On Congressional snack accounting

K. William Watson wrote an amusing little piece yesterday over at Cato. Riffing off a POLITICO article about Congressional staff bartering gifts of snack food, Watson highlighted the natural impetus to trade. In his own words he writes “[i]n order to be insufferably pedantic.”

On the contrary, Watson is insufficiently so. He writes

I think it’s worth pointing out how crazy it would be to restrict this trade. Should offices worry that they’re running a snack trade deficit? Are some snacks being unfairly traded at too low a price? Are other offices inadequately inspecting their exports for safety?

Obviously, the trade is highly regulated. Only certain gifts may be exchanged, and production of these snacks presumably fall under common regulatory schemes before entering into the staff barter system. Ultimately, though, I would like to focus on the question of the “snack trade deficit.” Offices should worry about the existence of such deficits– not because trade deficits do not matter; rather it is unclear what a legal snack-trade deficit might look like.

A trade deficit results from drawing down on currency or other capital stores to finance an excess of imports over exports. To a first approximation, then a snack trade deficit involves paying more cash for snacks obtained than the cash received for snacks given up. But the Congressional snack trade is regulated so no cash may change hands and everyone winds up with exactly the cash they started with. There can be no snack trade deficit so long as staffers merely barter snacks.

But snacks are not the only medium circulating in the Congressional snack trade. According to the POLITICO article, snacks have been exchanged for use of a cell phone charger. This is probably no big deal. Use of snacks for rewarding unpaid interns is probably a but more sketchy, but pales in comparison to the fact that there are unpaid interns. Ultimately, the critical question is what else might be exchanged for snacks?

Alabama Republican Rep. Robert Aderholt’s chief of staff, Brian Rell, said in an email that he doesn’t see a lot of trading going on; “it is more like a tailgate where food is readily available.”

To the extent this is true, great. Share and share alike. Perhaps there are offices which are snack-rich and others snack-poor and so there may be net transfers of snacks from rich to poor showing up in the snack accounts even if there are no snack trade deficits. But to the extent that there are any expectations for non-snack compensation offices should very much worry about large snack account imbalances.

Farmer’s Folly: The Sequel

The post below is part of an exchange with Roger Farmer with origins which predate the start of this blog. The ultimate question is should (or even can) the government control asset markets for purposes of managing the rate of inflation. I believe Farmer’s call for such interventions is misguided.

More specifically, Farmer declares that the fall in the stock market in 2008 “caused” the Great Recession. What he seems to mean is that current movements in stock prices can be shown to help predict future movements in unemployment. Unfortunately, there is evidence that the relationship has broken down in recent years. Indeed, Farmer dismisses my concern that his initial model produces poor forecasts by making this very point. Furthermore, it is difficult to distinguish between stock prices as forward-looking, as opposed to forward-causing. Thus, even if the actual association today may be discerned, it is not clear that if, say, the Federal Reserve bought up stocks to keep prices high that such action would actually lead to much reduction in unemployment.

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In a new working paper (PDF) UCLA’s Roger Farmer responds to last year’s investigation into his claim that declines in the stock market caused the Great Recession.(PDF) Farmer apparently failed to grasp the nature of the critique.

In his original paper, Farmer claimed to have found a stable relationship between the movements in S&P 500 and unemployment rates, and that the data “leads me to stress asset market intervention as a potential policy resolution to the problem of high and persistent unemployment.” In other words, the government should deliberately prop up the stock market as a way of boosting the economy. Farmer appealed to the apparent forecasting power of his model to support his policy preference.

In response we countered that his visual evidence of forecasting power was deceptive– playing off the serial correlation in the data to trick the naïve observer. Rather, his model was not in fact powerful, as was demonstrated by the fact that a simpler model that ignored stock prices produced superior forecasts. Our analysis showed that even if Farmer’s model was correct, movements in the stock market fail to explain– let alone cause– the Great Recession. Finally, we pointed out that the intervention necessary to prevent the recession was implausibly large to be considered serious.

Farmer now:

• Asserts as fact certain properties of his data shown to be consistent with, but unsupported by his analysis.
• Argues that the asserted properties require the use of a particular type of model.
• Suggests that despite using the proper kind of model, his model was “seriously mispecified” by failing to account for a structural break.
• Reasserts that despite this structural break the observed relationship is somehow “structurally stable.”
• Abandons the “correct way to model” and employs pre-break data in an effort to support the uncontroversial position that stock market data may help forecast unemployment.

We agree that his model may have failed due to structural breaks. In fact, post-2008 data may be completely different in structure than data prior, and therefore any model based on previous data is liable to produce forecasts only spuriously related to the post-2008 economy. In any case, we believe this undermines both his assertion that stock prices caused the Great Recession and his proposed policy solution.

Latvia: First Prize For What, Exactly?

Cato’s Steve Hanke awarded “1st Prize” to Latvia for its lowest misery index score among former Soviet Republics. He notes that to the extent there is misery in Latvia, the “Major Contributing Factor” is Latvia’s unemployment rate, currently at 10.7 percent according to the IMF.

