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June 16, 2014

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Paul Krugman: Yes He Could

Posted: 16 Jun 2014 12:33 AM PDT

"Mr. Obama is having a seriously good year":

Yes He Could, by Paul Krugma, Commentary, NY Times: Several times in recent weeks I've found myself in conversations with liberals who shake their heads sadly and express their disappointment with President Obama. Why? I suspect that they're being influenced, often without realizing it, by the prevailing media narrative.
The truth is that these days much of the commentary you see on the Obama administration — and a lot of the reporting too — emphasizes the negative: the contrast between the extravagant hopes of 2008 and the prosaic realities of political trench warfare, the troubles at the Department of Veterans Affairs, the mess in Iraq, and so on. The accepted thing, it seems, is to portray Mr. Obama as floundering, his presidency as troubled if not failed.
But this is all wrong. You should judge leaders by their achievements, not their press, and in terms of policy substance Mr. Obama is having a seriously good year. ... First, health reform is now a reality — and despite a shambolic start, it's looking like a big success story. ...
Then there's climate policy. The Obama administration's new rules on power plants won't be enough in themselves to save the planet, but they're a real start — and are by far the most important environmental initiative since the Clean Air Act. I'd add that this is an issue on which Mr. Obama is showing some real passion.
Oh, and financial reform, although it's much weaker than it should have been, is real — just ask all those Wall Street types who, enraged by the new limits on their wheeling and dealing, have turned their backs on the Democrats.
Put it all together, and Mr. Obama is looking like a very consequential president indeed. There were huge missed opportunities early in his administration — inadequate stimulus, the failure to offer significant relief to distressed homeowners. Also, he wasted years in pursuit of a Grand Bargain on the budget that, aside from turning out to be impossible, would have moved America in the wrong direction. But in his second term he is making good on the promise of real change for the better. ...
There are, I suppose, some people who are disappointed that Mr. Obama didn't manage to make our politics less bitter and polarized. But that was never likely. The real question was whether he (with help from Nancy Pelosi and others) could make real progress on important issues. And the answer, I'm happy to say, is yes, he could.

Fed Watch: FOMC Preview

Posted: 16 Jun 2014 12:15 AM PDT

Tim Duy:

FOMC Preview, by Tim Duy: The FOMC is set this week to cut another $10 billion from its asset purchase program.  The statement itself will most likely point toward additional confidence that the first quarter slowdown was an aberration, and may even point to signs that inflation has bottomed and is headed higher.  Both will give the Federal Reserve more confidence in their existing forecasts.  The forecasts will likely be very similar to those issued in January, albeit with some modifications.  The output forecast may be adjusted to account for Q1 weakness, while the unemployment forecast is likely to be edged down once again.  The latter is more important; the expected timing of the first rate hike may be pulled forward slightly.  The addition of new board members puts something of a wildcard into play, but my expectation is that if a policy change is brewing, it would more likely to show itself in Federal Reserve Chair Janet Yellen's post-FOMC press conference rather than the statement itself.
Incoming data continues to indicate the extreme weakness of the first quarter - estimates continue to fall, with Goldman Sachs now expecting -1.9% - was temporary.  Job growth has proved to be resilient, albeit I still feel it remains fairly restrained.  The recent bounce above the longer term trend does not signal to me a sizable acceleration in underlying economy:


Neither does the path of aggregate weekly hours:


Nor the growth of retail sales:


Nor industrial indicators:


The JOLTS report is a little more reassuring with the gain in job openings:


In short, maybe the economy is set to take-off as Joe Weisenthal at Business Insider expects, but my read is a little more cautious.  Regardless, the data are sufficient for Federal Reserve members to hold true to the basic outline of their January forecasts.  Any lingering thought of delaying the taper is long gone.  
Nor do I think that even if the economy does accelerate the Fed will step up the pace of tapering.  It is all about the calendar - by the time the Fed is confident that stronger growth is sustainable, the asset purchase program will be almost complete anyway.  At best it would impact the size of the final cut - $15 billion in October or $5 billion in December.  Little difference in either case.  For the most part, when and if stronger growth shows up in policy, it will show up in the form of moving forward the first rate hike and accelerating the pace of subsequent rate hikes.
The question on my mind is the possibility the Fed turns more hawkish in the months ahead even if output progresses along their existing expectation.  Even along the tepid pace of growth seen to date, the combination of falling unemployment:


and inflation potentially bottoming out and turning up:


means the Federal Reserve is closer to meeting their stated policy goals, a point made by St. Louis President James Bullard with pictures like this:


