Home

Syllabus

Hello everyone,

This blog of the economic crisis during the COVID-19 Pandemic began in March 2020 when schools closed in response to the pandemic. The blog reported and analyzed the economic news as the crisis happened. Now that school is back, I will be posting updates on a regular basis.

In addition, I will also answer people's questions about the current economy. You can send your questions to me at Richard_Donnelly@bedfordps.org.

Economic Update 6/ 11 - Making Sense of Prices and Job Creation

The past week, with the release of the unemployment numbers last Friday and the Consumer Price Index (CPI) yesterday, has resulted in a lot of confusion and debate about the current state of the economy. The job creation numbers for last month were lower than expected and the CPI came in higher than expected, which seems to imply the contradictory situation that the economy is both stalling out, resulting in poor job creation, and roaring ahead, resulting in higher than expected inflation. And some news outlets are hinting that this could be a return to the 1970's with stagflation - stagnant economic growth and high inflation. While headlines like this get attention, the comparison does not really work because the conditions that caused the stagflation of the 1970's are very different from the current economic situation. In short, the stagflation of the 1970's was the result of several major changes that had been building up for a decade in the American and global economy at a time when it was very hard for the economy to adjust to those changes. The current economic problems are the result of global shock to an economy that was working well before the shock and is much more flexible in responding to change. The adaptability of the current economy can be used to explain the underperforming jobs numbers and the high CPI. The economy is still working through the economic shock created by the pandemic last year and will, most likely, be continuing to work through the shock for the next few months. A good analogy to describe the current economy is to think of what happens when a large rock is thrown into the calm waters of a pond. The impact of the rock in the water will cause waves to ripple out across the pond and then back across the pond in a complicated crisscross pattern. It takes time for the water to settle back down into a calm state. Think about the current economy being similar to the complicated crisscross pattern in the pond as the water slowly adjusts to the shock of the large rock.

A good place to start in thinking about the current changes in the economy is to picture the economy as a large group of independent individuals engaging in business with each other. As you could expect, the ability of this large group to communicate across the whole group and coordinate action would be very limited - and a lot of the communication might be confused (think about the game "telephone"). In essence, this is how the economy works with people working in different markets that are all linked together. Prices are the way people in markets communicate with each other and communicate between markets. Prices going up indicate that more of a product is demanded and should be produced, and prices going down signal that less of a good should be produced. When the economy is operating smoothly, this process of organizing the economy through price signals works well since prices are stable and when they do change, they do not change by very much. However, when the economy is disrupted by a large shock, like the pandemic, price signals can become chaotic which makes it hard to coordinate economic activity in markets and across the whole economy. Over time, like the pond hit by the rock, the shock to the economy dissipates and the price levels stabilize and return to being reliable signals in organizing the economy. It is important to note that the process of economic adjustment can be slow - or at least seem slow by the measure of our fast moving society.

The Consumer Price Index (CPI) numbers released yesterday show an economy in which prices are moving at different rates, which is a sign of adjustment. The overall CPI was up 5% on a year ago. This is much higher than the Federal Reserve's target inflation rate of 2%, but the large jump in the 12-month CPI is deceptive. Last year at this time, the decline in prices brought on by the pandemic was at its low mark, so the 5% represents a trough to peak change. The speed of both the economic recession and the recovery has driven this large fast change in prices. Still, the one month price increase was quite high at 0.6%, which would be an annualized inflation rate higher than 7%. One question that economists are debating is whether prices will continue to go up by the current rate for a sustained period (which would be a problem). One thing that economists are looking at in trying to make sense of the price changes in the economy is the type of goods that are seeing sustained price increases. Three of the biggest price increases are used cars (up by 29.7% from last year), airplane tickets (up by 24.1% from last year) and rental cars (up by 110% from last year). All three of these industries were hit especially hard by the pandemic and are experiencing a very strong recovery as the economy moves out of the pandemic and into the summer vacation season. The fast jump in prices in these markets, along with prices for commodities like lumber, are a result of bottlenecks in production and supply - and these will be sorted out as post-pandemic production ramps up. Evidence that high CPI is driven by large spikes in specific industries can be seen in the evidence that food prices only increased by 2.2% over last year and new cars are only up by 3.3%. In short, the best way to look at the current price information is that it is very "noisy", which makes it hard to read as an economic signal. Unless there is another economic shock, prices will calm down - and some prices for things like used cars and rental cars will most likely go down later in the year (which will put downward pressure on the CPI). This is the process of crisscrossing waves in the pond that was described earlier.

The on-going economic disruption also can also explain the lower than expected job creation numbers announced in last Friday's jobs report. Last week, it was announced that the economy created 559,000 jobs in May and the unemployment rate dropped to 5.8%. In normal times, these would be considered to be good numbers and sign of a strong economy. However, with roughly 9.3 million people still unemployed (based on the number of people employed before the pandemic), the economy will have to keep creating jobs at this rate for a year and a half to fully return the unemployed to work. There has been a large debate going on between economists about why the job creation numbers have been so low given the high number of unemployed and the apparent strength of the economy - with so many "help wanted" signs. Some economists have argued that this is because of the extended unemployment benefits that discourage workers from returning to work while others say it is because of on-going child care issues and worker hesitancy due to health concerns. A number of economists have noted that the rapid change in the structure of the economy might explain why some types of jobs, such as lower paid service work in restaurants and stores, are not being filled because the workers who previously had those jobs are now choosing to work at better paying warehouse jobs for on-line retailers. There is also the idea that many older workers have decided on early retirement - which makes sense given the high values in the stock market and high housing prices. The reality is that all of these may be part of the explanation for the weaker jobs creation numbers. However, over the past week, a group of economists have proposed the idea that 600,000 jobs might be the "speed limit" for job creation in the economy. These economists are drawing on the work of Nobel Prize winning economist Peter Diamond and his idea of labor markets being a "matching market" that slows down the working of the market. Diamond's basic idea is that the job market is different from most other markets for goods, like say cans of soda, where prices work as the determining factors in making trades. In the soda market, consumers shop around by price and companies produce to sell at the price. The market for jobs involves more than just agreeing to a price (wage), it involves the worker and the employer being able to work together. The process of matching workers to employers is more complicated and involves interviews and trial work periods - and it can take a few matches to find the one that works the best. In many ways the job search is like dating - we have all had bad jobs and bad dates. The reality is that there is a lot of turmoil right now in the job market - some people are trying to return to jobs they had before, some are trying out new types of jobs and others are leaving their current jobs to trade up to better jobs. This turmoil will settle over the next few months.

I am not currently worried about the prospects for the American over the next several months. Yes, inflation might run a bit higher than the past decade and job creation may not be returning people to work quite so quickly, but given where the economy was last year, we are in a good place. The concern that I do have, and will be keeping an eye out for, is the uneven level of economic recovery around the world caused by different countries coming out of the pandemic at different speeds. For example, thanks to high rates of vaccination, America is moving out of the pandemic, and this can be seen in a strong economy. However, other parts of the world, especially the developing world, is still deep in the pandemic, which can mean on-going economic disruption in those places. This global economic imbalance could result in a developing world debt crisis, especially if the Federal Reserve raises interest rates to slow the rate of inflation in the United States. The last time that happened was in the late 1990's when the countries of East Asia were swept by a debt driven economic crisis that caused terrible problems in that part of the world. However, this crisis had very little effect on the United States at the time.

Economic Update - 5/ 16 - Making Sense of Unemployment & Inflation News

It has been a little while since the last economic update. Over the past month, I have thought that the economic updates were effectively retired because the economy was clearly on the path to recovery from the shock of the pandemic. And the reality is that the economic recovery is still largely on track. However, the economic news of the past few weeks about unemployment and inflation has shown that this recovery will have some bumpy patches - which is really to be expected. So, I am bringing the economic update back in this post to explain the reason for the unemployment numbers released in early part of May and last week’s inflation numbers, and how this information fits into the process of economic recovery. In short, the recent unemployment and inflation numbers are an expected bump in the road to recovery.

Before getting to the explanation, it is first good to review the numbers. I will start with the unemployment information. Two weeks ago, the Bureau of Labor Statistics (BLS) released the unemployment information for April that showed only 266,000 jobs were created and the unemployment rate actually ticked up from 6.0% to 6.1%. Normally, the economy creating 266,000 jobs in a month would be considered great. In this case the numbers were disappointing. Most analysts had expected job creation to be closer to one million, based on the past two month job creation numbers being 536,000 and 770,000. Given that there are still about 9 million fewer workers in the economy than there was before the pandemic, the number of jobs created should have been larger. There is a of dispute about the reason for the disappointing numbers ranging from excessive unemployment benefits causing unemployed workers to be reluctant to get new jobs, to many workers (particularly women) still be sidelined because of closed schools and childcare issues, to workers changing careers due to pandemic experience (and not going back to their previous jobs), to a problem in the process of gathering statistical data during this period of rapid economic change. The reality is that all of these answers could be, and most likely are, correct to some extent. How correct each of these ideas are will become more clear in next month’s jobs report, which will be released on June 4th.

The information on inflation that was reported by the BLS this week was higher than expected but is not as catastrophic as some media outlets report it to be. The Consumer Price Index (CPI) which measures the monthly changes in prices was reported as a monthly increase of 0.8% from the previous month and a 4.2% increase from last year. A 0.8% monthly increase is much higher than anytime in recent history and 4.2% increase is a large jump for one year - however, keep in mind that the 12 month number compares to last year when prices were falling due to the pandemic. Still, both numbers are above the 2% target inflation rate of the Federal Reserve, but do not indicate “out of control” inflation. The core inflation rate (which does not include energy and food prices that can be more volatile) had a 0.9% monthly increase and a 3% increase from last year. This shows that the price increases have happened more broadly across the whole economy. However, the price increases have not been uniform across all goods. For example, used cars jumped by a whopping 21% last month - which affected the overall number in the index. The large jump in used cars and houses (housing prices in February were up 11.9% over last year) can be attributed to bottlenecks in supply caused by the pandemic. Used cars are up in price because of the slow process of ramping up new car production (specifically, there have been shortages of computer chips for cars), which means there is more demand for used cars. The housing market is out of balance because many people who already have homes are reluctant to sell them for various reasons due to the pandemic - and there are some reports of investors also buying houses to hold (not live in). Both of these markets should normalize over the next few months (this does not mean prices will go down, but instead slow in price increases). Last week the BLS also released the Producer Price Index (PPI), which is similar to the CPI, but looks at goods that companies usually buy. The PPI also showed a large jump of 6.2% in the 12- month increase, but a lot of this increase can be explained by the prices last year being so low (going down due the the pandemic) and bottlenecks in production of resources.

The job creation numbers were disappointing and the inflation numbers were higher than expected, but that does not mean that the economy is spinning out of control. A good place to start in thinking about these numbers is to recognize that they are data points about the same economy. Poor job creation numbers are an indication of a weak economy while higher inflation numbers indicate a strong economy. So, the obvious question is what do contradictory numbers say about the state of the economy - is it strong or weak? Answering this question requires thinking about sharp and sudden changes the economy has gone through since the pandemic began in March 2020. The economic crisis that began with the pandemic was a massive economic shock across the whole economy. Millions of people lost their jobs and thousands of businesses failed as the economy closed for public health reasons and stayed largely closed for months on end. This disruption can be seen as having two effects on the economy. First, many business organizations were destroyed that created a large number of more permanent unemployed workers who could not easily return to work when the economy turned back on. Second, the long duration of the pandemic changed many parts of the economy because of how it affected the way many people changed their work and consumption patterns. In many ways, the pandemic accelerated many changes already happening in the economy, which makes the current quite different from the one of 14 months ago. The economy is now trying to adapt to both of these disruptions. In addition, the process of turning the economy back on has not been an even, or well organized process, which has created many of the disruptions that can be seen in the unemployment and inflation numbers. Just think about the way the uneven vaccine rollout has affected people’s behaviour and different willingness to re-engage in the wider world. In economics jargon, disequilibrium in the labor force and prices is the result of economic adjustment. This means that the uneven job creation and large price changes are not a sign of dysfunction, but actually show that the economy is doing what it should to adjust to the changes it has been through. This adjustment process can be more uneven than expected because of the large number of adjustments needing to happen simultaneously in the current economy.

Much of the current news with job creation numbers and prices should be expected, and might continue for some time as the economy recovers and continues to adjust. The issue of simultaneous poor job creation and inflation should fade because one issue should resolve the other (unless the economy is truly broken in a Venezuela kind of way). Simply, the higher inflation of a stronger economy means that employers will offer higher wages to get more workers, and the higher wages will encourage more people to join the labor force and lower unemployment. On the other hand, a weaker economy will result in people reducing their consumption, which will reduce the upward pressure on prices. Of these two options, the first one makes more sense given the amount of economic stimulus and excess savings in the economy which should keep consumer demand high for the next several months.

The reaction to the news of the CPI being 4.2% and the PPI being 6.2% is complicated by the reality that the media has done a poor job explaining it (often reporting the 12 month numbers as one month numbers) and many people associate inflation being a direct result the money supply (as in there is too much money in the economy). While a growing money supply can feed inflation in an economy, it is not the direct cause of inflation. Inflation is caused by the level of demand in the economy being greater than the supply of goods, which forces up the price level. An economy can have both a growing money supply and a sudden increase in demand and not have inflation if the supply side of the economy (that is the production of goods) can also increase by an equal amount. The reason demand is growing strongly across the economy as the pandemic wanes is because the Federal Reserve has increased the money supply to deal with the economic crisis and the government has put a lot of stimulus into the economy. Whether inflation becomes a problem really depends on the ability of the productive side of the economy to expand to match the growth in demand. This is where the issues of bottlenecks in production come into the story. The economy in general has lots of capacity, but there can be pinch points in the production process, such as the shortage of computers for cars, that can jam up complex supply chains and limit the overall amount of goods in the economy, resulting in higher prices. This is usually a short term process - very similar to the toilet paper shortage at the start of the pandemic - that can be resolved. Most economists think the jump in inflation is the result of these short term bottlenecks in production. The ability of inflation to become a sustained economic issue only happens if the economy cannot expand production. That is unlikely in an economy with millions of unemployed workers.

While higher inflation should be expected over the next few months, this does not mean that the economy is headed for an inflationary crisis. First, four percent inflation, while higher than the recent past, is far from a destructive level of inflation. Beyond that, the economy will adjust in response to higher prices with the supply side of the economy growing to match the demand in the economy. Consider that the economy was growing well with an unemployment rate below 4% and almost no inflation before the pandemic. Once the current bottlenecks in production are resolved the economy should return to that situation of full employment growth. It is unlikely that inflation will cause a deeper problem in the economy unless there is a way for it to turn into a vicious cycle where higher prices result in higher wages, that in turn feed back into higher prices and so on. This only really happens when inflationary expectations become widespread and get locked into long term contracts. That is unlikely because sustained higher inflation can be stopped by the Federal Reserve raising interest rates from their current low levels. The Federal Reserve will not destroy the economy by raising interest rates a few points. In fact, it is standard economic theory and practice to raise rates into a strong economy, and this should not stop investment. Yes, Wall Street might throw a tantrum at higher rates - but the stock market is not the economy. The reality is that the incentive of higher profits from investment in a stronger economy should not be hurt by the cost of slightly higher interest rates. In addition, a little bit of inflation might be good for the economy since it reduces the real cost of debt, which might benefit many people and businesses across the economy who had to increase their borrowing over the course of the pandemic recession.

Now, with all that said, could this really be the start of a larger economic problem? Yes, economic forecasting is a tricky business. Still, I think the best analogy for the current economic situation would be like hitting a rough patch of air turbulence in an airplane after flying through a thunderstorm. The turbulence does not mean the plane is going to crash - airplanes are well built and pilots know what they are doing. Passing turbulence should be expected after flying through a nasty storm.

Economic Update - 3/22 - The Economics of Vaccines

The most important economic issue right now is the process of mass vaccination for COVID-19 that is going on across the country. Successfully getting more than 70% of the population vaccinated in order to achieve herd immunity in the next few months is the key to having a full economic recovery (although, I should note that some scientists are questioning whether full herd immunity is possible due to new variants of the virus and because it is still unclear if the vaccines can also stop the transmission of the virus - more at this link). An economic view of the vaccination process would evaluate it by how efficiently it achieves this goal in terms of using resources. The more efficient a system the fewer resources used. By this measure, the vaccination process has been largely successful, but it has suffered from some real problems that affect the perception of success. This distinction can be seen if the vaccination process viewed as two separate processes: the productive process, which evaluates the development and production of the vaccines, and the allocative process, that evaluates how the vaccines are distributed out to the population. The productive process for vaccines has worked incredibly well, while the allocative process has worked well when considered from a national level, but has been largely terrible from the experiences of most people involved. The distinction between the national level and the individual perspective is important because a national success can be diminished if too many people have a poor view of it.

The development and production of the vaccines to fight COVID-19 has been an incredible success. First, the process involved in moving from a newly discovered virus to developing and mass producing a vaccine in under a year is a record. Impressively, the American Pfizer and Moderna vaccines represent a new form of vaccines based on mRNA. Additionally, the United States has done very well in the race for a COVID-19 vaccine compared to the rest of the world. Yes, both the Chinese and the Russians developed and began administering vaccines before the United States, but the testing results on those vaccines are still unclear (and they look less effective than the American vaccines) - Vladimir Putin has not taken the Russian Sputnik II vaccine. The only other successful vaccine has been the British made Astrazeneca/Oxford vaccine, which has been hurt by reports of a small number of blood clots. The European Union has not produced a vaccine. In terms of vaccine production, the United States has been a leader.

The development of the new vaccines is a good example of New Growth Theory in economics where government support of private industry results in the development of new technology. New Growth Theory holds that private companies are reluctant to invest in new technology if there is no a clear path to success in developing the technology or it is unclear whether they will be able to profit from the technology. Essentially, individual private companies will be reluctant to develop new technology, even if the new technology will be very beneficial to society, if they cannot profit from it. Evidence that the decision for a private company to invest in developing a COVID-19 vaccine was a risky and costly process is that Pfizer has said that it cost $1 billion to develop its vaccine. New Growth Theory says that the best way to overcome the reluctance of private companies is to have the government take a role in funding the development of the technology. This is what the Federal government did in Operation Warp Speed and contracting to buy vaccines even before the vaccines had been produced (or tested). Last year, the Federal government put $ 9 billion into 7 companies developing vaccines. New Growth Theory also notes that the technology developed with government support will result in additional economic growth because the new technology will jump start further technological development. It would be no surprise if Pfizer, Moderna and other companies developed a range of mRNA medicines over the next decade as a result of the learning involved in making a COVID-19 vaccine. In addition, the government put $2.5 billion into companies to build up the capacity to produce all of the glass vials and syringes needed to distribute the vaccines. As a result, the process of producing and distributing vaccines was ready to go once the FDA had approved the vaccines (it should be noted that both the FDA and the CDC have not done a great job in the pandemic and need to up their game in preparation for the next pandemic). The United States was productively efficient in producing a vaccine - yes it cost a lot of money, but time was the most important resource in the process.

At a national level, the allocation of vaccines seems to be successful, and getting stronger. This article by NPR has some good visuals that show the progress in vaccinations across the country. Currently, the country is averaging 2 million doses a day and should reach the 70% vaccination threshold by early October. As a point of reference, the United States currently has vaccinated three times as many people as the European Union (excluding Britain which has numbers comparable to the United States). However, some experts, including Nobel Prize winning economist Paul Romer, say we need to get to 3 million doses a day to get ahead of new variants and relaxation of COVID protocols that is already being seen around the country. Still, while the United States has been a success in the big picture, from the perspective of too many people the vaccination process is a mess.

