Monday, December 29, 2014

The Opportunity Cost of Driving Your Car Has Never Been Lower

In August, I posted an item showing how many miles you could drive your car on an hour’s wages. At that time, the average US price for gasoline was $3.60 per hour. Based on an average wage for production and nonsupervisory workers of $20.61 per hour and an average fleet economy of 24.3 miles per gallon, it turned out that an hour’s wages would buy you enough gas to drive 139 miles.

That was a lot better than the “good ol’ days.” Back in the time of the Model T (17 mpg), a production worker earning 50 cents an hour could buy just 2 gallons of gasoline, enough for a pitiful 34 miles. By the depths of the Great Depression, that had crept up to 49 miles, mainly because gas was cheaper. A post-WWII Ford got even worse mileage than a Model T, but wages were up, so miles driven per hour worked had risen to 123. Miles driven per hour worked peaked at 284 in 1998, but after that, rising gasoline prices and stagnant wages sent the cost of driving up again.

Until now. Over the past several months, the price of regular grade gasoline has plummeted to $2.40 per gallon, according to government data for the week ending December 22. That puts the fleet average at 209 miles per gallon and rising. However, the fleet average includes all cars on the road—not just new models. Even if you don’t drive an electric or a hybrid, you can do a lot better than 24.3 miles per gallon if you drive the best of today's technology. Earlier this year I bought a peppy little Ford Fiesta with a high-tech, 3 cylinder, 1 liter, supercharged gasoline engine. The EPA rates it at 36 miles per gallon, although it does quite a bit better than that for me. At $2.40 per gallon, the average wage would buy you enough gas to drive the Fiesta 311 miles, an all-time record.

Here’s a new version of my chart. This time, just for variety, I’ve inverted the vertical axis to show minutes worked per mile driven, rather than miles driven per hour worked. Take a look at that trend line for selected Ford models, and get ready to hit the road. It’s never been cheaper!

Follow this link to view or download a slideshow version of this post suitable for classroom presentation

Saturday, December 27, 2014

Behind the Fall of Russia's Ruble: Inflation, Oil Prices, Sanctions, and More

Russia’s economy is in trouble. Growth has come to a halt. A recession looms in 2015. Inflation, interest rates,
and capital flight are up. The government’s budget is under strain. More than any of these, what makes the headlines is the plunge of the ruble, which, at one point in mid-December, had lost half of its value against the dollar in less than a year. What lies behind the weakness of the ruble? Is it harmful in itself, or is it better understood as a symptom of other problems? What options are open to Russian policymakers as they struggle to manage their currency’s descent?

Accounting for inflation
As in many discussions of macroeconomics, we first need to deal with the effects of inflation. Economists use the term nominal to refer to quantities stated in the ordinary way  and  real to quantities that are adjusted to for inflation. Real wages are the most familiar example: We all understand that if our boss raises our nominal wage from $10 per hour to $12 per hour, but at the same time inflation adds 20 percent to the price of everything we buy, our true purchasing power has not changed.

A similar principle applies to exchange rates. Other things being equal, a change in the nominal exchange rate of the ruble would mean change in the competitiveness of goods the country produces for export and those it produces for sale at home in competition with imports. However, inflation also has an impact on competitiveness—one that can either amplify or offset changes in the nominal exchange rate. >>>Read more

Follow this link to view or download a slideshow tutorial with more information on real and nominal exchange rates

Wednesday, December 24, 2014

US GDP Grows at 5 Percent in Q3 2014, Best of the Recovery

The US economy grew at a 5 percent annual rate in Q3 2014, the fastest rate of the recovery, according to the third estimate released yesterday by the Bureau of Economic Analysis. That is an upward revision from the 3.9 percent of the second estimate. It comes on the heels of a 4.6 percent growth rate in Q2, making it the fastest six-month growth spurt since the 1990s.

Consumer spending led the way, contributing 2.21 percentage points to the quarterly growth. Investment spending contributed 1.18 percentage points to GDP growth. Business fixed investment accounted for most of that. Residential investment was below average in the quarter, and inventories were essentially unchanged. Exports continued to expand and imports fell slightly. A spurt of defense spending raised the contribution of the government sector.

Inflation, as measured by the national accounts, remained moderate. The broadest measure of inflation, the GDP deflator, rose at an annual rate of 1.4 percent in the quarter. The deflator for personal consumption expenditure rose at a 1.2 percent rate. The PCE deflator is especially important because it is the preferred inflation indicator for the Federal Reserve. PCE inflation remains well below the Fed's 2 percent target.

The BEA will release its advance estimate for Q4 GDP at the end of January. Employment indicators for the final quarter have been strong, so it is likely that growth will continue through the end of the year, although most forecasters expect a slightly slower pace than in Q3.

Follow this link to view or download a brief slideshow with detailed charts of the latest GDP numbers.

Saturday, December 6, 2014

As Jobs Surge, Term Structure of US Unemployment Remains Distorted

The US economy added 321,000 payroll jobs in November, the best in almost three years. Strong upward revisions to September and October numbers boosted the 12-month gain to 2,756,000, a new high for the recovery.

The official unemployment rate was unchanged at 5.8 percent. The broad unemployment rate, U-6, which takes into account discouraged workers and involuntary part-time workers, fell to a new low of 11.4 percent.

Although these data indicate a return to normal in many respects, distortions remain. One of the most conspicuous is an elevated rate of long-term unemployment. As the chart shows, the term structure of unemployment remains substantially different from the prerecession pattern:

On the one hand, we see that the short-term unemployment rate, made up of people who are out of work for four weeks or less, has not only returned to its pre-recession level, but has actually dropped below it. In 2007, short-term unemployment averaged 1.66 percent of the labor force; now it is 1.61 percent. Most unemployment in this category is voluntary, representing a minimum time needed for job search, interviews, moving, and perhaps a quick vacation between jobs. It includes people who find work soon after entering or reentering the labor force or find a new job quickly after leaving a former one. >>>Read more

Follow this link to view or download a brief slideshow with charts of the latest US employment situation

Monday, November 24, 2014

Universal Basic Income vs. Unemployment Insurance: Which is the Better Safety Net?

A universal basic income (UBI) and unemployment insurance (UI) are two possible forms of social insurance for an economy in which job loss is a significant risk. Which works better? How generous should either program be? Would a combination of the two be best of all? These are the questions that Alice Fabre, Stéphane Pallage, and Christian Zimmermann (FPZ) address in a recent working paper from the Research Division of the St. Louis Fed.

The answers that the authors give to these questions will disappoint UBI supporters:
  • When compared head-to-head, UI is a better social safety net than a UBI.
  • In an economy with no unemployment insurance, a UBI would be better than nothing, but the optimal level would be quite low, about $2,000 per person per year for the United States.
  • No combination of UI and a UBI is superior to UI alone.
Skeptics are likely to seize on these findings, but in my view, they do not support a blanket rejection of a UBI. Instead, as I will explain, they highlight how important it is for UBI proponents to pay attention to details of financing and program design. >>>Read more

Thursday, November 13, 2014

The Economics and Politics of a Variable, Price-Smoothing Energy Tax

Oil is down again. The price of Brent crude, which moves US gasoline prices, is below $100 a barrel
for the first time (save a single month) in five years.

Why am I not celebrating? No, I don’t own a portfolio of oil stocks. Instead, I am afraid that the recent fall in world oil prices may mean that we have missed our best chance for a better energy policy.
What would a better energy policy look like?

