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October 31, 2014

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Paul Krugman: Apologizing to Japan

Posted: 31 Oct 2014 12:15 AM PDT

What are the lessons we should learn from Japan?:

Apologizing to Japan, by Paul Krugman, Commentary, NY Times: For almost two decades, Japan has been held up as ... an object lesson on how not to run an advanced economy. After all, the island nation is the rising superpower that stumbled. One day, it seemed, it was on the road to high-tech domination of the world economy; the next it was suffering from seemingly endless stagnation and deflation. And Western economists were scathing in their criticisms of Japanese policy.
I was one of those critics... And these days, I often find myself thinking that we ought to apologize. ...
The ... West has, in fact, fallen into a slump similar to Japan's — but worse. And that wasn't supposed to happen. In the 1990s, we assumed that if the United States or Western Europe found themselves facing anything like Japan's problems, we would respond much more effectively... But we didn't, even though we had Japan's experience to guide us. ... And Western workers have experienced a level of suffering that Japan has managed to avoid.
What policy failures am I talking about? ... Japanese fiscal policy didn't do enough to help growth; Western fiscal policy actively destroyed growth.
Or consider monetary policy. The Bank of Japan ... has received a lot of criticism for reacting too slowly to the slide into deflation, and then for being too eager to raise interest rates at the first hint of recovery. That criticism is fair, but Japan's central bank never did anything as wrongheaded as the European Central Bank's decision to raise rates in 2011, helping to send Europe back into recession. And even that mistake is trivial compared with the awesomely wrongheaded behavior of ... Sweden's central bank, which raised rates despite below-target inflation and relatively high unemployment, and appears, at this point, to have pushed Sweden into outright deflation. ...
As for why the West has done even worse than Japan, I suspect that it's about the deep divisions within our societies. In America, conservatives have blocked efforts to fight unemployment out of a general hostility to government, especially a government that does anything to help Those People. ...
I'll be writing more soon about what's happening in Japan..., and the new lessons the West should be learning. For now, here's what you should know: Japan used to be a cautionary tale, but the rest of us have messed up so badly that it almost looks like a role model instead.

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Posted: 31 Oct 2014 12:06 AM PDT

'BEA: Real GDP increased at 3.5% Annualized Rate in Q3'

Posted: 30 Oct 2014 07:22 AM PDT

 Calculated Risk:

BEA: Real GDP increased at 3.5% Annualized Rate in Q3: From the BEA: Gross Domestic Product, Third Quarter 2014 (Advance Estimate)
Real gross domestic product -- the value of the production of goods and services in the United States, adjusted for price changes -- increased at an annual rate of 3.5 percent in the third quarter of 2014, according to the "advance" estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 4.6 percent. ... The increase in real GDP in the third quarter primarily reflected positive contributions from personal consumption expenditures (PCE), exports, nonresidential fixed investment, federal government spending, and state and local government spending that were partly offset by a negative contribution from private inventory investment. Imports, which are a subtraction in the calculation of GDP, decreased.
The advance Q3 GDP report, with 3.5% annualized growth, was above expectations of a 2.8% increase.
Personal consumption expenditures (PCE) increased at a 1.8% annualized rate - a slow pace. ...
Overall this was an OK report, however PCE was weak (I expect stronger PCE going forward).

October 30, 2014

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Fed Watch: FOMC Recap

Posted: 30 Oct 2014 12:24 AM PDT

Tim Duy:

FOMC Recap, by Tim Duy: In broad terms, the FOMC meeting concluded as I had expected. To the extent there were any surprises, they were on the hawkish side. Or, I would say, hawkish mostly if you believed the events of the last few weeks justified a radical revision of the Fed's anticipated policy path. I didn't, but was too busy those same past few weeks to scream into the wind.

As I anticipated, the Fed dismissed the decline in market-based inflation expectations. They clearly believe financial markets over-reacted to the decline in oil prices, and that that decline would ultimately prove to be a one-time price shock rather than the beginning of a sustained disinflationary process.

This is why we watch core-inflation.

And note that the Fed sent a pretty big signal along the way. In contrast to conventional wisdom, they do not hold market-based measures of inflation expectations as the Holy Grail. Especially with unemployment below 6%, pay more attention to survey-based measures. And recognize they will discount even those if they feel they are unduly affected by energy prices in either direction.

Somewhat more hawkish than I anticipated, they did not explicitly hold out the hope of future asset purchases. The statement shifts directly to the issue of rate hikes. On that point, they did as I had expected, emphasize the data-dependent nature of future policy:

However, if incoming information indicates faster progress toward the Committee's employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated.

In my opinion, this suggests that they want to retain the baseline expectation of a mid-2014 rate hike with the option for an earlier hike. I don't think they see recent data or market action as by itself justifying the shift to the latter part of 2015. If anything, remember that recent data is pointing to accelerating growth and a rapid decline in unemployment.