What Hanke leaves out is the fact that unemployment is so low because there has been a mass exodus of workers out of the Latvian labor market– and indeed the country. Since 2008, Latvia’s population has fallen 7.4 percent and the labor force has fallen by a whopping 16.7 percent.

(source)

First prize to Latvia indeed!

Some folks just imagine conflicts that do not exist

It may make great theater, but terrible science.

In the latest issue (#67) of the real-world economics review, Egmont Kakarot-Handtke presumes to moderate a debate (PDF) between Paul Krugman and Steve Keen (PDF). Sadly, Kakarot-Handtke’s paper lies at that unfortunate intersection of incomprehension and irrelevance. The paper is irrelevant, in that Kakarot-Handtke imagines a debate between loanable-funds and endogenous-money approaches to macroeconomics that to my eye does not exist (at least in this context.) The paper demonstrates incomprehension in that Kakarot-Handtke attributes to the loanable-funds model a non-existent property.

To the latter, we hardly need look beyond the final words Kakarot-Handtke offers:

The structural axiomatic analysis leads to the prediction that Krugman’s loanable funds model will be clearly refuted. It simply does not happen in the actual monetary economy that saving and dissaving of the households is exactly equal.

Here, Kakarot-Handtke appears to tear down a straw man. The textbook loanable funds model is one in which households lend to businesses– directly or indirectly– for investment purposes. If the loanable funds model predicted that households neither saved nor dissaved on net, then there would also be no investment. What Kakarot-Handtke actually argues is that even in a purely consumption-based economy, that households can save or dissave on net if businesses dissave or save, respectively. Surely nothing Krugman has written can make one wonder if he disputes this point.

Nevertheless, Kakarot-Handtke manages to get there. Specifically, Kakarot-Handtke quotes Krugman (twice!) as saying

If I decide to cut back on my spending and stash the funds in a bank, which lends them out to someone else, this doesn’t have to represent a net increase in demand.

So it is disconcerting to see Kakarot-Handtke then go on to comment

From the quote above it is clear that for Krugman savers and dissavers are not independent. For someone who saves there is someone else who takes the money, courtesy of the intermediation of the banking system, and spends it. Hence there is no effect on the rest of the economy.

(emphasis again added)

Kakarot-Handtke‘s paraphrase is disconcerting for multiple reasons. First, Krugman does not argue that “there is someone else who takes the money.” Rather, he makes a conditional argument– that if someone else takes the money, then this doesn‘t have to represent a net increase in demand. Nothing Krugman wrote implied that he believes saved money must be lent, making Kakarot-Handtke‘s paper a complete non-sequitur.

Further, nothing Krugman wrote implied that he believes that lending necessitated a prior act of household saving. A single offered example need not constitute an exhaustive list of the universe of possibilities. Importantly, this suggests no obvious endorsement of pure loanable funds modeling here, as Kakarot-Handtke insists. Quite to the contrary, Krugman wrote

Keen says that it’s because once you include banks, lending increases the money supply. OK, but why does that matter?

What part of “OK” does Kakarot-Handtke fail to understand? Krugman is not arguing against endogenous money, but rather wondering aloud what the complication adds. I am inclined to wonder as well. Kakarot-Handtke‘s contrived example sheds no light on the subject, arguing only that households may save or dissave.

In fact, Krugman is sympathetic to the idea that debt plays a role in influencing aggregate demand. He writes

In the kind of model Gauti and I use, lending very much can and does increase aggregate demand, so what is the problem?

Krugman goes on to take issue with the notion that lending by definition adds directly to aggregate demand. In truth, much of the problem is that Keen simply makes up his own definition of “aggregate demand” which includes

income plus the change in debt, and that this is expended on both goods and services and purchases of financial claims on existing assets

He then produces the equation \begin{equation} Y\!\left(t\right)+\frac{d}{dt}D\!\left(t\right)=G\!D\!P\!\left(t\right)+N\!AT\!\left(t\right) \end{equation} Yet this construction is catastrophically non-specific. Consider Keen‘s Figure 3, titled “Aggregate demand as income plus change in debt.” The figure shows, however, nominal GDP plus change in debt. Is $Y$ then equal to nominal GDP? In that case, we are left with \begin{equation} \frac{d}{dt}D\!\left(t\right)=N\!AT\!\left(t\right) \end{equation} and find that the “change in debt” is spent entirely on existing assets, and does not add to aggregate demand in the usual sense at all. Clear as mud, that.

Mitchell strikes out again

If Cato’s Daniel J. Mitchell is “particularly impressed” by Sweden’s “genuine fiscal restraint” from 1992-2001, he must love President Obama.

Mitchell shows a graph of total government expenditures in Sweden over the period, noting that “spending grew by an average of 1.9 percent per year” over those nine years. Let’s leave aside the fact that this is in nominal currency– a frequent oversight in Cato’s budget reporting. What I find particularly interesting is that equivalent spending in the United States grew only 0.9 percent per year from 2009-2013. Does that impress Mitchell? I’m guessing not, because spending was especially high in 2009 on account of the bursting of the housing bubble, and resulting unemployment, bailouts, and stimulus. But the story was hardly different in 1992 Sweden– suffering the fallout of a housing bust and banking crisis.