A better energy policy, as I have explained many times before, would be one that required people to pay the full costs of the energy they use. That would include not only costs of production, but also the external costs arising from harmful spillover effects. By and large, energy users in the United States now pay only costs of extraction, processing of fossil fuels, and generating of electricity. The result is that they use energy wastefully, pushing their consumption beyond the point where the benefits from using an additional unit fall below its full costs. (For details, see the links at the end of this post.)

And no, the full-cost argument is not just about climate change. Personally, I think there is a strong argument for counting climate change among the spillover effects of fossil fuel use, but if you are a skeptic, there are plenty of other, very tangible external costs to consider. >>Read more

Follow this link to view or download a slideshow on the economics of a price-smoothing oil tax

Saturday, November 8, 2014

US Job Growth Running at Highest Level in Six Years, Unemployment Falls to New Low of 5.8 Percent

The first major report on the health of the US economy for the fourth quarter of 2014 showed
continued gains in the job market. Payroll jobs were up by more than 200,000 for the ninth month in a row. With upward revisions to August and September data, the twelve-month jobs gain was 2,646,000. Annual job gains are now running at their strongest level since the peak of the pre-recession boom. The gains were broadly based, with construction, manufacturing, services and government all adding workers.

A separate survey of households also showed strong gains, with the unemployment rate falling to 5.8 percent. A broader measure of unemployment, U-6, which takes into account involuntary part-time workers and discouraged workers, fell to 11.5 percent. Both figures were new lows for the recovery. The civilian labor force grew by 416,000.>>>Read more

Follow this link to view or download a slideshow with additional charts from the latest jobs report

Tuesday, November 4, 2014

Why Quantitative Easing Did Not Work According to the Textbook Model

The Fed has declared an official end to quantitative easing. It is a logical time to ask, did QE work? gives the honest answer in a recent post on Vox: “It’s very, very hard to know.”
Danielle Kurtzleben
Still, we do know three things that QE did not do. These are worth pointing out, especially since back when QE was just getting under way, there were people who expected that QE 2 would do all of them.

1. QE did not work according to the textbook model
One thing was never in doubt.  As the Fed added massively to its assets, QE would cause an equally massive increase in the monetary base—the sum of bank reserves and currency that accounts for the bulk of its liabilities.

Some economists used to refer to the base as high powered money. It got that name from a familiar textbook model, according to which two simple ratios link the monetary base to the rest of the economy. One is the money multiplier, which is the ratio of ordinary money (M2) to the monetary base. The other is the ratio of nominal GDP to the M2 money stock, known as the velocity of circulation of money, or just velocity, for short.

If the money multiplier and velocity were constants, then the monetary base would be high-powered indeed. Any increase in the base (which the Fed can manipulate at will) would cause a proportional increase in nominal GDP. The only thing left to determine would be how much of the change in nominal GDP would express itself as an increase in real output and how much as inflation.>>>Read more

Follow this link to view or download the slideshow "Quantitative Easing and the Fed 2008-2014: A Tutorial"

Thursday, October 30, 2014

US Economy Grows at 3.5 Percent in Q3 2014 for Best Six-Month Run of Recovery

The Bureau of Economic Analysis reported today that US GDP grew at a 3.5 percent annual rate in
the third quarter of 2014. Combined with the strong 4.6 percent showing in Q2, the six-month average of 4.05 percent is the best half-year performance of the recovery. Even including the 2.1 percent annual rate of decrease for Q1, growth over the past full year was better than the average since the recession bottomed out in mid-2009.

Net exports were one of the biggest contributors to growth in the quarter. Net exports, which had been a negative factor in the otherwise strong second quarter, accounted for 1.32 percentage points of growth—more than a third of overall GDP growth for Q3. Export performance remained strong, as it has through most of the recovery, but the big turnaround was in imports. Imports have a negative sign in the national accounts, so the -1.77 percentage points for Q2 reflected an increase in imports for that quarter, while the +.29 percentage points for Q3 indicates a decrease in imports.

Another source of growth in Q3 was a .83 percentage point contribution by the government sector. Most of that was an unusual .69 percentage point growth of national defense consumption expenditure. Defense expenditures tend not to be spread evenly from quarter to quarter. They can account for abrupt jumps in the contribution of the federal government to GDP growth, as they also did in Q4 of 2012 (see the following chart). A recovering state and local government sector again made a positive contribution to GDP growth in Q3, as it has for six of the past seven quarters.>>>Read more

Follow this link to view or download a short slideshow with additional charts based on the latest US GDP release

Monday, October 20, 2014

Why Should Europe (or Anyone) Fear Deflation?

Europe is fearful as it teeters on the brink of deflation. As the chart shows, September consumer prices in the eurozone were just 0.3 percent higher than in the same month a year earlier. That is far below the 2 percent inflation target set by the European Central Bank (ECB). Five countries were already experiencing deflation, and inflation was at zero in three others.
Still, despite all the gloomy deflation headlines, the most common question I get about deflation is, “So what?” If inflation is bad, why isn’t deflation  good?  Why should we do anything but celebrate if the prices of goods and services fall steadily year after year, and the value of our money rises accordingly? In this post, the first of two parts, I will try to explain just why a majority of economists think deflation is bad. In the second part, I will look at the views of a minority who think that deflation is actually a good thing, at least sometimes. >>>Read more

Tuesday, October 7, 2014

The Economic Future of Eastern Ukraine ("Novorossiya")

Last May, I posted an item on the economic situation in the rebellious regions of Eastern Ukraine, or
“Novorossiya” (New Russia), to use the term increasingly favored by separatists and  their Russian sponsors. Novorossiya was the name of a province of Tsarist Russia that occupied much of the southern part of present-day Ukraine, stretching all the way to Odessa. At present, the separatist “Federal State of Novorossiya,” consisting of parts of Donetsk and Luhansk oblasts, lays claim to only a small slice of historical Novorossiya. As the map shows, expansion of the separatist-held territory toward the south-west would provide Russia with an overland route to Crimea.
In that earlier post, I outlined three possible outcomes of the conflict in Ukrainian Donbas, the heavily industrialized area around the cities of Donetsk and Luhansk that is the only part of historical Novorossiya that the separatists control as of early October. One was that Kiev would re-establish full control over the region with minimal concessions to local autonomy. The second was full Russian annexation, as of Crimea. The third was the emergence of yet another zone of frozen conflict like those of Transdniestria, Abkhazia, South Ossetia, and Nagorno-Karabakh.

Although the fighting has not yet entirely stopped, the conflict is rapidly congealing, making the third variant the most likely. It is time for an update, giving closer attention to that outcome. What would be the economic implications of a frozen conflict for the region itself, for the rest of Ukraine, and for Russia? >>>Read more

Sunday, October 5, 2014

US Unemployment Rate Falls to 5.9 Percent on Strong Job Gains

The US unemployment rate fell to 5.9 percent in September, dropping below 6 percent for the first
time in more than six years. The decrease was powered, in part, by strong growth of payroll jobs. Payroll jobs increased by 248,000 in September, well above the average for the year to date. In the same report, the BLS revised the weak August job gain upward from 142,000 to 180,000, and the July gain from 212,000 to 243,000.

In addition to the standard unemployment rate, the BLS also publishes a broader measure of labor market distress known as U-6. That measure takes into account discouraged workers, others who are marginally attached to the labor force, and people who are working part time but would prefer full-time work. U-6 decreased to 11.8 percent in September, also a six-year low. The unemployment rates are based on a survey of households that differs in several respects from the survey of employers from which payroll job numbers are drawn. According to the household survey, total employed workers increased by 232,000 in September while the number of unemployed decreased by 329,000. The civilian labor force decreased by 97,000, and the employment population ratio was unchanged. >>>Read more

Follow this link to view or download a brief slideshow with charts of the latest employment data

Friday, September 26, 2014

As Exports Soar, US Economy Closes in on Fed's Targets

Revised data released today by the Bureau of Economic Analysis show that the US economy grew at a 4.6 percent annual rate in the second quarter of 2014, even faster than the 4.2 percent previously
estimated. That was the most rapid quarterly growth since Q4 2010.