And that rapid decline in unemployment is important, as I have trouble imagining a scenario in which the Fed is content to watch unemployment fall below 5.5% without at least beginning the rate hike cycle. Remember that they think that even as they increase rates, they believe that policy will continue to be accommodative. In other words, they do not fear raising rates as necessarily a tightening of policy. They will view it as a necessary adjustment in financial accommodation in response to a decline in labor market slack. Hence the line:

The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.

I anticipated at least one dissent. In all honesty, this would have been a more impressive call if I had also indicated the direction of the dissent. I expected a hawk to reject the retention of the considerable time language. No such luck - quite the opposite, with noted-dove Minneapolis Federal Reserve President Narayana Kocherlakota protesting both the considerable time language (wanting a more firm commitment to ZIRP) and the decision to end QE. The hawks, in contrast, were generally comfortable with the direction of the discussion. Expect Dallas Federal Reserve President Richard Fisher to say as much soon.

The acceptance of the hawks with the general tone of the meeting is also important. Clearly hawkish in contrast with the shift in market expectations. Time will tell.

Bottom Line: Despite the market turbulence of recent weeks, the general outlook of monetary policymakers remain generally unchanged. In general, they continue to see the direction of activity pointing to a mid-year rate hike. The actual date is of course data dependent, but they have not seen sufficient data in either direction to change that baseline outlook.

Summers: Reflections on the new 'Secular Stagnation hypothesis'

Posted: 30 Oct 2014 12:15 AM PDT

In case you just can't get enough of Larry Summers talking about secular stagnation:

Reflections on the new 'Secular Stagnation hypothesis', by Larry Summers, Vox EU: The notion that Europe and other advanced economies are suffering secular stagnation is gaining traction. This column by Larry Summers – first published in the Vox eBook "Secular Stagnation: Facts, Causes and Cures" – explains the idea. It argues that a decline in the full-employment real interest rate coupled with low inflation could indefinitely prevent the attainment of full employment.

Summers_fig1a_0

Here's the end of a relatively long discussion:

3 Conclusions and Implications

 The case made here, if valid, is troubling. It suggests that monetary as currently structured and operated may have difficulty maintaining a posture of full employment and production at potential and that if these goals are attained there is likely to be price paid in terms of financial stability. A number of questions come to mind:

  • How great are the risks?

Alvin Hansen proclaimed the risk of secular stagnation at the end of the 1930s only to see the economy boom during the and after World War II. It is certainly possible that either some major exogenous event will occur that raises spending or lowers saving in a way that raises the FERIR in the industrial world and renders the concerns I have expressed irrelevant. Short of war, it is not obvious what such events might be. Moreover, most of the reasons adduced for falling FERIRs are likely to continue for at least the next decade. And there is no evidence that potential output forecasts are being increased even in countries like the US where there is some sign of growth acceleration.

  • What about Hysteresis?

On their own, secular stagnation ideas do not explain the decline in potential output that has been a major feature of the experience throughout the industrial world. The available evidence though is that potential output has declined almost everywhere and in near lockstep with declines in actual output; see Ball (2014) for a summary. This suggests a way in which economies may equilibrate in the face of real rates above the FERIR. As hysteresis theories which emphasize the adverse effects of recessions on subsequent output predict, supply potential may eventually decline to the level of demand when enough investment is discouraged in physical capital, work effort and new product innovation.

Perhaps Say's dubious law has a more legitimate corollary – "Lack of Demand creates Lack of Supply". In the long run, as the economy's supply potential declines, the FERIR rises restoring equilibrium, albeit not a very good one.

  • What about global aspects?

There is important work to be done elucidating the idea of secular stagnation in an open economy context. The best way to think about the analysis here is to treat it as referring the aggregate economy of the industrial world where – because of capital mobility – real interest rates tend to converge (though not immediately because of the possibility of expected movements in real exchange rates). If the FERIR for the industrialized economies were low enough one might expect capital outflows to emerging markets which would be associated with a declining real exchange rates for industrial countries, increased competitiveness and increased export demand. The difficulty is that this is something that emerging markets will accept only to a limited extent. Their response is likely to be either resistance to capital inflows or efforts to manage currency values to maintain competitiveness. In either case the result will be further downward pressure on interest rates in industrial countries.

4.What is to be done?

Broadly to the extent that secular stagnation is a problem, there are two possible strategies for addressing its pernicious impacts.

  • The first is to find ways to further reduce real interest rates.

These might include operating with a higher inflation rate target so that a zero nominal rate corresponds to a lower real rate. Or it might include finding ways such as quantitative easing that operate to reduce credit or term premiums. These strategies have the difficulty of course that even if they increase the level of output, they are also likely to increase financial stability risks, which in turn may have output consequences.

  • The alternative is to raise demand by increasing investment and reducing saving.

