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September 3, 2015

Latest Posts from Economist's View

Posted: 03 Sep 2015 12:12 AM PDT
From Larry Mishel and Josh Bivens at the EPI:
Understanding the Historic Divergence Between Productivity and a Typical Worker's Pay: Why It Matters and Why It's Real, by Josh Bivens and Lawrence Mishel: Introduction and key findings Wage stagnation experienced by the vast majority of American workers has emerged as a central issue in economic policy debates, with candidates and leaders of both parties noting its importance. This is a welcome development because it means that economic inequality has become a focus of attention and that policymakers are seeing the connection between wage stagnation and inequality. Put simply, wage stagnation is how the rise in inequality has damaged the vast majority of American workers.
The Economic Policy Institute's earlier paper, Raising America's Pay: Why It's Our Central Economic Policy Challenge, presented a thorough analysis of income and wage trends, documented rising wage inequality, and provided strong evidence that wage stagnation is largely the result of policy choices that boosted the bargaining power of those with the most wealth and power (Bivens et al. 2014). As we argued, better policy choices, made with low- and moderate-wage earners in mind, can lead to more widespread wage growth and strengthen and expand the middle class.
This paper updates and explains the implications of the central component of the wage stagnation story: the growing gap between overall productivity growth and the pay of the vast majority of workers since the 1970s. A careful analysis of this gap between pay and productivity provides several important insights for the ongoing debate about how to address wage stagnation and rising inequality. First, wages did not stagnate for the vast majority because growth in productivity (or income and wealth creation) collapsed. Yes, the policy shifts that led to rising inequality were also associated with a slowdown in productivity growth, but even with this slowdown, productivity still managed to rise substantially in recent decades. But essentially none of this productivity growth flowed into the paychecks of typical American workers. Second, pay failed to track productivity primarily due to two key dynamics representing rising inequality: the rising inequality of compensation (more wage and salary income accumulating at the very top of the pay scale) and the shift in the share of overall national income going to owners of capital and away from the pay of employees. Third, although boosting productivity growth is an important long-run goal, this will not lead to broad-based wage gains unless we pursue policies that reconnect productivity growth and the pay of the vast majority.
Ever since EPI first drew attention to the decoupling of pay and productivity (Mishel and Bernstein 1994), our work has been widely cited in economic analyses and by policymakers. It has also attracted criticisms from those looking to deny the facts of inequality. Thus in this paper we not only provide an updated analysis of the productivity–pay disconnect and the factors behind it, we also explain why the measurement choices we have made are the correct ones. As we demonstrate, the data series and methods we use to construct our graph of the growing gap between productivity and typical worker pay best capture how income generated in an average hour of work in the U.S. economy has not trickled down to raise hourly pay for typical workers. ...
Key findings from the paper include:
  • For decades following the end of World War II, inflation-adjusted hourly compensation (including employer-provided benefits as well as wages) for the vast majority of American workers rose in line with increases in economy-wide productivity. Thus hourly pay became the primary mechanism that transmitted economy-wide productivity growth into broad-based increases in living standards.
  • Since 1973, hourly compensation of the vast majority of American workers has not risen in line with economy-wide productivity. In fact, hourly compensation has almost stopped rising at all. Net productivity grew 72.2 percent between 1973 and 2014. Yet inflation-adjusted hourly compensation of the median worker rose just 8.7 percent, or 0.20 percent annually, over this same period, with essentially all of the growth occurring between 1995 and 2002. Another measure of the pay of the typical worker, real hourly compensation of production, nonsupervisory workers, who make up 80 percent of the workforce, also shows pay stagnation for most of the period since 1973, rising 9.2 percent between 1973 and 2014. Again, the lion's share of this growth occurred between 1995 and 2002.
  • Net productivity grew 1.33 percent each year between 1973 and 2014, faster than the meager 0.20 percent annual rise in median hourly compensation. In essence, about 15 percent of productivity growth between 1973 and 2014 translated into higher hourly wages and benefits for the typical American worker. Since 2000, the gap between productivity and pay has risen even faster. The net productivity growth of 21.6 percent from 2000 to 2014 translated into just a 1.8 percent rise in inflation-adjusted compensation for the median worker (just 8 percent of net productivity growth).
  • Since 2000, more than 80 percent of the divergence between a typical (median) worker's pay growth and overall net productivity growth has been driven by rising inequality (specifically, greater inequality of compensation and a falling share of income going to workers relative to capital owners). Over the entire 1973–2014 period, rising inequality explains over two-thirds of the productivity–pay divergence.
  • If the hourly pay of typical American workers had kept pace with productivity growth since the 1970s, then there would have been no rise in income inequality during that period. Instead, productivity growth that did not accrue to typical workers' pay concentrated at the very top of the pay scale (in inflated CEO pay, for example) and boosted incomes accruing to owners of capital.
  • These trends indicate that while rising productivity in recent decades provided the potential for a substantial growth in the pay for the vast majority of workers, this potential was squandered due to rising inequality putting a wedge between potential and actual pay growth for these workers.