Much of the upward revision was due to the growth of exports, which also turned in their best performance in four years. The strong performance of the export sector is especially noteworthy in view of slow growth or recession in many US trading partners and the strong dollar, which had not yet begun to weaken in Q2. The BEA also made an upward revision, but not as large, to the growth of imports.

Personal consumption expenditures also grew faster than previously reported, with durable goods accounting for more than half of total growth for that sector. Fixed investment was also significantly stronger than previously reported. The contribution to GDP growth from government consumption expenditures and gross investment was a little stronger than in the second estimate. All of the growth of the government sector came at the state and local levels. The contribution to growth from the federal level was negative, as it has been in 11 of the past 12 quarters. >>>Read more

Follow this link to view or download a slideshow with additional charts of the latest GDP data

Monday, September 22, 2014

One Chart that Shows What's Wrong with US Corporate Tax

Last week the Tax Foundation released its annual International Tax Competitiveness Index for 2014.

The United States ranked 32 out of 34 OECD countries surveyed. Only Portugal and France got lower competitiveness scores, and not by much. As if that were not bad enough, the competitiveness score is only half the story. When you put it together with other data, the US tax system looks like even more of a mess.

First a bit about the Tax Foundation and its competitiveness index. The foundation invites  journalists to describe it as “a non-partisan research think tank, based in Washington, DC,” but not all agree. For example, Dan Crawford, writing for Angry Bear, says, “Its work is aimed at one purpose–convincing Americans that they pay too much in taxes and that government is too big.” Others point out contributions from the Koch Family foundations and ties to other conservative groups as signs of partisan bias. Paul Krugman says flat-out that “knowledgeable people don’t trust the Tax Foundation.”

In an important way, though, the Tax Foundation’s conservative ties only reinforce its credibility as a monitor of tax system features that are perceived as burdensome by its corporate friends. The foundation is entirely up front about what the Tax Competitiveness Index tries to measure:
A competitive tax code is a code that limits the taxation of businesses and investment. In today’s globalized world, capital is highly mobile. Businesses can choose to invest in any number of countries throughout the world in order to find the highest rate of return. This means that businesses will look for countries with lower tax rates on investments in order to maximize their after-tax rate of return. If a country’s tax rate is too high, it will drive investment elsewhere, leading to slower economic growth.
When the foundation gives the United States a low competitiveness score, then, it is simply saying that there are a lot of things about our tax system that corporate businesses don’t like—the kinds of things they consider when they decide where to locate, how to operate, and where to find funds for their investments.

What really strikes me, though, is not just how uncompetitive the US tax system is (in the Tax Institute’s sense of the word), but that it manages to be so uncompetitive while raising so little revenue.>>>Read more

Wednesday, September 17, 2014

Ask Me Anything about Universal Basic Income Today on Reddit

Today at 1 p.m. Eastern (10 a.m. Pacific), I will be doing an "Ask Me Anything" session on Reddit on the topic of universal basic income (UBI). Here is the general link to the page where my discussion will appear. I will post an exact link to the discussion itself when the time comes.

The IAMA sub-Reddit requires that people provide "proof" of who they are by posting something that no imposter could easily do. My "proof" is this little video clip inviting you to join me today on Reddit. Sorry for the poor quality--I'm not very good at videos, but you can match the image in the video to the one posted in my profile. I guess that will constitute "proof."

As readers of this blog will know, I have posted lots of stuff about a universal basic income over the past year. Here is a partial list:

For more, you might check numerous contributions I made to the recent discussion of basic income on Cato Unbound, which starts here  or this short piece posted on Real Clear Markets  or this brief summary of my arguments in the Milken Review.

So please join me, and I look forward to answering your questions!

Sunday, September 14, 2014

The Looming Blood Surplus: A Case Study in Supply and Demand

A market for blood? Many Americans, used to being rewarded for a donation with a warm feeling of talking to WPTV of West Palm Beach, Florida.
public service rather than cold cash, might see the idea as offensive. “I would guess 99 percent of people don't know that blood is sold,” says Ben Bowman, CEO of General Blood, a national blood brokerage firm,

Yes, there is a blood market, a big one with a turnover of $3 billion per year by some accounts, and it is entering a period of turmoil.


Just a few years ago, people thought an aging population, in need of more hip replacements and heart bypasses, would mean an endlessly rising demand for blood. In recent years, though, doctors have come to realize that transfusions, life-saving though they can be, have a downside. The cost of unnecessary transfusions is one consideration, but the risk of transmitting disease is the real negative.

As anesthesiologist, Josh Martini remarked to Minnesota Public Radio, "I was told in medical school, 'don't bother giving one unit, you should just give two if you're going to give any.'" Now, he says, the mantra is changing to "why give two, when one will do?">>>Read More

Follow this link to view or download a brief slideshow with supply-and-demand graphics that can be used as an in-class quiz or independent reading for students.

Saturday, September 6, 2014

Broad and Long-Term Unemployment Fall in August Despite Slowdown in Job Growth

The Bureau of Labor Statistics reported Friday that the broad unemployment rate and long-term
unemployment have fallen to new lows for the recovery, despite a slowdown in the growth of payroll jobs. Payroll employment increased by 142,000 in August, significantly less than the 212,000 average for the previous three months. The standard unemployment rate fell fractionally, returning to the low of 6.1 percent first reached in June. The percentage of the labor force working part-time for economic reasons also decreased.

The standard unemployment rate, U-3, is the ratio of unemployed persons to the civilian labor force. Both the numerator and denominator of the ratio fell in August. The broad unemployment rate, U-6, also takes into account discouraged workers (people who would like to work but have stopped looking because they think no jobs are available) and involuntary part-time workers. As the following chart shows, that rate fell to 12.0 percent in August, a new low for the recovery. >>>Read more

Follow this link to view or download a brief slideshow with additional charts of the latest employment situation

Thursday, September 4, 2014

Reading Recommendations for You and Your Students

Living with Water Scarcity, David Zetland. Back in April I posted a review of David Zetland's book that recommended it not only as a short, readable treatment of the high-profile issue of water scarcity, but as a case-study in scarcity and markets in general. Now David has reduced the price of the download version, from $5 to $0. If the $5 put you off when you first read the review, download it for free and read it today. (You can still buy the paper or Kindle versions from Amazon if you prefer).

A People's Endowment, Karl Widerquist. Recently I have posted several items on the idea of a universal basic income (See here and here). These posts have included suggestions as to how a UBI could be financed by replacing or cutting back on existing welfare programs, middle-class tax expenditures, and other budget outlays. Karl Widequist, another supporter of a basic income, is currently writing a book that is scheduled to come out next year. He has recently posted a draft chapter setting out his own views of how a basic income could be financed by setting up a people's endowment, similar to the Alaska Permanent Fund or Norway's Sovereign Wealth Fund. It makes good reading as it is, and the author would welcome comments as he works on a final version.

Monday, August 25, 2014

A Universal Basic Income and Work Incentives: What Does the Empirical Evidence Tell Us?