This operates to raise the FERIR and so to promote financial stability as well as increased output and employment. How can this be accomplished? Appropriate strategies will vary from country to country and situation to situation. But they should include increased public investment, reduction in structural barriers to private investment and measures to promote business confidence, a commitment to maintain basic social protections so as to maintain spending power and measures to reduce inequality and so redistribute income towards those with a higher propensity to spend.

Links for 10-30-14

Posted: 30 Oct 2014 12:06 AM PDT

The Economics of Inequality: Emmanuel Saez and Laura Tyson

Posted: 29 Oct 2014 10:56 AM PDT

"In a panel discussion moderated by Dean Rich Lyons, Laura Tyson, professor of business administration and economics at the Haas School of Business, and Emmanuel Saez, economics professor and head of the Center for Equitable Growth at UC Berkeley, focus on income inequality, drawing from ideas central to Thomas Piketty's bestselling book Capital in the Twenty-First Century."

[Note: The discussion is summarized here.]

'Riksbank and ECB: Reverse Asymmetry'

Posted: 29 Oct 2014 10:25 AM PDT

Antonio Fatás:

Riksbank and ECB: reverse asymmetry: The Swedish central bank just lowered interest rates to zero because of deflation risks. This action comes after ignoring repeated warnings from Lars Svensson who had joined the bank in 2007 and later resigned because of disagreements with monetary policy decisions. What it is interesting is the parallel between Riksbank decisions and ECB decisions. In both cases, these central banks went through a period of optimism that make them raise interest rates to deal with inflationary pressures. In the case of Sweden interest rates were raised from almost zero to 2% in 2012. In the case of the ECB interest rates were raised from 1% to 1.5% during 2011. Also, in both cases, after a significant expansion in their balance sheets following the 2008 crisis, there was a sharp reduction in the years that followed. ... Their policies stand in contrast with those of the US Federal Reserve and the Bank of England...
The consequences of the policies of the ECB and Riksbank are clear: a continuous fall in their inflation rates that has raised the risk of either a deflationary period or a period of too-low inflation. What is more surprising about their policy actions is their low speed of reaction as the data was clearly signaling that their monetary policy stance was too tight for months or years. ...
What we learned from these two examples is that central banks are much less accountable than what we thought about inflation targets. And they ... use ... a policy that is clearly asymmetric in nature. Taking some time to go from 0% inflation to 2% inflation is ok but if inflation was 4% I am sure that their actions will be much more desperate. In the case of the ECB their argument is that the inflation target is defined as an asymmetric target ("close to but below 2%"). But this asymmetry, which was never an issue before the current crisis, has very clear consequences on the ability of central banks to react to deep crisis with deflationary risks.
What we have learned during the current crisis is that an asymmetric 2% inflation target is too low. Raising the target might be the right thing to do but in the absence of a higher target, at a minimum we should reverse the asymmetry implied by the ECB mandate. Inflation should be close to but above 2% and this should lead to very strong reaction when inflation is persistently below the 2% target.

'Is (Teaching) Economics Doing More Harm Than Good?'

Posted: 29 Oct 2014 10:25 AM PDT

Brian Lucey:

Is (teaching) Economics doing more harm than good?: Every September thousands of students enter into universities and institutes of higher education. A large number of these take some economics courses. ... Economists also typically teach courses such as statistics, or introductory mathematics for social scientists. And yet, we have no idea whether or not this does any good. Much worse, we have no idea whether or not this does harm. Maybe we should find out? ...

He goes through a large body of evidence showing that "Economists are different," and how student attitudes may be changed by taking economics courses.

'Digital Divide Exacerbates US Inequality'

Posted: 29 Oct 2014 10:25 AM PDT

The digital divide:

Digital divide exacerbates US inequality, by David Crow, FT: The majority of families in some of the US's poorest cities do not have a broadband connection, according to a Financial Times analysis of official data that shows how the "digital divide" is exacerbating inequality in the world's biggest economy. ...
The OECD ranks the US 30th out of 33 countries for affordability...
There is a very strong correlation with race and income. Just 45 per cent of households with an income of less than $20,000 a year have broadband whereas the rate for those earning $75,000 or more is 91 per cent. About a third of African American and Hispanic households are unconnected compared to 20 per cent for white households and 10 per cent for Asian households.

October 29, 2014

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Posted: 29 Oct 2014 12:06 AM PDT

Fed Watch: FOMC Meeting

Posted: 28 Oct 2014 01:28 PM PDT

Tim Duy:

Fed Watch: FOMC Meeting, by Tim Duy: I have been buried the past few weeks. So blogging has been, and will be, at least for a little longer, light. That said, I have trouble letting an FOMC meeting pass without at least few words before and after - even if there already exist broad agreement on the outcome.