The problem with the vaccines is really an allocation problem that specifically has to do with how individual people experience the process of trying to get a vaccination. The byzantine and constantly changing process of trying to secure a vaccination appointment has had all the clarity and chance of success of the old Soviet economy - wait in line forever without success and too many people can only succeed if they get help from a person with inside information or access. From an economics perspective, which accounts for all of the hours spent navigating and waiting on vaccine websites, this has been a terribly inefficient system. The very real frustration that so many people have with this system is because the process of allocating these vaccines is unlike anything else in the economy, which means that the people designing it have little experience in developing an efficient system of allocating a good under these conditions and participants erroneously compare it to the normally well functioning economy for buying goods.

The difficulty in developing a good system for allocating vaccines starts with reality that the starting point was the release of a very limited amount of vaccines at a time when hundreds of millions of people wanted them, followed by more limited releases of vaccines. Any system for allocating vaccines would have to deal with the challenge of having a way to prioritize the order in which people could get vaccines based on their vulnerabilities to COVID-19, the policy goals for reopening society and the ability of people to get to vaccine appointments. Trying to balance these three goals in a large scale system is a difficult process.

The unusual process for allocating vaccines becomes apparent when comparing the process to a normal market (which is the way society allocates most goods). The common terminology used for describing the situation with vaccines is to call it a “shortage”, which is correct but also misleading. In a market, the term “shortage” is used to describe a situation where the quantity of goods supplied is less than the quantity demanded. This problem is corrected by simply raising the price of the good until the shortage disappears. In a market, the price of a good is the tool that is used to decide how a good will be allocated - people who want it more will demonstrate this through their willingness to pay more. The reality is that the “shortage” of vaccines could be resolved by correctly pricing vaccines. However, while society does not have a problem with cars, sneakers and iphones being allocated by price, distributing vaccines to people based on who can pay the most would strike most people as wrong and “unfair”. The reality is that the people who most need the vaccines, the elderly, the sick and people of color, are also the people who are generally least able to pay the high price to get vaccinated.

As a society, we have decided to allocate the vaccines through a process that is a market. There is nothing inherently wrong with this decision - markets are very good for some things, but not everything. Unfortunately, the systems set up to get a vaccine appointment have been unclear and inconsistent and, for the most part, fail because they do not allow people to make a decision about how to participate in the process based on their own priorities. The vaccine distribution process did put broad priority categories in place based on expected individual needs and societal goals, but within those categories the process has been a first-come-first-served free-for-all that involves luck and personal connections. The problem is that the system for scheduling appointments is not able to differentiate between the people who feel they need a vaccine ASAP and those who are willing to wait a few weeks, but would like to lock in the appointment time now. The result is that everyone piles into the system because there is no way anyone can develop a rational strategy for securing a vaccine appointment. Essentially, the process of getting a vaccine appointment is more like trying to win a vacation through buying raffle tickets than using an online travel site. The unknown nature of raffle tickets, where that next ticket could be the winner, makes it hard to decide the correct amount of tickets to buy - or in this case refresh your screen. A system that could incorporate personal preferences into the system for prioritizing appointments would be good.

Now, in all fairness, the process for scheduling appointments has been haphazard because of the irregular supply of vaccines to vaccination sites and it has become better as the people running the system have gained more experience, more vaccines are being produced and more vaccine sites are being set up. While these problems may just be a “start-up” problem, a lot of these allocation problems should have been foreseen. The hours spent fruitlessly trying to secure a vaccine appointment do represent a real economic cost and should be measured against the success of the distribution system. Consider the billions of dollars the government put into developing the vaccines, perhaps more money should have been put into figuring out how to deal with the novel allocation problem posed by the vaccines and developing a better system - or at least, a less frustrating system.

Economic Update - 3/ 17 - The Federal Reserve is not Worried about Inflation

The most important and watched thing in economics news today was the conclusion of the two-day Federal Open Market Committee (FOMC) meeting. The FOMC is the decision-making body at the Federal Reserve that sets monetary policy, which covers interest rates and the amount of bonds that the Federal Reserve buys and sells (the Federal Reserve is currently buying $120 billion in bonds a month) to put money in the economy and support financial markets. Today’s meeting was watched closely for any indication of how the Federal Reserve might act if the economy begins to grow strongly and there is an uptick in inflation. The combination of the press release at the end of the meeting and Chairperson Jerome Powell’s remarks during his press conference show that the Federal Reserve does see much stronger economic growth in the second half of this year, but is unlikely to raise rates even if inflation goes over its 2% target rate.

Before getting into today’s news about the Federal Reserve meeting, it would be good to explain what the FOMC is and how it works. The FOMC is the group that makes the monetary policy decisions for the Federal Reserve. The FOMC is made up of seven Federal Reserve Governors who are appointed by the President and approved by the Senate - Federal Reserve Chairperson Jerome Powell is also a Governor - and five presidents from the twelve of the regional Federal Reserve Banks. The regional Federal Reserve presidents rotate on and off the FOMC - only the president of the New York Federal Reserve has a permanent seat on the FOMC. The FOMC meets eight times a year. It is important to understand that the way the FOMC currently operates with press releases and press conferences is very new. The Federal Reserve is an independent organization and is under no obligation to tell anyone of its policy decisions. Historically, the FOMC did not talk about the results of the meeting and meeting minutes would only be released months after the meeting happened. This changed during the 2008 Financial Crisis when the Chairperson, Ben Bernanke, began the practice of press releases and press conferences to calm markets by creating transparency about Federal Reserve Policy.

The Federal Reserve forecasts that the economy will grow by 6.5% this year. This is a very strong growth number - the economy generally averages a growth rate of 2-3% a year. While 6.5% is a strong rate of growth, keep in mind that the economy is still recovering from the economic crisis and, even after growing at a strong rate, the economy will most likely still be smaller than where it would have been if there had been no pandemic. The Federal Reserve also expects that unemployment will decline to 4.5%, which may not seem like very much given that the current unemployment rate is 6.2%. However, the current unemployment rate does not accurately reflect the real jobless situation in the country because it does not count the millions of workers who have dropped out of the labor force because they do not think they can find a job. As the economy gets stronger, many of these workers will return to the labor force, which will, curiously enough, may cause the unemployment rate to temporarily go up. The 4.5% unemployment rate forecast by the Federal Reserve includes those returning workers, so the small decline in the unemployment rate actually signifies a lot more people having jobs.

In terms of inflation, the Federal Reserve forecasts that core inflation will reach 2.2% by the end of the year. The term “core inflation” means a measure of inflation, like the Consumer Price Index (CPI), without including food or energy (there is a full explanation of inflation in the post on 2/22). The Federal Reserve bases its inflation measure on “core inflation” because it is less volatile and is considered a better measure of level of inflation across the economy. The problem with including food and energy prices in the measure of inflation is that the prices of these goods go up and down all the time (are volatile) for reasons unconnected to major economic events, such as a hurricane or poor harvest. An indication of the difference between “headline” and “core” inflation is that the current CPI is 1.7% and core CPI is 1.3%. The way to read the Federal Reserve forecast is that the CPI will go over 2% (maybe as high as 4%), but that core inflation will stay close to the Federal Reserve’s target rate of 2% - and that any inflation will not affect the larger economy in the long term. This is the reason the Federal Reserve will not raise interest rates, even if inflation starts to go up.

The FOMC minutes and Jerome Powell, in his press conference, said that the Federal Reserve expects to keep interest rates at their current level (close to 0%) until 2023. Powell justified this policy by noting that the economy is still in an unclear and uncertain condition, and that there are many potential risks out in the economy. If you read or watch business news, you will have heard references to the “Federal Reserve Dot Plot” and predictions of when interest rates will go up. The “Dot Plot” is an anonymous survey of FOMC members about when they think the FOMC will raise interest rates. It is called the “Dot Plot” because it shows one dot for each FOMC member on a timeline. In 2012, the FOMC, as part of Bernanke’s move to make the Federal Reserve more transparent, started releasing the “Dot Plot”. The news on the “Dot Plot” is that at the December meeting only one FOMC member thought interest rates should go up next year and that after today’s meeting that number had risen to four - but they only want to raise rates to 0.25 - 0.5%. This shows that the FOMC is becoming more optimistic about the economy, but is still well over a year from raising interest rates.

Economic Update - 3/ 15 - A Year of Economic Updates - Some Thoughts on Economics

I started posting the Economic Updates a year ago as the Bedford schools closed in response to the COVID-19 pandemic as a way to teach my students about the economic turmoil that accompanied the start of the pandemic and to also to help myself make sense of the unprecedented events. Soon after that I began to share the updates with the larger Bedford school community because I thought a lot of people had questions about what was going on in the economy. When I started posting these updates, I expected that the updates would only go for a few weeks because (like most people) I thought we would be returning to school later in the spring and the economic crisis would pass. But, here we are a year into the pandemic with the economy still in a hard place - that the reason for the $1.9 trillion spending package signed into law last week. I hope that you have found the posts over the past year to be useful and informative. I have enjoyed reading the emails many of you have sent me in response to the updates (the update about toilet paper on 4/14/20 and the one on GameStop on 1/27/21 generated the most response). I want to use today’s post to take a step back from the current economic news and talk about the subject of economics and how everyone should feel comfortable talking and thinking about economics.

My purpose in posting the economic updates has been to explain the economic events and the reasons for the economic policy responses. As an economics teacher, I recognize that economics is complicated, but I also believe that everyone can understand it, and that widespread understanding of economics is important in a democratic society. Unfortunately, a lot of people do not feel like they understand economics because they see it as a specialized subject that is complex, abstract and not clearly connected to daily life. I do not blame people for thinking this. I think the fault for this lies with the economics profession for poorly explaining economic events and economic policy. Regardless of the cause, I think that people should recognize that they actually know a lot more economics than they think they do. The reality is that everyone is constantly engaging in economic thinking as they go through their daily lives. That experience is a valuable form of economic knowledge. A lot of formal economics is about applying a structured thought process, supported with math, statistics and specialized terminology, to everyday economic experiences. You use economic thinking all the time, you just have not thought about it too much. The famous economist Paul Samuelson got at this when he said, “intuition is really just rationality in a hurry.” A good analogy for the relationship between everyday living and the formal economics used by professional economists is that of professional athletes to the study of physics. I doubt many professional athletes have spent a lot of time studying physics, yet they know through experience where the ball will be and how to get it to where they want it. More importantly, they can describe how the ball moves with a lot of sophistication. While these athletes may never have studied physics as a formal science, they actually do know a lot of physics. The same is true for economics. Nobody should think that they do not know economics, they should just recognize that they have not thought about it in a formal way.

One of the most important insights to be gained from studying economics is the realization that economics is not a set body of knowledge, but is instead a way of thinking. When I use my knowledge of economics to look at a problem, I am really drawing on a set of thinking tools or models that help me analyze what is happening in the problem. When economists use the term “model” they mean a simplified understanding that strips a complex event down to the simplified process that identifies the essential parts. Models take lots of forms that range from simple explanations to complex mathematical equations. The analogies I use in writing these updates are really a type of model. Economists use models in a way that is similar to a mechanic reaching into a tool box trying to find the right tool for the job. The thinking process in economics is about finding the right model to fit the problem. This is not an easy process because, just like there are many types of tools, there are many models. A lot of the debate between economists over the current economic situation and the best policy response is really like an argument between two mechanics about what is wrong with a car and how to best fix it (think about listening to Click and Clack on Car Talk). Diagnosing and fixing what is wrong with a car can be tricky because there are a lot different systems at work in a car (transmission, electrical, cooling, and so forth) and a mechanic needs to think about each system and how they interact with each other. This is the same situation with thinking about the larger national level macroeconomy. For example, how will government spending in a stimulus pacakge affect consumption, inflation, interest rates, financial markets, investment and long-run economic growth. The economist Tyler Cowen described this when he wrote, “economics is really, really, really, really, really, really, really hard. And that's leaving out a few of the "reallys." Good economists make this thinking process look easy because they engage in economic thinking all the time. This should not discourage (or worse intimidate) people from thinking and talking about economics anymore than professional athletes discourage people from playing sports. Yes, good economic thinking is hard and it takes practice, but everyone can and should do it - and should not be discouraged if they get things wrong or do not see how all the parts fit together.

I actually think that the main reason so many people feel unsure about their knowledge of economics is because of the poor quality of teaching in most economics classrooms, that many economists make little effort to clarify their ideas and a lot of what people see in economic debate is really motivated reasoning dressed up as economics. The quality of economics education is not good - there are studies that show this (in one, students who took an economics class actually did worse on an economics test after taking the class than students who had never taken an economics class!). This is because graduate programs in economics do not reward good teaching and many high school economics teachers do not really know that much economics. In addition, most professional and academic economists do not care about speaking to the larger audience of the general public about what they do. I have met a lot of economists and many of them have the social rigidity and empathetic connection of Sheldon on the Big Bang Theory. They are very smart and good people, but their communication skills are terrible. The problem is that, as a result, people mostly see economics when it is being debated in the news media, usually on cable television, between pundits who use economics jargon to push their agenda and deliberately make economics hopelessly complicated so the audience simply accepts their conclusions. This is not good.

That said, the best economists are actually really good at explaining their ideas and quite interested in sharing them with as many people as possible because they believe it is important for there to be widespread understanding of economics. This is not just the more well known names, such as Paul Krugman and Larry Summers, but also include economists like Tyler Cowen, Mark Zandi, Carmen Reinhart, Austan Goolsbee, Diane Swonk, Greg Mankiw, Diane Coyle, Robert Shiller and Justin Wolfers, who often appear on television and in newspapers to explain what is happening in the economy and how economic policy works. If you want to see good economics thinking, you should read and watch these people. This public outreach by top economists is nothing new. All of the most famous economists, such as Adam Smith, John Maynard Keynes, Milton Freidman and Paul Samuelson, wrote for the general public in addition to their academic work in economics. Perhaps my favorite example of this is Alfred Marshall, the most important economist that almost nobody knows. Marshall, who was born to a poor family in England, was a nineteenth century economist who wrote the first real economics textbook - it was his textbook that first introduced market supply and demand graphs (along with almost every other core concept in economics) - and established the first university department of economics at Cambridge University in England. Marshall is a bit like the unknown Delta Blues guitarist who inspired all the well known music stars. Marshall said that “economics is a study of man in the ordinary business of life" and, with that sense of Victoria optimism, that the goal of economics should be to “make every man a gentleman.” So, while the economics profession in general is not good at making itself understood, there are many good economists who are trying to teach economics to the general public - you just need to know where to look.

I hope that the economic updates over the past year have taught you some economics, given you some insight into the crisis we have been living through and helped you talk to other people about the economy. Talking about economics and the economy is one of the best ways to develop a more organized way of economic thinking, provided that you take the time to listen carefully to others. An important part of learning economics is recognizing the questions that you cannot answer and then trying to find an answer by listening to others and thinking about how to model the problem (I recommend making analogies as a good way to build models). The more you talk and think about economics the easier it becomes.

Always keep in mind that you have a lifetime of economics experience and do not let anybody bamboozle you with their economic ideas. If somebody, even a professional economist, tells you something that does not fit with your experience and seems deliberately obtuse, ask them questions until they can clearly explain their thinking. Recognize that it is on them to explain themselves. If you cannot understand what they are saying, the problem is not with you. The best question to ask in such circumstances is, “can you give me a real world example of this ever happening?” If they cannot answer that question, do not waste your time listening to them because their ideas are most likely not any good.

As a final note to this update, I would like to talk a bit about the issue of politics. It is impossible to discuss the current economic crisis, or any other large economic issue, without discussing politics. Still, as much as possible, I have tried to make the economic updates politically neutral and keep the focus on explaining the economic situation and how economic policy works. I apologize if any of the updates have been too political. That was not my intention.

I am not sure how long I will continue to write these economic updates. I expect that they will come to a natural end when I feel that I no longer have anything useful to add or the economy has returned to boring normality. Until then, I will continue to write updates. I hope they continue to be useful.

Economic Update - 3/12 - The $1.9 Trillion Stimulus is Now Law

Yesterday, president Biden signed the $1.9 trillion American Rescue Package into law. There is a lot being written about how big a deal this is, how it will help out Americans and whether Biden should be seen as a transformational president. In today’s update, I am going to focus on how to think about this spending bill. Specifically, I am dividing today’s post into parts based on the aspects that are clearly a “rescue” package and the parts that are more about “stimulating” an economic recovery. This distinction is important because it helps with understanding how this large amount of government spending will affect the economy. The way government spending affects the economy is through a process called the multiplier effect that I detailed in the post on 12/11. Basically, the multiplier effect is the way a dollar of government spending is re-spent through the economy creating more than a dollar's worth of economic activity. The $1.9 trillion in spending will stimulate the economy and help it recover, but not each dollar is equally simulative. The differences in how simulative the spending is could affect the outcome of whether this large amount of spending will push up inflation.

The parts of the $1.9 trillion spending package that can be put in the category of rescuing the economy are all focused on dealing with immediate needs in fighting the pandemic. At the top of the list is the $20 billion to help with vaccine distribution and the $50 billion for COVID-19 testing (this is important even after large scale vaccinations in order to monitor for new variants that are able to evade the vaccinations). In addition, the direct public health spending is the $350 billion to state and local governments to make up for lost tax revenue due to the pandemic. How much of this money is really necessary is not clear since the amount of tax revenue lost to the pandemic varies a lot between states. For example, due to the surge in the tech industry and strong returns in the stock market, California has not lost much tax revenue, while Texas has lost a lot of money (the drop in oil prices did a lot of damage to the Texas state economy). The final big part of the “rescue” part of the spending package is the $170 billion for K-12 education. This money is needed because school systems will have to spend a lot of money in the next year to give students the support to make up for the lost learning over the past year. In addition, schools need the money to re-hire personnel. Just last month, there were about 75,000 job losses in K-12 education across the country. This spending on directly fighting the pandemic will be very simulative of the economy over the next few months because all of that money will be spent on these programs and will have a high multiplier effect.

The extension of $300 a week in unemployment benefits until September is an important part of dealing with the economic pandemic that could be grouped with “rescuing” economy, but it is different from the “rescue” spending described in the previous paragraph because it may not all be spent. The amount of money paid out in unemployment benefits is based on the amount of people who qualify. If the economy has a strong recovery over the next few months, the full money allocated for unemployment benefits in the spending package may not be spent. Unemployment benefits generally have a strong multiplier effect because the benefits are quickly spent. However, that spending is stretched out over a long period of time, meaning it will come into the economy slowly over the next six months.

The other parts of the $1.9 trillion spending package are important, but they will be less simulative of the economy. The $1400 payment to each taxpayer with an income under $75,000 (along with $1400 for each dependent) could be a good income support policy, especially since many lower income workers who did not lose their jobs did suffer reduced hours during the pandemic. In addition, this will help many workers who suffered unemployment during the pandemic and were unable to pay rent get caught up on missed rent payments (there could be a rental eviction crisis following the pandemic). However, it is not clear how much of the $1400 payments will be spent and how much will be saved. It may be that some people will spend all of it, but that a large number of people will not. This means that this money may not have a large multiplier effect because it will not come rushing into the economy in the next few months. This is definitely the case with the increase in the child tax credit to $2000 and the action to make the first $10,200 in unemployment benefits tax free. These are sensible policies, but will not be simulative because they do not inject any money into the economy in the next few months.