In Part 1 of this series, I outlined some basic economic theory regarding a universal basic income
(UBI) and work incentives. By a UBI, I mean an income support policy that provides a set monthly benefit to every citizen. A UBI, as I define it, would to everyone, regardless of income, wealth, or employment status. In that respect it differs from means-tested income support policies (MTIS), such as current US welfare system programs or a negative income tax (NIT), which reduce benefits as the recipient’s income increases.

The fear that a UBI would undermine work incentives is among the most important sources of resistance to the idea. In Part 1, I argued, on theoretical grounds, that replacing the existing welfare system with a UBI would tend to increase average work effort. This part will look at several sources of evidence that support the theory, beginning with the famous income maintenance experiments (IMEs) of the 1970s and 1980s.

What we can learn from the IMEs and what we can’t learn

The income maintenance experiments in question followed a method known as randomized field trials. Each of the experiments enrolled from several hundred to several thousand households and divided them into two groups. They assigned one group to an experimental income support policy while a control group continued to be covered by existing welfare programs, including Aid for Families with Dependent Children (AFDC), food stamps, and others. IMEs testing various policies took place in New Jersey, Iowa, North Carolina, Indiana, Colorado, and Washington. They covered both urban and rural areas; both single parent and two-parent households; and various ethnic groups. >>>Read more

Monday, August 18, 2014

Universal Basic Income and Work Incentives: What Can Economic Theory Tell Us?

Everywhere you look, it seems, people are talking about a Universal Basic Income (UBI)—a monthly cash benefit paid to every citizen that would replace the existing means-tested welfare system.

Supporters maintain that a UBI would not only provide income support to people in need, but would also increase work incentives. That is because, unlike the current welfare system, it would not claw back 50, 70, or even 100 percent of the earnings of low-income workers who make the effort to get a job. Opponents are more skeptical. They fear that if everyone were given a basic cash income with no requirement to work, people would quit their jobs in droves and we would end up with a nation of layabouts.

Who is right? This post examines the relevant economic theory. Part 2 will look at the evidence. >>>Read more

Wednesday, August 13, 2014

Krugman vs. the Libertarians on Phosphorus, Freedom, and Environmental Economics

Paul Krugman is at it again with a stunningly ignorant NYT op-ed on libertarians and the environment, “Phosphorus and Freedom.” As the author of a book on the libertarian perspective on environmental policy, I would like to respond.

Phosphorus comes into the picture in the form of agricultural runoff that pollutes Lake Erie, recently making the Toledo water supply temporarily undrinkable. Krugman blames this kind of thing on libertarians, who, he says, endorse an idea of freedom that includes the freedom to pollute one’s neighbor’s water supply.

Sadly, Krugman’s knowledge of the libertarian position on environmental economics seems to be limited to what he hears on talk radio and what he reads on conservative web sites like Red State. That is problem No. 1: Krugman pretends not to understand the difference between conservatism and libertarianism. He should start by reading Friedrich Hayek’s classic essay “Why I am Not a Conservative,” but maybe he can’t tear himself away from Red State.

According to Krugman, libertarians believe that “anyone who worries about the environment is engaged in scare tactics to further a big-government agenda.” In truth, real libertarians care very much about environmental issues. They just see them through a different lens than Krugman does. >>>Read more

Wednesday, August 6, 2014

How Many Miles Can You Drive on One Hour's Wages? From the Model T to the Prius in One Chart

Recently I came across this assertion in a comment box on one of my favorite websites: “The cost to fuel your car has never been higher as a percentage of disposable income.” 

Really? I know gasoline prices are high, but you just can’t make that assertion without looking at incomes and fuel economy, too. I decided to check the data.

I was able to put together 50 years of pretty consistent data for the key variables, with only a little stitching together to make the starting points and end points fit. The series I used were:
  • Nominal wage in dollars per hour for production and nonsupervisory workers.
  • Average fuel economy of cars on the road, old and new, based on a series from the Department of Transportation for 1980 to 2012 and estimates from various sources to fill in the earlier years.
  • Average gasoline prices from the Bureau of Labor Statistics and Department of Energy.
For  years before 1964, data are harder to come by. Instead of trying to put together a complete series, I decided to go with spot estimates for three iconic cars of yore: A 1919 Model T (About 17 MPG), a 1935 Ford V-8 (about 15 MPG), and a larger 1950 Ford V-8, about 14 MPG.

To calculate the miles that you could drive per hour worked (MPHW), just divide your wage by the price you pay for gasoline and multiply by your car’s fuel efficiency in miles per gallon. >>>Read more

Friday, August 1, 2014

US Job Market Records Best Six-Month Gains in Years

Today’s report from the BLS showed that the US economy added 209,000 payroll jobs in July. With
upward revisions for May and June, total job growth for the past six months comes to 1,400,000, making it the best six-month stretch since the recovery began. Private sector employers added jobs in both goods and services. The government sector reported 11,000 new jobs, all at the local level. Federal employment was unchanged while state governments shed 1,000 jobs.

The household survey also showed solid gains. The civilian labor force grew by 239,000, well above the average monthly gain of recent years. Total employment increased by 131,000. (Because of sampling error and methodological differences, the number of new payroll jobs in the survey of employers often differs from the change in employment according to the household survey.) With so many workers entering the job market, the number of unemployed increased by 197,000, sending the unemployment rate up slightly to 6.2 percent. The broad unemployment rate, U-6, which takes discouraged workers and involuntary part-time workers into account, also rose by a tenth of a percentage point. >>>Read more

Follow this link to view or downward a brief slideshow with additional charts of the latest employment situation

Wednesday, July 30, 2014

First GDP Data for Q2 2014 Show US Economy was Stronger Than Previously Thought

Today’s report from the Bureau of Economic Analysis shows the US economy to be much stronger than previously thought. The advance estimate for the second quarter of 2014 showed real GDP expanding at an annual rate of 4 percent. The new data revised the dip in GDP for Q1 from -2.9 percent to -2.1 percent, and raised the estimated growth rate for three out of four quarters in 2013. The following chart shows previously reported and revised data for the past seven years.

As the following table shows, the turnaround in the economy was very broadly based. Consumption contributed 1.69 percentage points to the growth of GDP, a little above the average of the past two years. Investment was very strong, contributing 2.57 percentage points to growth, far above its recent average. Both fixed investment and inventory investment reversed their declines of Q1. >>>Read more

Follow this link to view or download a short slideshow with additional charts related to this post

Wednesday, July 23, 2014

US CPI Rises at 3.1 Percent Annual Rate in June. What Does That Mean? An Increase in the Cost of Living, or Inflation?

On Tuesday, the Bureau of Labor Statistics announced that the US Consumer Price Index (CPI) rose Mike Bryan on the Atlanta Fed’s Macroblog has made me think again.
at a seasonally adjusted annual rate of 3.13 percent in June. What does such a figure really mean? Is it a measure of inflation or of the change in the cost of living? Until recently, I would have answered that there was no difference, but a recent series of posts by

What’s the difference?

As Bryan explains it, the cost-of-living concept arises from the role of money as a medium of exchange. When we say the cost of living increases, we mean that it gets harder to maintain a given standard of living on a given income. Either we have to be satisfied with fewer goods or services, or save less, or work harder. In the language of economics, a change in the cost of living is a real phenomenon.

On the other hand, we can best understand inflation as a change in the value of our unit of account, the dollar. When there is inflation, the value of the unit is smaller each day than it was the day before, for all transactions. This earlier post includes a chart showing how dramatically the value of our unit of account has changed over the past 100 years.