The general expectation is that the Fed ends its bond buying program at the conclusion of the meeting tomorrow. That alone promises to knock down the FOMC statement to a more manageable size. While St. Louis Federal Reserve President James Bullard offered up the possibility of retaining the program for another meeting, there is little indication that other FOMC members are similarly inclined. They have long wanted to get out of asset purchase business, and see no shift in activity sufficient to delay that objective. Moreover, as Boston Federal Reserve President Eric Rosengren has noted, the remaining $15 billion is effectively a rounding error. If the Fed really wants to do something, they need to go bigger. But that is not on the table.

Regarding the statement, here is what I anticipate:

1. The general description of the economy will remain essentially unchanged, expanding at a "moderate pace." This would be consistent with expectations that the economy is currently on track to post 3%+ growth in the third quarter.

2. That said, they will mention they remain watchful of foreign growth.

3. They will acknowledge the further decline in unemployment rates yet retain the view that labor market indicators still suggest underutilization of resources. I would not be surprised by specific mention of low wage growth as evidence of underutilization.

4. I expect the Fed will acknowledge the decline in market-based measures of inflation expectations, but ultimately dismiss those measures for now in favor of stable of survey based measures. In general, I think they will take the approach of Rosengren in this Washington Post interview:

"Inflation breakevens," Rosengren explained, "are based on the pricing of Treasury securities and Treasury Inflation-Protected Securities (TIPS). So if you think about what the implication of significant financial market turbulence is, particularly about Europe, it's for foreign investors to buy Treasury securities. They disproportionately buy regular Treasury securities, so the flight to safety is going to start changing the relative prices of Treasury securities" and make it look like markets expect less inflation. But "if you look at inflation expectations based more on surveys, there's been a little bit of softening, but certainly nothing consistent with the kind of movements we've seen in the [Treasury] breakevens. So I wouldn't overreact to one or two weeks of sharp movements, because I think there are plenty of other reasons to explain" them.

5. I expect the risks to growth and employment will remain balanced, and the risk of persistently low inflation will continue to be "somewhat diminished."

6. They will announce the end of the asset purchase program, but emphasize continued reinvestment of principle and that the sizable asset holdings will continue to provide support for the recovery.

7. They will note that despite the end of asset purchases, such purchases remain in the monetary toolbox and could be revived if conditions warranted.

8. The "considerable time" language will remain. I don't anticipate any tweaks to the interest rate guidance, but I would expect if there are any such tweaks, they would be to emphasize the data-dependent nature of future policy decisions.

9. I expect at least one dissent.

Bottom Line: I am anticipating a pretty straightforward result from this FOMC meeting.

Are Economists Ready for Income Redistribution?

Posted: 28 Oct 2014 08:39 AM PDT

I have a new column:

Are Economists Ready for Income Redistribution?: When the Great Recession hit and it became clear that monetary policy alone would not be enough to prevent a severe, prolonged downturn, fiscal policy measures – a combination of tax cuts and new spending – were used to try to limit the damage to the economy. Unfortunately, macroeconomic research on fiscal policy was all but absent from the macroeconomics literature and, for the most part, policymakers were operating in the dark, basing decisions on what they believed to be true rather than on solid theoretical and empirical evidence.
Fiscal policy will be needed again in the future, either in a severe downturn or perhaps to address the problem of growing inequality, and macroeconomists must do a better job of providing the advice that policymakers need to make informed fiscal policy decisions. ...

The question of redistribution is coming, and we need to be ready when it does.

Has Fed Policy Made Inequality Worse?

Posted: 28 Oct 2014 08:33 AM PDT

At MoneyWatch:

Has Fed policy made inequality worse?: What effect did Federal Reserve policy during the Great Recession have on inequality? Did quantitative easing and the Fed's low interest rate policy benefit those at the top of the income distribution the most?

Many people seem to be convinced that is the case. According to this view, the Fed has been captured by the interests of wealthy bankers and its policies therefore benefit this group the most. But what does the evidence actually say about this question? Are Ron Paul and the Austrian economists, among many others on both sides of the political fence, correct to claim that loosening monetary policy to combat recessions makes inequality worse? ...

[The editors changed the intro, this is the original.]

Exploding Wealth Inequality in the United States

Posted: 28 Oct 2014 08:31 AM PDT

Emmanuel Saez and Gabriel Zucman:

