Dean Baker: The Social Security Scare Story Industry

 

The Social Security Scare Story Industry I’m on the road (literally, driving from southern Utah to western Oregon) but I thought I should quickly weigh in the on the scare stories we heard yesterday after the release of the 2023 Social Security and Medicare Trustees Reports. I’ll make four quick points: 1) The scare stories stem entirely from how we account for Social Security, as opposed to programs like education or the military; 2) We’ve already seen most of the increased burden associated with the retirement of the baby boomers; 3) It’s not true that our only choices are raising taxes or cutting benefits, as has been widely asserted; 4) We have seen great news on Medicare since the passage of the Affordable Care Act, which has been largely ignored. The Problem is Largely Accounting Starting with the accounting, Social Security is a program that we have decided to fund from dedicated taxes, primarily the 6.2 percent tax that employers and employees pay on the first $160,200 of income. (Part of the program’s problem is that the share of wage income going over the cap, and avoiding taxation, rose from 10.0 percent in 1982 to almost 20 percent today. This is because of the huge upward redistribution of wage income over the last forty years.) Most other items in the budget are not funded by a dedicated tax. If they were, we would have had many scary moments in the past and possibly in the future. For example, government spending on education increased from 1.3 percent in 1946 to a peak of 3.8 percent of GDP in 1970. This 2.5 percentage point increase in spending to accommodate the baby boomers needs when we were kids, is far larger than 1.8 percentage point projectedincrease in spending in Social Security from 2000 to 2040, the peak pressure of the baby boomers’ retirement. If we had funded education from a dedicated tax and were looking at accurate projections of future spending in 1946, it would have looked far more scary than the Social Security projections do now. In the same vein, many people want the U.S. to have a Cold War with China. China’s economy is already more than 20 percent larger than ours and is growing considerably more rapidly. (The Soviet economy peaked at around 60 percent of the size of the U.S. economy.) We are currently spending a bit more than 3.0 percent of GDP on the military. We spent 6.0 percent of GDP during the Reagan military buildup in the 1980s. If we went to this level of spending, or higher, to match the spending of a larger enemy, the projections would look much worse than anything we see with Social Security. We’ve Already Seen Most of the Cost Increase The Social Security trust fund built up a large surplus in the years when most of the baby boomers were in the labor force. This trust fund is helping to cover the current costs of the program. However, the cost themselves have been rising for the last fifteen years. We went from spending 4.19 percent of GDP on Social Security in 2000 to spending 5.22 percent of GDP this year, and increase of 1.03 percentage points. This cost is projected to increase further to 6.03 percentage points by 2040, a rise of 0.81 percentage points. This increased cost will impose some burden on the economy, but less than the increased burden we have seen to date. So, the idea that we are looking at some horror story down the road doesn’t make any sense, unless we think we are already living a horror story. It’s not True that Our Only Choices are Raising Taxes or Cutting Benefits Contrary to what NPR told us yesterday (“Patching the program will require higher taxes, lower benefits or some combination of the two”) there is an alternative. Historically, Social Security has been funded by its designated taxes, as noted earlier. But, if we are changing the law, we can also change this feature of Social Security. We could have it funded in part from general revenue, like the military or almost every other program. There are reasons we may not want to make this switch, but it is wrong for NPR and others to tell us that it is not a possible option. It is. Can we spend more from general revenue without raising some taxes? That is an open question. From an economic standpoint, it doesn’t matter whether spending comes from past surplus accumulated in the trust fund or whether it’s simply an appropriation from general revenue. As noted above, we have already seen most of the burden associated the retirement of the baby boomers, perhaps we could see the additional burden without any additional taxes. If the economy’s main problem is secular stagnation (a lack of demand) as economists like Larry Summers had arguedbefore the pandemic, there is little reason to believe that the additional deficits associated with higher Social Security spending will be a major problem. This would especially be the case if artificial intelligence leads to the huge productivity boom that many analysts are predicting. The Untold Great Story on Medicare The Trustees Report released yesterday showed a further improvement in Medicare’s finances. This is a huge deal that has gone largely unreported. In 2000, the Medicare Hospital Insurance Trust Fund was projected to face costs of 1.91 percent of GDP this year and 2.54 percent of GDP in 2040. In the most recent report we are projectedto spend 1.52 percent of GDP this year and 2.12 percent in 2040, a savings of 0.39 percentage points of GDP this year and 0.42 percentage points for 2040. These savings have hugely helped the program and meant that we have far more resources to spend elsewhere. People pushing scare stories probably don’t want to promote these facts, but that is the world. Anyhow, there are clearly issues with how we will deal with the retirement of the baby boomers, but the situation is not nearly as dire as many would like us to believe.