Imagine that you woke up one morning to find that someone had chopped an inch off all our rulers, so that today’s foot was now only as long as yesterday’s eleven inches. You might go from being six feet tall to six-foot-six, but it wouldn’t be any easier for you to reach the top shelf in the kitchen without a footstool. Similarly, if inflation raises both your income and the prices of everything you buy by the same percentage, the value of a dollar as an economic ruler shrinks, but it is neither harder nor easier to maintain the same real standard of living. In that sense, inflation is a purely nominal phenomenon. >>>Read more

Follow this link to view or download a brief slideshow with charts of the latest CPI data

Monday, July 14, 2014

Facial Justice: A Dystopian Classic of Beauty, Envy and Equality with a Solid Basis in Economics

I spent last week reading about beauty—not from the perspective of poetry or art history, but from
that of economics and social commentary.

The first of two books I read on the subject was Beauty Pays by my old classmate Daniel Hammermesh—a brisk, popular survey of research by the author and others on the question of why attractive people are more successful in the labor market. When I mentioned that book to my wife, the political scientist and ethicist of our family, she said I ought also to read L. P. Hartley’s Facial Justice, a 1960 dystopian novel in the genre of George Orwell’s 1984, but funnier, or Kurt Vonnegut’s story “Harrison Bergeron,” but more subtle. Although the literary styles of Hartley and Hammermesh couldn’t be more different, they share the premise that beauty is scarce and valuable.

The value of beauty

In Hartley’ post-World War III England, life is grim, but beauty still pays. The good jobs go to the good-looking Alphas, while the homely Gammas are lucky if they can find work as temporary subs for the better looking. The majority of average-lookers, the Betas, resent the Alphas and condescend to the Gammas. Most sinister of all, only Alphas can aspire to enter the privileged ranks of inspectors, who help the Dictator run the place. The heroine of the novel is a “failed Alpha”—a pretty girl who has just missed the cut to become an inspector because, she thinks, her nose is just a bit too retroussé. >>>Read more

Thursday, July 10, 2014

The Economics of Legal Marijuana in Washington State and Elsewhere

Like a majority of my neighbors, I voted in favor of Initiative 502, legalizing the sale of marijuana, in
the 2012 general election. Some voted for the measure so that they could get canabis of reliable quality at a reasonable price without risk of arrest. I voted for it because I believe in markets.

For the better part of two years, nothing happened. There is still no marijuana shop in our village shopping center. But this week things are starting to change—or are they? On Monday, the first licenses were issued for legal marijuana outlets. Will users get the safe and reasonably priced product they need? Will nonusers be free of the spillover of violence from drug criminals and the waste of law enforcement resources devoted to failed efforts to suppress them? The news says, “no.” Instead, at least in the short run, it looks like we are going to get shortages and high prices for the trickle of product that makes it into the handful of legal shops, while criminal purveyors continue business as usual.

Here is how I would explain what is going on to my Econ 101 students: >>>Read more

Follow this link to view or download a classroom-ready slideshow on the economics of legal marijuana markets

Saturday, July 5, 2014

US Job Market Shows Strong Gains, but Why is Part-Time Work Rising?

With improvement in all the headline indicators, today’s report on the US employment situation was
one of the strongest of the recovery. The unemployment rate fell 6.1 percent, a new low for the recovery. Payroll jobs rose by 288,000 in June. The broad unemployment rate and long-term unemployment also fell to new lows. At the same time, though, the number of people working part-time rose sharply. How should we understand the increase in part-time work even as the job market improves?

First, a look at the numbers

The monthly survey of business establishments showed gains in payroll jobs throughout the economy. The main goods-producing sectors--mining, construction, and manufacturing—all added jobs. In the service sector, retail trade and healthcare showed the largest gains. Government employment, which has been on a downward trend throughout most of the recovery, added 26,000 jobs, with local government, especially education, accounting for most of them. >>>Read more

Follow this link to view or download a slideshow with complete charts and commentary on the latest employment situation

Monday, June 30, 2014

Depending on How We Define "Recovery," the US Economy Has Already Recovered, May Recover Soon, or May Never Do So

According to the latest public opinion poll from CNNMoney, 61 percent of Americans think it will this slideshow for charts and analysis of the latest GDP revisions.)
take three more years for the U.S. economy to recover fully from the Great Recession. Only 3 percent think that it has already recovered, while 16 percent think it will never recover. And that was before last week’s news from the Bureau of Economic Analysis, which revised growth for the first quarter of 2014 downward to minus 2.9 percent. (See

Are the opinions of those who responded to the poll reasonable? How do their views stack up against those of professional economists?

What is a “recovery”?

The logical way to start this post would be to cite an official definition of “economic recovery,” but it turns out there isn’t one.  The Business Cycle Dating Committee of the National Bureau of Economic Research, which is the group that calls the economy’s cyclical turning points, does not use the term “recovery” at all. In the committee’s words, “a recession is a period between a peak and a trough, and an expansion is a period between a trough and a peak.” That leaves no room anywhere for “recovery.” >>>Read more
According to the latest public opinion poll from CNNMoney, 61 percent of Americans think it will take three more years for the U.S. economy to recover fully from the Great Recession. Only 3 percent think that it has already recovered, while 16 percent think it will never recover. And that was before last week’s news from the Bureau of Economic Analysis, which revised growth for the first quarter of 2014 downward to minus 2.9 percent. (See this slideshow for charts and analysis of the latest GDP revisions.)
Are the opinions of those who responded to the poll reasonable? How do their views stack up against those of professional economists?
What is a “recovery”?
The logical way to start this post would be to cite an official definition of “economic recovery,” but it turns out there isn’t one.  The Business Cycle Dating Committee of the National Bureau of Economic Research, which is the group that calls the economy’s cyclical turning points, does not use the term “recovery” at all. In the committee’s words, “a recession is a period between a peak and a trough, and an expansion is a period between a trough and a peak.” That leaves no room anywhere for “recovery.”
- See more at:
According to the latest public opinion poll from CNNMoney, 61 percent of Americans think it will take three more years for the U.S. economy to recover fully from the Great Recession. Only 3 percent think that it has already recovered, while 16 percent think it will never recover. And that was before last week’s news from the Bureau of Economic Analysis, which revised growth for the first quarter of 2014 downward to minus 2.9 percent. (See this slideshow for charts and analysis of the latest GDP revisions.)
Are the opinions of those who responded to the poll reasonable? How do their views stack up against those of professional economists?
What is a “recovery”?
The logical way to start this post would be to cite an official definition of “economic recovery,” but it turns out there isn’t one.  The Business Cycle Dating Committee of the National Bureau of Economic Research, which is the group that calls the economy’s cyclical turning points, does not use the term “recovery” at all. In the committee’s words, “a recession is a period between a peak and a trough, and an expansion is a period between a trough and a peak.” That leaves no room anywhere for “recovery.”
- See more at:

Saturday, June 28, 2014

Revisions for Q1 Show Biggest Drop in US GDP in Five Years

The third estimate of U.S. real GDP for Q1 2014, released this week by the Bureau of Economic Analysis, showed that the economy contracted at a 2.9 percent annual rate in the quarter. That was the fastest rate of contraction since the recovery began five years ago. The second estimate, released in May, had indicated a rate of contraction of just 1 percent.

The pause in the economic expansion had several causes. Unusually severe winter weather hurt the economy across the board. Exports, which had been a positive factor through most of the recovery, slowed sharply in the first quarter. A decrease in inventories adversely affected investment. Finally, although personal consumption continued to grow, the rate was slower than previously estimated, in part because of technical changes in the measurement of spending on healthcare.

The third revision confirmed a sharp decrease in corporate profits that had been reported previously. Profits fell by more than 9 percent before taxes, and nearly as much after taxes. Despite the drop, after-tax profits, which had been running at record levels in recent years, are still higher than the peak reached during the prerecession boom.