Exploding wealth inequality in the United States, by Emmanuel Saez and Gabriel Zucman, Vox EU: Wealth inequality in the US has followed a U-shaped evolution over the last century – there was a substantial democratisation of wealth from the Great Depression to the late 1970s, followed by a sharp rise in wealth inequality. This column discusses new evidence on the concentration of wealth in the US. Growing wealth disparity is fuelled by increases in both income and saving rate inequalities between the haves and the have nots.
There is no dispute that income inequality has been on the rise in the US for the past four decades. The share of total income earned by the top 1% of families was less than 10% in the late 1970s, but now exceeds 20% as of the end of 2012 (Piketty and Saez 2003). A large portion of this increase is due to an upsurge in the labour incomes earned by senior company executives and successful entrepreneurs. But is the rise in US economic inequality purely a matter of rising labour compensation at the top, or did wealth inequality rise as well?
Before we answer that question (hint: the answer is a definitive yes, as we will demonstrate below) we need to define what we mean by wealth. Wealth is the stock of all the assets people own, including their homes, pension saving, and bank accounts, minus all debts. Wealth can be self-made out of work and saving, but it can also be inherited. Unfortunately, there is much less data available on wealth in the US than there is on income. Income tax data exists since 1913 – the first year the country collected federal income tax – but there is no comparable tax on wealth to provide information on the distribution of assets. Currently available measures of wealth inequality rely either on surveys (the Survey of Consumer Finances of the Federal Reserve Board), on estate tax return data (Kopczuk and Saez 2004), or on lists of wealthy individuals, such as the Forbes 400 list of wealthiest Americans.
In our new working paper (Saez and Zucman 2014), we try to measure wealth in another way. We use comprehensive data on capital income – such as dividends, interest, rents, and business profits – that is reported on individual income tax returns since 1913. We then capitalise this income so that it matches the amount of wealth recorded in the Federal Reserve's Flow of Funds, the national balance sheets that measure aggregate wealth of US families. In this way we obtain annual estimates of US wealth inequality stretching back a century.
Wealth inequality, it turns out, has followed a spectacular U-shaped evolution over the past 100 years. From the Great Depression in the 1930s through the late 1970s there was a substantial democratisation of wealth. The trend then inverted, with the share of total household wealth owned by the top 0.1% increasing to 22% in 2012 from 7% in the late 1970s (see Figure 1). The top 0.1% includes 160,000 families with total net assets of more than $20 million in 2012.

Figure 1. The return of the Roaring Twenties

Saezfig1

Notes: The figure plots wealth share owned by the top .1% richest families in the US from 1913 to 2012. Wealth is total assets (including real estate and funded pension wealth) net of all debts. Wealth excludes the present value of future government transfers (such as Social Security or Medicare benefits). Source: Saez and Zucman (2014).

Figure 1 shows that wealth inequality has exploded in the US over the past four decades. The share of wealth held by the top 0.1% of families is now almost as high as in the late 1920s, when The Great Gatsby defined an era that rested on the inherited fortunes of the robber barons of the Gilded Age.
In recent decades, only a tiny fraction of the population saw its wealth share grow. While the wealth share of the top 0.1% increased a lot in recent decades, that of the next 0.9% (families between the top 1% and the top 0.1%) did not. And the share of total wealth of the "merely rich" – families who fall in the top 10% but are not wealthy enough to be counted among the top 1% – actually decreased slightly over the past four decades. In other words, family fortunes of $20 million or more grew much faster than those of only a few millions.
The flip side of these trends at the top of the wealth ladder is the erosion of wealth among the middle class and the poor. There is a widespread public view across American society that a key structural change in the US economy since the 1920s is the rise of middle-class wealth, in particular because of the development of pensions and the rise in home ownership rates. But our results show that while the share of wealth of the bottom 90% of families did gradually increase from 15% in the 1920s to a peak of 36% in the mid-1980s, it then dramatically declined. By 2012, the bottom 90% collectively owns only 23% of total US wealth, about as much as in 1940 (see Figure 2).

Figure 2. The rise and fall of middle-class wealth

Saezfig2

Notes: The figure plots wealth share owned by the bottom 90% poorest families in the US from 1917 to 2012. Wealth is total assets (including real estate and funded pension wealth) net of all debts. Wealth excludes the present value of future government transfers (such as Social Security or Medicare benefits). Source: Saez and Zucman (2014).

The growing indebtedness of most Americans is the main reason behind the erosion of the wealth share of the bottom 90% of families. Many middle-class families own homes and have pensions, but too many of these families also have much higher mortgages to repay and much higher consumer credit and student loans to service than before (Mian and Sufi 2014). For a time, rising indebtedness was compensated by the increase in the market value of the assets of middle-class families. The average wealth of bottom 90% of families jumped during the stock-market bubble of the late 1990s and the housing bubble of the early 2000s. But it then collapsed during and after the Great Recession of 2007–2009  (see Figure 3).

Figure 3. The new wealth divide in the US

Saezfig3

Notes: The figure depicts the average real wealth of bottom 90% of families (right y-axis) and top 1% families (left y-axis) from 1946 to 2012. The scales differ by a factor 100 to reflect the fact that top 1% of families are 100 times richer than the bottom 90% of families. Wealth is expressed in constant 2010 US dollars, using the GDP deflator. Source: Saez and Zucman (2014).