 The Silicon Valley Bank Bailout: The Purpose of Government Is to Make the Rich Richer #63,486

There is a standard tale of politics where conservatives want to leave things to the market, whereas the left want a big role for government. The right likes to tell this story because it advantages them politically, since most people tend to have a positive view of the market. The left likes to tell it because they are not very good at politics and have an aversion to serious thinking.

The Silicon Valley Bank (SVB) bailout is yet another great example of how the right is just fine with government intervention, as long as the purpose is making the rich richer. Left to the market, the outcome in this case was clear. The FDIC guaranteed accounts up to $250k. This meant that the government’s insurance program would ensure that everyone got the first $250,000 in their account returned in full.

The amounts above $250,000 were not insured. This is both a matter of law and a matter of paying for what you get. The FDIC chargesa fee on the first $250,000 in an account based on the size and strength of the bank. This fee ranges from 0.015 percent to 0.40 percent annually, depending on the size and riskiness of the bank. Most people would not see the insurance fee directly, because it is charged to bank, but we can be sure that the bank passes this cost on to its depositors.

However, these fees only apply to the first $250,000 in an account. This means that people who had more than $250,000 in an account were not paying for insurance. Nonetheless, when they needed insurance from the government, they got it, even though they didn’t pay for it.

As we are now hearing, in many cases this handout ran into the tens of millions, or even billions, of dollars, almost all of it going to the very richest people in the country. Compare these depositors’ sense of entitlement to a government handout, to the outrage over President Biden’s proposal to forgive $10,000 of student loan debt. (To be clear, depositors likely would have gotten 80 to 90 percent of their money back in any case.)

In the case of SVB, rich depositors could not bother themselves with taking steps to ensure that their money was parked in a safe place. This is in spite of the fact that almost all of them pay people to help them manage their money.

By contrast, in the case of student loan debt, many 18-year-olds may have misjudged their future labor market prospects. This sort of error would not be surprising given the economic turmoil we have seen since the collapse of the housing bubble and the Great Recession.

Making the Rich Richer with Drugs and Vaccines

The idea that the purpose of government is to make the rich richer pervades every aspect of economic policy. When we were confronted with a worldwide pandemic, the government spent billions of dollars to quickly develop effective vaccines and treatments. And then, after developing them, we gave private companies like Moderna intellectual property rights over the product.

Naturally, this sent Moderna’s stock soaring and made at least fiveModerna executives into billionaires. Only children and elite intellectuals could think the extreme inequality we see in this story has anything to do with the market, but we will get the same tale again and again. The right wants to accept market outcomes, while the left wants to use the government to address inequality.

It’s striking that even now the government is acting to make the Moderna crew still richer. Moderna and Pfizer have announced that they want to charge between $110 and $130 a shot for their new Covid booster.

Peter Hotez and Elena Bottazzi, two highly respected researchers at Baylor University and Texas Children’s Hospital, developeda simple to produce, 100 percent open-source Covid vaccine. It uses well-established technologies that are not complicated (unlike mRNA). Their vaccine has been widely used in India and Indonesia, with over 100 million people getting the vaccine to date.

If we want to see the vaccine used here it would need to be approved by the Food and Drug Administration (FDA). In principle, the FDA could rely on the clinical trials used to gain approval in India, but it indicated that they want a U.S. trial. (In fairness, India’s trials are probably lower quality.)