Observers believe that many of the factors leading to the first quarter decline in GDP are temporary. Relatively strong labor market performance during April and May make it very likely that growth will resume in Q2. Still, the weakness early in the year has caused the Federal Reserve to reduce its forecast of growth for the full year from a range of 2.8 to 3.0 percent down to a range of 2.1 to 2.3 percent.

Follow this link to view or download a classroom ready slideshow with additional charts and analysis of the Q1 2014 national income accounts.

Wednesday, June 25, 2014

Does Inherited Wealth Really Help the Economy? A Reply to Greg Mankiw

Writing for the Upshot section of the New York Times, Harvard economist Greg Mankiw has weighed
in on the Pikkety debate. He accepts Pikkety’s scenario of ever increasing inequality as at least a “provocative speculation,” if not established fact, but then asks, So what? What is wrong with inequality and inherited wealth?

Nothing, says Mankiw. In fact, he maintains that if we consider not only the direct effects on the family but also the indirect effects on the broader economy, inherited wealth is good not just for the rich but for the rest of us as well:
When a family saves for future generations, it provides resources to finance capital investments, like the start-up of new businesses and the expansion of old ones. Greater capital, in turn, affects the earnings of both existing capital and workers.
Because capital is subject to diminishing returns, an increase in its supply causes each unit of capital to earn less. And because increased capital raises labor productivity, workers enjoy higher wages. In other words, by saving rather than spending, those who leave an estate to their heirs induce an unintended redistribution of income from other owners of capital toward workers.
This may be good textbook economics, but it should not be allowed to pass without three major caveats. >>>Read more

Monday, June 16, 2014

The Roll of Bloggers in Disseminating Economic Research

Recently Bill Gardner, a contributor to the healthcare policy blog The Incidental Economist, posted a piece titled “Disseminating Research: Translators Needed.” His comments are relevant to economics in general, not just healthcare policy. I would like to pass them along and add some of my own.

Gardner writes:

Most research papers are rarely read, few are cited, and very few directly influence the policy decisions that they are meant to inform. How can we  get our data out of the journals and into the public square?
Articles in specialist journals are largely inaccessible to non-specialists, even other scientists. The field needs translators, great researcher/writers like Atul Gawande, who can take research findings and restate them in a way that connects the data to the concerns of the educated lay reader.
Gawande is a practicing surgeon who is a staff writer for the New Yorker. I’m not sure who the equivalent would be in economics. A few years ago, the Daily Beast published a list of the 15 top economics and financial journalists. It included people like the David Leonhardt, who heads up the new Upshot venture for the New York Times. He is one of the best economics writers around, but, like most of those on the list, he is a professional journalist and neither a PhD or a practicing economist. The exception on the Beast’s list is Paul Krugman, although some might consider him too partisan to qualify as a “translator.”
Gardner suggests:
Perhaps everyone could become his or her own translator, writing about their research on blogs and other social media. This proposal, however, collides with the contempt many researchers hold for social media.
David Grande and his colleagues (including the physician/writer Zach Meisel) surveyed researchers about their perceptions of social media: “Researchers described social media as being incompatible with research, of high risk professionally, of uncertain efficacy, and an unfamiliar technology that they did not know how to use.”
Our discipline does have some distinguished academic economists who blog regularly. >>>Read More

Friday, June 13, 2014

Russian Business Leaders who Joined Alexei Navalny's Anti-Corruption Drive Face Now Face Arrest

On Wednesday, the Russian news agency RIA-Novosti  announced that Konstantin Yankauskas, a this earlier post, the fight against corruption was the principal plank in Navalny’s campaign.
deputy of the Moscow city council, had been placed under house arrest. At the same time, the agency suggested that the arrests of two businessmen, Vladimir Ashurkov and Nikolai Lyaskin, were immanent. All of them are active in the anti-corruption campaign led by blogger and political activist Aleksey Navalny, and all are charged with embezzling funds from Navalny’s 2013 campaign for Mayor of Moscow—an intentionally vicious accusation, since, as I detailed in

Ashurkov’s name will be familiar to readers who remember an interview with him that I posted here two years ago. For those who came in late or have forgotten the details, Ashurkov was a star student in the American business school where I taught in Moscow in the 1990s and later earned an MBA at Wharton. After returning to Russia, his career blossomed, and he ended up as a top asset manager at Alfa Group, a Moscow investment powerhouse run by Mikhail Fridman, one of Russia’s richest men.

A few years ago, Navalny’s anti-corruption campaign caught Ashurkov’s attention. Although he had not previously been active in politics, he began to work with Navalny on corporate governance cases. His boss, Fridman, was at first OK with that, as long as it was done in his spare time. However, the political situation in Russia became more tense during Vladimir Putin’s campaign for a third term as president. As it did so, Fridman’s attitude changed. He told Ashurkov that he would either have to drop his work with Navalny or quit his job. As Fridman later explained in a radio interview,
When we parted ways, he [Ashurkov] had the right to a choice: Either not engage in politics or leave the business. He decided for himself to go the political route. . .  We live in Russia, and there is no question that in our Russian conditions, involvement in such an active political life is, as a general rule, not altogether appropriate for business.
>>>Read more

Friday, June 6, 2014

Long-term and Broad Unemployment Rates Fall to New Lows as Labor Force Expands

The Bureau of Labor Statistics reported today that the broad unemployment rate, U-6, fell to 12.2
percent in May. As the following chart shows, that was a new low for the recovery. The decrease was especially welcome because it was accompanied by an increase of 192,000 in the civilian labor force, reversing some of April’s losses. The standard unemployment rate remained at 6.3 percent in May, also a low for the recovery.

In another welcome development, the share of unemployed workers out of work for 27 weeks or more fell to 34.6 percent in May. That, too, is a low for the recovery, although long-term unemployment remains high by historical standards. The mean and median duration of unemployment also declined in May.

Involuntary part-time unemployment also fell. This group, which the BLS refers to as working part-time “for economic reasons,” include those whose employers have reduced their hours because of slack business conditions and those who can only find part-time work. The percentage of people in the labor force with involuntary part-time work resumed its downward trend in May, but has not yet reached February’s low. The number of people working part-time because that is what they prefer (“noneconomic reasons”) rose in the month. >>>Read more

Follow this link to view or download a short slideshow with additional charts of the latest employment situation

Thursday, May 29, 2014

US Corporate Profits Take a Big Hit in Q1 2014 as GDP Falls at a One Percent Annual Rate

The second revision of the US national income accounts for the first quarter of 2014, released today by the Bureau of Economic Analysis, showed that real GDP fell at an annual rate of -1.0 percent. The advance report had shown an annual rate of increase of 0.1 percent. Today's report also showed that corporate profits fell sharply in the quarter.

Most of the change in the numbers between the advance and second estimates for the quarter came from a much faster rundown of inventories than had previously been reported. Inventory depletion contributed -1.62 percentage points to growth, compared with the advance estimate of -.57 percent. Fixed investment was marginally higher than previously reported.

Other sectors showed less change. Consumption was fractionally stronger than previously reported. Government spending decreased a bit more than reported earlier, with all the change due to a bigger decrease at the state and local government level. Exports decreased a bit less than previously estimated, but the decrease in net exports was slightly greater because imports rose, rather than decreasing slightly, as reported in the advance estimate. >>>Read more

Follow this link to view or download a slideshow with complete charts of the latest GDP and profits data

Why the Correct Answer to “What Should we do About Slowing Growth?” is “Nothing.”

