Category Archives: Scott Sumner is Coherent

Thoughts on Inflation

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Scott Sumner writes,

Take a look at the fiscal situation in Europe and Japan, and then the inflation rates in Europe and Japan, if you are still skeptical that monetary policy drives inflation.

My comments:

1. This sounds like a good retort to a view that government deficits determine inflation, because deficits are high in those countries. However, it might also be a retort to the view that money growth determines inflation.

2. I think that you want to hear that “X determines inflation.” The most common view of X is that it is money growth. And when I say that it is not money growth, you want to jump to the conclusion that I must mean that X is the budget deficit. But my troubling answer is that “there is no X.”

3. Prices have meaning in an economy because people expect to wake up tomorrow to find prices very similar to what they find today. Money has value today because people expect money to still have value tomorrow. Thus, I say that money and prices are a consensual hallucination.

4. When have seen money and prices break out of a stable pattern? During hyperinflations, we see governments unable to borrow at reasonable interest rates but still determined to run deficits. Then they print so much money that prices lose their meaning.

5. In general, then there is a regime with very low and stable inflation, and there is another regime with very high and variable inflation, and a necessary condition for the latter is high budget deficits. However it takes more than high budget deficits to get to the high-inflation regime. It takes a deficits that reach a point where the credit markets attach a punitively-high risk premium to the government’s debt.

6. The biggest puzzle for this point of view is an intermediate-inflation case, such as the U.S. in the 1970s. I am left with hand-waving, like saying that wage-price controls created a backlash, where people tried to charge as much as they could, while they could, before they got hit with wage-price controls again. Or the rise in the price of oil created an “inflation psychology.” However, I take a Fischer Black view of monetary policy in that period, which is that money is passively supplied to meet the need for transactions. Remember that the 1970s was also a period in which “money” as we knew it was radically changed by money market funds and the erosion of interest ceilings on deposits.

7. In the 1960s, monetarists wanted to set targets for money growth. Today, there are no money-growth targeters left. That is a tacit admission that there is no reliable relationship between money and other nominal variables.

Did Scott Sumner Stumble?

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He wrote,

Unfortunately, the Fed doesn’t get to decide the path of interest rates. It looks like they do, but that’s a cognitive illusion. The bond market determines the path of interest rates, reflecting factors such as global credit markets, as well as NGDP growth and the level of NGDP in the US.

I am fond of Winston Churchill’s remark about someone who “stumbles across the truth, but then picks himself up as if nothing happened.”

That is what I feel took place here. I think that the implication of the quoted sentences is that it is the bond market, not the Fed, that is in control. As I write in the Book of Arnold, the Fed is just another bank. It has no more ability to “target” macroeconomic variables than does Citibank. Of course, Citibank is free to set a ridiculous interest rate for its on loans and deposits, and so is the Fed. And if the Fed set a ridiculous rate on reserves (right now negative 1 percent would be ridiculous, as would positive 5 percent) lots of crazy things would happen. With a negative rate on reserves, cash would dominate reserves as an asset. With a rate of 5 percent, reserves would dominate pretty much any loan as an asset.

But leave aside such hypotheticals. The Fed is not the macroeconomic driver it is made out to be.

Confirmation Bias, Illustrated

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Scott Sumner writes,

And I just want to make sure readers are not getting lost in the weeds here. This is not one of those “he said, she said” where reasonable people can disagree on whether the PCE or CPI is a better price index. This is a pay/productivity gap being invented by using the slowing moving price index (NDP, which is similar to the PCE) to make worker productivity look better, and the faster moving price index (CPI) to make real wages look lower. That’s not kosher. You need to use the same type of index for both lines on the graph.

Brad DeLong writes,

I score this for Larry Mishel….

Pointer from Mark Thoma.
DeLong and Sumner are on opposite sides, and each is certain.

Fundamentally, I think that the reason that this happens is that economic propositions are not falsifiable. They only hold “other things equal,” and other things are never equal. A measure of worker productivity that is reasonable according to one person’s framework is not reasonable according to another person’s framework.

If you continue to insist that economics is a science in spite of the non-falsifiability of propositions, you end up deciding that those who disagree with you are evil and anti-science. As I say in the Book of Arnold, you end up wallowing in confirmation bias.

On this particular, by the way, my inclination is to agree with Sumner. That may be political bias on my part. But also, I think you would be seeing a lot of other dramatic things happening if productivity were outstripping wage growth. Very high demand for labor. A big improvement in international competitiveness, leading to large trade surpluses. etc. At the minimum, it seems to me that Mishel and DeLong owe us some comment on why these other developments do not seem to have taken place.