Since the housing and financial crises of the late 2000s there has been no recovery in the wealth of the middle class and the poor. The average wealth of the bottom 90% of families is equal to $80,000 in 2012 – the same level as in 1986. In contrast, the average wealth for the top 1% more than tripled between 1980 and 2012. In 2012, the wealth of the top 1% increased almost back to its peak level of 2007. The Great Recession looks only like a small bump along an upward trajectory.
How can we explain the growing disparity in American wealth? The answer is that the combination of higher income inequality alongside a growing disparity in the ability to save for most Americans is fuelling the explosion in wealth inequality. For the bottom 90% of families, real wage gains (after factoring in inflation) were very limited over the past three decades, but for their counterparts in the top 1% real wages grew fast. In addition, the saving rate of middle-class and lower-class families collapsed over the same period while it remained substantial at the top. Today, the top 1% families save about 35% of their income, while the bottom 90% families save about zero (Saez and Zucman 2014).
The implications of rising wealth inequality and possible remedies
If income inequality stays high and if the saving rate of the bottom 90% of families remains low then wealth disparity will keep increasing. Ten or 20 years from now, all the gains in wealth democratisation achieved during the New Deal and the post-war decades could be lost. While the rich would be extremely rich, ordinary families would own next to nothing, with debts almost as high as their assets. Paris School of Economics professor Thomas Piketty warns that inherited wealth could become the defining line between the haves and the have-nots in the 21st century (Piketty 2014). This provocative prediction hit a nerve in the US this year when Piketty's book Capital in the 21st Century became a national best seller because it outlined a direct threat to the cherished American ideals of meritocracy and opportunity.
What should be done to avoid this dystopian future? We need policies that reduce the concentration of wealth, prevent the transformation of self-made wealth into inherited fortunes, and encourage savings among the middle class. First, current preferential tax rates on capital income compared to wage income are hard to defend in light of the rise of wealth inequality and the very high savings rate of the wealthy. Second, estate taxation is the most direct tool to prevent self-made fortunes from becoming inherited wealth – the least justifiable form of inequality in the American meritocratic ideal. Progressive estate and income taxation were the key tools that reduced the concentration of wealth after the Great Depression (Piketty and Saez 2003, Kopczuk and Saez 2004). The same proven tools are needed again today.
There are a number of specific policy reforms needed to rebuild middle-class wealth. A combination of prudent financial regulation to rein in predatory lending, incentives to help people save – nudges have been shown to be very effective in the case of 401(k) pensions (Thaler and Sunstein 2008) – and more generally steps to boost the wages of the bottom 90% of workers are needed so that ordinary families can afford to save.
One final reform also needs to be on the policymaking agenda – the collection of better data on wealth in the US. Despite our best efforts to build wealth inequality data, we want to stress that the US is lagging behind in terms of the quality of its wealth and saving data. It would be relatively easy for the US Treasury to collect more information – in particular balances on 401(k) and bank accounts – on top of what it already collects to administer the federal income tax. This information could help enforce the collection of current taxes more effectively and would be invaluable for obtaining more precise estimates of the joint distributions of income, wealth, saving, and consumption. Such information is needed to illuminate the public debate on economic inequality. It is also required to evaluate and implement alternative forms of taxation, such as progressive wealth or consumption taxes, in order to achieve broad-based and sustainable economic growth.
References
Kopczuk, W and E Saez (2004), "Top Wealth Shares in the United States, 1916–2000: Evidence from Estate Tax Returns", National Tax Journal 57(2), Part 2, June: 445–487.
Mian, A and A Sufi (2014), House of Debt, University of Chicago Press.
Piketty, T (2014), Capital in the 21st Century, Cambridge: Harvard University Press.
Piketty, T and E Saez (2003), "Income Inequality in the United States, 1913–1998", Quarterly Journal of Economics 118(1): 1–39, series updated to 2012 online.
Saez, Emmanuel and Gabriel Zucman (2014), "Wealth Inequality in the United States since 1913: Evidence from Capitalized Income Tax Data", CEPR Discussion Paper 10227, October.
Thaler, R H and C R Sunstein (2008), Nudge: Improving Decisions about Health, Wealth, and Happiness, New Haven: Yale University Press.

October 28, 2014

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Posted: 28 Oct 2014 12:06 AM PDT

'Climate Change: Lessons for our Future from the Distant Past'

Posted: 27 Oct 2014 10:59 AM PDT

David Hendry at Vox EU:

Climate change: Lessons for our future from the distant past, by David F. Hendry: Summary Climate change has been the main driver of mass extinctions over the last 500 million years. This column argues that current evidence provides a stark warning. Human activity is producing greenhouse gases, and as a consequence global temperatures and ocean heat content are rising. Such trends raise the risk of tipping points. Economic analysis offers a number of ideas, but a key problem is that distributions of climate variables can shift, invalidating stationarity-based analyses, and making action to avoid possible future shifts especially urgent.