There has been a lot of agonizing lately about slowing economic growth. Some of it understandably laments the slow recovery from the Great Recession, but the more interesting part concerns long-term growth prospects. Brad DeLong has recently written a thorough review of the stagnation literature under the title “Is Economic Growth Getting Harder? If so, why, and what can we do about it?”

DeLong is a little less pessimistic than some of the others. He thinks the growth of real GDP per capita will slow only by three-tenths of a percentage point from its historic norm of 2 percent. But, more importantly, he suggests an entirely different way of thinking about growth policy—one that changes the question from “What can we do about slow growth?” to What should we do about it?” If we follow DeLong’s reasoning to its logical conclusion, I think the correct answer is that we should do nothing.

The rest of this post will highlight a couple of DeLong’s key themes and flesh out some of his generalizations with relevant data.>>>Read more

Sunday, May 25, 2014

Why it's Risky to Trade with Putin's Russia: An Application of Jane Jacobs' "Systems of Survival"

I spent the 1990s teaching economics at a business school in Moscow. Our students were graduates of FizTech, Mekh-Mat, MIFI—the whole alphabet soup of science and technology schools that had fed the Soviet military-industrial establishment. These young men and women had degrees in things like “laser weapons platform design” that weren’t in much demand in Boris Yeltsin’s new Russia. Now they wanted to become financial analysts, accountants, and business IT specialists.

The students were incredibly bright and had great quantitative skills, but there were ideas in our American-style MBA curriculum that many of them found hard to grasp. Not my subject, economics. None of them had ever had an econ course before, but they ate up equations and models like breakfast cereal. Instead, the hardest thing for some of them to grasp was the idea that business could be something other than a zero-sum game.

The zero-sum mentality

Our Russian students had been brought up in a system where the central question, at least in dealing with strangers, was the quintessentially Russian “кто-кого?” Who is going to get the best of whom? The question reflects a belief that every human interaction with outsiders necessarily has a winner and a loser. The idea that arms-length business dealings with people to whom you owe no prior duty of loyalty could have mutual benefits was new. Some students caught on, some did not.

Attempts at trade in which one party has a кто-кого mentality and the other is looking for mutual gains are fraught with risk. For the party with the zero-sum mindset, the risk is that of missing out on genuine opportunities for mutual gain. For the party looking for mutual gain, the risk is that the benefits promised in return may not materialize . . .>>>Read more

Sunday, May 18, 2014

US Consumer Price Inflation Accelerates in April but Inflation Expectations Remain Flat

The Bureau of Labor Statistics announced this week that the U.S. consumer price index rose at an annual rate of 3.17 percent in April. That was the fastest rate in 10 months. Prices for gasoline, cars, and medical services helped push the index higher.

The core CPI, which excludes volatile food and energy prices, rose at an annual rate of 2.87 percent, also a faster rate than in March.

The Cleveland Fed publishes an index of expected inflation over various time horizons based on prices of Treasury Inflation Protected Securities (TIPS). As of April, inflation was expected to average 1.7 percent over the next five years, and 1.9 percent over the next ten years. Those rates were essentially unchanged from March.

The Fed has set a target of 2 percent inflation, as measured by the deflator for personal consumption expenditures in the national income accounts. Because of differences in methodology, inflation as measured by the CPI tends to run about half a percentage point higher than as measured by the PCE deflator. Taking into account both current and expected inflation, then, we can say that inflation appears to be gradually approaching the Fed's target, but it is not there yet.

Follow this link to view or download a classroom-ready slideshow with charts of the latest inflation data.

Monday, May 12, 2014

What Ever Happened to the Phillips Curve? An Interpretation of Fifty Years of Inflation-Unemployment Data

A couple of weeks ago, I wrote a post on the Fed’s success, or lack thereof, in meeting its dual targets of 5.5 percent unemployment and 2 percent inflation. The post featured the following “bullseye” chart, which had first come to my attention when Chicago Fed President Charles Evans used it in a recent speech. James Hamilton has since used the same type of chart on Econbrowser. It is a handy graphical device that looks likely to catch on.

The axes on the chart show the unemployment rate and the inflation rate, as measured by the Fed’s preferred index for Personal Consumption Expenditure (PCE). An alert reader of my post commented that the axes are the same as those for a Phillips curve, yet the recent trend, shown by the arrow, has a negative slope, exactly the opposite of what the classic Phillips curve supposes. What is going on? Whatever happened to the Phillips curve?

What the raw data do (or don’t) tell us 

The original paper by A. W. H. Phillips, published in Economica in 1958 (downloadable here) showed an impressively close inverse relationship between inflation and unemployment for the British economy up to World War I, as shown in the next chart. It also noted a similar, if slightly messier, relationship for the interwar years.

However, if we make the same kind of chart for the US economy over the past half-century, we see essentially no correlation. The R2 is an insignificant .006 and the faint trace of a trend, if we draw it in, runs in the wrong direction.

If that had been all there was to see, popular writers, policymakers, and some academic economists would never have seized on the Phillips curve as they did in the 1960s. They never would have declared it a policy menu that allowed policymakers to choose a combination of inflation and unemployment that suited their political tastes. The curve never would have survived for fifty years as a staple of college textbooks. To understand why the Phillips curve made such an impact, and to judge whether there is anything left of it, we have to make a much closer interpretation of the data. Here goes.

The Kennedy-Johnson years

The Phillips curve was at the height of its popularity when John F. Kennedy became president in 1961. Kennedy had been elected on a promise to “get the country moving again.” He and his successor, Lyndon Johnson, set out to do so with the help of some of the best and brightest economists of the day. We can catch the spirit of that self-confident decade in this passage from the 1966 Economic Report of the President, written by a Council of Economic Advisers consisting of Arthur Okun, Gardner Ackley, and Otto Eckstein:

We strive to avoid recurrent recessions, to keep unemployment far below rates of the past decade, to maintain price stability at full employment . . . and indeed to make full prosperity the normal state of the American economy. It is a tribute to our success . . .  that we now have not only the economic understanding but also the will and determination to use economic policy as an effective tool for progress.

The result of their efforts at economic stimulus was something that, at least at first, looked very much like the classic Phillips curve, as we see in this next chart:

The only bothersome part of the 1960s expansion was the fact that the tradeoff between unemployment and inflation appeared to getting less favorable over time. As that became increasingly apparent, Milton Friedman and Edmund Phelps, among others, proposed an explanation. The the positively sloped Phillips curve, they suggested, is only a short-run relationship. The long-run Phillips curve is better represented as a vertical line at the economy’s natural rate of unemployment. In the Friedman-Phelps version, the short-run Phillips curve shifts up and down along the long-run vertical curve as the expected rate of inflation changes. 

The shifting Phillips curve and the stop-go cycle

The next chart shows the dynamics of inflation in a simple version of the shifting Phillips curve model. The long-run Phillips curve is vertical at the assumed natural unemployment rate of 5 percent. The figure includes three short-run Phillips curves, each intersecting the long-run curve at the corresponding expected rate of inflation.

In this simple version of the model, we assume that each year’s expected rate of inflation is equal to the previous year’s observed rate. The observed rates of inflation and unemployment for each year are jointly determined by the position of the short-run Phillips curve and the rate of growth of aggregate nominal demand. Finally, we assume that policymakers alternately apply expansionary measures when they feel political pressure to “do something” about unemployment and contractionary measures when they are pressured to do something about inflation.