However, the government could fund a trial of Hotez-Bottazzi vaccine (Corbevax) with pots of money left over from Operation Warp Speed, or alternatively from the budgets of National Institutes of Health or other agencies like Biomedical ​Advanced Research and Development Authority (BARDA). With tens of billions of dollars of government money going to support biomedical research each year, the ten million or so needed for a clinical trial of Corbevax would be a drop in the bucket.

The arithmetic on this is incredible. Shots of Corbevax cost less than $2 a piece in India. If it costs two and a half times as much in the U.S., that still puts it at $5 a shot. That implies savings of more than $100 a shot.

That means that if we get 100,000 people to take the Corbevax booster, rather than the Modern-Pfizer ones (Pfizer is planning to also charge over $100 for its booster), we’ve covered the cost of the trials. If we get 1 million to take Corbevax, we’ve covered the cost ten times over, and if 10 million people get the Corbevax booster, we will have saved one hundred times the cost of the clinical trial.

But for now, we are not going this route. Remember, the purpose of government is to make the rich richer.

This is a huge story in the pharmaceutical industry more generally. We will spend close to $550 billion this year on prescription drugs. These drugs would almost certainly cost less than $100 billion a year if they were sold in a free market without government-granted patent monopolies or related protections.

The differences of $450 billion is roughly half the size of the military budget and more than four times what we will spend on the Food Stamp program. It comes to more than $3,000 per household each year, and yes, it mostly goes to people at the top end of the income distribution.

We would have to replace the roughly $100 billion a year that the industry spends on research, but we would almost certainly come out way ahead in that story, as with the Hotez-Bottazzi vaccine.

In addition, by making drugs cheap, we will end the crisis that many people face in trying to come up with the money to pay for life-saving drugs. We would also eliminate the enormous incentive that patent-protected drug prices give drug companies to lie about the safety and effectiveness of their drugs.

Structuring Finance to Serve the Market, not the Rich

We don’t need to have a financial system that has periodic bank collapses and makes millionaires and billionaires out of top bank executives. This is a policy choice by a government committed to making the rich richer.

The most obvious solution would be to have the Federal Reserve Board give every person and corporation in the country a digital bank account. The idea is that this would be a largely costless way for people to carry on their normal transactions. They could have their paychecks deposited there every two weeks or month. They could have their mortgage or rent, electric bill, credit card bill, and other bills paid directly from their accounts.

This sort of system could be operated at minimal cost, with the overwhelming majority of transactions handled electronically, requiring no human intervention. There could be modest charge for overdrafts, that would be structured to cover the cost of actually dealing with the problem, not gouging people to make big profits.

Former Fed economist (now at Dartmouth), Andy Levin, has been etching the outlines of this sort of system for a number of years. The idea would be to effectively separate out the banking system we use for carrying on transactions from the system we use for saving and financing investment.

We would have the Fed run system to carry out the vast majority of normal financial transactions, replacing the banks that we use now. However, we would continue to have investment banks, like Goldman Sachs and Morgan Stanley, that would borrow on financial markets and lend money to businesses, as well as underwriting stock and bond issues. While investment banks still require regulation to prevent abuses, we don’t have to worry about their failure shutting down the financial system.

Not only would the shift to Fed banking radically reduce the risk the financial sector poses to the economy, it would also make it hugely more efficient. We waste tens of billions of dollars every year maintaining the structure of a financial system that technology has made obsolete.

The current system also makes some people incredibly rich, even when they fail disastrously. Greg Becker, the President and Chief Executive Officer, earned$9,922,000 in SVB’s 2021 fiscal year (the most recent year for which I could find the data). That would be roughly 684 times what a minimum wage worker would earn for a full year’s work. (Top execs at the largest banks can earn three or four times this amount.)

If we think that a worker has a 45-year working lifetime, then Mr. Becker pulls down more in a year than what a minimum wage worker would get in 15 working lifetimes. The CEOs at Lehman and Bear Stearns, two of the huge failed banks in the financial crisis, walked away with hundreds of millions of dollars for their work.

So, the basic story is that the government has designed a financial system designed to redistribute massive amounts of money to the rich. We could have a hugely more efficient system, but since that would end the gravy train for those at the top, it is not on the political agenda.