His conclusions:

Economic analysis offers many insights – externalities need to be either priced or regulated, and climate change is the largest ever worldwide externality. All approaches are affected by the possibility of abrupt changes and the resulting unknown uncertainty when distributions shift, making action more urgent to avoid possible future shifts. Adaptation is not meaningful if food, water, and land resources become inadequate. Conversely, mitigation steps need not be costly, and could stimulate innovation. International negotiations are more likely to succeed if the largest players act first in their own counties or groups – also creating opportunities for their societies as new technologies develop.
Planet Earth will survive whatever humanity is doing – the crucial issue is the effect of climate change on its present inhabitants. It is a risky strategy to do nothing if there are potentially huge costs when the costs of initial actions are small. The obvious time to start is now, and the obvious actions are the many low-cost implementations that mitigate greenhouse gases (see Stern 2008 for a list) – just in case.

[See also "U.N. Climate Change Draft Sees Risks of Irreversible Damage - Scientific American".]

Adair Turner: The Consequences of Money-Manager Capitalism

Posted: 27 Oct 2014 09:43 AM PDT

This is from INET:

The Consequences of Money-Manager Capitalism: In the wake of World War II, much of the western world, particularly the United States, adopted a new form of capitalism called "managerial welfare-state capitalism."
The system by design constrained financial institutions with significant social welfare reforms and large oligopolistic corporations that financed investment primarily out of retained earnings. Private sector debt was small, but government debt left over from financing the War was large, providing safe assets for households, firms, and banks. The structure of this system was financially robust and unlikely to generate a deep recession. However, the constraints within the system didn't hold.
The relative stability of the first few decades after WWII encouraged ever-greater risk-taking, and over time the financial system was transformed into our modern overly financialized economy. Today, the dominant financial players are "managed money"—lightly regulated "shadow banks" like pension funds, hedge funds, sovereign wealth funds, and university endowments—with huge pools of capital in search of the highest returns. In turn, innovations by financial engineers have encouraged the growth of private debt relative to income and the increased reliance on volatile short-term finance and massive uses of leverage.
What are the implications of this financialization on the modern global economy? According to Adair Lord Turner, a Senior Fellow at the Institute for New Economic Thinking and a former head of the United Kingdom's Financial Services Authority, it means that finance has become central to the daily operations of the economic system. More precisely, the private nonfinancial sectors of the economy have become more dependent on the smooth functioning of the financial sector in order to maintain the liquidity and solvency of their balance sheets and to improve and maintain their economic welfare. For example, households have increased their use of debt to fund education, healthcare, housing, transportation, and leisure. And at the same time, they have become more dependent on interest, dividends, and capital gains as a means to maintain and improve their standard of living.  
Another major consequence of financialized economies is that they typically generate repeated financial bubbles and major debt overhangs, the aftermath of which tends to exacerbate inequality and retard economic growth. Booms turn to busts, distressed sellers sell their assets to the beneficiaries of the previous bubble, and income inequality expands. 
In the view of Lord Turner, we have yet to come up with a sufficiently robust policy response to deal with the consequences of our new "money manager capitalism." The upshot likely will be years more of economic stagnation and deteriorating living standards for many people around the world. 

October 27, 2014

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Paul Krugman: Ideology and Investment

Posted: 27 Oct 2014 12:24 AM PDT

What's really behind the GOP's opposition to infrastructure investment?:

Ideology and Investment, by Paul Krugman, Commentary, NY Times: America used to be a country that built for the future. Sometimes the government built directly: Public projects, from the Erie Canal to the Interstate Highway System, provided the backbone for economic growth. Sometimes it provided incentives to the private sector, like land grants to spur railroad construction. Either way, there was broad support for spending that would make us richer.
But nowadays we simply won't invest, even when the need is obvious and the timing couldn't be better. And don't tell me that the problem is "political dysfunction" or some other weasel phrase that diffuses the blame. Our inability to invest doesn't reflect something wrong with "Washington"; it reflects the destructive ideology that has taken over the Republican Party.
Some background: More than seven years have passed since the housing bubble burst, and ever since, America has been awash in savings ... with nowhere to go. ...
There's an obvious policy response to this situation: public investment. We have huge infrastructure needs,... and the federal government can borrow incredibly cheaply... So borrowing to build roads, repair sewers and more seems like a no-brainer. But what has actually happened is the reverse. After briefly rising after the Obama stimulus went into effect, public construction spending has plunged. ...
Yet this didn't have to happen. ... But once the G.O.P. took control of the House, any chance of ... money for infrastructure vanished. Once in a while Republicans would talk about wanting to spend more, but they blocked every Obama administration initiative.
And it's all about ideology, an overwhelming hostility to government spending of any kind. This hostility began as an attack on social programs, especially those that aid the poor, but over time it has broadened into opposition to any kind of spending, no matter how necessary and no matter what the state of the economy. ... Never mind the obvious point that the private sector doesn't and won't supply most kinds of infrastructure, from local roads to sewer systems; such distinctions have been lost amid the chants of private sector good, government bad.
And the result, as I said, is that America has turned its back on its own history. We need public investment; at a time of very low interest rates, we could easily afford it. But build we won't.