Putting all of these assumptions together produces a dynamic in which the economy moves in a clockwise direction around an irregular loop. Starting from equilibrium at point A, with moderate inflation and unemployment at its natural rate, suppose that fiscal or monetary stimulus increases the growth rate of aggregate nominal demand. With inflation expectations still anchored at 2 percent, the economy moves up along SRP1 to point B, where unemployment falls to 3 percent and observed inflation rises to 4 percent.
The 4 percent inflation observed at point B raises the next year’s expected inflation to 4 percent, shifting the short-run curve upward to SRP2. Assuming continued expansionary policy, the economy next moves to point C.

At point C, inflation is a worrisome 6 percent. The government must do something, so it puts on the fiscal and monetary brakes. However, the economy can’t simply slide back down along SRP2, because the 6 percent inflation observed at point C has shifted the short-run curve upward again to SRP3. Instead, contractionary policy pushes the economy across to point D. We get the dread “stagflation” scenario where unemployment rises even as the rate of inflation remains stubbornly high.

If the authorities have the political fortitude to stick to a contractionary policy, they can eventually purge the economy of inflation. In the next year, the economy would slide down along SRP3 to point E. At that point, observed inflation is finally less than expected, so the short-run Phillips curve begins to shift downward. In theory, skillful policy could steer the economy back to a soft landing at point G, right where it started.

Simple though it is, the inflationary dynamics of this model correspond remarkably well to the behavior of the US economy over the two decades following Kennedy’s inauguration. The next chart plots the actual data. The main difference between the historical pattern and the stylized version is that the loops of the historical stop-go cycle seem to drift upward over time. A reasonable explanation would be that policymakers react more rapidly and more strongly to political pressures to reduce painfully high unemployment than to subsequent pressures to reduce unwanted inflation.

The Great Moderation

Just as it seemed that the stop-go cycle with an inflationary bias might become a permanent feature of the US economy, vindicating the shifting Phillips curve model, the picture changed. The US economy entered a 20-year period now known as the Great Moderation. As the next chart shows, during that period the unemployment and inflation rates stayed remarkably close to the bullseye defined by the Fed’s current targets of 5.5 percent unemployment and 2 percent inflation.

During the Great Moderation, the looping stop-go cycle so evident in the 1960s and 1970s becomes both diminished and more irregular. It is hard to tell if the Phillips curve has disappeared entirely in this period, but if it is still there, its effects seem to be obscured by random shocks. The correlation of inflation and unemployment is faintly positive and the R2 of just .025 is insignificant.

From the Great Moderation to the Great Recession

The Great Moderation ended with the Great Recession, which began in late 2007. The next chart compares the most recent data to the behavior of the economy in the 1960s and 1970s. To sharpen the focus, this chart differs in two ways from our earlier ones. First, it shows quarterly rather than annual data. Second, it shows data only for the trough-to-peak phases of the business cycle (recovery and expansion), leaving out quarters in which GDP decreases. Because the main purpose of the chart is to compare the recent expansion with those of the 1960s and 1970s, when the shifting Phillips curve model was clearly operating, it omits the four cyclical recoveries between 1980 and 2006.

The three earlier cycles are similar in certain ways that we can explain easily in terms of the shifting Phillips curve model.

First, the earlier recoveries all begin with a phase during which the rate of inflation begins to fall while the unemployment rate is still rising. In the shifting Phillips curve model, that pattern can occur when tight fiscal and monetary policy restrain the growth of aggregate nominal demand while falling inflation expectations are shifting the short-run Phillips curve progressively downward. According to the model, the rate of unemployment should still be above the natural rate during this phase of the recovery, as it appears to be. The CBO estimates that the natural rate rose from about 5.5 percent in 1960 to about 6.5 percent by 1980, which would explain the rightward drift in the first three recovery tracks shown in the chart.

Second, in each of the three early cases, inflation and unemployment both begin to rise no later than seven quarters into the recovery. The subsequent segments are the ones that look superficially like classic negatively-sloped Phillips curves, but are better explained as the result of expansionary policy acting on a short-run Phillips curve that is shifting upward under the influence of rising inflation expectations. The shifting-curve model suggests that unemployment should fall below its natural rate as inflation accelerates, which seems generally consistent with the data.

Good data on inflation expectations for the 1960s and 1970s would bolster the shifting curve model as an explanation of the patterns followed by the three early recoveries shown in the chart. Unfortunately, data on expectations for those years is skimpy. In an attempt to fill the gap, a recent study by Jan Groen and Menno Middeldorp of the New York Fed attempts to construct a proxy series for inflation expectations that reaches back to the 1970s. Their reconstruction is consistent with the notion that inflation expectations fell in the early part of the recovery of 1975 to 1980, but it does not go back far enough to cover the two earlier recoveries.

Let’s turn now to the recovery from the Great Recession, which began in mid-2009. Its pattern is very different. As in the early cycles, the unemployment rate lags behind GDP and continues to rise in the first few quarters of the recovery. However, in this case, the rate of inflation rises, rather than falling, in the early part of the recovery. It does not reach its mid-recovery peak of 2.9 percent until the third quarter of 2011.

During the whole period from Q3 2009 to Q3 2011, unemployment is far above its natural rate. It is impossible to produce the combination of rising inflation together with unemployment that is both rising and above the natural rate with a simple shifting Phillips curve. In that model, unemployment can be above the natural rate only if the observed rate of inflation is less than the expected rate, and that, in turn, would cause a steady downward shift of the short-run Phillips curve from quarter to quarter. Under those circumstances, either the unemployment rate or the inflation rate would have to fall from quarter to quarter.

After Q3 2011, the current recovery takes a different direction. From then until the most recent observations, the trend has been falling unemployment combined with falling inflation. It is technically possible to produce that result in the shifting Phillips curve model if we combine an unemployment rate initially above the natural level, falling inflation expectations, and demand management policy that is gradually becoming more expansionary. A few short segments  seem to fit that pattern during the earlier cycles, most notably the period from the fourth quarter of 1975 through the fourth quarter of 1976.

The problem is that there is no evidence of falling inflation expectations in the most recent period. If anything, as the next chart shows, inflation expectations have been gently rising from mid-2011 to the present. Without falling inflation expectations, the shifting Phillips curve model is incapable of producing a sustained period during which both the inflation rate and the unemployment rate decrease.

The bottom line

This post began with the question, What ever happened to the Phillips curve? We now have our answer.
The classic stationary Phillips curve—the version that people once optimistically viewed as a stable policy menu—died long ago. Already by the end of the 1960s, the Friedman-Phelps shifting Phillips curve model had taken its place. In our simplified version, that model has these four components:
  1. A vertical long-run Phillips curve
  2. A negatively sloped short-run Phillips curve that intersects the long-run curve at the expected rate of inflation
  3. An expected rate of inflation primarily determined by observed inflation in the recent past
  4. Aggregate nominal demand as the determinant of the economy’s position along the short-run Phillips curve that applies at any given time
When we combine these assumptions with fiscal and monetary policies that react to alternating political pressures to do something about unemployment and then do something about inflation, the shifting Phillips curve model produces a stop-go cycles very much like observed from the early 1960s through the mid-1980s.

After that, even the shifting version of the Phillips curve runs into trouble. Its usefulness begins to fade already during the Great Moderation, and it becomes altogether incapable of producing the pattern of inflation and unemployment we see during the first five years of the recovery from the Great Recession. The reason appears to be a breakdown of two of its key principles, first, that unemployment higher than the natural rate can occur only when inflation is slower than expected, and second, that inflation persistently slower than expected must cause a downward revision of expectations.

Instead, what we see during the past five years is persistently high unemployment combined with low and stable inflation expectations and a falling observed rate of inflation. If the Phillips curve is not dead, we must at least declare it in a persistent vegetative state from which it will not awaken without some radical change in circumstances.

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