The Big Lie: Conservatives Don’t Like Big Government

As this bailout should make clear is that, contrary to what the media tell us, conservatives love big government. They just think that the focus of big government should be making the rich as rich as possible, not helping ordinary people and securing the economy and society.

To be clear, I do think this bailout was necessary given the fragility of the economy at present (unlike the 2008-09 bailout, that was sold with the lie that we faced a Second Great Depression). However, we need to get our eye on the ball here.

The idea that conservatives like the market and not the government is unadulterated crap. It is a myth that they use to conceal the ways they have rigged the market to make income flow upward. Unfortunately, virtually the entire left has agreed to go along with this absurd myth. Moments like the bailout of the rich depositors at SVB make the truth about conservatives and the market apparent to all. (And yes, this is the point of Rigged [it’s free].)

Joseph Stiglitz: Another Predictable Bank Failure

 ar 13, 2023

JOSEPH E. STIGLITZhttps://www.project-syndicate.org/commentary/predictable-silicon-valley-bank-collapse-by-joseph-e-stiglitz-2023-03?utm_source=Project+Syndicate+Newsletter&utm_campaign=47be6695f6-sunday_newsletter_03_19_2023&utm_medium=email&utm_term=0_73bad5b7d8-47be6695f6-93461969&mc_cid=47be6695f6&mc_eid=6194caf520

The collapse of Silicon Valley Bank is emblematic of deep failures in the conduct of both regulatory and monetary policy. Will those who helped create this mess play a constructive role in minimizing the damage, and will all of us – bankers, investors, policymakers, and the public – finally learn the right lessons?


NEW YORK – The run on Silicon Valley Bank (SVB) – on which nearly half of all venture-backed tech start-ups in the United States depend – is in part a rerun of a familiar story, but it’s more than that. Once again, economic policy and financial regulation has proven inadequate.
2
Lessons from the SVB Coll


The news about the second-biggest bank failure in US history came just days after Federal Reserve Chair Jerome Powell assured Congress that the financial condition of America’s banks was sound. But the timing should not be surprising. Given the large and rapid increases in interest rates Powell engineered – probably the most significant since former Fed Chair Paul Volcker’s interest-rate hikes of 40 years ago – it was predicted that dramatic movements in the prices of financial assets would cause trauma somewhere in the financial system.

But, again, Powell assured us not to worry – despite abundant historical experience indicating that we should be worried. Powell was part of former President Donald Trump’s regulatory team that worked to weaken the Dodd-Frank bank regulations enacted after the 2008 financial meltdown, in order to free “smaller” banks from the standards applied to the largest, systemically important, banks. By the standards of Citibank, SVB is small. But it’s not small in the lives of the millions who depend on it.

Powell said that there would be pain as the Fed relentlessly raised interest rates – not for him or many of his friends in private capital, who reportedly were planning to make a killing as they hoped to sweep in to buy uninsured deposits in SVB at 50-60 cents on the dollar, before the government made it clear that these depositors would be protected. The worst pain would be reserved for members of marginalized and vulnerable groups, like young nonwhite males. Their unemployment rate is typically four times the national average, so an increase from 3.6% to 5% translates into an increase from something like 15% to 20% for them. He blithely calls for such unemployment increases (falsely claiming that they are necessary to bring down the inflation rate) with nary an appeal for assistance, or even a mention of the long-term costs.1

Now, as a result of Powell’s callous – and totally unnecessary – advocacy of pain, we have a new set of victims, and America’s most dynamic sector and region will be put on hold. Silicon Valley’s start-up entrepreneurs, often young, thought the government was doing its job, so they focused on innovation, not on checking their bank’s balance sheet daily – which in any case they couldn’t have done. (Full disclosure: my daughter, the CEO of an education startup, is one of those dynamic entrepreneurs.)