When thinking about the economic impact of the $1.9 trillion spending package, and whether it will push the economy toward higher inflation, it is important to recognize that not every dollar spent in the package is equally simulative. The parts described in the first part of the post as “rescue” spending will be simulative, and the parts described in the later part of the post will be less simulative. This is not the same as saying this spending is “bad” or “unnecessary”. It is saying that it will not have an immediate effect on the economy.

Economic Update - 3/5 - Unemployment, Inflation and Policy Priorities

The Bureau of Labor Statistics released the February jobs report this morning announcing that the economy added 379,000 jobs in February and the unemployment rate moved down to 6.2%. The information in this report along with the downward movement in the stock and bond markets provide a good way to think about the current condition in the economy and the choices policy makers face as the $1.9 trillion spending package moves to being passed by the Senate (the Senate voted 51-50 to take of debate of the spending package yesterday). Basically, the choice is between a continuing unemployment problem or a potential situation of higher inflation. The support this spending package has from economists and policy makers represents a big change in their policy priorities from just a few years ago.

Today’s jobs report said that the United States added 379,000 jobs in February. This is a very good number - especially compared to the 49,000 jobs added in January and the loss of 227,000 jobs in December. The reason for the uptick in jobs numbers last month is a combination of the $900 stimulus package passed in December, the growing number of vaccinations across the country along with the decline in new COVID-19 cases across the country (although the news of the new variants of the virus are concerning). The Bureau of Labor Statistics reported that the unemployment rate ticked down to 6.2% (down from 6.3%). However, this number does not really reflect the unemployment situation in the economy. There are about 4 million people who have dropped out of the labor force since the pandemic began last year and are no longer counted in the unemployment numbers. A better measure of the unemployment problem in the country is that the economy currently has about 9.5 million fewer jobs than it has at this time last year. The economy needs to keep adding jobs at the rate of 400,000 to 500,000 a month for the next year and a half to get back to the number of pre-pandemic jobs. This fact is one of the core points supporting the passage of the $1.9 trillion spending package. Basically, there is a long way to go in getting the economy back to the point of full employment. Most economists hold that sustained inflation can only become a problem when the economy gets back to full employment.

The issue of inflation, and interest rates, connects to yesterday’s decline in the stock and bond markets. The rate on the 10-year bond went above 1.6%. This was a repeat performance of last week’s decline in financial markets. As I explained in Monday’s post, financial markets declined in reaction to expectations that the $1.9 trillion spending package will create inflation in the economy. The specific catalyst for yesterday's market movement were remarks by Jerome Powell, Chairperson of the Federal Reserve, where he said, “If we do see what we believe is likely a transitory increase in inflation... ....I expect that we will be patient.. .... There’s a difference between a one-time surge in prices and ongoing inflation.” In saying this, Powell was telling financial markets that if the $1.9 trillion spending package and the economic recovery does spark inflation, the Federal Reserve expects that this will be a passing burst of inflation and that it will not raise interest rates until the inflation seems to be a sustained issue. Powell emphasized that the Federal Reserve sets its policy to have a long run target rate of 2% inflation and that it does not feel it needs to raise rates until inflation is above that rate. In the past decade, inflation has only risen above 2% a few times and is currently well below 2%. Powell’s position is that getting the large number of unemployed Americans back to work is more important than fighting inflation.

The passage of the $1.9 trillion spending package is a big deal, and not just because it is a lot of money, but because it represents a defined policy position about what is a more important economic priority for the government: unemployment or inflation. Up until the Financial Crisis in 2008, most economists, central banks and governments prioritized fighting inflation over problems of unemployment (and related problems of wage stagnation and economic inequality). However, during the deep recession and slow recovery following the 2008 Financial Crisis, economists, central banks and government policy makers began to reevaluate their position about the risk of inflation and the problems created by slow economic growth (which can take the form of wage stagnation and economic inequality). The full transformation of priorities for favor fighting unemployment happened with the pandemic when the government decided to spend trillions to prevent a full economic crisis. Now as the economy recovers, the question is whether to have one more “big push” spending package to address the unemployment problem even if it risks higher inflation. The $1.9 trillion spending package is that “big push”. In general, the policy position from economists and policy makers supporting the spending package is a moment where they are putting their cards on the table showing that they are now prioritizing fighting unemployment over preventing inflation. This is a very different choice from the one they would have made just a few years ago.

Economic Update - 3/ 1 - The Connection between the $1.9 Trillion Spending Package, Bonds, Interest Rates and Inflation

The drop in both bond prices and the stock market were at the top of the business news at the end of last week and may be a signal of financial market volatility in the future. The movement in the bond market and stock market were caused by the $1.9 trillion spending package that is currently working its way through Congress (passed by the House on Friday night) and expectations about how this could result in higher inflation (which I posted about last week). While Thursday’s decline in bonds appears to be more of a tempest in a teapot than a full market correction, there will be more market actions like it over the next few months as the economy recovers from the pandemic. The purpose of this post is to explain how the bond market works and what it can indicate about the direction of the economy.

The story of the drop in the bond market last week began with an government auction of seven year bonds that did not sell as quickly as they normally do. This slower purchase of bonds was seen as an indication that the government will have to offer higher interest rates to sell the bonds to support the $1.9 trillion spending package because bond holders will want higher interest rates to compensate for the inflation risk. After this auction, the interest rate on the 10-year government bond jumped 0.2% to over 1.5% (the 10-year bond rate is used as a benchmark for the whole bond market). Now, 1.5% is a very low interest rate by historical standards. So low that it has a real negative interest rate given that the long term rate of inflation is 2%. Still, the 1.5% interest rate is 0.5 % above the rate at the start of February (the rate on the 10-year bonds has been below 1% since the pandemic began). So, what happened last Thursday was a big jump in the rate but it happened at a very low level. While the increase to 1.5% might be an indication of inflation, keep in mind the Federal Reserve’s target inflation rate is 2%, so the move to 1.5% does not mean that there will be high inflation future - it could just be a return to inflation around 2%. In addition, another way of looking at the bond market movements at the end of the week is that they are a sign of a strong economic recovery after the pandemic ends (I will return to this point toward the end of this post).

A good place to start with explaining the movement in the bond market last week is with explaining how bonds work. Bonds are a form of debt and typically governments and large corporations use bonds to fund their long term borrowing needs. A bond is a legal contract to repay the borrowed money at a set point in the future, the date of maturity for the bond. The price of a bond and the rate of return of the bond are directly related. When a bond is issued it has a face value, which is the amount of money to be repaid at maturity, and the rate of return on a bond is the difference between the face value and the price at which the bond is sold. For example, a bond that is sold at $100 with a face value of $110 has a rate of return over 10%.

The bond market is where a holder of a bond can sell their bond if they do not want to wait until maturity to get their money back. The bond market works in a similar manner to the stock market. The price of a bond is affected by the prevailing interest rates. If the prevailing interest rates go down then the price for the bond will go up because more people will want to get the higher rate of return offered by the bond. For example if interest rates dropped to 5%, then the price of the hypothetical bond mentioned earlier would rise from $100 to around $105. The price of the bond will stop going up when the rate of return on the bond equals the prevailing interest rate. The drop in bond prices last week meant the rate of return on those bonds increased, and was interpreted to mean that prevailing interest rates in the economy will rise in the future. Now, the big question is whether the bond market is expecting interest rates to go up because inflation might go up or because the economy will grow, or both.

The bond market is sensitive to changes in expectations of future inflation because inflation can cut into the rate of return on a bond. An increase in inflation reduces the real value of the rate of return on a bond and a decrease in inflation will raise the real rate of return. For example, a bond that has a 5% rate of return, really has a 3% rate of return if the inflation rate is 2%. If the inflation rate goes up to 3%, then the real rate of return on the bond goes to 2%. This in turn affects the price of a bond. When inflation lowers the real rate of return on a bond, the price of the bond will go down to the point where it again pays a 3% real rate of return. So, the decline in the bond market last week that raised the return on the 10-year bond to 1.5% could be an indication of higher inflation in the future - but again, higher inflation does not mean a high rate of inflation.

At the same time the bond market dropped last week, the stock market also went down. The reason for this is interesting and a bit unusual. Typically, the bond market and the stock market work in opposite directions. When the economy is good, investors want to hold stocks because of the expectation of higher profits. Bonds, which have a fixed rate of return, are generally not as attractive and prices in the bond market are low when the economy is booming. This is also because a strong economy means higher interest rates, which push down bond prices. However, when the economy is in recession and companies are not profitable, investors generally want to hold bonds because they are seen as having a guaranteed rate of return (stock do not). The fact that both markets went down at the same time is an indication of the strange condition in financial markets created by the Federal Reserve policies in reaction to the start of the pandemic last spring (parts of this effect could be traced back to the Financial Crisis in 2008). Basically, last spring, the Federal Reserve responded to the economic crisis created by the pandemic by buying bonds (to push down interest rates) and provide direct support to financial markets (to put a floor under the collapsing stock market). This caused the prices in the bond market to shoot up and also started the rally on the stock market as many investors began to move money into the stock market because it was effectively the “only game in town” for finding a high return on investments. Investors pushed up stock prices by putting excess savings and taking larger risks to chase gains, such as engaging in more speculation (remember GameStop) and investing in companies with only marginal expectations of profits. The result has been a high bond and stock market. Last week, the drop in the bond market which seemed to signal an increase in interest rates, was interpreted by stock investors to mean that there might be better (safer) opportunities to get a good return in other investments, and it might be a good time to sell out of the stock market to balance out an investment portfolio. That explains the strange situation of both markets going down at the same time.

This does not mean the stock market is in trouble and due for a “correction”. There are a lot of indications that once the country moves beyond the pandemic the economy will grow quickly which should result in an increase in the stock market. The primary reason for this is that there is a lot of pent up demand and excess savings in the economy. The $600 stimulus checks sent out last month are a major reason the savings rate in January shot up from 13% to 20%. It is estimated that Americans are currently sitting on $1.5 trillion in excess savings built up since the start of the pandemic. This will fund a strong recovery when the pandemic is over. However, it should be noted that most of the excess savings are held by upper income Americans. Lower income Americans have seen their savings decline during the pandemic (this is a good reason for sending $1400 to them - and not middle and upper income Americans). If the economy quickly recovers and shows strong growth, the Federal Reserve should respond by raising interest rates to keep inflation at its 2% target rate. Still, it is unlikely that interest rates will need to go very high to control inflation. So, prices in the bond market should go down as the economy recovers, but a strong recovery should be good for the stock market because companies, especially large corporations, will have higher profits.

Economic Update - 2/ 22 - Inflation Explained and Evaluating the Risk of Inflation

President Biden’s planned $1.9 trillion COVID-19 relief package is making its way through Congress with the expectation that it will be signed into law in the middle of March, before the current extension of unemployment benefits runs out. Before February Vacation, I posted about the debate between Larry Summers and Paul Krugman about whether the $1.9 trillion spending package will cause inflation. That debate has continued with more big name economists weighing in on the issue. Suffice it to say that there are very smart well informed people on both sides of the debate of whether this spending plan will cause inflation. Perhaps the better question is how much of a problem is inflation and how does it compare to the other problems that the economy is facing.

A good place to start is with explaining the concept of inflation. Inflation is an increase in the general price level across the whole economy. A price increase in some things (milk, gasoline or cars) does not mean inflation. Prices for specific things go up and down all the time due to all sorts of market events that are examined in microeconomics. Inflation looks at the general move in prices across the whole economy is an important part of macroeconomics. The numerical value of inflation is calculated by tracking prices across the economy and compiling them into an index. The most well known inflation index is the Consumer Price Index calculated by the Bureau of Labor Statistics. The Bureau of Labor Statistics tracks the prices of about eight thousand items purchased by people in stores and online and then crunches all of the data into the Consumer Price Index (it also calculates a separate Producer Price Index that follows business goods). The inflation rate determined by these indexes reflects how prices in general are changing across the country - this means that at any time in the economy there are some prices rising faster than inflation and others that are rising at a slower rate. One way of thinking about the inflation rate is that it is a rough average of price changes in the economy. And as an aside, yes, there can be deflation or a general decline in the price level, but that is a problem for another post.

The basic story explaining inflation is that it is caused by too much money chasing too few goods. This simplified view leaves many people thinking that inflation is simply the result of too much money and the way to prevent inflation is to control the money supply. However, this view does not work well because the amount of money in circulation in the economy is not constant - it is affected by many things such as the interest rate and people’s expectations of the future. A better way to understand the causes of inflation is to think about the relationship between the demand for goods in the economy and the ability of the economy to produce goods. If the general demand for goods across the economy is higher than the supply goods available, then prices will go up. This is roughly how both Paul Krugman and Larry Summers (and other prominent economists) think about inflation. They use the terms “aggregate demand” to describe how much people want to buy and “potential GDP” to describe how much the economy can produce. The crux of their debate with whether Biden’s $1.9 trillion will cause aggregate demand to rise above potential GDP - which will cause inflation. How much inflation there could be and whether it will be a problem is the focus of this debate.

Most economists consider inflation to be a problem if the rate of inflation is too high, increasing at a rapid rate or unexpectedly volatile. A steady rate of low inflation is not a problem (and can actually be a good thing for the economy). Most economists and central banks, like the Federal Reserve, consider a 2% rate of inflation to be the right amount. The reason a steady rate of low inflation is not a problem is because it is easy to plan for it in economic decisions, such as making investments or long-term contracts. The problem with higher rates or sudden bursts of inflation is that it can make it difficult and costly to make long-term investments or contracts. Investors and businesses respond to the risk of high or unexpected inflation by demanding higher interest rates and contracted future prices. It is through this process of making contracts based on expectations of higher inflation that inflation can become a long-term problem for an economy. Countries that have higher inflation rates generally have lower rates of economics growth because of the corrosive effect on inflation in investment decisions. Additionally, over the long run inflation can affect people’s incomes if people are unable to adjust salaries to the rate of inflation. On the other hand, inflation can be really helpful to people who owe money or have debts because it reduces the real (inflation adjusted) amount of money they need to repay their debts.

Most economists see inflation as a long run issue and chronic problem that can cause an economy to work poorly. It is not a problem that brings about sudden economic catastrophe. Yes, there are cases of inflationary catastrophes, or hyperinflation, in countries such as Weimar Germany, Zimbabwe, Venezuela or the Confederate states. However, these are really cases of deeply broken economies with governments that have trouble in carrying out basic economic policies. No country falls into hyperinflation by accident. It is a deliberate policy choice to hyperinflate a currency because it requires a sustained effort by the government to simply print that much money. The United States is nowhere near having any sort of hyperinflation - the inflation problem being discussed by economists would be inflation on the order of 5%. Anyone peddling stories of Biden’s $1.9 trillion plan causing hyperinflation has a knowledge of economics equivalent to any QAnon believer’s hold on reality.

It is unlikely that inflation will become a rampant problem because the Federal Reserve’s tools are very good at dealing with the problem of inflation. The Federal Reserve can respond to inflation by raising interest rates which will reduce the amount of aggregate demand in the economy by lowering the amount of consumer spending and business investment. The willingness of the Federal Reserve to raise interest rates to fight inflation is one of the main reasons inflation in the United States has been low for the past forty years. Federal Reserve Chairperson, Jerome Powell, has been advocating for more government spending and has said it is better to have too much and not too little. His statements can be read as saying that the Federal Reserve does not see the $1.9 trillion spending package as causing inflation, and if it does, it can easily deal with the inflationary problem. So, inflation should not be the only argument against the size of the spending package.

One of the reasons many people are spooked by talk of inflation is that inflation has not been a problem in the United States since the early 1980s - inflation hit about 15% in 1980. The Federal Reserve ended the inflation problem by raising short term interest rates to 20%. While this did cause a short deep recession, it also brought down the rate of inflation and convinced everyone that the Federal Reserve would do anything to prevent high inflation in the future. Since the Financial Crisis in 2008, the whole world has been experiencing a period of low inflation. Even when the economy has been at full employment inflation has remained low - barely getting above 2%. Economists believe this is largely because globalized trade has meant that excessive aggregate demand in the American economy was fulfilled by purchasing goods from other countries. This means that global trade acts as a pressure valve to release the excess demand so it does not push up inflation (this can also be seen in how global trade has an effect of keeping wages down in the United States). Prior to the pandemic, economists were actually debating whether inflation could ever become a problem again because of the combination of globalization and low levels of economic growth. Economists also started to think that the history of low inflation had created a virtuous cycle, in which people’s expectations of low inflation meant there would not be any long-term inflation because it would not be priced into investments and contracts. Any sudden burst of inflation would not have a lasting effect on the economy.

Before considering the inflationary impact of the $1.9 trillion COVID-19 relief package, it is important to recognize that many economists were expecting that the end of the pandemic would cause a burst of inflation as people get and do all the things they could not do over the past year. The people who have kept their jobs throughout the pandemic, but have been able to spend on things like vacations and getting out, have built up a large amount of savings, and it is expected this savings will surge into the economy as a sharp increase in aggregate demand at a time when the ability of the economy to supply these things will be limited. It will take time for resorts, airlines, amusement parks and other recreational places to ramp up their capacity after being closed down (or on limited capacity) for so long. These businesses would solve the problem of limited capacity by raising prices - which will cause a widespread price increase across the economy. However, it was expected that this inflationary pressure would fade as these businesses got back to capacity - which would raise potential GDP back to the level of aggregate demand.

It may be that the $1.9 trillion COVID-19 relief package will add to post-pandemic inflation and extend the burst of inflation. However, it is not clear that this port-pandemic inflation will become a long-term economic problem because of the combination of people having expectations of low inflation and the Federal Reserve’s ability to stop inflation by increasing interest rates.

The debate about the $1.9 trillion COVID-19 relief package and inflation is about weighing risks and making a choice based on a cost-benefit analysis. Yes, the package could cause inflation. However, inflation is a long-run problem that may or may not happen and, in any case, is an entirely solvable problem. The country, especially unemployed and low income Americans (who tend to work in the service sector), are currently facing real economic problems that can only be dealt with through this spending package. Keep in mind that the economy is still short about 9 million jobs and many businesses are still in crisis.

Perhaps the best way to think about the argument over the $1.9 trillion COVID-19 relief package and inflation is to go back and look at the parts of the relief package and consider which parts of the package are worth taking the risk over inflation and which parts are not as necessary and are not worth the risk - or at least adjusting those parts to reduce the risk of inflation.

Economic Update 2/ 10 - Debate Over the Size of the $1.9 Trillion Spending Package

The second impeachment trial of former President Trump is currently getting most of the attention in Washington, but, behind the scenes, there is a lot of work being done on the $1.9 trillion COVID relief package that President Biden has been pushing. I have previously posted about the details of this $1.9 trillion plan - most recently on 1/22 and 1/20. As the details of this spending package are being worked out, an interesting debate has developed about the size of the spending package between Nobel Prize winning economist Paul Krugman and the former Treasury Secretary Larry Summers. Both Krugman and Summers are well known public figures who are also highly respected economists (it should be noted that a lot of the criticism of Summers is for things he has said and done outside of economics) who generally agree on most things. Their disagreement over Biden's $1.9 trillion spending package provides a good framework for understanding the potential economic impact of this program.