And note too that traditional indicators of monetary policy also continue to point higher:


This kind of data will put increasing strain on the underemployment story.  To date, the Fed has been committed to that story on the basis of low wage growth:


Increasingly the Fed will be concerned that the balance of risks is shifting from prematurely reducing financial accommodation to concern about falling behind the curve.  And that transition may be abrupt - not unlike what we witnessed recently on the other side of the pond.  Via Bloomberg:
Mark Carney said rising U.K. mortgage debt may threaten Britain's recovery as he signaled interest rates might start to rise earlier than anticipated.
While investors don't see the Bank of England's benchmark rate increasing until next April, the central bank governor said it "could happen sooner than markets currently expect." Higher borrowing costs could stretch over-leveraged households and undermine financial stability, he said.
All that said, if such a change were to occur, it will not be in this week's statement.  My expectation is that Yellen sticks to the fairly dovish tune she has been singing.  If there are clues that the tenor of the tune is changing I think they would be subtle.  Watch for any language from Yellen regarding proximity to goals, optimism on the JOLTS numbers, or references to inflation bottoming out and turning higher.  These would be hints that the Fed is increasingly concerned of the possibility of falling behind the curve.  Such talk would also hint at the possibility that the new Board members seek to edge policy in a different direction.
On the other side of the coin, look for policymakers to make note of geopolitical risk.  The mess in Iraq is already pushing oil prices higher, which the Fed should read as more likely to soften the recovery rather than fuel inflation
Bottom Line:  My baseline expectation is minimal policy changes this week.  Moreover, my baseline remains a still long period of low rates.  I think the Federal Reserve would like to hold onto the "low wage growth means plenty of slack and no inflation story" as long as possible.   Watch also the geopolitical risk, as that will tend to reinforce the Fed's existing path.  Overall, the situation altogether still argues for the first rate hike in the second half of next year.  The Fed's low rate story, however, will come under increasing pressure as the Fed gets closer to reaching its policy goals.  And that pressure will only intensify if growth does in fact accelerate.  That leaves me feeling that the risk to my baseline assumption is that the first rate hike comes sooner than currently anticipated.

Links for 6-16-14

Posted: 16 Jun 2014 12:06 AM PDT

'Why Does Inequality Grow? Can We Do Something About It?'

Posted: 15 Jun 2014 08:09 AM PDT

"The liberalization of labor-market institutions since 1980 has ... contributed substantially" to income inequality:

Why does inequality grow? Can we do something about it?, by Coen Teulings, Vox EU: Over the past couple of years, the OECD asked attention for the rapidly widening income dispersion in OECD countries (see e.g. OECD 2008, OECD 2014). The recent publication of Thomas Piketty's Capital in the 21st Century, gave new impetus to this debate.

There were large shifts in the distribution of total income, both from labor to capital, and within the labor share – from low- to high-earning workers. This growing inequality has a large impact on many aspects of society, from diverging educational opportunities, to the distribution of health and overall well-being. Though there are marked differences between countries, the rise in inequality has been a general phenomenon. Hence, there is a quest for more inclusive strategies that allow larger parts of society to benefit from the growth of GDP.

Causes of income inequality

There has been much debate on the causes of this trend.

  • At the turn of the century, skill-biased technological progress was considered to be the main culprit.

The skill bias in the change in production technology reduced the demand for high school dropouts and raised that for college graduates. To the extent that the education system could not keep pace with the increased demand for graduates, the skill premium soared.

The rapid pace of technological progress makes that we move increasingly to a 'the-winner-takes-it-all' society, where early entrants in new industries capture an incredible amount of rents, with Microsoft, Google, and Facebook as the most extreme examples. This contributed to a steady shift in the distribution of income from labor to profits.

  • More recently, the attention shifted to the role of globalization.

Where the share of the BRIC countries in the world economy was too small to account for the large shifts in relative wages during the nineties, this share has grown so rapidly in the last two decades that its impact on the income distribution can no longer be ignored. However, this impact of globalization is more subtle than an outright increase in inequality. For the BRIC countries, globalization is equivalent to a large increase in GDP and, hence – a large improvement in the standards of living for the majority of their population.

For the developed countries, the effect of globalization on the income distribution is more subtle. The wage distribution becomes increasingly skewed to the right. Low and medium educated workers earn more and more similar wages, forming a large mass on the left side of the income distribution, while the share of the top 10% in total income skyrocketed, leading to a long and fat right left tail of the distribution.


  • The middle class loses (see Autor et al. 2013).