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Posted: 27 Oct 2014 12:06 AM PDT

'Why the Eurozone Suffers from a Germany Problem'

Posted: 26 Oct 2014 08:44 AM PDT

Simon Wren-Lewis:

Why the Eurozone suffers from a Germany problem: When, almost a year ago, Paul Krugman wrote six posts within three days laying into the stance of Germany on the Eurozone's macroeconomic problems, even I thought that maybe this was a bit too strong, although there was nothing in what he wrote that I disagreed with. Yet as Germany's stance proved unyielding in the face of the Eurozone's continued woes, I found myself a couple of months ago doing much the same thing (1, 2, 3, 4, 5, 6)...

I'm not going to review the macroeconomics here. I'm going to take it as read that

1) ECB monetary policy has been far too timid since the Great Recession began, in part because of the influence of its German members.
2) This combined with austerity led to the second Eurozone recession, and austerity continues to be a drag on demand. The leading proponent of that austerity is Germany.
3) Pretty well everyone outside Germany agrees that a Eurozone fiscal stimulus in the form of additional public investment, together with Quantitative Easing (QE) in the form of government debt purchases by the ECB, are required to help quickly end this second recession (see, for example, Guntram Wolff), and the main obstacle to both is the German government.

The question I want to raise is why Germany appears so successful in blocking or delaying these measures. ...

The Eurozone's current problem arises because one country - Germany - allowed nominal wage growth well below the Eurozone average, which undercut everyone else.... Within a currency union, this is a beggar my neighbour policy.

In other words, as Simon Tilford suggests, Germany is viewed by many in the Eurozone as a model to follow, rather than as a source for their current problems. ... Of course ... Germany may well have many features which other countries might well want to emulate, like high levels of productivity, but the reason why it's national interest is not currently aligned with other union members is because its inflation rate was too low from 2000 to 2007. That in itself was not a virtue...

It may well come down to the position taken by countries like the Netherlands. They have suffered as much as France... As Giulio Mazzolini and Ashoka Mody note, "For the Netherlands …. less austerity would have been unambiguously better." Yet until now, politicians in the Netherlands (and the central bank) appear to have taken the German line that this medicine is for their own good. If they can eat a bit of humble pie and support a kind of 'grand bargain' that would see fiscal expansion rather than contraction in the Eurozone as a whole, and a comprehensive QE programme by the ECB, then maybe some real progress can be made. Ultimately this is not the Eurozone's Germany problem, but a problem created by the macroeconomic vision that German policymakers espouse.

October 26, 2014

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Posted: 26 Oct 2014 12:06 AM PDT

'Scale, Profits, and Inequality'

Posted: 25 Oct 2014 11:08 AM PDT

Dietz Vollrath:

Scale, Profits, and Inequality, Growth Economics: After my post last week on inequality, I got a number of (surprisingly reasonable) responses. I pulled one line out of a recent comment ... because it encapsulates an argument for *not* caring about inequality.
"Gates and the Waltons really did probably add more value to humanity than the janitor at my school."
The general argument here is about incentives. Without the possibility of massive profits, people like Bill Gates or Sam Walton will not bother to innovate and create Microsoft and Walmart. ... But if we take seriously the incentives behind innovation, then it isn't simply the genius of the individual that matters for growth. The scale of the economy is equally relevant. ...
People like Gates and the Waltons earn profits on the scale effect of the U.S. economy, which they did not invent, innovate on, or produce. So the "rest of us", like the janitor mentioned above, have some legitimate reason to ask whether those profits are best used in remunerating Bill Gates and the Walton family, or could be put to better use. ... Investing in health, education, and infrastructure all will raise the aggregate size of the U.S. economy, and make innovation more lucrative. Even straight income transfers can raise the effective scale of the U.S. economy be transferring purchasing power to people who will spend it.
Can we argue about exactly how much of the profits are due to "genius" (the markup) and how much to scale? Sure... But you cannot dismiss the idea of taxing high-income "makers" because their income represents the fruits of their individual genius. It doesn't. Their incomes derive from a combination of ability and scale. And scale doesn't belong to individuals.
The value-added of "the Waltons" is particularly relevant here. ... Alice Walton is worth around $33 billion. She never worked for Walmart. She is a billionaire many times over because her dad was smart enough to take advantage of the massive scale of the U.S. economy. I'm not willing to concede that Alice has added more value to humanity than anyone in particular. So, yes, I'll argue that Alice should pay a lot more in taxes than she does today. And no, I'm not afraid that this will prevent innovation in the future, because those taxes will help expand the scale of the economy and incent a new generation of innovators to get to work.