Before I get to the debate over the $1.9 trillion spending plan, it is first important to recognize the current state of the economy and the need for this spending. The economic recovery remains stalled at a level far below the level it was at last year, which was close to full employment. The economy currently has 9 million fewer jobs than it had last year before the pandemic. Last week’s unemployment numbers shows that the economy is growing far too slowly to return the economy to full employment on its own anytime in the near future. In the month of January the United States only added 49,000 new jobs, and most of these were in government and education. While the unemployment rate did go down from 6.7% to 6.3%, that is not a good sign in the current situation. The unemployment rate measures the number of people in the labor force who have jobs. The unemployment rate can go down because more people are employed or because people have left the labor force, either because they are discouraged about being able to find a job or, in the case of many women, have to take care of children who are attending school remotely. This second reason explains a lot of the recent decline in the unemployment rate and the argument about reopening schools as part of economic policy. The current rate of labor force participation is 6.14%, which is much lower than the labor force participation rate of 63.3% a year ago. It should also be noted that 40% of the current unemployed have been out of work for more than six months. Under the current circumstances, an increase in the unemployment rate might be a good sign because it would indicate more people re-entering the labor force in the hope of getting a job. Another indication that the economy is still far below its potential is the CNN/ Moody’s Back-to- Normal Index that says the economy is 82% of where it was before the pandemic. According to this index, the economy has been stalled out at this level since September.

The $1.9 trillion spending package is designed to both fund government programs to fight the pandemic, with increased vaccinations and testing, and support the economy through this last phase of the pandemic until enough Americans have been vaccinated, which could be late summer. This spending program for economic support provided an extension of unemployment benefits, funds for small businesses and state governments and direct payments of $1400 for most Americans. The root of the Summers-Krugman debate is not about whether a large spending program is needed (the large number of American living in desperate circumstances shows that there is a need), but over how much spending is necessary to meet that need and what impact too much spending will have on the economy.

Larry Summers thinks that the $1.9 trillion spending package will cause inflation to go up. Summers cites a recent forecast by the Congressional Budget Office that the output gap for 2021 will be $420 billion. The output gap is the term economists use to describe the difference between the current level of economic output in the economy and the potential output that could be produced if the economy was at full employment. Summers' argument is that the amount of spending is too much and that it will push the economy beyond full employment, which will create inflation. Summer’s analysis is pretty standard economic thinking, but it depends on the estimate of the output gap made by the Congressional Budget Office. This estimate should be taken with a large grain of salt since the massive shock of the pandemic has made it hard to get a good understanding about the current potential capability of the economy - not to mention a good measure of how large the economy would have been at this point had there been no pandemic. Still, there are good reasons to think that the $1.9 trillion spending package is larger than the current output gap in the economy - how much larger is really the question. Summers also points out that over the course of the pandemic many Americans saved large amounts of money - there is about $1.6 trillion in excess savings - that they will most likely spend after the pandemic when they can travel and go out more. In addition, there is also the effect of the December $900 billion spending package that is working its way into the economy. All of this put together means that, in the view of Larry Summers, “If we get COVD behind us, we will have an economy that is on fire.”

Paul Krugman responded to Summers' argument by saying that it is incorrect to call the $1.9 trillion spending program a “stimulus” since the purpose of the program is not to stimulate the economy, but instead is to fight the pandemic. Krugman makes the analogy that fighting the pandemic is like fighting a war, which means government spending should be primarily measured against achieving the goal of ending the pandemic. In addition, he notes that the spending to support the program is really about replacing lost income and not providing additional income. Essentially, this money is going to fill a void in the economy to keep the economy from sinking back into recession. The risk of slipping back into recession is real - the economy actually lost jobs in December. Krugman’s point is that unlike an economic stimulus program which has the goal of creating additional spending in the economy to push an economic recovery, this program is more like disaster relief after a hurricane or an earthquake, only at a national level, to keep people going until a recovery can happen. Krugman’s view is that there can be no real recovery until the pandemic is defeated, so spending right now is more about rescue than stimulus. While this is a good point for many parts of the $1.9 trillion package, there are some parts of the package (such as the $1400 for each American) that do not cleanly fit this analogy - at least not for most middle class Americans who have kept their jobs through the pandemic.

Krugman goes on to argue that the problem of potential inflation is not that big a deal for a couple of reasons. First, a large amount of the income support through programs like unemployment insurance will not be fully spent if the economy recovers faster than expected. Basically, this money will only be spent if a large number of people continue to qualify for unemployment. Second, there has been no history of high inflation for over a decade - even when the economy was at full employment before the pandemic - which is an indication that even if the $1.9 trillion spending package pushes the economy beyond potential output there will not be any sustained inflation. Third, the Federal Reserve is well positioned to stop any significant inflation through raising interest rates. Using interest rates to slow the economy is normal economic policy. It should be noted that both Jerome Powell, current Chair of the Federal Reserve, and Janet Yellen, current Treasury Secretary and former Chair of the Federal Reserve, both are arguing for more spending.

In short, Krugman is not disagreeing with Summers' economics, he is saying that Summers is framing the policy incorrectly and that the problem of inflation is not that big of a problem because it can be dealt with through normal economic policy.

A final point about this debate ties back to the roughly $700 billion economic stimulus that President Obama enacted in the spring of 2009 to deal with the recession that followed the 2008 Financial Crisis. At that time, there was a debate about the size of that spending program and a large number of economists working for Obama said that it should have been a $1 trillion program. The smaller stimulus meant that the recovery from that recession was not very strong - it took years for the economy to fully recover. President Biden was Vice President at that time and that lesson is having a big impact on Biden’s decision now to “go large”. Biden, looking to the political future, wants there to be a strong economic recovery.

Economic Update - 1/ 30 - GameStop - How Robinhood Gets Rich Off "Free" & Notes on Financial Regulation

The role that the on-line trading platforms like TD Ameritrade, Robinhood and Interactive Brokers that offer free stock trades in the GameStop story has led to a good look at how these companies make money. The reality is that these companies work closely with many of the large investment firms demonized by the Reddit traders and that the “free trading” services offered by these companies might actually be pretty expensive for their users.

A good place to start is with how these on-line trading platforms make money even though they allow customers to trade for free. Traditional brokers charge their customer either a set price fee or a percentage fee for each trade the customer makes. In this arrangement, it was clear that a broker made more money the more a customer traded and cost-per-trade discouraged a customer from trading, since it could get expensive and a customer could lose their gains through trading fees. The rise of commission free trading platforms like TD Ameritrade, Robinhood and Interactive Brokers, created a situation where customers are not aware of how much a trade costs and, because each trade is seemingly free, have no incentive to limit their trading activity. However, the trades that these on-line trading platforms offer are not really free, it is just that the price of the trade is hidden in the prices at which the trade is executed. The on-line platforms make money by selling their trades to investment companies that make money through carrying out trades.

While most people see the on-line trading platforms like Robinhood, TD Ameritrade and Interactive Brokers as offering a free service to small investors, a better way to understand their business model is to see these companies as making money by channeling stock market trades to “market making” investment companies like Citadel Securities. A market making investment company basically matches up buyers and sellers (and will also act as a buyer or seller) in stock transactions. The company makes money on the small difference between the “ask price” paid by the buyer and slightly lower the “bid price” earned by the seller. The difference between the “ask price” and the “sell price” is really the cost of the transaction for the buyer and seller of the stock. This small price difference between the bid price and ask price can be a significant amount of money on large transactions - possibly larger than a regular brokerage fee (the brokerage fee pays for the better trade price). These market making companies make money on carrying out a large amount of trades, so the fact that “free trading” encourages customers of Robinhood to engage in more trades, really makes more money for the market making companies. This is the reason the market making companies, like Citadel, pay the on-line trading platforms, like Robinhood, money for these “order flows”. In the first half of 2020, Robinhood made $271 million from sending trades to Citadel - Robinhood sends about half its trades through Citadel. In the same time period, TD Ameritrade made $560 million from its “order flows”.

Now, there is nothing wrong with Robinhood making money from routing its trades though Citadel which makes money on executing the trades. After all, both are private companies that are offering a service that people value. The fact that customers may not be aware that they are actually paying a cost in slightly worse trading prices for the free trading service might seem like a less than transparent business practice, but it is disclosed in the fine print. The reality that “free trading” encourages customers to make more trades at poor prices resulting in both Citadel and Robinhood making more money means that Robinhood’s ideal of democratizing trading does not fit its namesake’s claim to be “stealing from the rich”.

The larger point might be that the simple view of the GameStop squeeze play of the “small investor” sticking it to the hedge funds misses the reality that Robinhood is proverbially in business with the Sheriff of Nottingham. The close business relationship between Robinhood and Citadel and between Citadel and many hedge funds is the type of thing that financial regulators are interested in - and this is getting closer scrutiny - because it may have affected the way the markets moved last week in a way that was not fair to all market participants.

Moving on to the issue of financial regulation, a good place to start is by noting that effective financial regulation is a complicated topic that involves more than simply banning certain practices in financial markets. This is because the problem is often not the practices themselves but how they can affect the larger market under certain conditions. For example, take the case of short selling which has been a big part of the GameStop story. In this case, hedge funds put themselves in a bind by short selling GameStop only to get squeezed by the small investors on Reddit. The cause of this problem is poor judgement on the part of the hedge funds not short selling. In fact, short selling has a valuable role to play in markets. Typically, in market crashes short sellers are often the ones buying into a crash providing valuable liquidity by buying the investments that other traders are desperately trying to sell. Simply stopping a practice might have other consequences for markets. Now, the deeper problems, like the potential conflict of interest relationships between Robinhood, Citadel and hedge funds, are harder to make rules about but are more important because they can have a large effect on markets. Financial regulation needs to be developed with an eye to the general goals of the regulation and the effect it will have on financial markets.

In general there are three purposes of financial regulation. The first, and most obvious, purpose is to prevent financial crimes. As P.T. Barnum said, “a fool and his money are soon parted” and complexities of finance have always attracted swindlers and fools hoping to get easy money. The history of finance is filled with all sorts of creative financial swindles from John Law and the Mississippi Company to Charles Ponzi to Bernie Madoff. A lot of financial regulation is designed to stop financial crimes. A second purpose of financial regulation is to create a fair market environment where participants have the same opportunity. Regulations about disclosure of information and competition are about creating this fair market environment. For example, trading on information is illegal because it means that some people can profit from having an information advantage that was unavailable to other people. The problem with inside information is that it creates a situation where people begin to see financial markets as fixed and, in order not to be taken advantage of, choose not to put their money in financial markets. This creates a problem because long-term term economics growth is based on investment and capitalist societies organize investment through financial markets. Creating a fair market environment encourages investment, which is good for society. The final purpose of financial regulation is to protect the financial system from a self-generated crisis. The nature of the complex web of transactions in a modern financial system means that sometimes the wrong problem in the wrong place at the wrong time can set in motion a cascading series of crises that can tear down the whole financial system. The story of the failure of the hedge fund Long-Term Capital Management in 1999 or the failure of Lehman Brothers in 2008 as examples of how the failure of one company can put the whole financial system at risk. When thinking about new financial regulation, it is important to consider how that regulation might fit with these three purposes.

It is important to recognize that financial regulation comes at a cost. This cost can take the form of the explicit price of complying with regulatory requirements, which can take the form of additional legal documentation and licencing. There is also the more hidden cost that the regulation will discourage business activity and investment - this is really about lost opportunity. Now, just because there is a cost to regulation does not mean regulation should not happen. It means that the cost of the regulation needs to be weighed against the benefits of the regulation. Consider the three principles of regulation listed in the previous paragraph, there are many things that happen in financial markets that go against those principles but still happen because the cost of dealing with them is greater than the benefit from regulatory enforcement.

As a final note, it is important to recognize that regulation cannot prevent all bad things from happening in markets. Financial markets reflect the core idea that the world is a risky place and bad things happen and people sustain losses. But, more often, good things happen and people benefit. In anything financial markets allow people to set the level of risk and reward they are comfortable with when making investments. Still, people make mistakes, and those mistakes can cost money. This is the current situation with GameStop. The people who have, and will, lose money on GameStop will learn a valuable lesson from this situation. It may be the the lessons the market teaches fills the places in financial markets that cannot be well regulated.

Economic Update - 1/ 28 - GameStop - Robinhood Limits on Buying & Market Manipulation

The GameStop story has continued to get more interesting yesterday as it grew to a debate about placing limits on trading, market manipulation and regulation of financial markets. All of this is being framed in the terms of the David versus Goliath story, that I described in the last post, can be useful in framing this story, but also leaves out some crucial details for understanding yesterday's events with with trading platforms like Robinhood, Interactive Brokers and TD Ameritrade limiting the trading of GameStop and similar stocks. There is a good reason the trading platforms Robinhood, Interactive Brokers and TD Ameritrade moved to limit the trading of GameStop, but the ramifications of this action reinforce the unequal playing field in financial markets and begs the question about whether financial markets need more regulation.

First, the rationale for these trading platforms for limiting trades into GameStop involves the background operations in financial markets. The popular images of brokers making deals on the trading floor is how most people think about financial markets. The reality is that action is only the start of any financial transaction. Behind the scenes, there is a more complicated legal process of exchanging shares of stock, bond and other investments for money. This is typically done by organizations called clearing houses and the actual transaction of stocks for money takes place a few days after the deal made by the brokers. The time period between when a deal is made and the actual exchange of shares for money creates a period of risk for the clearing houses because a buyer may not actually have the money to purchase the stock - a problem described by the term "counterparty risk". Clearing houses typically resolve the problem of counterparty risk by finding another buyer for the stock. However, this becomes difficult if the price of a stock is fluctuating wildly because the replacement buyer has to be willing to agree to the terms in the original deal. If not, the clearing house has to pay the difference. Clearing houses deal with this problem by requiring brokers to put up money to cover the potential losses from counterparty risk. The amount of money needed to cover counterparty risk increases in cases like GameStop where the price of the stock becomes erratic (the price of GameStop stock has ranged anywhere from $61 to $483 in the past week). This is what happened to many of the trading platforms like Robinhood, Interactive Brokers and TD Ameritrade. Clearing houses made them put up more money for GameStop trades and these companies responded by limiting trading for their customers because they did not have the money to cover the increased counterparty risk. Now this seems reasonable, but it was done in a clumsy way and the optics were terrible - the terrible optics on this became clear with Ted Cruz and Alexandria Ocasio-Cortez agreeing that the actions of these trading platforms was bad (I am not sure if anything those two agree on is a good point or a terrible idea since it is so unusual).

These trading platforms moved yesterday to limit the trading options for their customers by not allowing them to buy anymore shares of GameStop (and other similar companies). However, they did allow their customers to hold or sell the shares of GameStop they already owned. Again, this makes sense, but creates another problem I will get to in a minute. First, the claim that these companies made that they were acting to protect customers seems a bit strange since Wall Street generally operates with a "caveat emptor" or "let the buyer beware" approach to the things they sell. The reality is that all of these platforms sell lots of financial instruments that can quickly bankrupt their customers if they are not careful and they generally do not discourage their customers from doing risky things. So, why prevent customers from doing something at this moment that they can do at any other time raises all sorts of questions about the rules in trading and need for more regulations. Now, the one-sidedness of the trading restrictions that stopped small traders from getting potential profits essentially stopped the upward move on the price of GameStop stock. In fact, it set up the market for a price drop as many of these small investors felt that the only option they had was to sell their holdings of GameStop and take the profits they had made (based on the expectation that the bubble would now pop). This created an exit ramp market opportunity for the hedge funds who had shorted GameStop that made it possible for them to stop bleeding cash. So, this action to limit traders only reinforced the popular narrative that Wall Street plays an insider's game that takes advantage of the outsider small investors. This is the story that the news media picked up on yesterday, that was joined by people in Washington like Cruz and AOC.

An additional problem with the trading platforms putting the limits on trading yesterday was that it was stopping a game that was already in play, which hurt many market participants in a way that was unforeseen and with timing that was seemingly arbitrary. This announcement on limiting trade affected the market and disrupted trading plans and caused many investors to lose money who had been in a position to make money. Many small investors rightfully cried foul at this rewriting of the rules. Especially since the large investment companies had faced no restriction. This uneven restriction is a result of access to markets. The large trading firms have direct access to financial markets and as long as the New York Stock Exchange or the Securities and Exchange Commission did not put any market restrictions in place, they were free to trade. In contrast, the small investors need to operate through a regulated broker platform like Robinhood, Interactive Brokers and TD Ameritrade to access the stock market, which meant the decision by these companies created this uneven situation. Now, while the explanation above about clearing houses explains why the broker platforms put the restrictions in place, it is important to recognize it also makes the market unfair.

The question about limits being placed on small investors that do not exist for large financial institutions is really the wrong question. The better question is whether something that is too dangerous for small investors should not be more heavily regulated for the large investment companies as well. Clearly, these hedge funds and other large investors got themselves into a real bind by shorting GameStop. The simple fact is that, similar to the 2008 Financial Crisis, big Wall Street firms, hedge funds and banks can create situations in financial markets where they blow themselves up. Making the argument that small investors should have equal opportunity in doing this is not a really good argument. Regulations to prevent this from happening would be good. However, any regulation of financial markets needs to be well crafted and will be complex in order to be effective. A simple rule against short selling would not work and most likely would be counterproductive. People who work on financial markets are viciously smart (yes, that is the right adjective) and find ways around simple regulations. Regulations will make financial markets less profitable, but it may be the best way to make the markets more fair and stable. The anger motivating the small investors in the struggle over GameStop reflects a real belief that the current situations in financial markets is unfair to small investors and benefits large investment companies. Instead of cheering on social media driven "financial justice" as a way to make markets more fair, it would be better to enact regulation that will make markets work better for all participants.

There has also been a lot of discussion about whether the speculative bubble of GameStop stock was a case of market manipulation. I doubt that this was a case of market manipulation. The phrase "market manipulation" is very broad and it implies a lot more control over the market than I think happened in this case. This is much more of a story about how a bunch of factors came together in the right way at the right time. The pandemic brought more small investors into financial markets because of the suspension of sports betting. These investors brought a different approach to investing that is more geared to speculating, which is what happens in betting on sports. In addition, they tend to be younger and more tied into social media. Finally, their coordination on investing in GameStop seems more like fan action than it does a conspiracy to control a market. This combination created the situation where, for lack of a better phrase, these small investors could form a "flash mob" to buy GameStop. While this buying of GameStop might have been coordinated at some level, it is not really market manipulation in any kind of organized sense of trying to control a market. I actually think that a lot of the talk of "market manipulation" is coming from Wall Street trying to blame the speculative bubble on "bad actors" as a way of squelching any discussion of more regulation. I suspect that a lot of the anger seen on Wall Street about the "small investors" mobilized by social media to drive this speculative bubble is really about the fact that big Wall Street firms are upset that they missed this opportunity to profit from inflicting suffering on other traders.

Overnight, trading platforms eased the restrictions on small traders and GameStop shot up by 100% to over $400 a share - the madness continues.

Economic Update - 1/ 27 - GameStop - Speculative Bubble & Short Selling

There has been a lot of economic events this week from Janet Yellen becoming Treasury Secretary to Federal Reserve meeting today, but the big economics news seems to be the curious story of GameStop and the more than 1700% jump in its stock price from $4 a share earlier in the year to $345 today. This is a classic case of a speculative bubble because people are buying GameStop stock on the expectation of higher prices and not because of any real value in the company. GameStop is basically a retail business that faces a dim future. This is the full financial description of GameStop - it is not pretty. It is important to note that there are only about 70 million shares of outstanding GameStop stock. This is not very much and it means that it does not take a lot of market action to push up the price of the stock. There are a couple of other interesting factors in the GameStop story, but the core of the story is stock speculation - and it will end (most likely sooner rather than later) with a bunch of people losing a lot of money.