While new technologies haven’t changed the fundamentals of banking, they have increased the risk of bank runs. It is much easier to withdraw funds than it once was, and social media turbocharges rumors that may spur a wave of simultaneous withdrawals (though SVB reportedly simply didn’t respond to orders to transfer money out, creating what may be a legal nightmare). Reportedly, SVB’s downfall wasn’t due to the kind of bad lending practices that led to the 2008 crisis and that represent a fundamental failure in banks performing their central role in credit allocation. Rather, it was more prosaic: all banks engage in “maturity transformation,” making short-term deposits available for long-term investment. SVB had bought long-term bonds, exposing the institution to risks when yield curves changed dramatically.


New technology also makes the old $250,000 limit on federal deposit insurance absurd: some firms engage in regulatory arbitrage by scattering funds over a large number of banks. It’s insane to reward them at the expense of those who trusted regulators to do their job. What does it say about a country when those who work hard and introduce new products that people want are brought down simply because the banking system fails them? A safe and sound banking system is a sine qua non of a modern economy, and yet America’s is not exactly inspiring confidence.

As Barry Ritholtz tweeted, “Just as there are no atheists in Fox Holes, there are also no Libertarians during a financial crisis.” A host of crusaders against government rules and regulations suddenly became champions of a government bailout of SVB, just as the financiers and policymakers who engineered the massive deregulation that led to the 2008 crisis called for bailing out those who caused it. (Lawrence Summers, who led the financial deregulation charge as US Treasury Secretary under President Bill Clinton, also called for a bailout of SVB – all the more remarkable after he took a strong stance against helping students with their debt burdens.)1

The answer now is the same as it was 15 years ago. The shareholders and bondholders, who benefited from the firm’s risky behavior, should bear the consequences. But SVB’s depositors – firms and households that trusted regulators to do their job, as they repeatedly reassured the public they were doing – should be made whole, whether above or below the $250,000 “insured” amount.

To do otherwise would cause long-term damage to one of America’s most vibrant economic sectors; whatever one thinks of Big Tech, innovation must continue, including in areas such as green tech and education. More broadly, doing nothing would send a dangerous message to the public: The only way to be sure your money is protected is to put it in the systemically important “too big to fail” banks. This would result in even greater market concentration – and less innovation – in the US financial system.

After an anguishing weekend for those potentially affected throughout the country, the government finally did the right thing – it guaranteed that all depositors would be made whole, preventing a bank run that could have disrupted the economy. At the same time, the events made clear that something was wrong with the system.

Some will say that bailing out SVB’s depositors will lead to “moral hazard.” That is nonsense. Banks’ bondholders and shareholders are still at risk if they don’t oversee managers properly. Ordinary depositors are not supposed to be managing bank risk; they should be able to rely on our regulatory system to ensure that if an institution calls itself a bank, it has the financial wherewithal to pay back what is put into it.

SVB represents more than the failure of a single bank. It is emblematic of deep failures in the conduct of both regulatory and monetary policy. Like the 2008 crisis, it was predictable and predicted. Let’s hope that those who helped create this mess can play a constructive role in minimizing the damage, and that this time, all of us – bankers, investors, policymakers, and the public – will finally learn the right lessons. We need stricter regulation, to ensure that all banks are safe. All bank deposits should be insured. And the costs should be borne by those who benefit the most: wealthy individuals and corporations, and those who rely most on the banking system, based on deposits, transactions, and other relevant metrics.

It has been more than 115 years since the panic of 1907, which led to the establishment of the Federal Reserve System. New technologies have made panics and bank runs easier. But the consequences can be even more severe. It’s time our framework of policymaking and regulation responds.

Dean Baker on SVB - Its a billionaire bailout; and it's Trump's Fault

 

There are two key points that people should recognize about the decision to guarantee all the deposits at Silicon Valley Bank (SVB):

• It was a bailout

• Donald Trump was the person responsible.

The first point is straightforward. We gave a government guarantee of great value to people who had not paid for it.

We will get a lot of silly game playing on this issue, just like we did back in 2008-09. The game players will tell us that this guarantee didn’t cost the government a penny, which will very likely end up being true. But that doesn’t mean we didn’t give the bank’s large depositors something of great value.

If the government offers to guarantee a loan, it makes it far more likely that the beneficiary will be able to get the loan and that they will pay a lower interest rate for this loan. In this case, the people who held large uninsured deposits at SVB apparently decided that it was better, for whatever reason, to expose themselves to the risk by keeping these deposits at SVB, rather than adjusting their finances in a way that would have kept their money better protected.