  • Policies to spur widespread wage growth, therefore, must not only encourage productivity growth (via full employment, education, innovation, and public investment) but also restore the link between growing productivity and the typical worker's pay.
  • Finally, the economic evidence indicates that the rising gap between productivity and pay for the vast majority likely has nothing to do with any stagnation in the typical worker's individual productivity. For example, even the lowest-paid American workers have made considerable gains in educational attainment and experience in recent decades, which should have raised their productivity.
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Posted: 03 Sep 2015 12:06 AM PDT
Posted: 02 Sep 2015 12:07 PM PDT
In response to Paul Krugman's recent post, "The Triumph of Backward-Looking Economics" -- no surprise here -- there is  disagreement from Steve Williamson. So let me offer this from Blanchard and Johnson's intermediate macroeconomics text discussing this issue. But first, a brief review of the controversy. Krugman says:
... What did orthodox salt-water macroeconomists believe about disinflation on the eve of the Volcker contraction? As it happens, we have an excellent source document: James Tobin's "Stabilization Policy Ten Years After," presented at Brookings in early 1980. Among other things, Tobin laid out a hypothetical disinflation scenario based on the kind of Keynesian model people like him were using at the time (which was also the model laid out in the Dornbusch-Fischer and Gordon textbooks). These models included an expectations-augmented Phillips curve, with no long-run tradeoff between inflation and unemployment — but expectations were assumed to adjust gradually based on experience, rather than changing rapidly via forward-looking assessments of Fed policy.
This was, of course, the kind of model the Chicago School dismissed scathingly as worthy of nothing but ridicule, and which was more or less driven out of the academic literature, even as it continued to be the basis of a lot of policy analysis. ...
Krugman goes on to claim that the Chicago School was wrong. Williamson says:
... Tobin is using what he thinks is a conventional macroeconometric model. It's got adaptive expectations and a Phillips curve with what people then would have called a "high sacrifice ratio." You have to suffer a lot of unemployment to get a small reduction in inflation. Of course, Tobin's simulation looks nothing like what happened. ...
He is focused on whether a particular set of assertions by Tobin are correct, and he claims they do not fully fit the evidence. But there is a larger issue here that goes far beyond the particulars of Tobin's paper (and a broad view of the evidence is supportive of Krugman's view of the Volcker disinflation). Blanchard and Johnson:
... Fighting inflation implied tightening monetary policy, decreasing output growth, and thus accepting higher unemployment for some time. The question arose of how much unemployment, and for how long, would likely be needed to achieve a lower level of inflation, say 4%-which is the rate Volcker wanted to achieve. Some economists argued that such a disinflation would likely be very costly. .....
The natural conclusion was that it would make sense to go slowly, so as not to increase unemployment by too much in a given year. Some economists argued that disinflation might in fact be much less costly. In what has become known as the Lucas critique, Lucas pointed out that when trying to predict the effects of a major policy change-like the change considered by the Fed at the time-it could be very misleading to take as given the relations estimated from past data. In the case of the Phillips curve, taking equation (8.10) [note: this is the backward looking Phillips curve specified below] as given was equivalent to assuming that wage setters would keep expecting inflation in the future to be the same as it was in the past, that the way wage setters formed their expectations would not change in response to the change in policy. This was an unwarranted assumption, Lucas argued: Why shouldn't wage setters take policy changes directly into account? If wage setters believed that the Fed was committed to lower inflation, they might well expect inflation to be lower in the future than in the past. ...
Lucas did not believe that disinflation could really take place without some increase in unemployment. But Thomas Sargent, looking at the historical evidence on the end of several very high inflations, concluded that the increase in unemployment could be small. The essential ingredient of successful disinflation, he argued, was credibility of monetary policy-the belief by wage setters that the central bank was truly committed to reducing inflation. Only credibility would cause wage setters to change the way they formed their expectations. Furthermore, he argued, a clear and quick disinflation program was more likely to be credible than a protracted one that offered plenty of opportunities for reversal and political infighting along the way.
Who turned out to be right? In September 1979, Paul Volcker started increasing the interest rate so as to slow down the economy and reduce inflation. From 9% in 1979, the three-month Treasury bill rate was increased to 15% in August 1981. The effects on inflation, output growth, and unemployment are shown in Table 8-1. The table makes clear that there was no credibility miracle: Disinflation was associated with a sharp recession, with negative growth in both 1980 and 1982, and with a large and long-lasting increase in unemployment.
Does this settle the issue of how much credibility matters? Not really. Those who argued before the fact that credibility would help argued after the fact that Volcker had not been fully credible. After increasing the interest rate from September 1979 to April 1980 and inducing a sharp decrease in growth, he appeared to have second thoughts, reversing course and sharply decreasing the interest rate from April to September, only to increase it again in 1981. This lack of consistency, some argued, reduced his credibility and increased the unemployment cost of the disinflation. A larger lesson still stands: The behavior of inflation depends very much on how people and firms form expectations. The Lucas critique still stands: The past relation between unemployment and inflation may be a poor guide to what happens when policy changes. ...