Before getting into the details of the GameStop story, it is good to review the reasons most investors buy stocks. Typically, investors buy stocks for two reasons. One is to get the dividends that companies pay to shareholders when they earn profits. The other is to make money on the increase in stock prices. In general when people buy stocks for speculative reasons it is because they are expecting to make money on the price increase and not care much about the future profitability of the company - that is its ability to pay dividends. Now, individual investors speculate on stocks all the time - this is a large part of the daily churn in the stock market. However, sometimes large numbers of investors will focus their speculative buying on a specific investment and this becomes the start of a speculative bubble.

A speculative bubble gets going when speculative investment begins to drive up the price of a stock far above any reasonable expectation of the future profitability of a company. At this point, more investors are drawn into buying the stock on the expectation that they will be able to turn around and quickly sell the stock for a profit - which only has the effect of pushing the price up further. In this way, the price increase only fuels more speculation and further drives up the price. The problem with a speculative bubble is that it is driven by greed unconnected to any rational value of the company, which means there is no clear upper limit to the price. Basically, the stock price will continue to go up as long as investors are willing to take a chance of buying the stock to speculate on rising prices. However, there will come a point where, for no good reason, investors will stop buying the stock and the price will crash as investors try to sell off their holdings before they lose their money. This has happened in every speculative bubble in history from Tulipomania in the Netherlands to Beanie Babies in the 1990's to houses a decade ago. It will happen again with GameStop. The reason for speculative bubbles happening is best described by the "Greater Fool" Theory (great name for a theory). The basic idea behind the Greater Fool Theory is that people who buy into a speculative bubble know they are doing something risky but fully expect that they will make a lot of money and other people will suffer the losses. This is because investors often are overconfident in their own ability to recognize when the speculative bubble is about to burst and believe that they will be able to sell their investment off to a "greater fool", who will then suffer the losses. The problem is that there are not enough "greater fools" out there, so when the bubble bursts and prices crash the investors are not able to off load their investments - and they all lose money. So, if you are thinking of buying into GameStop, be aware that you are late to the party and are more likely to be somebody else's "greater fool".

Now the GameStop story is also interesting because it has taken on the dimension of being a David versus Goliath story. The "Davids" in this story are small individual investors who were drawn to speculating on GameStop because of social media posts. These investors have been driving up the price of the stock. The Goliaths in this story are large hedge funds that made financial bets that the stock would go down in price - which it should because the company is losing cash and has not real future as a business. The way hedge funds make money on the downward price of a stock is to engage in a practice called "shorting the stock". Shorting a stock involves an investor borrowing shares of stock from another investor (it might be better to think of renting the shares of stock) and then selling the stock at the current market price and taking the money. Later, after the stock has dropped in price, the investor rebuys the stock and returns it to the investor they borrowed it from. An investor make money on the price difference between the high price they sold the stock and the low price they repurchased it. The problem with shorting a stock is that an investor can be caught short when the stock starts going up in price. In this case, the investor has to buy it back at the higher price and take a financial loss on the transaction. In the GameStop story, the small investor "Davids" are driving up the price and forcing large financial losses on the hedge fund "Goliaths" that shorted GameStop. The small investor "Davids" are basically forcing up the stock price when they are buying it and then profiting from selling it to the hedge fund "Goliaths" who need to buy it. So, there may be some sort of financial market karma being dealt to the hedge funds right now, but keep in mind that the GameStop bubble will end and many of the small investor "Davids" will most likely also end up losing on their speculative investments.

Economic Update - 1/ 22 - A Closer Look at Biden's $1.9 Trillion Plan

It is time to take a closer look at president Biden's $1.9 trillion economic stimulus program that he announced last week. This is a large spending proposal that represents about 9% of GDP (the total annual economic output of the country). There are a number of different major proposals in this program and not all of them are of equal economic merit. Some of the proposals are much needed spending programs to deal with the pandemic and provide an economic lifeline to the millions of Americans while others are more political agenda pieces than serious economic policy. The reality that this first big economic stimulus program has a mix of proposals is not a surprise. After all, this is a new presidential administration that is both trying to deal with the crisis and move forward on its political agenda. This is a breakdown of the different parts of the Biden plan starting with those parts most needed to deal with the current crisis and those which could be described as being part of the political "wish list".

The most important parts of the economic stimulus program are the ones that are better described as being more of an economic rescue package than stimulus. These are the programs that are about fighting the pandemic and minimizing the economic damage caused by the pandemic. The rationale for these programs is that the economy will not begin to fully recover until the pandemic is defeated. The money spent on these programs is really offset by the additional economic gains from ending the pandemic faster. Biden's plan to spend $20 billion on vaccine distribution and $50 billion on testing is the core of this part of the program. Vaccinations are the only real way to the other side of the pandemic (trying to get to herd immunity through infection is an awful idea - even Sweden has given up on it). Expanding testing is very important, especially with the news of new and more contagious variants of the coronavirus. The new British strain of the virus was first detected in Britain because Britain is doing more testing (the variant of the virus could have started someplace else and went undetected until Britain). Honestly, these are spending programs that should have happened months ago, but for no good reason were not acted on.

In addition to the spending to directly attack the pandemic, additional spending that could be grouped into the rescue package would be the increase in unemployment benefits to $400 a week and the extension of unemployment benefits to September, the $190 billion for small businesses, $350 billion for state and local governments and $130 billion for schools. Each of these programs are to minimize the economic damage caused by the pandemic. Increasing the weekly unemployment payment by $100 will help the unemployed and extending the benefits to September is good because, hopefully, the pandemic will be done by then. Keep in mind that $400 a week is not a lot of money and the country is still down 10 million jobs from last year. It is also important to note that money allocated to unemployment will not be fully spent if the economy recovers faster and the unemployed are able to get back to work. The money for small businesses is important because many small businesses are still in deep financial trouble. These businesses will be needed to rehire unemployed workers when the economic recovery happens. It is better to keep these businesses on life support for the next few months, until the economic recovery, than to hope the enough new businesses will be formed during the recovery to hire the millions of unemployed workers. The money for state and local governments is needed because these governments have seen a large decline in tax revenue and have had much higher expenses in the past year. The same can be said for schools (which are funded mostly though local taxes). In addition, local governments and schools will have higher expenses after the pandemic as they deal with the social costs of the pandemic, which could last for years.

The next allotment of spending is on programs that are more political than economic. The largest part of this is the plan to give $1400 to each American with an income under $75,000 in annual income. This is meant to be in addition to the $600 in the December package to bring the total for each recipient up to $2000. While this spending would help the poorest of Americans (who have suffered the worst in the economic crisis caused by the pandemic), it is not needed by most middle income Americans. The reality is that most Americans have been able to save money during the pandemic (mostly because they had to reduce their spending). American after-tax income is 4.3% higher than it was last year. Yes, you read that correctly - on average, Americans are wealthier than they were last year. Many people (professionals who could work from home) have become wealthier during an economic crisis. The reality is that some Americans have suffered terribly during the economic crisis while others have been financially fine - if not better. Giving these people money will not help the economy since the parts of the economy they will spend money on are already doing well. Consumer spending is only down 2.3% from where it was last year. The business (and unemployed workers) are not suffering because of a lack of consumer spending. They are suffering because they work in the parts of the economy shut down, or limited, by the pandemic. These parts of the economy will recover when the pandemic ends. It is much better to give direct support to businesses and the unemployed than to throw money to middle income Americans. This spending is really political - started by the Democrats last summer, picked up by Trump in December and now supported by many Republicans. The extension of the eviction moratorium could also be put in the more political than economic category. Yes, millions of people are having trouble paying their rents (although at this point it may be more of a problem in making up for missed rent payments) and the eviction moratorium made sense last spring through fall when the economy was in deep crisis. However, at a certain point the rental market has to be returned to normal with people paying the rent for the places where they live. At this point, it would be better to have a program of "missed rent" forgiveness that would help landlords and tenants put the past behind them and start fresh with moving forward on current rents. The reality is that rents in many cities may need to come down and removing the eviction moratorium can help that process.

The final part of the Biden plan, which is really a Democratic political agenda point more than sound policy, is the push for a $15 minimum wage. This is really a simplistic campaign slogan about dealing with the more complicated problem of economic inequality. Just the way "Build the Wall" was a terrible idea for how to deal with the complex issue of illegal immigration, "$15 minimum wage" is not a good way to solve economic inequality. Before getting into the economic reasoning for this, it is first important to look at the reality of the minimum wage in the United States. The current Federal minimum wage is $7.25 an hour. Moving the minimum wage to $15 would mean doubling the Federal minimum wage. Now, many states have minimum wages above the Federal minimum wage. However, sixteen states have minimum wages at the current Federal minimum wage. Massachusetts, California and Washington are the only states with minimum wages over $13 an hour - these are the highest in the country. So, the Biden plan is to move the Federal minimum wage rate above every state. While businesses in expensive states, like Massachusetts, might be willing to pay workers $2 more an hour, a doubling of the minimum wage in many poor states would be an economic shock that would result in higher unemployment. The Congressional Budget Office estimated before the pandemic that moving the minimum wage to $15 an hour would cause 1.3 million people to lose their jobs. Raising the minimum wage to $15 an hour now, when the economy is trying to recover, will be even more disruptive. There are two reasons for this. First, companies set wages based on worker productivity. Companies will avoid hiring workers if they are forced to pay high wages for jobs with low levels of productivity. Second, the higher the wages are for a job, the more likely companies are to move to automate those jobs. The reality is that many lower wage jobs can be automated - think about the self-check out at the supermarket. Would a $15 an hour minimum wage result in fully automated fast food restaurants? Setting a high minimum wage will create an incentive for companies to invest in automating low wage jobs, which will reduce job opportunities for workers with few skills.

The issue of economic inequality is a real problem that was made worse by the pandemic. The government should have policies to address this problem. Raising the minimum wage is not the policy that will deal with the problem. It would be better for the government to fund job training through community colleges for low wage workers to make them more productive and able to do high wage jobs. Another solution would be for the government to directly subsidize low wage work, through a negative income tax, so that more people can get entry level jobs that will lead to better jobs over time. People develop skills at work that they can use to get better jobs. It is hard to get that better second job without the first job. Government funding to build high-speed internet to rural communities would make them more economically viable and encourage more tech jobs to move to these regions, which would create higher paid jobs in low income regions. Yes, these programs would cost money, but they get to the heart of the problem by addressing things that limit economic growth. Of course, these types of policies do not belong in an economic plan that is focused on dealing the the economic crisis caused by the pandemic. Then again, neither is the $1400 to each American or a $15 minimum wage.

Economic Update - 1/20 - The Issue of the Size of the Federal Debt

Today at noon, president-elect Biden will be sworn in as the 46th President of the United States. It is expected that president elect Biden is planning to move quickly to pass the $1.9 trillion stimulus package that he proposed last week. Today, Janet Yellen, Biden's nominee for Treasury Secretary had her Senate hearing and it is expected that she will win Senate confirmation. I covered Yellen's qualifications for becoming Treasury Secretary on post for 11/ 24.

Last week, I covered the announcement of Biden's $1.9 trillion stimulus package. This is a large spending package and it follows in the wake of several large stimulus packages to deal with the economic shock of the coronavirus pandemic - $3 trillion last March and then $900 billion last month. Biden's large spending plan has brought up questions about the size of the Federal Debt and whether the country can afford to spend so much right now. The short answer to the question is yes the country can spend the money and the size of the Federal debt is not the most pressing problem right now. As I have said before, fighting the coronavirus is the most pressing economic problem because the economy will not fully recover until the pandemic is over and in the current situation, only the Federal government has the resources to deal with the pandemic and help needy Americans get to the other side of this crisis. Borrowing money is not a problem. In fact it is a tool to get the resources to fight the pandemic and the economic crisis. The large Federal debt may be a problem, but it is one that the country can deal with after the pandemic. There are things in Biden's plan that should be debated (and there parts of it that I think are not the best economic policy), but the general scope and purpose of the program is on the mark. I will get to those in a post later this week, but first, back to explaining the reason the Federal debt is not a problem right now.

The size of the Federal debt is an issue that people worry about for all the wrong reasons because the real reason to worry about it is complicated. I think many people talk about the size of the debt with a concerned look on their face because they think that is what serious people do. Yes, the Federal debt is large - currently about $22 trillion, which is about 100% of GDP - and this is before the Biden plan adds $2 more. It is a lot of money, but the government does not need to worry about ever paying off the debt. The Federal government funds the deficit by borrowing money on the bond market. The Federal government never needs to pay off the debt because it pays off the bonds that reach maturity by issuing new bonds. As long as investors are willing to lend money to the Federal government the United States can keep operating this way. The interest rate on government bonds can be used as a way of measuring the willingness of investors to lend money to the government. Currently, the interest rate on a 10-year government bond is 1.1% (you can see all the rates on the Treasury web page). This is a very low interest rate and it signals two things: investors trust their money with the government and expect inflation to stay low for a long time (I will post on the issue of inflation at some point soon).

As long as interest rates stay low, the Federal government can easily manage the debt. If interest rates go up, then it will cost the Federal government more to manage the debt, but again, as long as it can borrow money there is no real problem - but I will come back to this point in a minute. One point to note in Yellen's testimony to the Senate today is that she did not rule out having the Treasury Department issue 50-year bonds. Many economists are advocating this policy because it will allow the Federal government to lock in the current very low interest rates for the debt to decades to come. The longest bond currently on offer from the government is the 30-year bond at a current rate of 1.84%. There is no reason that thirty years is the upper limit for a bond. A bond can have a maturity of any length. An interesting piece of financial history, the British government in 1715 offered bond no maturity date that were called "consols" and issued them routinely to deal with major expenses, such as fighting Napoleon and the First World War - curiously, the British government fully paid off these bonds in 2015. A fifty-year bond sounds like a big deal, but if it is an investment that investors will put their money into it, then the government should take advantage of it. The reason for putting the debt into long term bonds is to secure the current low interest rates - it has nothing to do with any chance that the Federal government will not be able to borrow money in the long -term. The reality is that the Federal government can keep borrowing money because it has the ability to create dollars (which are backed by the full faith and credit of the government). In theory, the government could promise an almost infinite interest rate on its bonds to attract buyers. So, the Federal government will never face a debt crisis where it is unable to borrow money the way Greece did in 2012.

The problem with the size of the Federal debt is really one of interest rates and how that could affect the economy in the long-run. When the Federal government sells bonds it competes for investment dollars against companies that are also looking to borrow for investment purposes. That private investment is important to the long-run economic growth of the economy. If the Federal debt becomes too large, then the government will have to offer higher interest rates to get people to buy its bonds. This will discourage private investment because the prevailing interest rates will be too high for companies to borrow at a profitable rate for investment. The result will be lower levels of investment, lower levels of economic growth and a poorer future. Economist describe this as a "crowding out" problem - the government borrowing "crowds out" private investment.

Now, while a large government debt could possibly result in a poorer economic future, so can an economy hobbled by the coronavirus pandemic and a long stagnant economic recovery. The economy hobbled by the coronavirus pandemic is the reality the country continues to suffer through. Spending money to defeat the pandemic is the best plan there is. As I have said before, concern about how all this spending contributes to the Federal debt is missing the true extent of the current crisis for a more distant possible future problem - similar to arguing against using water to put out a house fire because of concerns over the water bill.

As a point of historic perspective, the Federal government had a debt larger than 100% of GDP when it was fighting World War Two. The important point is that the government never had a debt crisis after the war even though the government never engaged in a policy to pay down debt - in fact, the government went on to spend a lot more on money on fighting the Cold War. The reason there was no post-war debt crisis was because the economy grew and the relative size of the debt compared to GDP went down. Borrowing massive amounts of money to fight World War Two and managing down the debt over decades made sense then and it makes sense now. If the post pandemic economy can grow at a rate of 2.5% (average over the past 20 years) and the interest rate on the debt is locked in a low rate between 1-2% (with 50 year bonds), the country can out grow the debt.

To sum up - the pandemic is by far the biggest economic problem for the United States, borrowing to fight the pandemic is the best plan and, even though the size of the Federal debt seems scary, in reality the long-term debt is manageable.

Economic Update - 1/ 14

It has been a while since the last Economic Update - first there was the holidays and then the terrible attack on the Capitol Building, and subsequent impeachment. Still, while all of that happened, the pandemic and economic crisis have continued. However, the economic plan announced by president elect Joe Biden this evening means that the country may soon get a large additional stimulus that will be targeted on dealing with the pandemic, which is the root cause of the economic crisis, and provide the economy the support it needs to weather the next few months of hardship.

The economy has started to slide back toward recession in the past few weeks. The CNN/Moody's Analytics "Back to Normal" Index currently rates the economy at 74% over where it was before the pandemic (the index stood at 80% in mid-December). This economic decline is supported by the recent unemployment numbers. The monthly jobs report, released last Friday by the Bureau of Labor Statistics, said that the United States lost 140,000 jobs in the month of December. This is the first month of job losses since May 2020. While the unemployment rate is still at 6.7%, the reality is that the economy has 10 million jobs less than it had before the pandemic. The new weekly unemployment claims for last week, announced today, was 965,000, which is much higher than the 784,000 from the previous week.

The root cause of the on-going economic crisis is the pandemic, which has only become worse over the past month. The country has been averaging well over 200,000 new COVID cases a day and has been averaging 4000 deaths a day. Currently, there are more than 130,000 people hospitalized for COVID-19 - pushing many hospitals (especially in California) to capacity. Unfortunately, the rollout of the vaccine has been slow and confusing. At this point, the economic recovery depends on vaccinations. Fortunately, new vaccines are on the way (and they are simpler one-dose vaccines) and there will be more funding for vaccine distribution.

The big economic news today is president-elect Biden's plan for stimulus. This plan is to spend $1.9 trillion on economic relief and fighting the pandemic. Specifically, it will send direct payments of $1400 to most Americans and increase unemployment benefits to $400 a week (and extend the benefits to September). The unemployment benefits are the more important piece of economic policy (I explained this back on 12/11). The $1400 payments are more politics - but an important part of selling the plan. The plan will also give states and local governments $350 billion in financial assistance and spend $170 billion on education. For fighting the pandemic, Biden plans to spend $50 billion on testing and $20 billion on vaccine distribution. This is clearly a big spending plan and it is designed to push the economy through to the end of the pandemic.

Unlike the previous pandemic spending bills which took months to pass through Congress, because the Democrats won both Senatorial elections in Georgia at the start of the month and took control of the Senate, Biden will be able to quickly pass his spending bill.

In short, Biden's spending plan is big and bold - and it is happening when the economy most needs the help. Yes, this will increase the Federal debt, but as I have mentioned in many posts, that is not a concern right now. The current interest rate on a ten-year government bond is 1.15%. The country can worry about repaying the debt after the pandemic is over and the economy has recovered.

Economic Update - 12/ 23

The news that has grabbed the headlines overnight was president Trump's video statement that the $900 billion coronavirus relief package was a "total disgrace" because it did not include $2000 on-time payments to every American. Now that the Congress and Senate have passed the relief package that includes a one-time payment of $600 to every American with an income under $75,000, president Trump is saying that it is not enough and has hinted at vetoing the relief package. This may be more than just political theater because the threat of a veto can slow the relief package, which passed through Congress and the Senate with a veto proof majority, if president Trump exercises a "pocket veto" by neither signing or vetoing the bill. The delay in getting the bill passed means that the pocket veto may outlast the Congress, meaning the bill for the relief package would die and Congress would have to start on the legislation again in the new year. There is no way that the Senate will approve of expanding the one-time payment from $600 to $2000. What will happen is still up in the air.