This would have meant either parking their deposits at a larger bank that was subject to more careful scrutiny by regulators, or adjusting their assets so that they were not so exposed to a single bank. They also could have taken ten minutes to examine SVB’s financial situation, which was mostly a matter of public record.    

For whatever reason, the bank’s large depositors chose to expose themselves to serious risk. When their bet turned out badly, they in effect wanted the government to provide the insurance that they did not pay for.

This brings us to the second point; this is Donald Trump’s bailout. The reason this is a bailout is that the government is providing a benefit that the depositors did not pay for. It also is, in effect, a subsidy to other mid-sized banks, since it tells their depositors that they can count on the government covering their deposits, even though they are not insured and the bank is not subject to the same scrutiny as the largest banks.

This is where the fault lies with Donald Trump. It was his decision to stop scrutinizing banks with assets between $50 billion and $250 billion that led to the problems at SVB.  

Prior to the passage of this bill, a bank the size of SVB would have been subject to regular stress tests. A stress test means projecting how a bank would fare in various bad situations, like the rise in interest rates that apparently sank SVB.

If regulators had subjected to SVB to a stress test, they would have almost surely recognized its problems. They then would have required it to raise more capital and/or shed deposits.

But Trump pulled the regulators off the job. This is wrongly described as “deregulation.” It isn’t.

Deregulation would mean both eliminating the scrutiny of SVB and ending insurance for the bank. (In principle that would mean ending all deposit insurance, not the just the insurance for large accounts that is at issue here.)

What happened in 2018 was effectively allowing SVB to still benefit from insurance without having to pay for it. It is comparable to telling drivers that they don’t have to buy auto insurance, but will still be covered if they are in an accident. Or, perhaps a better example would be telling a restaurant that it is covered by fire insurance, but it doesn’t have to adhere to safety standards.

It is dishonest to describe this as “deregulation.” It is the government giving a subsidy to the banks in question. It is understandable that the banks prefer to describe their subsidy as deregulation, but it is not accurate.

Anyhow, this bailout is the Donald Trump bailout. He touted the 2018 bill when he signed it. We are now seeing the fruits of his action.  

Dean Baker -- beating the Post --

The $119 Billion Spent on Food Stamps Last Year Was 1.9 Percent of Federal Spending, but You All Knew That, Right?

via Patreon

 The $119 Billion Spent on Food Stamps Last Year Was 1.9 Percent of Federal Spending, but You All Knew That, Right?

In a lengthy piece on Republican proposals for cutting the food stamp program, the Washington Post found room to tell us that we spent $119 billion on the food stamps last year. It did not find any room to put this figure in a context that might make it meaningful to its readers.

Yeah, $119 billion is a lot of money, more than almost anyone other than Elon Musk (pre-Twitter) will ever see, but is it a big deal for the federal government? We can debate what is “big” or “small,” but the federal government spent$6,272 billion last year, which means that food stamp program accounted for a bit less than 1.9 percent of total spending.

If the Republicans cut the program by 20 percent, which would be a large cut, it would reduce federal spending by $24.8 billion, or a bit less than 0.4 percent. It would have been helpful to provide this context, since it would make the point clear that Republicans will not get very far towards balancing the budget with cuts to the food stamp program.

It also would have been worth noting that research on the proposal for strengthening food stamp work requirements, a measure that is discussed at length in the piece, shows that these requirements have no impact on work. They do reduce the number of people getting benefits.

This research indicates that if the point of these requirement is to encourage work, they are not successful. However, if the point is to reduce the number of people benefitting from the program, the requirements will have this effect.

JOSEPH E. STIGLITZ: How Not to Fight Inflation

 

via Project Syndicate, Jan 26, 202

A careful look at US economic conditions supports the view that inflation was driven mainly by supply-side disruptions and shifts in the pattern of demand. Given this, further interest-rate hikes will have little to no effect – and will cause far-reaching problems of their own.