Contrary to what you see in online debates “this one chart” is never a debate-settler. You don’t make a convincing case with one chart. You need lots of disparate, corroborating evidence.

Puzzling Statistics from the GDP Factory

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Scott Sumner writes,

This 4 and 1/2 years of sub-2% growth (on average) occurred during a period of rapidly falling unemployment, and above trend employment growth

The implications for productivity growth are terrible. Supposedly, firms got rid of their ZMP workers during the recession. Are we saying that subsequently they were hired back???

Again, I do not trust data that treats the entire economy as a GDP factory. If I had to bet, I would go with the Goldman Sachs view that inflation is over-stated, which means that real GDP growth has been under-stated.

Scott Sumner on Greece

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He writes,

To summarize, given that Greece has chosen to use a non-market economic model, its done amazingly well. It’s done something no other sizable non-market economy has done–achieved developed country status without vast oil wealth. This may partly reflect its long-time inclusion in the EU, partly the fact that it is both small in population and has highly desirable tourist attractions, and partly the entrepreneurial skill of its citizens. But for whatever reason it is vastly outperforming expectations. Greece is doing shockingly well, given its economic model.

Read the entire post, which is interesting. However, my guess is that the Heritage economic freedom index makes Greece seem worse than it really is. However, the Fraser economic freedom index also makes Greece look bad.

But I am going to guess that it is much easier for an international company to do business in Greece than in other countries with low indices of economic freedom. And if that is true, there is probably more competitive life in the Greek economy than there is in those other countries.

The Hopeless Argument over Productivity Stagnation

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Scott Sumner writes,

Do I believe these numbers? Not really, as I don’t believe the government’s price level numbers. Lots of this “growth” occurred in the 1990s and is just Moore’s Law in computers, not the US actually producing more “stuff.” I don’t consider my current office PC to be 100 times better than my 1990 office PC.

Well, Scott, Your current PC’s hard disk capacity is measured in gigabits. Your 1990 PC’s hard drive was measured in megabits. Let me know which of your applications and documents to wipe out to get what’s on your current office PC to fit on your 1990 PC.

Oh, and have fun surfing the net with that 2400 baud modem. That is, if you can figure out how to install a TCP-IP stack on Windows.

In fact, as James Pethokoukis points out, there are those who argue that the official statistics have more recently under-stated the improvement in computers. (The Commerce Department numbers no longer track Moore’s Law.)

Of course, nobody is arguing that we don’t have better personal computers. What we are trying to assess is the amount of the multiple. But I do not know how to make that assessment. Or what fraction (multiple) of a 1990 PC’s value to assign to a smart phone.

To argue for or against stagnation, you have to assign a value to total output in a year and divide it by what you think is an appropriate measure of (labor) input. Then you have to take the second difference of that ratio. Cyclically-adjusted, of course.

Seems futile to me.

Relate this to Tobin’s q

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Justin Fox reported,

>Ocean Tomo calculates intangible assets simply “by subtracting the tangible book value from the market capitalization of a given company or index,” so the rise in intangibles since the 1970s is in part just a reflection of rising stock market valuations. But that’s not all it is: the cyclically adjusted price-earnings ratio on the Standard & Poor’s 500 Index has risen about 2 1/2 times since 1975, while the intangibles increase has been almost fivefold.

Tobin’s q is the ratio of the stock price to the replacement cost of capital. I am tempted to write:

q = P/K = (P/E)(E/K), where P is the stock price, E is earnings, and K is capital.

As Fox points out, a fair amount of the rise in q since the late 1970s comes from a higher P/E ratio. But I gather that if you think of K as tangible capital, then E/K also has soared.

Fox’s piece was mentioned in Scott Sumner’s discussion of what I called the fifth force. But Robin Hanson got me to take a look.

I would note that intangibles in the economy include not just firm-specific intangibles but also general intangibles that lead to better patterns of specialization and trade. Institutional improvements in India and China, as well as lower transportation and communication costs, come to mind.

Tyler Cowen has much more, including a hypothesis that accounting issues are involved.

Regulation as a Fifth Force

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Scott Sumner writes,

Building restrictions are increasing rental income as a share of national income. Intellectual property rights are barriers to entry that tend to create a winner-take-all situation (although other factors like network effects also play a role.) And other types of regulations (financial, human resources, etc.) are especially burdensome for small firms, and this favors the growth of inequality-intensive large firms.

