Thursday, December 22, 2016

What Is the Nairu and Why Does it Matter?

In December 2016, after a year-long pause, the Fed resumed its tightening of monetary policy. As usual, the action took the form of a quarter point increase in the target range for the federal funds rate (a key rate that banks charge  on short-term loans to one another).

Is still more tightening in store?  Most observers think the answer is “yes,” but the Fed is leaving its options open. Its most recent projections, released immediately after its December meeting, hint at the possibility of as many as ten more quarter-point increases over the next three years—or perhaps none at all. So what will actually happen?

The wonkiest number in all of economics

What actually happens will depend , in large part, on what may be the wonkiest number in all of economics—the Nairu. Nairu stands for Non-Accelerating Inflation Rate of Unemployment—such a mouthful that no one ever says it out loud. Often, it is spelled out as an acronym, NAIRU, but increasingly, it is written as an actual word, with only the first letter capitalized. In the 1960s, Milton Friedman used the more civilized term, natural rate of unemployment. Today, many economists treat “Nairu” and “natural rate” as synonyms.

The basic idea behind the Nairu is simple. It is widely accepted that as the economy moves through the business cycle from recession to expansion to boom, shortages develop in labor and product markets that put upward pressure on prices and wages. The Nairu is supposed to capture the sweet spot—the lowest level to which the unemployment rate can safely fall before inflation starts to accelerate.

The Nairu is a natural fit with the Fed’s statutory objectives for the conduct of monetary policy. Under its so-called dual mandate, the Fed is supposed to aim for “maximum employment and stable prices.” The Nairu captures both parts of the dual mandate, being the maximum employment (or minimum unemployment) that is consistent with prices that are stable in the sense that the inflation rate does not accelerate from month to month.

In order actually to implement its dual mandate, the Fed needs to fill in some numbers. In recent years, it has maintained an inflation target of 2 percent per year, as measured by the personal consumption expenditure (PCE) index published quarterly by the Bureau of Economic Analysis. Putting a number on the Nairu, however, has posed more of a challenge.

Why the Nairu is so hard to pin down

Back in the 1960s, things seemed simpler. Consider the following chart, which shows the pattern of unemployment and inflation that prevailed during the Kennedy-Johnson years, 1960-1969:

The points in this chart fit closely around a trendline that economists call a Phillips curve—a curve that shows an inverse relationship between inflation and unemployment over the course of the business cycle. Taken literally, the value of the Nairu would be 6.7 percent, the level at which inflation started to accelerate after reaching its low of 0.6 percent in the fourth quarter of 1961. If, instead, we interpret the Nairu as the value of unemployment beyond which inflation begins to rise above  the 2 percent target, then the chart suggests an unemployment target of about 4.3 percent.

Sunday, December 18, 2016

Does Paul Krugman Really Want to Say Hillary Could Have Won Only by Keeping the Truth from Voters?

Paul Krugman says the election was hacked. He thinks Hillary Clinton would have won the presidency, but for two problems:

I’m talking about the obvious effect of two factors on voting: the steady drumbeat of Russia-contrived leaks about Democrats, and only Democrats, and the dramatic, totally unjustified last-minute intervention by the F.B.I. . .
Does anyone really doubt that these factors moved swing-state ballots by at least 1 percent? If they did, they made the difference in Michigan, Wisconsin and Pennsylvania — and therefore handed Mr. Trump the election, even though he received almost three million fewer total votes. Yes, the election was hacked.
I’m not sure Krugman has any hard statistical evidence to back this up, but he may very well be right. Is so, what is the implication? 

Krugman wants us to focus on the fact that the people who did the hacking were “bad guys.” Vladimir Putin is a devious authoritarian who arguably had no business trying to tilt the US election to his favored candidate. The FBI may really, as he says, “have  become a highly partisan institution, with distinct alt-right sympathies” (although I find that a bit of an overstatement.) 

In my view, though, we should not allow the fact that “bad guys did it” to distract our focus from one key fact: What we learned from the Russian hackers and the FBI was true.

Yes, Clinton really did have a private email server. At a minimum, by her own admission, that showed bad judgement. It seems to have been at least a technical violation of State Department rules, even if the FBI was right to recommend against criminal prosecution. The server, and Clinton’s handling of the issue, really did turn off some voters.

Yes, the DNC, as revealed by Wikileaks, really did put its thumb on the scale in the primaries, contrary to its professed neutrality. Without the DNC’s covert aid—or with a more timely revelation of that aid—a fairer primary process might well have resulted in the nomination of Bernie Sanders.

Yes, Clinton’s paid speeches to banks really did contain material that could have swayed undecided primary voters, had it come out earlier in the year — her embrace of free trade and open borders, her offer to give Wall Street executives a larger role in crafting regulations, her casual willingness to say one thing behind closed doors and another in public.

None of this was false news. It was true news. I agree, it would have been more  palatable if it had been revealed by an earnest, all-American whistle blower within the DNC campaign rather than by the Russians, but that does not change the fact that the material released was true.

So here is my question: When Krugman says that Clinton would have won the presidency of only the election had not been hacked, isn’t that exactly the same as to say that she could have won only if she had been able to keep the truth safely under wraps?

If it is, then the blame for Clinton’s defeat lies with the message, no matter how much effort Krugman makes to shift our focus to the messengers.

Wednesday, December 14, 2016

Just About Managing: How the "Jams" Elected Donald Trump

Hillary Clinton famously characterized Donald Trump’s voters as a “basket of deplorables,” but she was wrong. Our friends, the British, have figured it out: Trump was elected not by deplorables, but by jams.

“Jams,” short for “Just About Managing,” is the new term has swept British political discourse. They are defined as a social class consisting of people who have jobs and a home, but little by way of savings or discretionary income; people who see themselves as precariously comfortable at best, with nothing to fall back on if adversity strikes.

The instant popularity of the term may have something to do with the way it echoes another typically British political expression, “jam tomorrow,” meaning an often made but never fulfilled promise.

James Frayne of the British think tank Policy Exchange has written a thorough and thoroughly wonky report on jams. For statistical purposes, he equates jams with the middle half of the British class structure, sandwiched between professional and managerial classes above, and unskilled workers and those who live on social benefits, below.

What Frayne says about jams certainly makes them sound a lot like Trump voters. They work hard, pay their taxes, and play by the rules. What they want is to see “society run in a fair way.” American translation: They want to see that the system is not rigged.

Monday, December 5, 2016

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.

Sunday, December 4, 2016

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.