This Chart Shows Why the Fed Will Be Tightening Monetary Policy Soon

Will policymakers at the Fed raise interest rates at their December meeting? Wall Street  oddsmakers increasingly think they will. One simple chart shows why.

The chart tracks the economy’s progress toward the central  bank’s target of “stable prices and maximum employment.”  The Fed’s rate-setting Federal Open Market Committee (FOMC) has operated under this so-called  dual mandate since Congress amended the Federal Reserve Act in 1977. In recent years, the Fed has interpreted “stable prices” to mean a rate of inflation close to 2 percent per year, as measured by the annual change in the price index for personal consumption expenditures (PCE). It interprets “maximum employment” to mean the highest level that is consistent with its 2 percent inflation goal, currently thought to be an unemployment rate of about 4.8 percent.

We can use the two components of the dual mandate to draw a bullseye that the Fed is aiming for.  Here is how things are going, seven years into the recovery from the Great Recession. (All data shown in the chart are quarterly, except for the last point, which shows the latest, still-incomplete data for the fourth quarter of 2016—unemployment of 4.6 percent for November 2016 and PCE inflation of 1.5 percent for October.)

As recently as the fourth quarter of last year, the Fed was missing the inflation target by a wide margin on the downside and the unemployment target by a smaller margin on the upside. Small wonder, then, that when the FOMC raised interest rates at its December 2015 meeting, many critics saw such an action as premature. That was especially true for those who hold the orthodox view that 2 percent inflation is a not an unconditional ceiling, but rather, a target that may acceptably be exceeded for a time after a long period of below-normal price increases.

Why a Protectionist Shock Would Do More to Harm Than to Help the Job Market

Dramatic promises to restrict international trade were a signature element of Donald Trump’s presidential campaign. So far, he seems to be following through, with an early reaffirmation of his intent to withdraw US participation in the Trans-Pacific Partnership (TPP).

An aggressive stance on trade played a key role in gaining the support of working class voters in Midwestern manufacturing states, where upset wins swept him into the White House.  What is more, trade is one area in which Trump, as President, will have the power to act on his own without action by Congress. As Gary Clyde Hufbauer of the Peterson Institute has explained, both the US Constitution and past acts of Congress give the President ample authority to do things like withdraw from the TPP or NAFTA, label China a currency manipulator, or impose retaliatory tariffs on any country he sees as a threat to US economic security.

But how would American workers actually fare under a protectionist regime, especially older workers, and those with few skills and little education, who voted for Trump by wide margins? Not well. Here is why a protectionist shock could do more to harm than to help the US job market.

Free Trade Under Fire

The recent presidential election was characterized by attacks on free trade from leading candidates in both parties. As I detailed in my earlier post, "The Bipartisan War on Free Trade," eventual winner Donald Trump broke sharply with the traditional free trade position of the Republican party. Populist Democrat Bernie Sanders drove his rival Hillary Clinton to abandon her earlier embrace of trade. Cracks have even appeared in the formerly almost monolithic support of trade among economists.

I have now pulled together the key points from several earlier posts and articles for a new slideshow, "Free Trade under Fire," available for viewing or free download on my Slideshare page. The slideshow is suitable for classroom presentation or for discussion by community groups. Contact me if you would like me to present the slideshow to your class or community group.

Highlights of the slideshow:

Four flawed arguments against free trade:

• Deficits mean we are losers
• Blame it on currency manipulation
• Protectionism will bring back manufacturing jobs
• Don't trade with the poor 

Why the real problem with trade is slow adjustment to trade shocks

Five factors that slow adjustment to trade shocks, with discussion of reforms that could speed adjustment:

• Work disincentives in the social safety net
• Insufficiently portable healthcare
• Ownership bias in housing policy
• Spread of occupational licensing
• Too many people with criminal records

Why protectionism is not the answer

Follow this link to view or download the slideshow

Why Does Big Business Fear Trump?

It is not surprising that there is little love for Donald Trump’s presidential candidacy among the leaders of top US multinational corporations. Why then, asks Andrew Ross Sorkin of the New York Times, do they not speak out? Why do they quickly follow up their private comments with, “I could never say that on the record”? I find some of the views reflected in Sorkin’s article disturbing.

The attitudes of top executives would be more understandable if they centered on the issue of free trade, but they do not. Yes, big business has profited from past trade deals and backs new ones like the TPP and TTIP, which Trump promises to cancel. But Trump’s Democratic opponent and a majority of Congressional candidates from both parties have also joined the anti-trade bandwagon, so trade policy is in for a change no matter who wins this election. As Trump himself would say, there’s something else going on.

Trump the bully is one broader fear of the executive class. Sorkin quotes Reid Hoffman, co-founder of LinkedIn, who was one of the few willing to speak to him on the record:

People are fearful that, especially in a circumstance where he might be in a position of extreme power as a potential presidential candidate, that would be used in a retaliatory way, that would be used in vengeful way. Everyone gets worried about being attacked, and part of the logic and mechanics of bullies is that they cause people to be fearful that they’ll be singled out and attacked.

It’s the same thing like on school grounds, when people won’t go help the kid who is being bullied because they’re worried that the bully will focus on them.