The economic statistics released today further support the need for the $900 relief package. First, the new unemployment claims for last week came in at 869,000. This is down from last week's number of 885,000, but it is still very high - and, if you keep in mind that this is a noisy statistic, the small decline in new claims is not as significant as the overall number. Additional economic weakness can be seen in personal income for November which dropped by 1.1% and consumer spending which was down by 0.4%, which is a surprise in the run up to the holidays. So, in general, the economy is weakening. The $900 billion relief package will hopefully prevent the economy from falling into a new recession.

Economic Update - 12/ 22

It took Congress and the Senate all weekend and a day, but they finally were able to agree on and pass the $900 billion stimulus coronavirus relief package. The package that has been agreed to does provide relief to millions of Americans and will help them through the next few months. Whether it will be enough to carry the most needy to the end of the pandemic and the economic recovery is another question. It may be that another stimulus package will be needed. However, given the difficulty of getting the Congress and the Senate to agree on this one makes it doubtful that another will be passed unless the economy gets much worse (any future stimulus spending depends on the Georgia senatorial elections).

This $900 billion spending package has many parts. The two that have gotten the most attention are the $600 on-time check to Americans with incomes under $75,000 and the 11-week extension of unemployment benefits of $300 a week. The extension of unemployment benefits is needed and the one-time $600 check will help some people somewhat, but as I have discussed earlier it is not the most effective use of government spending right now. The relief package will spend $120 billion on unemployment insurance and $166 billion on the one-time stimulus check. A better policy for the economy and for the unemployed would have been to double the length of the $300 a week unemployment benefits to 22 weeks (which would help carry the unemployed to expected economic recovery). This spending package will also provide $284 billion to businesses through the Paycheck Protection Program - and this time the program has money specifically earmarked for restaurants and entertainment venues that have been especially hard hit by the pandemic. The bill also extends the moratorium on evictions and provides $25 billion in rental assistance. Finally, the program has $30 billion for vaccine distribution. In total, the program will do a lot of good at a time when it is needed. If you are interested in the full details of the $900 billion relief package you can read this post from the Committee for a Responsible Federal Budget.

Yes, it is absurd that it took Washington so long to get to a deal that was basically the same deal they could have reached months ago. Additionally, it is problematic that this spending bill is not providing any financial assistance to state and local governments. This is largely because Republicans were determined to oppose any spending bill that did this. Curiously, due to the strong stock market and many upper income professionals being able to work from home, many states have not suffered the large budget shortfalls projected earlier in the pandemic. Specifically, "blue" states that have income taxes have done better while "red" states that depend more on sales taxes are facing large budget shortfalls. The New York Times has a good description of the current financial outlook for states.

The weekend hold-up on the $900 billion relief package was due to Republicans wanting to end several of the emergency programs to support financial markets set up at the start of the pandemic by the Treasury Department and the Federal Reserve. These lending programs were designed to calm financial markets in March and April when financial panic was forcing up borrowing costs and making it difficult for many businesses to borrow. The purpose of the program was to have the Federal Reserve directly intervene in some financial markets so that large companies, states and cities would be able to continue borrowing to finance their operations. Companies borrowing to meet operational needs is the type of financial transaction is a routine part of what happens in financial markets. However, in a financial panic, this borrowing can be interrupted causing a cascading problem of financial shortfalls that can ripple out into the economy. The important thing to know about financial crises is that they are more often caused by the fear that something bad might happen than the actual sudden onset of a real problem (often the problems that cause a financial crisis have been know for a long time and have gone ignored). Basically, the financial crises are driven by investors fearful that they might lose money acting to pull their money out of the market and, in doing so, trigger the crisis. The Federal Reserve, can intervene in financial markets as the "lender of last resort" to calm the market because investors know that they will be able to sell their positions. The Federal Reserve first developed these emergency lending programs during the 2008 Financial Crisis. The Treasury Department supports these programs to absorb any of the financial losses the Federal Reserve might suffer through these programs. This spring, in face of another financial panic at the start of the pandemic, the Federal Reserve and the Treasury Department started up these types of emergency lending programs again. In the end, the Federal Reserve did not have to lend out much of the money that the Treasury Department gave it because news of the Federal Reserve's ability and willingness to act was enough to calm financial markets. As I described a few weeks ago when Treasury Secretary Steve Mnuchin asked the Federal Reserve to return the unused funds, the simple existence of these funds can be enough to ward off any financial panic.

In the weekend hold-up of the $900 billion relief package, the Republicans wanted to specifically prevent the Federal Reserve from enacting these special lending programs again without specific permission from Congress - and it seems they were mostly focused on the Federal Reserve lending to state and local governments. The Republicans said they were concerned than the Biden administration might use the funds and the Federal Reserve to help finance state and local governments - the fact that Janet Yellen, the former Chair of the Federal Reserve, will be the next Treasury Secretary feeds into this view. The Democrats objected to the Republican's demands because they felt it was placing limits on the Biden administration even before it took office and brought up the specter of another financial crisis. In this, both sides are really playing politics. Yes, Janet Yellen does have close contacts with the Federal Reserve, but the officials at the Federal Reserve are singularly focused on protecting the Federal Reserve's independence (which is its most important asset in any crisis). Yes, there could be another financial crisis (it is their unexpectedness that makes them "panics"), but a crisis seems to be unlikely and if there was a real crisis it would most likely stop all partisan bickering and Congress would act (note what happened last spring). In the end, the Democrats and Republicans reached an agreement that does not limit Federal Reserve powers but does wind down the existing programs. In general, it was strange that a dispute over the Federal Reserve threatened the $900 billion relief package. The agreement that ended the dispute basically recognized that the Federal Reserve Policy did work, at very little cost, to stop financial panic, but that the Federal Reserve is limited in what it can do to help the economy recover. Federal Reserve chair Jerome Powell spoke to this in his press conference last week. More importantly, making an agreement that removes the Federal Reserve from the political limelight while preserving its independence would be good.

Economic Update - 12/ 18

It is Friday and hopefully the Congress and Senate are closing in on a deal for an economic stimulus package (although it is better to think of it as a rescue plan). The news in Washington the past few days is that the leadership for both parties are close to a $900 billion deal that would extend unemployment benefits of $300 a week for ten weeks and send one-time payments of $600 each American and a new round of funding for businesses hurt by the pandemic. As I described last week, the unemployment benefits are both more needed and better policy, but the one-time $600 will also help the economy. The leadership in the Congress and Senate have been able to close in on a deal because they have set aside any attempt to agree on the two issues that most divide them: aid for states and local governments and liability protections for businesses from COVID-19 related lawsuits. Yes, states and local governments (in all states) need financial help from the Federal government, but they can wait until January and a new president. The unemployed need help before the end of the year - the program for extended unemployment benefits ended the day after Christmas. Hopefully, the leadership in the Senate and Congress can get this deal done now and then start to work on another program in January to help states and local governments - and provide the support the economy will continue to need through the spring until the effect of vaccinations takes hold. Again, as I said last week, any concern about how all this spending contributes to the Federal debt is missing the true extent of the current crisis for a more distant possible future problem - similar to arguing against using water to put out a house fire because of concerns over the water bill.

The economic news this week shows that the economy is slipping under the weight of the coronavirus pandemic. The new unemployment claims for last week was 885,000, up from last week's number of 853,000. In addition, the retail sales numbers for November were down 1.1%, with restaurant sales down 4%. At the same time, on-line sales were only up 0.2%. The economic stimulus package is needed to head off this economic decline (and prevent it from falling back into recession). In addition, the $900 billion is needed to limit the economic pain that millions of people will feel over the next few months. Simply put, there is no way that the economy will create the 10 million jobs needed to return the country to full employment over the next few months - and any chance of creating new jobs will be crushed by businesses failing in the next few months because they cannot get enough money to tie them over to the recovery. The reason for the economic stimulus is similar to last March, only now there are now millions more people in desperate need of help. The large extent of economic suffering can be shown in the rise in percent of Americans living in poverty from 9.3% in July to 11.7% in November (the government says the rate of poverty for a family of four is an annual income of $26,200). There are also 14 million families at risk for eviction (Federal eviction protections stop at the end of this month).

As bad as the current economic situation is, the worsening situation with the pandemic will only make the economy worse. COVID-19 has become the leading cause of death in the United States. The number of new cases and deaths continue to go up. Yesterday the number of new cases was 238,189 and the number of deaths was 3,293. The situation with hospitalizations continues to be grim. The growth of the pandemic has caused more local governments to enact restrictions on businesses in order to limit the pandemic. Until the situation with pandemic improves, the economy will be getting worse. So, let's all keep our fingers crossed and hope that Congress and the Senate gets the job done.

Economic Update - 12/ 11

It has been a week since the last Economics Update and the situation in Washington remains roughly the same with the fiscal stimulus stalled while the situation in the country is getting worse. In Washington the $908 billion stimulus program put forth by a bipartisan group of senators is still the most viable option for a stimulus package (the White House put forward a $916 billion offer and Mitch McConnell has a roughly $500 billion offer - but neither plan has any real support). At this point, the major points of contention are financial aid to states and local governments and granting liability protection to businesses from lawsuits over COVID-19. While this has been happening in Washington, the situation with the pandemic and the economy has become worse. First, the numbers on the pandemic have never been so bad. Yesterday, there were 232,570 new cases (those are only the ones shown by testing - which is falling short), 3,055 deaths and new records on hospitalizations (this number is now becoming less reliable since many hospitals are turning away patients for home care that would have previously been admitted because hospitals are trying to preserve their limited capacity for the sickest patients). The resurgence in the pandemic has hurt the economy and that damage is starting to show up in the economic statistics. Yesterday, the number for new unemployment claims were reported at 853,000. This is the highest weekly number since September and is up from 716,000 last week (last week's number was lower because it was from the week of Thanksgiving. In addition, the CNN-Moody's Back-to-Normal Index is showing the recovery regressing. Basically, as I have been writing about for weeks, the economy is in need of economic stimulus (better thought of as a rescue package), but Washington is unable to make a deal, with only one week until Congress goes on recess until the new year.

An important part of the debate over the stimulus package being debated is whether money should be put into unemployment benefits or into one-time stimulus checks of $600 being sent out to everyone. Now, with the current interest rate on 10-year government bonds at 0.92% there is no reason not to do both policies. However, if there has to be a choice between the two policies, the extension of unemployment benefits is a better economic policy than a one time stimulus check of $600.

The reason unemployment benefits are a better policy is based on the economic concept of the multiplier effect in which a dollar of government spending is re-spent through the economy creating more than a dollar's worth of economic activity. The effectiveness of government spending in generating economic activity depends on how much of the government spending is re-spent (economists use the term "marginal propensity to consume" to describe this process). This means the best policy is the one that will send money to people who are most likely to spend most, if not all, of the money. Currently, this population is the unemployed, especially the 12 million people who will reach the end of their benefits at the end of this month. In contrast to this population, there are millions of people who have not really been economically hurt by this pandemic. These are the generally well educated professional workers who are able to work from home - in fact, many of these people have been made economically better off over the past few months because of the rise in the stock market. Economists have been describing the shape of the limited economic recovery as "K" shaped because some people have recovered from the economic shock of the pandemic while other people have continued to sink into economic crisis. Sending $600 checks to millions of people who are doing well economically is a foolish policy because a large part of this money will not be spent, which means it will have no immediate simulative effect on the economy. This population has increased its savings rate over the past six months and has no need for additional money. The probability that this money will be saved, rather than spent, is increasing as the pandemic worsens and many people are choosing to hunker down at home (like in the spring). On the other hand, the millions of unemployed people who are having trouble with getting the basics (housing and food) will spend all of the money they are given, which will support businesses and stimulate the economy (or a least prevent a new recession). Sending a one-time check of $600 to these people will not really help these people - they need months of steady financial support until they can get a new job. Keep in mind that the economy still has 10 million fewer jobs than it did last February.

Again, as I have mentioned earlier in this post and in other posts, the argument for limiting the stimulus because of worries about the size of the debt does not carry much weight right now - it is a bit like arguing against using water to put out a house fire because of concerns over the water bill. But, if the choice is to go with a smaller stimulus package, then at least make it so the spending is as simulative as it can be. The best choice is unemployment benefits.

Economic Update - 12/ 4

The talk of economic stimulus is back on the front burner in Washington as the Senate and Congress count down the days to the end of year recess. Earlier this week a bipartisan group of senators came out with a proposal for a $908 billion stimulus program that would contain money for extended unemployment benefits, aid to businesses and funding for state and local governments. The proposal is half of what Nancy Pelosi and Democrats in Congress were pushing for during the fall and twice what Mitch McConnell and the Republicans in the Senate were offering. The two questions right now are is this a good stimulus package and will it get passed.

The short answer to whether this is a good stimulus package is that at the current time anything is better than nothing - and the country is in need of something. The current situation with the pandemic and economy is bleak and the next few weeks, to months, are going to be bad. In terms of the pandemic, things are bad and they will get worse. Yesterday, the United States had 216,500 new cases (this is based on testing and there are a lot of cases going untested) and 2857 deaths. In addition, the number of people in the hospital because of COVID-19 is over 100,000, which is pushing hospital capacity to the breaking point. Keep in mind the lag times involved with COVID-19 - hospitalizations rise two weeks after infections and deaths follow two weeks after hospitalizations. In addition, it should be noted that some of the worst COVID hotspots right now are rural areas with low levels of health care capacity and limited ability to increase that capacity. The real limit on capacity is not rooms and beds, it is trained doctors, nurses and medical specialists to care for all of these patients. A real concern is the physical and psychological stress the pandemic is putting on medical workers. The record numbers of new cases and deaths are bad, exceeding hospital capacity is the nightmare. The worsening situation in the pandemic is hurting the economy. The new unemployment numbers announced today show that the economy is weakening. In November, the United States added 245,000 new jobs, which about half of the 440,000 that economists had been expecting. Not only was the number of new jobs below expectation, but is much less than the past few months. In October the economy added 610,000 new jobs and in September it added 711,000 new jobs. As a point of perspective, last November the economy added 261,000 new jobs - which is more than last month. Still, the Bureau of Labor Statistics said that the unemployment rate declined from 6.9% to 6.7%, but that because said that 611,000 people dropped out of the labor force and are no longer considered unemployed. Finally, about 13 million unemployed people will lose their unemployment benefits at the end of the month when their benefits expire. Basically, the country is in terrible need of a government stimulus package to help the unemployed, support businesses that are on the cusp of failing and support local governments.

The size of the stimulus matters, but not as much as what the money is being spent on. A smaller stimulus that is focused on the most crucial current needs may be sufficient. The announcements of COVID-19 vaccines in the past few weeks have been a game changer in terms of the economic outlook. The existence of several proven vaccines (still waiting FDA approval) and the possibility of more on the way means that an end of the pandemic is in sight - the directors of Operation Warp Speed have said that the vaccines will be available to all Americans by the end of the Spring. Many economists are predicting that there will be a strong economic recovery once vaccines have been widely distributed. The rationale for this is that many Americans who have been able to keep their jobs have increased their savings during the pandemic (largely because they could not spend the money) and that this savings will drive the recovery. This article by the economist Tim Duy in Bloomberg explains this perspective. This means that the stimulus package needs to get the economy through the next few months by preserving businesses and local government jobs until the recovery and also save the unemployed from poverty. The logic for stimulus today is much the same as it was back in the Spring - it is to help the economy get through a natural disaster with a minimum amount of damage. Lowering the amount of damage will make the recovery faster. So, a stimulus of $908 billion that well spent could be sufficient.

The question of whether the stimulus package will pass in Washington is an open question. Both Nancy Pelosi and Chuck Schumer have come out in support of this proposal, at least in general principles. Mitch McConnell has given it tepid to lukewarm support - although it seems he is still holding to his $500 billion proposal. Donald Trump is best described as the x-factor in all of this. If there is to be a deal for a stimulus, it will have to come together quickly. The Senate and Congress have about two weeks left before their winter break - after that a new Congress will be sworn in and any stimulus package will have to wait until president-elect Biden is sworn in.

Economic Update - 11/ 24

Yesterday, president-elect Biden announced that he was selecting Janet Yellen to be the Treasury Secretary in his administration. She is an outstanding choice for this position. A lot of the news coverage about her has focused on the fact that she will be the first woman to hold this job. This is an important point, but I think that coverage misses the recognition that she is one of the best people for this job. I can only think of a few people (maybe four) who can match her combination of academic achievement and policy experience. This combination is especially important during a time of economic crises when policy makers need to be flexible but not reckless in their thinking and know to talk to other policy makers (and who to talk to).

As an academic, Yellen was a professor at the University of California Berkeley and her work focused on how the economy responds to adverse shocks that cause a recessions. One of the large questions, and debates, in economics is how much should the government do to help an economy recover from a recession. The answer to this question depends on how well the economy can fix itself. Most mainstream economists feel that the economy will adjust to an economic shock and that the period of a recession is a period of adjustment. The debate is over how well the process of adjustment works and if it could be improved. Economists who think that the process of adjustment is relatively smooth because markets work well do not think the government needs to help the economy recover. Basically, government assistance cannot improve the process adjustment. Economists who think that the process of adjustment is rough because markets are imperfect and get stuck think that the government needs to help the economy recover to avoid needless economic damage. Yellen is in the second group. Academic economists closely examine how well markets work and whether an problems in markets can affect the economy. Yellen's work has been to show (with a lot of complex math) that imperfectly competitive markets create a situation in a recession where individual companies find it is to their benefit to not lower prices even though this action would help the larger economy recover from the recession. In short, her work supports government action to assist the economy through stimulus programs.

As a policy maker, Yellen was the president of the San Francisco Federal Reserve, which basically covers the entire western part of the United States. She served in that position through the 2008 Financial Crisis. In 2010, she was then promoted to be the vice-chair of the Federal Reserve where she worked with Ben Bernanke to help the recovery from that crisis (Ben Bernanke is one of the four people who match Yellen in academic and policy experience). In 2013, she was nominated by president Obama to be the chair of the Federal Reserve - becoming the first woman to hold that position. In 2017 she left the Federal Reserve when president Trump appointed Jerome Powell to replace her. As a leader at the Federal Reserve, Yellen has met with many of the other policy makers in other countries in dealing with crises - such as the eurozone crisis. This experience will be invaluable in the as the economy grapples with the on-going crisis.

And now the fun fact about Janet Yellen - she is married to George Akerlof who won the Nobel Prize in Economics in 2001 for his work on asymmetric information and market failure.

Economic Update - 11/ 23

There are two major issues in the economy right now: the coronavirus pandemic and the freezing up of the political process in Washington (which is related to president Trump's refusal to concede the election, but involves many more factors). The exploding number of COVID-19 cases is quickly becoming a major health crisis, which could cause a significant decline in the economy. The bank JP Morgan is forecasting a 1% decline in GDP for the first quarter of 2021. The frozen political situation in Washington is stalling any policy action that happen to confront both the health and economic crises.