They are saying that a Phillips curve of the form π = πe - α(U - Un), where πe  at time t equals πt-1 is a good model of the Volcker era (that is, expectations were backward looking), and that was reasonable at the time. However, as expectations formation changes with experience this may no longer hold true -- the tradeoff could change as expectations are more responsive to Fed announcements. Krugman is arguing that recent experience lends credence to the idea that a backward looking model (or a model with a linear combination of past and rationally expected inflation, i.e. a model with persistence in unemployment in response to policy changes) continues to hold.
Posted: 02 Sep 2015 09:30 AM PDT
This is a question I have wanted to see an answer to for a long time. What is the minimum efficient scale for financial institutions? This is an important question with respect to breaking up large banks into smaller entities. Some have argued, based on very little compelling evidence as far as I can tell, that breaking up big banks would be costly because large banks are able to exploit economies of scale. Others disagree, but again evidence for either point of view is unclear. I don't mean there is no evidence at all, the existing research is described in the introduction to this paper, but the results do not point strongly in any particular direction. Hopefully, more work on the topic will shift the weight of the evidence in one direction or another:
The Evolution of Scale Economies in U.S. Banking, by David C. Wheelock and Paul W. Wilson, August 2015: Abstract Continued consolidation of the U.S. banking industry and general increase in the size of banks has prompted some policymakers to consider policies to discourage banks from getting larger, including explicit caps on bank size. However, limits on the size of banks could entail economic costs if they prevent banks from achieving economies of scale. The extent of scale economies in banking remains unclear. This paper presents new estimates of returns to scale for U.S. commercial banks based on nonparametric, local-linear estimation of bank cost, revenue and pro t functions. We present estimates for both 2006 and 2012 to compare the extent of scale economies in banking some four years after the financial crisis and two years after enactment of the Dodd-Frank Act with scale economies prior to the crisis. We find that most banks faced increasing returns to scale in cost in both years, though results for the very largest banks in 2012 are somewhat sensitive to specification. Further, most banks faced decreasing returns in revenue in both years, though nearly all banks could still increase revenue and pro t by becoming larger.
[As I've written many, many times, I do not think that breaking up big banks will do a lot to reduce our susceptibility to bank crises. After all, we had a financial crisis about every 20 years in the 1800s, and this continued through the Great Depression, and at that time banks were relatively small. Thus, it seems that crises have more to do with the diversity of activity and connectedness than bank size. I favor breaking up the biggest banks to reduce their political power, which I believe is excessive, and to reduce their economic power. If the above results had shown that the minimum efficient scale was much smaller than the typical large, systemically important bank, breaking them up would be an easy call. But that's not what the results imply. Thus, in this case, there is a tradeoff between the benefit or reducing political and economic power versus losing economies of scale (not sure how steep the cost function is at the existing size -- if it's relatively flat the loss of scale economies could be small). The other alternative is to treat them along the lines of a public utility. We allow them to be large to exploit scale economies, then regulate pricing and other behavior. However, this is where the political power of the large banks matters, and it's not clear that a policy of "large but with regulatory oversight" is the best option to pursue.]
Posted: 02 Sep 2015 08:57 AM PDT
Simon Wren-Lewis says:
Corbyn, QE and financial interests: ... I want to talk about Quantitative Easing (QE). The basic idea behind QE is that by buying long term assets at a time when their price is high (interest rates are low) to make their price even higher (interest rates even lower) in the short term, and selling them back later when asset prices are lower (and interest rates higher), you could stimulate additional demand. At first sight it seems not too dissimilar to a central bank's normal activities in changing short rates. There are however two major differences....
After discussing the differences, and some of the problems with QE, he continues with:
That should mean that everyone is looking around for a better way of doing things when short rates hit their lower bound. Fiscal stimulus is the obvious candidate, but we know the political problems there. ...
In the absence of an appropriate government fiscal policy, I find the logic for helicopter money compelling and the arguments against it pretty weak. But just as with fiscal policy, just because something makes good macroeconomic sense does not mean it will happen. I have always been reluctant to pay too much attention to the distributional impact of monetary policy, because it seemed like one of those occasions when even well meaning attention to distribution can mess up good policy. Yet in terms of the political economy of replacing QE, perhaps we should.
It is more likely than not that QE will lead to central bank losses. ... After all, they are buying high, and selling low. That is integral to the policy. Who gains from these losses. Where does the money permanently created because of these losses go? To the financial sector, and the owners of financial assets (who are selling to the central bank high, and buying back low). In that sense, likely losses on QE will involve a transfer from the public to the financial sector.
If QE was the only means of stabilizing the economy in a liquidity trap, because fiscal policy was out of bounds for political reasons, then so be it. The social benefits would far outweigh any distributional costs, even if the latter could not be undone elsewhere. But if QE is a highly ineffective instrument, and there are better instruments available, you have to ask in whose interest is it that we stick with QE?

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