Of course, Sweden went as far as nationalizing banks to deal with the banking crisis and was fully recovered by 1995. So maybe the U.S. should take a lesson from Sweden: nationalize a few banks, get to full employment, and then consider some “fiscal restraint” of its own.

German fiscal policy is not so obviously “onerous”

In Germany last year, households and nonprofits directly consumed 57.4 percent of domestic production. Foreigners (on net) bought another 6.3 percent. Germany invested another 16.7 percent. That comes to 80.5 percent of production. So how can Cato’s Daniel J. Mitchell reasonably claim that “government spending consumes about 44 percent of economic output” as he does in today’s blog post?

The answer is, he cannot. The German government claimed only 19.5 percent of economic output, and even then consumed only 7 percent. The remaining 12.5 percent of economic output– though counted as government expenditure– was in fact consumed by the private sector.

Thus, the domestic private sector eventually claimed almost 93 percent of all economic output.¹ So what did Mitchell really mean? The German government received taxes sufficient to purchase 44 percent of GDP, and spent money sufficient to purchase 44 percent of economic output. That’s fine as far as it goes, but it does not tell us how burdensome the government spending. After all, traders spent $108 trillion on stocks in 2008. Does Mitchell believe that they therefore consumed 175 percent of the economic output of the entire world?

Suppose that government directly confiscated every bit of income produced by the economy, but then returned it dollar-for-dollar to each person. Though the government did nothing, Mitchell claims that government consumed 100 percent of economic output. He may not like that governments take money from some and give to others to spend, and he may not like that governments purchase goods and services and give to others to consume, but he inexcusably exaggerates the amount of output actually consumed by the German government.

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1 claims include the amount saved through net sales to foreigners^↩

Is It Really Time for the Fed to Worry About Inflation?

Ylan Mui at The Washington Post’s Wonkblog had a piece Thursday titled “This is why the Fed should start worrying about inflation again.” The main bit of evidence is a graph attributed to Kevin Logan showing a negative relationship between the unemployment rate and increasing rates of inflation. But this graph actually says far less than Mui says.

Indeed there is a relationship between unemployment and inflation. The Federal Reserve is tasked with balancing inflation and unemployment, and when the Fed fears inflation, it raises interest rates with the intent of slowing the economy and creating unemployment. To some extent, then, the relationship is the Fed’s doing.

Let us put that aside, however, and take the observed relationship at face value. First, it is far from obvious that 6.5 percent unemployment represents a threshold below which inflation is as likely to rise as fall– particularly given the small sample size. In Figure 1, I was unable to reproduce exactly Logan’s figure, but according to data available at the Fed, four of the five years with the highest unemployment rates under 6.5 percent are associated with decreasing inflation.

Figure 1: Unemployment and Changes in Inflation

Source: FRED, series JCXFE and UNRATE and author’s calculations

Rather than cherry picking, we may regress changes in inflation against the unemployment rate. As it turns out, the relationship is statistically weak. The expected change in inflation switches between positive and negative somewhere between 2.5 and 7 percent. Likewise, this suggests that the 50/50 point lies closer to 5 percent than 6.5.

Table 1: Regression results

		(1)	(2)	(3)
$\beta_0$	constant	0.52 (0.37)	0.52 (0.43)	0.52 (0.39)
$\beta_1$	unemployment rate	-0.11 (0.06)#	-0.11 (0.07)	-0.11 (0.06)#
variance/covariance estimator		OLS	jackknife	bootstrap
$-\beta_0/\beta_1$		2.6-7.1	2.9-6.8	3.0-6.7

Standard errors in parenthesis
# Significant at 10% level
Source: FRED, series JCXFE and UNRATE and author’s calculations

In Figure 2, we see the probability that inflation will be higher in 2014 than it was in 2013– assuming various year-round average unemployment rates for 2014. At 6.5 percent unemployment, the probability is closer to one in three than one in two.

Figure 2: Probability of Increased Inflation in 2014

Note: The widest (lightest) confidence band covers 95 percent of outcomes and the most narrow (darkest) band covers 50 percent.
Source: FRED, series JCXFE and UNRATE and author’s calculations

More importantly, increasing inflation is the wrong consideration. The Fed has tolerated inflation below 2.0 percent ever since 2007, and in 2013 core inflation ran only 1.2 percent. If the Fed must target some rate of inflation, it should target a higher rate of inflation. Yet, even if the relationship is meaningful then there is less than a 5 percent chance that 2014 inflation will run even as high as 2.0 percent.

Figure 3: Probability of At Least 2% Inflation in 2014

Note: The widest (lightest) confidence band covers 95 percent of outcomes and the most narrow (darkest) band covers 50 percent.
Source: FRED, series JCXFE and UNRATE and author’s calculations

To the extent that the relationship is both meaningful and a result of Fed activity, then, this suggests that meeting a 2% inflation target would require the Fed to be less hawkish than would be normal for the rate of unemployment. It may yet be some time before the Fed raises interest rates.

(This post originally appeared on the CEPR blog.)