The exploding number of cases of COVID-19 across the country is a terrible health problem that threatens to overwhelm the healthcare system. Last Friday, the United States had 198,585 new cases of COVID-19 (which was a record high). The country will most likely break that record today or tomorrow (the case counts usually drop off during the weekend because of less testing and lab processing). Just as epidemiologists predicted a few weeks ago, the country is on track to break 200,000 cases a day before Thanksgiving. The rate of increase in new cases is growing at an uncontrollable rate. At the start of the month, the country was having 70,000 new cases a day (already a record, but small compared to the current numbers). Worse, the general trend of this pandemic has been increasing in cases, followed two weeks later by an increase in hospitalizations, followed two weeks later by an increase in deaths. Currently, hospitals across the country are reporting that they are at capacity and the daily death rate is approaching 2000 (which is the highest level since last spring). Medical experts are back to talking about the importance of "flattening the curve" to protect the healthcare system from being overwhelmed. Unlike the surge in cases in the spring and summer, which were concentrated in specific geographic regions of the country, the pandemic is now growing everywhere in the country, which means that the country cannot respond to it by moving healthcare resources from one part of the county to another. Yes, vaccines are on the way (another one announced promising results today), but this solution to the crisis is still months away. The worst point of crisis might be starting now and the country can only fight it with the tools it already has.

The rising number of cases across the country has caused many governments to place restrictions on businesses (particular restaurants) as a way to slow the spread of the virus. This has brought back the debate about the trade-off between the economy and public health that boils down to the idea that saving lives will cause economic destruction. This debate is often used to argue against government restrictions on businesses. However, the evidence from this spring and summer shows that trade-off does not really exist. First, as I have noted in earlier posts, the long-term economic damage done by the pandemic is about the same in states that locked down to deal with the virus and those that did not. University of Chicago economist Austan Goolsbee has studied the impact of the pandemic on the economy and concluded that the largest driver in reducing economic activity during the pandemic was people choosing to avoid activities where they might get infected (this is the link to the abstract for the study he did). In other words, the official lock down orders largely reflected actions people were already taking. Second, economic policy, such as the large stimulus programs enacted last spring were successful in bringing the economy through previous waves of the pandemic. The economy was quickly recovering from the economic downturn in the spring until the surge of cases in the summer. After that the economic recovery slowed, but did continue to grow due to the large build-up of savings during the spring. You can see the current state of the stalled recovery in the CNN/ Moody's Back-to Normal Index. Third, the only way to get back to real economic health is by beating the pandemic. Full economic recovery will only happen when people can begin to move about freely and businesses have confidence that they can invest and expand their operations. Until then, the best option is an incomplete recovery. So, there is no long-term trade-off between public health and the economy - the road to a strong economy is through strong public health. Now, this does not mean the country should go into a full lock down again. A program of targeted restrictions on places with high rates of infection, enforced masking policies and a strong system of testing and tracing is still the best policy option. However, sadly, these policy options might be impossible under the current political system in this country - and unless there is more funding, they are also beyond the current capability of the government.

The frozen political system in Washington has made it impossible to enact any coherent policy to address both the new emerging health crisis and the economic deterioration expected as the pandemic worsens again. President Trump's refusal to concede the election has both stalled the ability of president-elect Biden to start his transition and the ability of the rest of the government to move past the election and deal with the current crisis. Any talk of passing an economic stimulus package in the next month has faded (at this point, the government may not even be able to pass a budget extension to prevent a government shutdown on December 11th). Without additional stimulus funds it is hard to see how states will oversee and coordinate the distribution of millions of doses of vaccines - due to large budge deficits, many states will be hard pressed to keep basic functions of government going at the current level. Worse, last week, Treasury Secretary Steve Mnuchin asked the Federal Reserve to return $170 billion of the $195 billion the Federal government gave the Federal Reserve to support its programs for lending money to businesses and to support financial markets beginning last spring. These funds were crucial to the Federal Reserve programs to prevent a financial crisis last spring. The reason the Federal Reserve needed this money is a bit tricky. The Federal Reserve has the legal ability to literally create dollars and lend these dollars out to support the economy. However, the Federal Reserve can only lend in return for "credit worthy" assets as collateral. This means the Federal Reserve will not lend to any business or institution that cannot repay the loan. This created a large problem last spring when the Federal Reserve was being asked to support the economy by lending to businesses and financial markets where it could reasonably be expected to take a loss. The $195 billion from the Federal government was meant to absorb those losses if they should happen. As it was, the Federal Reserve did not have to lend out the money. The reality was that once financial markets knew that the Federal Reserve was willing and able to act to stop any financial crisis from happening, the panic in financial markets subsided as investors could look beyond the crisis - they knew the Fed would help get them through any crisis. Yes, financial markets can be a confidence game. Mnuchin asked the Fed to return the "unused" money. His reason for asking for the money back at this time is, how to best put it, murky. The action of Mnuchin to request the return of most of these funds makes financial markets nervous just at a time when investors are growing more worried about the pandemic and a Washington frozen in transition. The Federal Reserve responded to Mnuchin by saying that it "would prefer that the full suite of emergency facilities established during the coronavirus pandemic continue to serve their important role as a backstop for our still-strained and vulnerable economy." While this seems like a dry bureaucratic response, in "Fed Speak" it is screaming "what are you doing - this is not the time for this!" Just as things are getting worse with the pandemic, the government seems to be less able and interested in fighting the pandemic.

Economic Update - 11/ 9

The announcement this morning by Pfizer that their COVID-19 vaccine has shown a 90% effectiveness rate is great news and it may have a significant economic effect in both the short and long-run. This level of effectiveness is higher than what experts were expecting and is on an effectiveness level with many of the vaccines currently given to children. This vaccine is a two dose vaccine that would require people to get one shot and then a second shot about a month later for the vaccine to have the full effect. This vaccine is going through simultaneous stage two and stage three trials for long-term safety and efficacy (showing that the vaccine has the desired result). This is the first vaccine in the later stage trials to show a high rate of effectiveness (there are eleven other vaccines also currently in the late stage trials). The combination of Pfizer's reported success and the large number of other vaccines in late stage trials are a reason to be very hopeful that vaccines will be able to end the pandemic in the foreseeable future.

The news of successful vaccines will begin the debate over how to distribute the vaccines once they are produced. Pfizer says that it can produce 15 - 20 million doses by the end of the year (although some reports in the business media have said 50 million) and 1.3 billion by this time next year. Who has priority in the first doses is an important decision. One way of setting out the basic framework for this decision would be to think about who should get the first 20 million doses: people who are likely to die or have complications if they get COVID-19 or "frontline" workers. There are good arguments for each group to be first in line. Today, Joe Biden announced the people on his coronavirus task force. One of their first projects will be to set up the framework for the priority list for who gets the vaccine. In addition, they will also have to do a lot of work educating people about the vaccine safety (due to the large size of the anti-vaccine movement) and building the infrastructure to transport and distribute the vaccine (the Pfizer vaccine is an RNA vaccine need to be stored at -94° Fahrenheit).

As an additional note on the Pfizer announcement today, Pfizer did not participate in the Federal government's program "Operation Warp Speed" for vaccine development begun by the Trump administration. However, it is part of the program for producing a vaccine once one is developed. The Federal government has previously agreed to pay Pfizer $1.95 billion for 100 million doses. This works out to $19,500 per dose. Yes, that is a high price, but before you say that it is too much, think about three things. First, ask yourself how much you would pay right now for a vaccine. Second, producing this vaccine quickly in large amounts will require scaling up vaccine production at a rapid rate, which is not cheap. Paying a high price for the vaccine incentivizes companies to move quickly to large scale production. Third, paying a high price is the best way the U.S. government can secure vaccines for Americans (remember, other countries will also be willing and able to buy the vaccines).

The timing of the announcement is very important and, in itself, may save many lives. Right now, coronavirus is spreading at a rate that is being described as "exponential" and "out of control". The U.S. has been averaging over 120,000 new cases a day for the past week and estimates are that the country could be averaging up to 200,000 a day by Thanksgiving. This explosion of cases is happening at a time when people are suffering pandemic fatigue, starting to behave in less cautious ways and even talking about trying to achieve "herd immunity" (a foolish strategy that is based on a willingness to accept the deaths of millions of people). Today's announcement will help in getting people to redouble their efforts to fight the pandemic. Now that a vaccine may be a few months away, people can have real hope that they can get to the other side of this pandemic without getting infected. It should be remembered that the cost of getting COVID-19 is not only death. A lot of people (including a large number of young people) have suffered serious potential long-term damage from getting sick (there are still a lot of unknowns). A vaccine means that the expected value of delaying the chance of getting sick has gone up. The best analogy for this would be to a running race. It is easy to drop off the pace and slow down when you do not know how long the race will last. That changes when the finish line comes into sight - then the urge is to pick up the pace and finish strong. The news of a vaccine might be the news we need to keep up the public health practices to get through the next, and hopefully last, phase of the pandemic.

The stock market jumped significantly on the news this morning. One reason for this is that Americans have increased their savings by $2 trillion (or 10% of GDP) during the pandemic. The end of the pandemic could bring a large increase in spending. This does not mean there should not be an additional economic stimulus. The argument for a stimulus still holds because much of the savings is held by upper income Americans who have kept their jobs through the pandemic. The millions of Americans who have lost their jobs and have been pushed into poverty need the stimulus money now. The economic stimulus is to get the economy through the next few months until a vaccine can be widely distributed. Still, once a vaccine comes into widespread use, the economy could go through a fast expansion.

Economic Update - 11/ 8

Now that the election has been effectively decided and Joe Biden is the president-elect, the country can return to focusing on the coronavirus pandemic and the economic crisis. While it is still slightly more than two months before Joe Biden will be sworn in as president, the decision in the presidential race and the run-off elections for the two senate seats for Georgia have created the opportunity for there to be an economic stimulus before the inauguration in January. The combination of the accelerating resurgence in the coronavirus pandemic and the slowing rate of economic recovery means the sooner a new economic stimulus can be enacted the better. The timing of another economic stimulus in the next few weeks compared to early February (which would be the timing if it has to wait until after the inauguration) would be very good for the economy.

Before getting into the importance of timing for a new stimulus, it would be good to get into the details for the need for additional economic stimulus. The Bureau of Labor Statistics (BLS) released the new unemployment numbers on Friday. Friday's jobs report said that 638,000 jobs were created in the United States in September and that the unemployment rate dropped to 6.9% - down from the previous unemployment rate of 7.9%. Both of these numbers are good, but they are not good enough. First, at this point, the economy has only recovered half of the 22 million jobs lost since the start of the pandemic in February. That means the economy has to continue to grow by a large amount to regain the 11 million jobs needed to get back to pre-pandemic levels of unemployment. One reason the unemployment rate is down to 6.9% is because the BLS has categorized roughly 5 million former workers as no longer being in the labor force - a large part of this group are women who are staying home with their children because so many schools are operating remotely. To put the 638,000 jobs last month in perspective, that number is down from the 1.5 million created in August and the 1.8 million created in July. This slower rate of job creation means that it would take 18 months to regain the lost jobs. Speeding up the rate of recovery with more economic stimulus is the best way to regain the lost jobs.

The argument for economic stimulus to speed up the rate of job recovery is made stronger by a deeper look at the unemployment data. The percentage of temporary lay-offs of the people who lost their jobs in September is only 29% (this was as high as 80% back in March). This means that 70% of job losses now are permanent job losses and that new jobs will have to be created in order to put these people back to work. In addition, 32.5% of unemployed workers have been out of work for more than 27 weeks (longer than six months). Historically, workers who suffer long-term unemployment have a harder time getting a new job and a harder time of getting a job that has wages equivalent to what they had in their previous job. The slower the recovery, the harder it will be to re-employ these workers. In addition, 192,000 of the 638,000 jobs created in September were in the food and drink industry (mostly restaurant type jobs). It is not clear how well this sector of the economy will do over the winter. In addition, the steep increase in COVID-19 cases in the past week (averaging above 120,000 a day) will also mean increasing restrictions on this sector of the economy, which will be slower job growth (or a return to job losses).

The economic need for additional economic stimulus is clear. But that was true before the election when the Democrats and Republicans in Washington were incapable of reaching a deal on additional economic stimulus. The question is whether the parties in Washington can make a deal on stimulus prior to the inauguration in January. A stimulus package passed in December will help the country get through the winter (and also provide much needed funding for more COVID-19 testing). Waiting until after the inauguration will mean the economy will suffer more needless long-term damage in the form of bankrupt and lost businesses. The reason to hope that both parties will be willing to make a deal in the near future is the two run-off elections that will be held in Georgia in January. These elections will decide which party will control the Senate next year. The negotiations over the stimulus will be the way both parties can signal how they will govern after the inauguration. In addition, both parties can gain from a stimulus passed in December. A new stimulus bill, even if it is smaller than what Democrats want, will mean that Joe Biden will have funding to use when he is inaugurated and starts his administration. This type of financial hand off has happened before. In December of 2008, president George Bush authorized $17 billion from the Troubled Asset Relief Package (TARP) for the automotive industry to be distributed by president Barack Obama when he became president. The Republicans do not want to be seen as needlessly obstructionist before the January election in Georgia since the state is now clearly in purple territory (while is historically a Red state, the ability of Stacey Abrams to organize and register voters has given the Democrats an unexpected edge). In addition, Republicans are also more likely to support a stimulus program now that is more likely to be in-line with their ideas and goals than they are likely to get after Joe Biden is inaugurated. The unknown situation about who controls the Senate next year creates a situation where both sides are more likely to accept a deal that they do not feel is ideal because it may be the best option if the January elections in Georgia turn against them. Any deal now is better than zero. Of course, the big wild card in all of this is president Trump and his willingness to support any additional stimulus during the twilight of his presidency.

Economic Update - 10/ 29

The big economic news today was the release of the third quarter GDP growth rates. Gross Domestic Product, or GDP, is the statistic that measures the amount of economic output in the country and it is released four times a year (once every three months or quarter). GDP growth is the percent growth of the economy each quarter. The news today was that the economy grew by 7.4% during the third quarter (July to September), which would translate to an annual growth rate of 33%. This is the fastest rate of growth the United States ever recorded - the United States has averages a annual growth rate slightly above 2% for the past thirty years. Of course, this fastest rate of growth on record follows the quarter with the largest decline on record - second quarter GDP (April to June) declined by 9% (which would translate to an annualized rate of - 31%). It is also important to note that a lot of this recovery growth was driven by large amounts of government spending, which is now gone.

Now, for a little bit of math. The rate of decline seems similar to the rate of growth and many people would think that we are back where we were before the pandemic. The reality is that the economy now is 3.5% lower than where it was in February. Why is that? It is because you measure a percentage from where you started. For example, if you start with 100 and reduce it by 10% you will be at 90. If you then grow by 10% you will go up to 99 - less than where you began. This is the situation with the economy. Yes, the economy has grown by a lot, but it is significantly below where it started. Ian Shepherdson of Pantheon Economics estimated that the economy needed to grow at an annualized rate of 45% to get back to where it was in February. Worse, it would have needed to grow at an annualized rate of 63% to get to where the economy would have been if there had been no pandemic. To get a sense of what it means that the economy is 3.5% smaller today than where it was in February, the entire GDP decline in the 2008-2009 Financial Crisis recession was 4%. Another way of looking at the current state of the economy is that it is 82% recovered from where it was in February (according to the CNN- Moody's Analytics Back to Normal Index). In short, the rate of third quarter recovery is good, but we are still below where we should be and the future is far from certain - the combination of a resurgent pandemic and the absence of any additional economic stimulus darkens any future expectations. There is no way to extrapolate a trend line from the past few quarters of data to forecast the future.

The other news for the day was that last week's new unemployment claims were 750,000, which is down from the previous week's 787,000. This is a good downward trend, and it is the second week in a row it is below the average of 800,000 of the past several months. Still, it is hard to have a lot of confidence in the current state of the economy. The number of new COVID-19 cases has hit new highs today with 81,457 cases today. This moves the seven-day average up to 75,000. The rate of growth in new cases is shocking - the number of daily cases has grown by 41% in the past 14 days.

Economic Update - 10/ 26

The rising number of COVID-19 cases has again emerged as the most significant economic story. The seven day average on Sunday was 68,767 cases, which is a record for the seven day average in the whole pandemic. This trend is worrisome because the number of cases are increasing in all parts of the country (the earlier upswings in the spring and the summer were concentrated in specific parts of the country) and the coming colder weather will be putting more people indoors and in closer contact with each other. This is the reason the forecasts for the next few weeks are so dark. Financial markets, which had seemed to shrug off the news of the uptick in cases over the past few weeks, reacted to the news of rising cases today by going down by nearly 2%. The seeming failure of the negotiations over another economic stimulus package also contributed to this decline.

The rising number of cases will bring back the debate about shutting down parts of the economy to fight the pandemic. Most mainstream economists have come to view this as a false choice between fighting the pandemic or saving the economy. The reality is the only way to have a strong economy is to defeat the pandemic. The evidence from the past six months shows that the decision shut down the economy to fight the pandemic can have severe short-term effects on the economy but do not have significant longer term effects on the economy. Over the past seven months the United States has carried out a brutal "natural experiment" in the effectiveness of different pandemic strategies (I noted this back in a post on 3/ 3) that can show the effect of public health strategies on the economy. The Northeast carried out strict lockdowns while the South was very lenient. The Northeast did suffer a deeper and faster drop in its economic statistics in the spring than the South. However, since the summer, the two regions have converged in terms of economic statistics. In other words, there was no real long term difference in economic performance caused by public health restrictions. Look at the data yourself - this is the link for the Harvard and Brown University Economic Tracker and this is for the Homebase statistics.

One reason the different government policies do not have significant long-term impact is because the policies are not the sole determinant of people’s behavior. When the number of cases are high, many people choose to reduce their amount of economic activity to avoid getting sick. Even in parts of the country with little official restrictions saw large declines in economic activity because people chose to stay home. Even in the absence of government restrictions, there will be significant economic damage caused by people’s individual choices to stay healthy. So, a state that chooses strict public health policies will save lives without really suffering any more economic harm than if they do not.

Still, shutting down the economy in the short-run does create terrible economic pain for many people. That is where economic policy, like the large stimulus packages in the spring came into play. These policies limited the economic damage created by the public health policy pain. The economic policy worked, the public health part did not work - largely because the political leadership let up before the pandemic was defeated. Sadly, we missed the best opportunity to beat the pandemic. The best analogy for the spring was that the shutdown and economic stimulus was like using an elephant gun - you have one shot and you better get it right. We did not. Lots of other countries (such as Taiwan and New Zealand) did get it right.

In the current circumstances, it is unlikely that there will be any additional stimulus before January (and even then, it is not clear if there will be a stimulus package - a lot hangs on the election) and it is even less likely that there will be another closing down of the economy. European countries have been trying to do that in the past few weeks and the push back against the policies there has been strong.

The problem is that a pandemic is not really a manageable problem because there is no way to have a manageable level of any highly infectious illness. There are many illnesses that people can suffer where society can both manage the medical problems and let the larger society keep functioning in a normal way. Hepatitis, tuberculosis and sexually transmitted diseases all exist at some manageable level in society. This is largely because it is pretty easy to limit the ability of these to spread, and even when they do spread they do not cause an exponential growth in cases. In contrast to these diseases, COVID-19 is highly infectious and can have sudden rapid increases in case levels.

The only way to deal with a non-manageable disease is to drive it out of the population - either you are defeating it or it is winning. To get a little bit technical, the coronavirus pandemic is a non-linear problem where the normal decision making process of weighing cost and benefits to find the right amount of policy does not work. Any policy that is not sufficient will simply be overwhelmed at some point. This is really more of an "all or nothing" situation. The country is now at a point where the policy choices of widespread lockdowns and massive economic stimulus are off the table, which means that the only option is a massive testing program combined with enforced quarantine. Nobel prize winning economist Paul Romer has pushed this program from the beginning of the pandemic, and yesterday he tweeted out, "My recommendation is make (tests) universally available to every household, and if somebody in the household is positive … [make isolation possible] by paying them to stay home -- the whole family -- for 14 days." Yes, this will cost a lot of money, but it may be the only real policy that we have left - everything else is really just a policy based on hopes and wishes.