The middle class is employed exactly in the type of jobs that both face fierce global competition and are highly vulnerable to automation. Demand for workers with intermediate levels of education, therefore, falls and hence their wage surplus above workers with lower education. Despite the overall growth, US real wage of the median worker has fallen since 1990.

  • The upper class commands specialized human capital that is in high demand in a technology-driven world.
  • The lower class is mainly employed in personal services that are non-tradable and cannot be imported from the BRIC countries.

Moreover, jobs in these industries are less sensitive to technological innovation than jobs in manufacturing.

From a policy perspective, this diagnosis poses new challenges. The old story for emancipation relied on investment in human capital, for the lower strata of society, education was the best means for improving their position. The future of your children was safeguarded most effectively by better education – make sure that they spend all effort to obtain the highest possible degree. That story no longer applies for everybody. It still works for the upper tale of the distribution of educational attainment, since the return to obtaining a degree from good university has gone up. It no longer works for the lower tale of the distribution, since the return to the completion of high school, or adding some years of college, has gone down.

However, trade and technology are not the only explanations for the dramatic increase in inequality over the past couple of decades.

  • The liberalization of labor-market institutions since 1980 has also contributed substantially.

DiNardo, Fortin and Lemieux (1996) have shown that the fall in minimum wages and the demise of the union increased inequality in the United States during the 1980's. Later work by Lee (1999) and Teulings (2003) suggests that a large part – if not all – of the rise in wage inequality in the lower half of the distribution is due to the fall in minimum wages during that period. This applies in particular for females, who earn lower wages anyway, and for whom the minimum wage therefore has a larger impact. Starting from the low levels of the minimum wage that prevail in the US currently, the job-losses of an increase in that minimum are limited. This fits the recent experience in the UK, where the introduction of a minimum wage had a substantial effect on wage inequality, but hardly any effect on the chances of low skilled workers to find a job. It might be different in France, where minimum wages are much higher to begin with. In that case, further increases in the minimum wage have large detrimental effects on the job opportunities for low-skilled workers.

  • Minimum wages – provided that they are not set too high – therefore have a large effect on wage inequality, and a relatively small effect on employment.

The obvious question is then what wage would be not too high. I use as a rule of thumb that at most 4% of the workers may actually earn the minimum wage. If more than 4% earns the minimum, job loss becomes substantial. However, there is no empirical evidence to support the rule of thumb other than the differences in outcomes between the US and France. Regrettably, the strategy of a limited increase in the minimum wage reaches this critical point of 4% earlier now that the wage differential between low and medium educated workers has gone down, and more workers earn wages not that far from the minimum wage.

Institutions and the labor market

Why are institutions so important on the labor market? Why would the free market not lead to the best possible outcome? We gradually start to understand why the institutions for wage setting matter so much. The standard auction model taught in economics 1.01 is a bad representation of how labor markets actually operate. The auction model assumes that all job seekers and all firms with vacancies meet at the same place and time. A hypothetical auctioneer calls a potential wage rate, records potential supply and demand at that wage, and then adjusts his call until he arrives at an equilibrium rate that sets supply equal to demand. Reality looks different. Individual job seekers and firms meet and bargain bilaterally on an acceptable wage. If they fail to reach agreement then both continue search for other options. The point is that there is no auctioneer to set the wage. The worker and the firm have to agree among themselves. Hence, it is critical which of the two parties has the best bargaining skills – the worker or the firm? There is no guarantee whatsoever that the free market yields a proper distribution of bargaining power from the point of view of social well-being.

When the theoretical apparatus for analyzing these models was first developed by Pissarides (1990) and Burdett and Mortensen (1988) – who received the Noble prize for this work – it looked as though, by a kind of divine miracle, the actual distribution of bargaining power was reasonably in line with the social optimum. Later on, Stevens (2004) showed that firms can save on their wage bill by using deferred compensation schemes. Workers get paid low wages initially, only to receive higher wages after staying at the same firm for a couple of years. If the worker quits before, the firm never has to pay these higher wages. Deferred payment binds a worker to the firm and, therefore, reduces the threat of outside competition. No practical man would be surprised by this result because this is what we see employers do every day. Most wage contracts contain extensive experience and tenure scales. However, what is surprising is that these schedules shift the balance of power in favor of the employer beyond what is desirable from societal point of view. Hiring a worker becomes too attractive. Firms start poaching workers from each other, leading to a waste of resources on recruitment activity, excess job mobility, and training cost to make workers familiar with their new job, from which they are likely to quit shortly afterwards by new incoming job offers anyway. This change in the balance of power might also have contributed to the shift of the distribution of total income from labor to capital.