Megan McArdle writes,

Homeowners in low-density neighborhoods will fight like tigers to preserve what they have. We’ve given them the legal tools to frequently win that fight — and if you try to take those tools away, they’ll fight that, too.

In the Four Forces story, gentrification is driven by the New Commanding Heights and bifurcated family patterns. Universities and hospitals replace manufacturing firms as the leading enterprises in cities. They hire marshmallow-test winners, some of whom want to live near where they work. Other marshmallow-test winners, looking to marshmallow-test-winner mates, also move into cities. These gentrifiers like restaurants and trendy shops, but otherwise they want to try to re-create suburban living, with low-density housing and easy biking.

Four Forces Watch: Larry and the Robots

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Mike Konczal writes,

There’s been a small, but influential, hysteria surrounding the idea is that a huge wave of automation, technology and skills have lead to a massive structural change in the economy since 2010.

He goes on to say that Larry Summers has demolished this notion, by pointing out that we have not seen rapid productivity growth over this period.

This looks suspiciously like a straw man to me. I am about as big a believer as there is in the significance of structural change, but I do not see a “huge wave of automation” that has taken place over the past five years.

My thoughts:

1. What I do see are the four forces: the New Commanding Heights (demand for physical goods tapering off while demand for health care and education rises); demographic dispersion–what Charles Murray calls Coming Apart; factor-price equalization (American workers confronting stiffer foreign competition); and Moore’s Law (improvements in computers and communication).

2. These four forces have been operating for decades, and there was nothing peculiar about the 2010-2014 period. The New Commanding Heights force has been operating for more than 50 years. The demographic dispersion force got started about 50 years ago, but for the first 25 years or so the impact was small. Instead, the most notable demographic change from 1965 to 1990 was the increase in female labor force participation. Factor-price equalization had to await liberalization of the economies of China and India, which did not really get started until the 1980s and even then took a while to have an impact. Moore’s Law was articulated in the 1960s, but as recently as the late 1980s Robert Solow’s quip that we see computers everywhere but in the productivity statistics seemed apt.

3. The four forces cause the economy to move in the direction depicted in Neal Stephenson’s The Diamond Age. In that novel, we see Thetes, who work very little and live inexpensively (think of a consumption basket dominated by big-screen TVs). And we see Vickies, who work creatively and hard in order to consume unnecessary luxury services (think of high-tuition education, high-end precautionary medical care, and exotic vacations).

4. Larry Summers looks at the last twenty years and sees a “secular stagnation” in aggregate demand, interrupted by the dotcom bubble and then the housing bubble. Instead, I look at the last 15 years and see The Diamond Age starting to become reality. The housing bubble gave Thetes the impression of being wealthier than they really were, and when it popped they had to adjust to reality. (Although one could argue that, illusions aside, they did not lose home equity, because they did not have any in the first place.) The process of adjusting to reality can take time–look at Greece.

5. Consider the statement, “If we had more aggregate demand, then more non-high-skilled people would have jobs and wages would be higher.”

I do not believe that statement, Instead, I believe that nothing short of direct intervention in labor markets (government make-work jobs and wage subsidies, or you could hope for an impact from changes in means-tested programs that reduce implicit marginal tax rates) will change macroeconomic outcomes. But as long as jobs and wages are lower than what Summers/Krugman/Sumner think they should be, there is no way to falsify the statement that “if we had more aggregate demand….” The alleged lack of jobs and wages can be viewed from their perspective as proof that there is insufficient aggregate demand. There is no measure of “sufficient aggregate demand” that exists independently from the desired result of a larger wage bill. Indeed, Sumner would say that the wage bill is a measure of aggregate demand that can be targeted by the Fed.

Facts do not change Minds

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Scott Sumner tries,

Here we have not only the economy reacting to the Great Austerity Experiment better than predicted by the CBO, but even far better than predicted if there were no austerity.

Does this ring a bell? Do you remember the Great Stimulus Experiment of 2009? The time that the unemployment rate didn’t just rise much more than expected in response to the stimulus, it rose far more than expected under the alternative scenario of no stimulus!

Do you think that Jared Bernstein is going to change his mind because of these facts? I don’t.

Granted, I don’t think that anyone should completely change their mind based on macroeconomic observations. There is too much causal density to take any empirical evidence as definitive. But by the same token, no one is entitled to hold a view of macroeconomics without a scintilla of doubt. I wish that more commentators were willing to allow that there is a significant probability that they are wrong when it comes to macro.