Economic Update - 10/ 22

With the last presidential debate scheduled to start in a few hours, there is still talk of an economic stimulus deal being made at some time in the next few days - still, the lack of details and the expectation of strong opposition in the Senate still makes it extremely unlikely that any deal will actually become law. The politics of the moment seem to be more about keeping alive the idea on a stimulus instead of actually making a deal. That said, the economic need for additional economic stimulus continues to be strong. The weekly new unemployment claims for last week was reported as 787,000, which is the lowest number since March. However, this is a noisy statistic that is very volatile. Last week, the weekly new unemployment (for the week before) was 898,000, which was the highest since March. The important factor is that the weekly new unemployment claims number continued to be around 800,000. This statistic is being seen as an indication that the economic recovery has stalled. The news of rapidly increasing COVID-19 cases across the country and the coming of colder weather, which reduces outdoor economic activity, are seen as forces that will be further slowing the economic recovery. Some other statistics to show the level of economic distress in the country are that about 8 million Americans have fallen into poverty since the pandemic began and the economy has about 11 million fewer jobs than it had back in February.

It was reported this week that the Federal deficit grew to $3.1 trillion in fiscal year 2020. The deficit is the difference between the amount the Federal government spends and the amount that it collected in revenue in one year (the Federal government’s fiscal year runs from July 1 to June 30). To put this year's deficit in perspective, the deficit for 2019 was $984 billion. The size of this year's deficit is not a surprise. The combination of the large stimulus packages and the decline in tax revenue meant the deficit would grow a lot.

The size of the deficit (and debt) is often held up as a reason against additional stimulus. This is not a good argument at the current time. As I mentioned many times over the spring, while the deficit (and debt) are large, the absolute number is not as important as the interest carrying cost of the debt. The Federal government finances its borrowing by selling bonds and as long as the interest rates on the bonds are low, the deficit (and debt) are not a problem. Right now the Federal government can borrow money for twenty years at an annual interest rate of 1.43% (the one year rate is 0.13%). If you expect the long-run rate of inflation to be 2%, the federal government can currently borrow at a real negative interest rate. The opportunity to spend $2 trillion, to save millions of Americans from real economic hardship, borrowed at a real negative interest rate seems like a pretty easy decision.

The boom in the housing market is continuing. It was reported that existing house sales (as opposed to new home sales) jumped by 9.5% in September, and the median price went up by 14.8%. The jump in prices is because there are very few houses coming onto the market. In fact, the inventory of existing houses on the market has gone down by 19.2% to 1.47 million (which would be a 2.7 month supply of houses). This is an interesting phenomenon since high prices should bring more supply on to the market. This can be explained by noting that pandemic has seen a migration of people from living in urban areas to more suburban areas (as people seek more space for staying at home) while many existing home owners choose to stay in their current houses (where they have space for staying at home). Now, under a non-pandemic situation, older people, who are empty nesters, might take advantage of the high prices to cash in and move to a retirement community. However, given the nature of COVID-19, many older people are choosing to stay in their larger houses because it is much safer than a retirement community. So, the record high housing prices and sales may not be a good economic sign - or an indication of the larger economy.

Economics Update - 10/ 15

The talk about a stimulus in Washington continues and even though the stimulus is badly needed the expectation that there will be any stimulus before the election (or even before January) is still zero. Before getting into the reason for this, it is first important to cover the news that shows the need for the stimulus. The new weekly unemployment claims number released today was 898,000, which is the highest weekly claim since August 22nd. While this number is higher than previous weeks, this is a noisy statistic and the jump in numbers is not as significant as the fact that the weekly unemployment claims number has been around 800,000 for several months. High unemployment and job turnover is a problem that is not getting better and it signals that the economic recovery has stalled. In addition, it was reported today that studies in the poverty level show that the number of American living in poverty has grown by six to eight million people since May. Clearly, many Americans are suffering economic hardship and there seems to be little chance of an economic recovery to save them in the near future. Added to this is the growing number of COVID-19 cases across the country and the colder weather, which will have an adverse effect on economic activity that has moved outdoors during the summer (like eating at restaurants), which as are both factors which will also slow the rate of economic recovery. At this point, additional economic stimulus is needed to help the economy continue its recovery, or at least not fall back into recession. Jerome Powell, chairperson of the Federal Reserve made this point in a speech last week.

Still, the politics of Washington make it unlikely that there will be a stimulus. Basically, there are three parties to the stimulus discussion right now (Democrats in Congress, Trump administration and Republicans in the Senate) and it is hard to see how these groups will make a deal so close to the election. The Democrats in Congress have been pushing for a $2.2 trillion stimulus package since the summer and show little willingness to give in on that amount. It should be noted that even liberal economists think that $2.2 trillion is on the high side for a stimulus at this point - $1.8 trillion seems to be more in the estimates of what is needed. The Republicans in the Senate are opposed to this level of spending and are unwilling to go above $500 billion - and even that is a stretch as many Republican Senators are opposed to any additional stimulus. It does seem like the Republicans in the Senate do want a small stimulus aimed as specific businesses, such as the airlines, but the Democrats in Congress are opposed to a small stimulus bill. The reality is that any larger stimulus bill would need significant Democratic support to pass the Senate (which only strengthens the hand of Democrats in the Congress to hold out for a high amount). In the negotiations, the dollar amount has become a symbol of victory to one side or the other. So, these discussions have become about political positioning and are not really about a making a well crafted piece of economic policy - still, even poor policy is preferable to no policy. The question since the summer has been about the goal of the Trump Administration in these negotiations. As last week and this week shows, nobody seems to know what president Trump's goal and strategy is because it seems to change by the day. Currently, it seems president Trump wants to "go big" on the stimulus. He might have been able to push the Senate Republicans to make this deal in the summer, but now (less than three weeks to the election) he does not have that power over them (low poll numbers are weakening his hold over them). So, president Trump's best option is to strike a deal for a big stimulus with the Democrats. However, while the Democrats may want a deal, they are also hesitant to make one because it is not clear that president Trump will follow through on any deal. Any stimulus agreed to now would not have any effect on the economy before the election - so, any agreement at this point is really about politics. This gives president Trump the incentive to make a big deal and then bail on it after he claims success. President Trump’s practice of erratic actions in negotiations can be strategically smart in the process of making a deal. However, his tendency of erratic actions after making a deal hurt this process because people cannot trust the deal that has been struck will actually come to fruition. The Democrats do not want to give president Trump a win so close to the election - especially if he makes them look like a bunch of suckers. In short, the political incentives of the current situation in Washington make it impossible to make a deal in the near future. The Democrats are hoping the election will let them do a big stimulus in January.

The problem with this situation is that without an economic stimulus there will be significant economic destruction done to the economy by January. Carmen Reinhart, chief economist for the World Bank in an interview with Bloomberg today said, "This did not start at a financial crisis but it is morphing into a major economic crisis, with serious financial consequences." The lack of stimulus now to support the economy can set off a series of cascading problems that will cause long-term economic damage. Businesses that fail cannot be put back together, people who suffer long term unemployment find it harder to get a job at their previous wages (and actually find it harder to get any new job at all), and creditors find it harder to keep extending loans or not acting on foreclosures. The longer the economy takes to recover, the less likely it is that it will fully recover since the parts that are still left to recover will no longer exist. If the economic recovery stalls for a significant amount of time, the resulting economic destruction will mean that the only way to get back to where the economy was in February will be to start new businesses that will employ the workers who need jobs - and that can be a slow process. If the Financial Crisis of 2008 is any indication, it could take years to fully recover.

Economics Update - 10/ 12

Amid all of the other news today, the Nobel Prize in Economics was awarded to two American economists, Paul Milgrom and Robert Wilson for their work in auction theory. Yes, I know, it sounds like a strange topic to get the notice of such a prestigious award. However, their work directly affects the way radio bandwidths are allocated to telecom companies, which means their work directly affects your cell phone (which is pretty important to most people these days).

Milgrom and Wilson stand out as economists because their work involved actually creating economic systems for efficiently allocating resources that have both common and private value, but not clear market value (more on that in a little bit). Their work is related to the idea of market design theory and game theory, which look at how individuals make decisions and then proceeds to build systems so that individual decisions fit together to create an optimal social outcome (the post on 8/ 2 describes how this works in conjunction to schools). A cornerstone idea in market design theory is that some goods cannot be easily sold in markets because of the way the good exists or the difficulty in making a market work to create a correct price for the good. Because there is no natural way to price and allocate this type of good, economists try to develop a system that works like a market to do this. Radio waves for communication are an example of this type of good. The government starts with ownership of radio frequencies and has to find a way to transfer that ownership to private companies to use them. Originally, the government just gave radio frequencies to companies, but about thirty years ago, it began to auction them off to companies. The reason for auctioning them off was so that the government could earn some money and make it so the frequencies would go to the companies that most wanted them, because they were willing to pay the most to obtain them. However, these auctions did not work very well because they were badly designed.

Auctions have been around for centuries as a way to sell single items and there are many different types of auctions. As part of their work, Milgrom and Wilson researched different types of auctions to see which was the most efficient in getting a price that best reflected the market value for a good. The problem with auctions is that the process of bidding for a good creates a situation known as the "winner's curse" where the winner over pays for a good. This would not normally be a problem for a seller, except if buyers become adverse to bidding the full amount that they value a good because they do not want to fall victim to the winner's curse. In that case, the bid may be too low. In essence, a buyer may not want to bid the price they privately value a good because they think it is well above the common value for a good - if they bid their private value they will over pay. The problem for the buyer is that when an item is unique, it is hard to find out the common value for a good because their is no market price to show the common value.

An additional problem is that sometimes a buyer wants to buy a bundle of goods, but they have to buy them as individual items. A buyer may not want to pay a high price for each good if they do not know if they can buy the whole bundle. This is the case of radio frequencies for telecom companies - they want to buy a group of frequencies, but they have to buy them separately. Milgrom and Wilson set up a system of simultaneous auctions where a large number of radio frequencies would be auctioned off at the same time in a way where companies could bid on all available frequencies. In this system, the companies can see the top bids for each frequency, and then enter new bids in a process that goes on until all the frequencies bid up. This way companies could see the bid strategies of other companies can then adjust their own strategy to get the bundle of frequencies they want.

Milgrom and Wilson's system has worked so well that it was used to transfer ownership of radio frequencies from television broadcasters winding down their operations to telecoms that need more frequencies to meet customer demand. In this process, the television companies sold their frequencies back to the government in a reverse auction and then the government re-actioned them to telecom companies. This process allowed frequency ownership to be reorganized in a way that created more usable frequencies for telecom companies, and their customers. This would have been impossible if the telecom companies had to buy the frequencies directly from the television companies.

A funny touch to today's award is that Milgrom did not get the call from the Nobel Committee because his phone was switched off. Wilson (his neighbor) had to walk over to his house to tell him that they had both just won the Nobel Prize. This is the video (from Twitter) showing Wilson knocking on Milgrom's front door.

Economics Update - 10/ 3

Today was a case of economic policy whiplash. The day started with hopes that a there would be real movement toward an agreement over another stimulus package and it ended with any hopes of a stimulus package being killed. The hopes for a stimulus package deal being reached began yesterday when it was reported that president Trump told Secretary of the Treasury Steve Mnuchin to make a deal with the Democrats for a new stimulus package. At that point the negotiations had been bogged down with a difference of $1 trillion between the two sides. The Democrats were asking for $2.3 trillion and the Republican had only agreed to $1.3 trillion. It seemed that with president Trump's support the Republicans would raise their offer to be closer to the Democrats. Two reasons to support this view are that the Republicans in the Senate would need Democratic votes to pass a bill (too many Republicans are against any additional stimulus and that president Trump is looking to improve the economy before the election (although any government spending done now will not affect the economy before the election). The reality is that any stimulus deal made at this point is really about moving the political needle one way or the other. The stock market rose this morning based on these expectations.

The case for stimulus looked stronger in the early afternoon when Federal Reserve Chairperson Jerome Powell spoke in favor of additional stimulus. Powell, who was appointed to his position by president Trump, presented the case for additional stimulus by saying "the risks of policy intervention are asymmetric" and explaining that no additional stimulus increased the risk of a stalled recovery and, potential another recession, while an additional stimulus most likely not cause inflation or debt problems.

Then in mid-afternoon, president Trump told Mnuchin to end all negotiations over the next stimulus package. At 3:30 in the afternoon, Mnuchin called House Speaker Nancy Pelosi to inform her that the negotiations were over. Trump followed this up by tweeting, “The Stock Market is at record levels, JOBS and unemployment also coming back in record numbers. We are leading the World in Economic Recovery, and THE BEST IS YET TO COME!” After this the the stock market dropped by 600 points, ending about 400 points below where it started the day.

The story of the day is that there will be no more stimulus spending in the next month, and most likely not before January. The reality is that the incentive for one side of the other other to make a deal for a stimulus after the election is almost zero. If president Trump is reelected, the Democrats will be less willing to make a deal. If Biden wins, the Republicans will not want to make a deal. So, there will be not additional relief for the unemployed or businesses (including the airlines), money for states with large budget deficits, schools in dire financial shape and money for COVID-19 testing.

Economics Update - 10/ 2

It has definitely been a big news day with president Trump being diagnosed with COVID-19. As a result, the news of the new unemployment rate has been pushed pretty far down in the news stream. The Bureau of Labor Statistics reported today that the United States added 661,000 jobs in September, which would be great news in any other economic situation. However, these large job gains only pushed the unemployment rate down to 7.9% (previously at 8.4%) - and there are some issues with this that I will get to in a minute. First, it is important to put the September job gains of 661,000 in perspective. In June the economy added 4.8 million jobs and in August it added 1.5 million. This newest jobs number shows that the rate of job creation has slowed down significantly, which matches the story told by other economic data that the economic recovery is slowing. The economy is still about 10 million jobs less than were it was in February.

A more interesting point is that the decline of half a percent in the unemployment rate (from 8.4% to 7.9%) is more a result of people leaving the workforce than gaining employment. The unemployment rate is calculated by dividing the number of unemployed people with the number of people in the labor force. So, the unemployment rate can go down as a result of more people getting jobs (lower number of unemployed people) or fewer people in the labor force (because they gave up on looking for a job). In this case, the main reason the unemployment rate went down was because 695,000 people left the labor force last month. If the number of people in the labor force had stayed the same, then the current unemployment rate would be largely unchanged. The fact that such a large population has left the labor force is important economic news. A large part of the decline in the size of the labor force is because women have chosen to stop working or are not looking for a job because they are at home taking care of children, due to many schools operating with a hybrid model or a fully remote model. Labor force participation by women dropped from 56.1% to 55.6%. - which is about 600,000 women. The deeper news of today's jobs report is that trouble schools have had in fully reopening (due in part to alack of Federal support, which is a result of Washington not able to agree to a new stimulus package) and this has hurt women's employment - reflecting the gender imbalance in society over the issue of taking care of children. If the BLS treated the women who have been forced out of the labor force in order to take care of their children as unemployed workers instead of not in the labor force, the unemployment rate would not have changed very much.

Economics Update - 10/ 1

The economics news continues to be mixed, which is what should be expected given the uneven nature of this recovery. On the one hand the consumer information for the past month has been good, and this is a clear sign that the population that is secure in their jobs, able to work from home and have investments in the stock market are doing well in the recovery. On the other hand, the employment news continues to be poor, and this is a clear sign that many people are struggling in the current economy and facing real economic hardship. The economic downturn has further exacerbated the issue of economic inequality in the country and has made the current economic situation one of two recoveries - one strong and the other quite weak and fragile.

The positive news for the economy has been the strength of consumers. Earlier this week, it was reported that consumer confidence in September was at 101.8, up from 86.3 in August. The absolute number in this measure doesn't matter that much. The important point is that it is significantly higher than it was last month. Consumer confidence is considered a leading indicator of future economic activity. In addition, The Bureau of Labor reported that consumer spending increased 1% in the past month. This increase in spending happened at the same time that personal income declined by 2.7%, due to the end of the enhanced unemployment benefits of $600 a week. It is a bit strange to see consumption going up at a time when personal income is going down. But, this can be explained by the uneven economic recovery. The measure of personal income going down by 2.7% is made up of two populations. One population has not lost any income and the other has gone down by a lot more than 2.7%. In this case, the population without any income loss are the people who are consuming more - causing consumption to go up. The size of consumer spending is important because it represents 70% of economic activity and strong consumption spending is crucial to the economic recovery. The high level of consumer confidence is a good sign. What is not clear is the strength of that confidence. There is a big question whether an increase in COVID cases, colder weather curtailing outdoor activity and political uncertainty reduce that confidence. In addition, while consumer confidence is strong, it is still well below where it was prior to the pandemic. Consumer confidence in February was 130 and now it is at 101.8.

The negative news for the economy is in the jobs situation. The new unemployment claims for last week came in at 787,000, which is better than last week's number of 825,000. However, this is a noisy statistic that jump around week to week. While there is a small downturn in the weekly number, it is still really close to 800,000, which is not good. As I have mentioned, the concern with the job losses happening now is that the represent permanent job losses (not the temporary losses that happened in the spring). This could be seen clearly this week with the major companies announcing furloughs and layoffs. The big news today was that American Airlines and United Airlines announced that they were furloughing more than 30,000 workers. The airlines were hit hard by the pandemic, but had avoided large layoffs because of large amounts of government assistance this spring. These companies had been waiting for additional assistance in the next government spending package. Unfortunately, that is still tied up in negotiations with little hope of being passed. So, these layoffs are connected to the government deadlock over additional stimulus. Still, even with that assistance, it is likely that the airlines would have to reduce their workforce to match the decline in air travel. Walt Disney parks also announced that they were laying off 28,000 workers because of declines in tourism and park attendance. The insurance company Allstate is laying off 3800 workers, about 8% of its workforce. All of these companies are making permanent workforce reductions that are tied to adjusting their business operations to the current situation in the economy - and also expectations of how the economy will be for the foreseeable future.

The new unemployment rate will be announced tomorrow morning. While the rate of unemployment is important, the more important part of the new jobs report will be the types of jobs lost because it will give an induction of how many of the new job losses are permanent.

Economics Update - 9/ 28

The combination of the coronavirus pandemic, presidential election and Supreme Court nomination has put the issue of healthcare back at the top of the news. This post will explain the economics of the problem with health insurance and how the Affordable Care Act (ACA), or Obamacare, was designed to fix those problems. Before I get too far into this post, I want to say that the debate over health insurance can get very complicated very quickly and there is no good solution. In this post I am trying to focus on the core issues and will not be covering many points in an effort to keep a long post to a manageable length. An important thing to keep in mind is that anyone who tells you there is a simple solution to this problem does not know anything about the subject.

First off, the health care problem is really a health insurance problem and not a problem of providing health care. Healthcare in the United States is very good (the poor statistics for life expectancy and infant mortality have more to do with how people live). The problem is paying for this healthcare. In fact, the very success of improvements in health care are the reason it has become so expensive, which is the driver in the health insurance problem. Modern medicine means that many people are alive today, who would have died from health problems not very long ago, and are living productive lives. Of course this medical care is very expensive - which is really the problem.

The solution to the problem of health insurance involves making trade-offs knowing that no plan will be really optimal for everyone. At its core, the health insurance problem is an economic problem involving many different forms of “market failure”. