Friday, January 27, 2023

Dean Baker contra Fed recession plans....


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After Fourth Quarter GDP, Economy Looks Solid Unless Fed Derails Economy

While the media keep touting the prospects for a recession, it is difficult to see why there would be one in the immediate future. Just to start with the basic picture, growth in the fourth quarter was a very solid 2.9 percent, following a slighter stronger 3.1 percent in the third quarter. This is very far from the negative growth that we see in a recession.

When we look at the individual components the picture is somewhat mixed. Inventory accumulation accounted for half the growth, adding 1.46 percentage points to growth in the quarter. This obviously will not be sustained and after the rapid growth in the fourth quarter, we are likely to see inventories as a drag on growth in future quarters.

However, the flip side is that some of the items dragging growth down in the fourth quarter will have less of negative impact in future quarters. Housing stands out here. The drop in residential investment knocked 1.29 percentage points off the quarter’s growth, after lowering third quarter growth by 1.42 percentage points.

The reason for thinking the hit to growth will be much smaller in future quarters is that housing has already fallen so far. The 1.38 million rate of starts in December is roughly the same as the pre-pandemic pace. The December figure was only a small drop from the November rate, so for the moment the rapid plunges of the summer and fall seem to be behind us.

New home sales actually rose slightly in the last two months. And, with vacancy rates still near historic lows, it’s hard to envision builders cutting back on construction much further from what is already a slow pace of construction. In addition, mortgage interest rates have been falling in the last couple of months and are likely to fall further, barring a big hawkish turn by the Fed.

Another bright spot for housing is that mortgage refinancing has fallen back to almost zero. The costs associated with refinancing a mortgage count as residential investment. The plunge in refinancing and new mortgages accounted for 34.6 percent of the decline in residential investment over the last year.

Non-residential investment is also likely to look better in future quarters. It rose at just a 0.7 percent annual rate in the fourth quarter. It was held down by a 3.7 percent drop in equipment investment. This component will likely turn around in 2023 due to a surge in airplane orders.

Structure investment seems to also be turning upward. There was a sharp falloff in most categories of structure investment in the pandemic, especially office buildings and hotels. These components seem to have hit bottom. A recent surge in factory construction is likely to pull this component further into positive territory in 2023. Overall structure investment grew at a 0.4 percent rate in the fourth quarter.

Consumption is the bulk of the story for GDP, and here we should see a picture of continuing modest growth. Consumption grew at a 2.1 percent rate in the fourth quarter, nearly identical to the 2.0 percent rate of the second quarter and 2.3 percent rate of the third quarter.

The data on unemployment claims indicate we are not seeing any noticeable jump in unemployment, in spite of some large layoff announcements. With a healthy pace of jobs growth, and rising real wages, there is no reason to expect any sharp downturn in consumption.

This stable growth rate has gone along with a rebalancing of consumption back to services after a sharp rise in goods consumption in the pandemic. Goods consumption rose at a 1.1 percent annual rate in the fourth quarter after declining in the prior three quarters. Services rose at 2.6 percent annual rate.

The share of goods consumption in GDP is still roughly 2.0 percentage points above its pre-pandemic level. It is likely to continue to decline modestly, with the growth in services more than offsetting it, and keeping overall consumption growth in positive territory.

The drop in goods consumption will also have the benefit of leading to a smaller trade deficit. After rising sharply during the pandemic, the trade deficit has been decreasing for the last three quarters. As we see less demand for consumption goods, and also a reduction in the pace of inventory accumulation, we should see further declines in imports in 2023.

The dollar has also been dropping in the last couple of months, losing close to 10 percent of its value against the euro and other major currencies. While the dollar is still well above its pre-pandemic level, the recent drop in the dollar should help to reduce the trade deficit by making U.S. goods and services more competitive.

In addition, the fact that Europe’s economy is looking better than had been generally expected, and that China’s economy is now largely reopened, should be a boost to U.S. exports. Together, these factors should mean that the trade deficit continues to shrink and be a positive factor in growth.

The most recent data also suggest continued improvement on inflation. The core PCE rose at a 3.9 percent rate in Q4, down from 4.7 percent in Q3. This is still well above the Fed’s 2.0 percent target, but we know that rental inflation will be slowing sharply in coming months, which will be a huge factor lowering the core inflation rate.

Also, the fourth quarter GDP report provided more evidence to support the view that wage growth is moderating. Total labor compensation grew at a 4.9 percent annual rate in the fourth quarter. If we assume that hours grew at 1.5 percent rate, that translates into a 3.4 percent pace of growth in average hourly compensation. This would be very much consistent with the Fed’s 2.0 percent target.

This is especially true with productivity growth in the range of 1.5 percent. After falling in the first half of 2022, productivity grew at a modest 0.8 percent rate in the third quarter. If hours growth comes around 1.5 percent (the index of aggregate hours increased at a 1.1 percent rate, but there was a sharp rise in reported self-employment), then productivity growth should be close to 1.5 percent in the quarter.

Compared to the falling productivity in the first half, even a modest pace of positive growth will go far towards alleviating inflationary pressure. And of course, with modest positive productivity growth, we can sustain a modest rate of real wage growth without causing inflation.

In short, the world is looking good, we just have to keep the Fed from messing it up.

Wednesday, January 11, 2023

Dean Baker refutes the Summers-Fed thesis on the recession threat

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The Good and Better News About the Economy
Dean Baker

Everyone who carefully follows the news about the economy knows that we are in the middle of the Second Great Depression. On the other hand, those who read less news, but deal with things like jobs, wages, and bills probably think the economy is pretty damn good. We got more evidence on the pretty damn good side with the December jobs report and other economic data released in the last week.

The most important part of the jobs report was the drop in the unemployment rate to 3.5 percent. This equals the lowest rate in more than half a century. While many in the media insist that only elite intellectual types care about jobs, not ordinary workers, since the ability to pay for food, rent, and other bills is tightly linked to having a job, it seems that at least some workers might care about being able to work.

For these people, the tight labor market we have seen as the economy recovered from the pandemic recession is really good news. Not only do people have jobs, but the strong labor market means they can quit bad jobs. If the pay is low, the working conditions are bad, the boss is a jerk, workers can go elsewhere.

And, they are choosing to do so in large numbers. In November, the most recent month for which we have data, 2.7 percent of all workers, 4.2 million people, quit their job. This is near the record high of 3.0 percent reported at the end of 2021, and still above the highs reached before the pandemic and at the end of the 1990s boom.

The ability to quit bad jobs has predictably led to rising wages. Employers must raise pay to attract and retain workers. Real wages were dropping at the end of 2021 and the first half of 2022, as inflation outpaced wage growth, but as inflation slowed in the last half year, real wages have been rising at a healthy pace.

From June to November, the real average hourly wage has increased by 0.9 percent, a 2.2 percent annual rate. (We don’t have December price data yet.) Workers lower down the pay scale have done even better. The real average hourly wage for production and non-supervisory workers, a category that excludes managers and other highly paid workers, has risen by 1.4 percent since June, a 3.3 percent annual rate of increase. In the hotel and restaurant sectors, real pay has risen by 1.8 percent since June, a 4.4 percent annual rate of increase.

These real pay gains follow declines in 2021 and first half of 2022, but for many workers pay is already above the pre-pandemic level. For production and non-supervisory workers, the real average hourly wage is 0.3 percent above the February, 2020 level.  For production and non-supervisory workers in the hotel and restaurant sectors real pay is up by 4.7 percent. The overall average for all workers is only down by 0.3 percent, a gap that will likely be largely eliminated by the wage growth reported for December.

While we may still have problems with inflation going forward, the sharp slowing in recent months was an unexpected surprise. We saw gas prices fall most of the way back to pre-pandemic levels. Many of the items where prices rose sharply due to supply chain problems, like appliances and furniture, are now seeing rapid drops in prices. Rents, which are a huge factor in the Consumer Price Index (CPI) and people’s budgets, have slowed sharply and are now falling in many areas. It will be several months before this slowing shows up in the CPI because of its methodology for measuring rental inflation, but based on private indexes of marketed housing units, we can be certain we will see rents rising much more slowly soon.

In short, there are good reasons for believing that we will see much slower inflation going forward. If we continue to see moderate nominal wage growth in 2023, that will translate into a healthy pace of real wage growth.


Also, contrary to what is widely reported, we had a largely positive picture on housing in the last three years. While current mortgage rates are pricing many people out of the market, homeownership did rise rapidly since the pandemic

The overall homeownership rate increasedby 1.0 percentage point from the fourth quarter of 2019 to the third quarter of 2022. For Blacks, it rose by 1.2 percentage points, from 44.0 percent to 45.2 percent. For young people it rose by 1.7 percentage points, from 37.6 percent to 39.3 percent.  For lower income households it rose by 1.3 percentage points from 51.4 percent to 52.7 percent.

It is striking that this rise in homeownership, especially for the most disadvantaged groups, is 180 degrees at odds with whatis being reportedin the media. These data come from the Census Bureau, which is generally considered an authoritative source. Nonetheless, the media have insisted that this has been a period in which young people, minorities, and low-income households have faced extraordinary difficulties in buying houses.

Income Growth

The media have also frequently told us that people are being forced to dip into their savings and that the saving rate is now at a record low. While the saving rate has fallen sharply in the last year, a major factor is that people have sold stock at large gains and are now paying capital gains taxes on these gains. Capital gains do not count as income, but the taxes paid on these gains are deducted from income in the national accounts, thereby lowering the saving rate. It’s not clear that people who sold stock at a gain, and then pay tax on that gain, are suffering severe financial hardship.

We also have the story of rapidly rising credit card debt. This has been presented as another indication of financial hardship. There actually is a simple and very different story. In 2020 and 2021, tens of millions of homeowners took advantage of extraordinarily low mortgage rates to refinance their homes. When they refinanced, they often would borrow more than their original mortgage to pay for various expenses they might be facing.

The Fed’s rate hikes have largely put an end to refinancing, including cash-out refinancing. With this channel closed to households, people that formerly would have looked to borrow by refinancing mortgage are instead turning to credit cards. This is hardly a crisis. Furthermore, tens of millions of families that were paying thousands more in mortgage interest, now have additional money to spend or save. This is not reflected in aggregate data.

It’s also worth noting one reason that inflation may have left many people strapped: the cost-of-living adjustments for Social Security are only paid once a year. This meant the checks beneficiaries were getting could buy around 7.0 percent less in December than they had the start of the year. However, Social Security beneficiaries are seeing an 8.7 percent increase in the size of their checks this month. That should make life considerably easier for tens of millions of retirees, and also modestly boost the saving rate.

Productivity Growth and Working from Home

Other bright spots in the economy include the return of healthy productivity growth and the huge increase in the number of people working from home. We saw two quarters of negative productivity growth in the first half of last year.

Productivity growth is poorly measured and highly erratic, but there seems little doubt that productivity growth was very poor in the first and second quarters of 2022. This added to the inflationary pressure that businesses were seeing.

This situation was reversed in the third quarter, with productivity growth coming in at close to 1.0 percent, roughly in line with the pre-pandemic trend. It looks like productivity growth will be even better in fourth quarter. GDP growth is now projected to be well over 3.0 percent, while payroll hours grew at just a 1.0 percent annual rate, implying a productivity growth rate close to 2.0 percent. This would be great news if it can be sustained, but as always, a single quarter’s data has to be viewed with great caution.

The other big positive in the economic picture is the huge increase in the number of people working from home. One recent paper estimated that 30 percent of all workdays are now remote, up from around 10 percent before the pandemic. While that number may prove somewhat high, it is clear that tens of millions of workers are now saving thousands a year on commuting costs and hundreds of hours formerly spent commuting. That is also a huge deal which is not picked up in our national accounts.

If the Economy Is Great, Why Do People Say They Think It Is Awful?

I’m not going to try to answer that one, other than to note that there has been a “horrible economy” echo chamber in the media, where facts have often been distorted or ignored altogether. I don’t know if that explains why so many people say they think the economy is bad, I’m an economist, not a social psychologist.

I will say that people are not acting like they think the economy is bad. They are buying huge amounts of big-ticket items like appliances and furniture, and until very recently houses. They are also going out to restaurantsat a higher rate than before the pandemic. This is not behavior we would expect from people who feel their economic prospects are bleak.

To be clear, there are tens of millions of people who are struggling. Many can’t pay the rent, buy decent food and clothes for their kids, or pay for needed medicine or medical care. That is a horrible story, but this unfortunately is true even in the best of economic times. Until we adopt policies to protect people facing severe hardship we will have tens of millions of people struggling to get the necessities of life.

But this is not the horrible economy story the media is telling us. That is one that is suppose to apply to people higher up the income ladder. And, thankfully that story only exists in the media’s reporting, not in the economic data.

Dean, while you are correct that the media is more interested in clickbait than informing the public, one place where the economy still looks dismal is Wall Street. My IRA lost the price of a new Bentley last year. For a retiree - 2021 was a very bad year for retirement investments. Also, many of the COLAs only start to kick in this month - ergo many checkbooks might not yet be balancing. Lastly, we have been bombarded by GOP claims that the US economy is in terrible financial shape due to radical liberal Democrats. We need to drastically cut federal spending and balance the budget immediately. Of course, as Stephanie Kelton points out in her book the Deficit Myth, zero deficits usually trigger a recession.