Yes, it is frightening to think about the ways a thin-skinned and vengeful President might misuse the office. The entanglement of corporations with government is such that there would be many opportunities to punish enemies. Taxes, regulations, and government contracts would be some of the most direct, but backdoor methods like planting rumors or leaking documents might be easier, and just as damaging. A President Trump might install a compliant security chief who would give him access to a company’s internal phone and email communications, encrypted or not. The tools at the disposal of a spiteful president would make something like closing a bridge look like a playground prank.

How Hillary Clinton's Social Policies Could Raise Effective Marginal Tax Rates for the Middle Class

Hillary Clinton is often said to be a policy wonk, deeply enmeshed in specifics and details, but that may be a mischaracterization. In some ways, her approach seems disturbingly superficial, skipping one perceived problem to another with little attention to their underlying causes. In some cases, Clinton seems to have paid little attention to the unintended consequences of her proposals, as a real policy expert would do. A look at the tax implications of some of her social policy proposals will illustrate these shortcomings.

How progressive? Nominal vs. effective tax rates

Discussions of by both supporters and critics have characterized Hillary Clinton’s tax policies as progressive. The appearance of progressivity arises from her pledge to raise tax rates and close loopholes for the wealthiest Americans, while leaving nominal tax rates for middle-class families largely unchanged. According to an analysis by the Tax Policy Center, her proposals would increase revenue by $1.1 trillion over the next decade, with nearly all of the tax increases falling on the top 1 percent.

However, the conclusion that Clinton’s policies would have little effect on middle-class families is based on a narrow view of taxes—one that takes into account only the money that taxpayers hand over to the IRS. Economists have long favored a broader concept called the effective marginal tax rate (EMTR), which includes reductions in government benefits that occur as income rises as well as increases in taxes paid. Some little-noticed features of Clinton’s education and healthcare policies would have the unintended consequence of raising effective marginal tax rates on middle-class families to levels far above those that top earners would face.

How Occupational Licensing Undermines Labor Fluidity, and Who is to Blame

A healthy economy requires a fluid labor market. Even when total employment and output are stable, the labor market is in constant motion. Jobs disappear when firms close or downsize. Other jobs appear when new firms open or old ones expand. People move freely from one job to another in search of career advancement or better fit between their work and their personal lives.

Unfortunately, the US labor market is becoming less fluid. We can trace part of the decrease in fluidity to outside factors like an aging labor force and changing business practices, but much of it stems from ill-considered labor market policies. Of these, one of the most damaging is the spread of occupational licensing over recent decades. As we will see, Democrats and Republicans share the blame.

How can we measure labor fluidity and why do we care?

A paper by Stephen J. Davis of the University of Chicago and John Haltiwanger of the University of Maryland  charts the decline in US labor market fluidity. Using data on quits, layoffs, and job openings from the Bureau of Labor Statistics, supplemented by other data sources, the authors construct three fluidity indicators:

• The job reallocation rate is the sum of the number of jobs created at new and expanding firms each calendar quarter and jobs destroyed at firms that close or downsize. Newly created jobs include both those that are immediately filled and job openings that become newly available but not yet filled.
• The worker reallocation rate is the sum of the number of hires, quits, and layoffs. It includes people who move directly from one job to another; those who move from a job into unemployment or out of unemployment into a job; those who leave a job and, at the same time, leave the labor force; and those who enter the labor force and immediately take a job.
• Churning is the amount by which the worker reallocation rate exceeds the job reallocation rate. If people changed jobs only when their current job disappeared and took only newly created jobs, the rate of churning would be zero. The rate of churning, then, represents job changes that are motivated by career advancement opportunities or personal choices, rather than forced by job creation or destruction.

The following chart from Davis and Haltiwanger shows that all three measures of fluidity have been decreasing in the United States. Their paper includes many more charts showing decreases in other measures of fluidity, decreases in underlying indicators like quits and hires, and decreases by state and demographic group. The decreases in fluidity have been widespread, but they appear to have affected men more than women and less educated workers more than those with college educations. Key aspects of the decline in labor fluidity appear to be unique to the United States, or at least more pronounced here than in other advanced economies.

What Does the Unemployment Rate Measure? Labor Market Slack or the Social Stress of Joblessness? Why Does it Matter?

The unemployment rate published monthly by the Bureau of Labor Statistics is one of the most widely watched of all economic indicators. But why? What does it really measure?

The news media, politicians, and voters tend to see the unemployment rate as an index of the social stress of joblessness. There is ample evidence to support that view. Researchers have linked high unemployment rates to increased mortality and impaired mental health. A recent cross-sectional analysis shows a strong relationship between unemployment  and suicide. There is evidence that unemployment undermines personal relationships, although the impact on divorce rates is ambiguous: A weak job market can break up some couples while leaving others stuck in bad marriages because they can’t afford divorce. Rising unemployment is also associated with higher crime rates, for both violent and property crimes. There is even something called the misery index, which is the sum of the unemployment rate and the inflation rate.

Economists, on the other hand, more often view the unemployment rate as an indicator of economic slack. People who want to work but are not working are a wasted resource. Finding jobs for them would add to GDP. Monetary and fiscal policymakers watch employment indicators closely because the more slack there is in the labor market, the more room there is for economic stimulus without risk of inflation.
The questions we need to address, then, are, first, can the standard unemployment rate do double duty as an indicator of both macroeconomic slack and social stress? And if not, what might be better?