NEW YORK – Despite favorable indices, it is too soon to tell whether inflation has been tamed. Nonetheless, two clear lessons have emerged from the recent price surge.



First, economists’ standard models – especially the dominant one that assumes the economy always to be in equilibrium – were effectively useless. And, second, those who confidently asserted that it would take five years of pain to wring inflation out of the system have already been refuted. Inflation has fallen dramatically, with the December 2022 seasonally adjusted consumer price index coming in just 1% above that for June.

There is overwhelming evidence that the main source of inflation was pandemic-related supply shocks and shifts in the pattern of demand, not excess aggregate demand, and certainly not any additional demand created by pandemic spending. Anyone with any faith in the market economy knew that the supply issues would be resolved eventually; but no one could possibly know when.

After all, we have never endured a pandemic-driven economic shutdown followed by a rapid reopening. That is why models based on past experience proved irrelevant. Still, we could anticipate that clearing supply bottlenecks would be disinflationary, even if this would not necessarily counteract the earlier inflationary process immediately or in full, owing to markets’ tendency to adjust upward more rapidly than they adjust downward.

Policymakers continue to balance the risk of doing too little versus doing too much. The risks of increasing interest rates are clear: a fragile global economy could be pushed into recession, precipitating more debt crises as many heavily indebted emerging and developing economies face the triple whammy of a strong dollar, lower export revenues, and higher interest rates. This would be a travesty. After already letting people die unnecessarily by refusing to share the intellectual property for COVID-19 vaccines, the United States has knowingly adopted a policy that will likely sink the world’s most vulnerable economies. This is hardly a winning strategy for a country that has launched a new cold war with China.

Worse, it is not even clear that there is any upside to this approach. In fact, raising interest rates could do more harm than good, by making it more expensive for firms to invest in solutions to the current supply constraints. The US Federal Reserve’s monetary-policy tightening has already curtailed housing construction, even though more supply is precisely what is needed to bring down one of the biggest sources of inflation: housing costs.

Moreover, many price-setters in the housing market may now pass the higher costs of doing business on to renters. And in retail and other markets more broadly, higher interest rates can actually induce price increases as the higher interest rates induce businesses to write down the future value of lost customers relative to the benefits today of higher prices.

To be sure, a deep recession would tame inflation. But why would we invite that? Fed Chair Jerome Powell and his colleagues seem to relish cheering against the economy. Meanwhile, their friends in commercial banking are making out like bandits now that the Fed is paying 4.4% interest on more than $3 trillion of bank reserve balances – yielding a tidy return of more than $130 billion per year.

To justify all this, the Fed points to the usual bogeymen: runaway inflation, a wage-price spiral, and unanchored inflation expectations. But where are these bogeymen? Not only is inflation falling, but wages are increasing more slowly than prices (meaning no spiral), and expectations remain in check. The five-year, five-year forward expectation rate is hovering just above 2% – hardly unanchored.

Some also fear that we will not return quickly enough to the 2% target inflation rate. But remember, that number was pulled out of thin air. It has no economic significance, nor is there any evidence to suggest that it would be costly to the economy if inflation were to vary between, say, 2% and 4%. On the contrary, given the need for structural changes in the economy and downward rigidities in prices, a slightly higher inflation target has much to recommend it.

Some also will say that inflation has remained tame precisely because central banks have signaled such resolve in fighting it. My dog Woofie might have drawn the same conclusion whenever he barked at planes flying over our house. He might have believed that he had scared them off, and that not barking would have increased the risk of the plane falling on him.


One would hope that modern economic analysis would dig deeper than Woofie ever did. A careful look at what is going on, and at where prices have come down, supports the structuralist view that inflation was driven mainly by supply-side disruptions and shifts in the pattern of demand. As these issues are resolved, inflation is likely to continue to come down.

Yes, it is too soon to tell precisely when inflation will be fully tamed. And no one knows what new shocks await us. But I am still putting my money on “Team Temporary.” Those arguing that inflation will be largely cured on its own (and that the process could be hastened by policies to alleviate supply constraints) still have a much stronger case than those advocating measures with obviously high and persistent costs but only dubious benefits.

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.