Joint with Gautier and Van Vuuren (2010), I showed that even when firms don't use Stevens' seniority profiles, but instead offer a fixed flat wage contract, efficiency emerges only when there are strongly increasing returns to scale in job search, and when firms can commit to pay hiring premiums before even meeting a potential candidate. In all other cases, firms have too much bargaining power.

Robin and Postel-Vinay (2002) have shown that firms can use even more aggressive strategies, by paying wage increases only when an outside firm threatens to poach its worker. A firm can then hire apprentices and other young workers for very low starting salaries, waiting for outside offers to these workers before paying any wage increase. Empirical evidence shows that this type of arrangements is used in practice indeed, in particular for low skilled workers. This type of wage contract shifts the balance of power even more in favor of employers, so even further beyond the social optimum than in Stevens' analysis.

In this type of environment, small institutional details in wage setting can have a large impact on the outcome. Hence, the wave of liberalization of labor-market institutions in the eighties and nineties of last century might have a negative impact on society after all. It has made labor markets more flexible and thereby created many jobs, but beyond a certain point, the net effect of further liberalization might be negative from a societal point of view. Both the Financial Times and the Economist expressed sympathy for the idea of raising the minimum wage in the United States and introducing it in Germany. This support might be well taken. There is likely to be some kind of an optimum degree of liberalization of labor- market institutions. In some instances, the world might have moved beyond that point.


Autor, David, David Dorn and Gordon Hanson (0213), "Untangling Trade and Technology: Evidence from Local Labor Markets", NBER working paper 18938.

Burdett, Kenneth and Dale Mortensen (1988), "Wage differentials, employer size, and unemployment", International Economics Review, Vol. 39, No.2, May, pp. 257-273.

DiNardo, John, Nicole Fortin, and Thomas Lemieux (1996), "Labor market institutions and the distribution of wages, 1973-1992: A semiparametric approach", Econometrica, Vol. 64, No.5, September, pp. 1001-1044.

Gautier, Pieter, Coen Teulings, and Aico van Vuuren (2010), "On-the-job search, mismatch, and efficiency", The Review of Economic Studies, Vol. 77, Issue 1, pp.245-272.

Lee, David (1999), "Wage inequality in the United States during the 1980s: Rising dispersion or falling minimum wage?", The Quarterly Journal of Economics, Vol. 114, No.3, August, pp. 977-1023.

OECD (2008), Growing Unequal?: Income Distribution and Poverty in OECD Countries, OECD Publishing, 21 October.

OECD (2014), Society at a glance, Directorate for Employment, Labour, and Social Affairs, OECD.

Piketty, Thomas (2014), Capital in the 21st century, Harvard University Press.

Pissarides, Christopher (1990), Equilibrium Unemployment Theory, MIT Press.

Postel-Vinay, Fabien and Jean-Marc Robin (2002), "Equilibrium wage dispersion with worker and employer heterogeneity", Econometrica, Vol. 70, No.6, November, pp. 2295-2350.

Stevens, Margaret (2004), "Wage-tenure contracts in a frictional labour market: Firms' strategies for recruitment and retention", The Review of Economic Studies, Vol. 71, pp. 535-551

Teilings, Coen (2003), "The contribution of minimum wage to increasing wage inequality", The Economic Journal, Vol. 113, Issue 490, October, pp.801-833.

Trends in CEO Compensation

Posted: 15 Jun 2014 08:09 AM PDT

Via the EPI:

... Trends in CEO compensation last year:

  • Average CEO compensation was $15.2 million in 2013, using a comprehensive measure of CEO pay that covers CEOs of the top 350 U.S. firms and includes the value of stock options exercised in a given year, up 2.8 percent since 2012 and 21.7 percent since 2010.

Longer-term trends in CEO compensation:

  • From 1978 to 2013, CEO compensation, inflation-adjusted, increased 937 percent, a rise more than double stock market growth and substantially greater than the painfully slow 10.2 percent growth in a typical worker's compensation over the same period.
  • The CEO-to-worker compensation ratio was 20-to-1 in 1965 and 29.9-to-1 in 1978, grew to 122.6-to-1 in 1995, peaked at 383.4-to-1 in 2000, and was 295.9-to-1 in 2013, far higher than it was in the 1960s, 1970s, 1980s, or 1990s.
  • If Facebook, which we exclude from our data due to its outlier high compensation numbers, were included in the sample, average CEO pay was $24.8 million in 2013, and the CEO-to-worker compensation ratio was 510.7-to-1.

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