.

US Army and Defense Department thinkers – please go back to the drawing board. Think about American values that guide us at home. These values don't include utopian social engineering, and certainly not by outside armies.

Rogoff: America Should also Look to its Fiscal Health

Kenneth "The Hawk" Rogoff:

America should also look to its fiscal health, by Kenneth Rogoff, Commentary, Financial Times: America desperately needs a better framework for providing healthcare and Barack Obama's administration is right to press on for change... Yet given the explosion of the federal debt, it is extremely important to craft a plan that will not excessively risk the government's own fiscal health. The risks cannot easily be overstated.

The US government is already entering a prolonged period where it is extremely vulnerable to a loss in investor confidence from the Chinese and other main holders of its Treasury securities. Foreign investors are rightly concerned about the deeply ingrained reluctance of Americans to tax themselves. The last thing the US needs is to be viewed as one giant California, rich but unwilling to pay enough taxes to fund the services its citizens demand. A sharp rise in taxes to pay for healthcare initiatives could potentially weaken the credibility of the government's promise to raise taxes as needed to pay off debtors. ...

[I]n principle, fixing the imbalances in the Social Security and, especially, the Medicare programmes could provide a powerful offset to the huge increase in debt burdens visited by the financial crisis.

Unfortunately, the idea that healthcare reform will alleviate debt problems rather than exacerbate them is far-fetched..., many proposed healthcare reforms are more likely to worsen the government's budgetary health than to improve it. This should hardly be surprising, given that a main purpose of reform is to help provide better care for Americans who cannot afford insurance.

Higher taxes to pay for healthcare are also likely to reduce US growth, making it far more difficult to escape the debt trap. This comes at a time when other policy initiatives, such as tackling environmental degradation and income inequality, are also likely to imply higher tax burdens... In addition, the continuing weakness of the financial sector weighs on growth, and it is by no means clear yet when and how some semblance of normality will be restored. ...

All of these considerations appear to underscore the importance of finding ways to keep the new health plan from being overly burdensome, and to avoid unduly optimistic projections on efficiency savings. Healthcare reform is no substitute for finding a credible path to fiscal sustainability. ...

Make no mistake, the US and much of the developed world is in a frighteningly precarious fiscal state. ... It is a disgrace that the world's richest country cannot provide reliable basic care for its poorest citizens. But if the politics of reform produces too extravagant a plan when the nation's fiscal health is already so weak, the US may experience a form of financial crisis even more virulent than the one it is recovering from. Any healthcare plan would then be dead on arrival.

Setting the fear mongering about the future aside - and there's no evidence in long-term interest rates that financial market participants are worried about these issues - here are a few things to keep in mind when thinking about health care reform First, it is not a demographic problem. This graph is from a CBO presentation on this point, and is fairly self-explanatory:


Second, rising health care costs is not just an issue for Medicare and Medicaid, the same rise in costs is also projected to hit private sector health care. Again, from the CBO:


Projected Spending on Health Care Under an Assumption That Excess Cost Growth Continues at Historical Averages (Percentage of GDP)

Going back to the question of the effect of health care reform on the long-run budget, though expanding coverage will expand increase the total amount of medical care that is provided, and hence increase costs, there seems to be some confusion between expanding overall coverage and simply moving the dividing line between the public and private sectors upward so that the public sector expands and the private sector contracts by the same amount. Changing the dividing line, all else equal, simply changes how the bills are paid, it has no effect at all on the overall health care burden that people face (it moves the dividing line in a graph like the one above showing the public and private sectors explcitly without changing the total area). So it's hard to see why higher taxes driven by this type of a change would have the negative economic effects Rogoff is worried about.

But he is more worried that expanding the size of the public sector both by moving the dividing line up and by including more people - the latter in particular - will increase increases health care costs and add to the debt burden, which in turn would require higher taxes. Is that true? It would if the only effect of the expansion of the public sector was to increase the number of people receiving care, and his claim that costs won't fall, or at least not by much, presumes this is how it will work. But when we look at other countries that have substantially expanded the public sector we see lower costs - on the order of 50% lower - and no reduction in the quality of the care that people receive. That's a huge reduction in costs, a reduction large enough to allow a significant expansion of coverage without increasing costs at all. I don't think we'll reduce costs by that magnitude, 50% seems like a lot to hope for, but it does imply that it's possible to reform the system without compromising quality or experiencing the dire consequences Rogoff fears.

Marx and Ideologies

Daniel Little discusses three components that underlie Marx's analysis of the political behavior of class. One component is the existence of ideologies (the other two are rationality and class consciousness):

...Marx's theory of political behavior incorporates the concept of ideology. Ideologies, or "false consciousness", are systems of ideas that affect the worker's political behavior by instilling false beliefs and self-defeating values in the worker. An ideology may instill a set of values or preferences that propel individual behavior in ways that are contrary to the individual's objective material interests. Further, ideologies modify purposive individual action by instilling a set of false beliefs about the causal properties of the social world and about how existing arrangements affect one's objective interests. Rational individuals, operating under the grip of an ideology, will undertake actions that are contrary to their objective material interests, but are fully rational given the false beliefs they hold about the social world they inhabit and their mistaken assumptions about their real interests and values. An ideology is an effective instrument, then, in shaping political behavior within a class system; it induces members of exploited classes to refrain from political action directed at overthrowing the class system. And this is indeed Marx's use of the concept; an ideology functions as an instrument of class conflict, permitting a dominant class to manipulate the political behavior of subordinate classes. It is an important task to try to identify the institutions and mechanisms through which an ideology is conveyed to a population.

Interesting how much Marx's theory of ideology sounds like the right wing's "Noise Machine," and how it relates to questions like this:

What's the matter with San Francisco?, by Andrew Leonard: Are "rich liberals" who vote for Democrats and higher taxes for themselves displaying the same irrational behavior as working-class men and women who vote for Republicans and lower taxes... for the rich?

Yes, says Derek Thompson, blogging at the Atlantic Business Channel (which he also produces). ...

Thompson is annoyed with Thomas Franks' argument in "What's the Matter with Kansas" suggesting that Republicans "tricked" working class voters to go against their economic self-interest by mobilizing them on social "value" issues like abortion and gay rights. Thompson's position is that liberals who believe that government will actually improve the lives of Americans with their taxpayer dollars are demonstrating their own economically irrational "values" voting behavior. ...

But to take that position seems to me to be ignoring the reality of what we've just witnessed in this country. In a time of great economic turmoil, working class voters appear to have suddenly decided that Republican "family values" aren't such a sexy turn-on after all. The latest polling indicates that only 25 percent of the country views the GOP favorably. As far as I can guess, rich liberals did not change their views of what the government economic policy should be because of the downturn, but working class voters experienced a sudden dose of "rationality."

So yeah, working class voters who voted Republican did get tricked. Either that, or they just rationally changed their mind when they saw that trickle-down economics and irresponsible deregulation was a big failure.

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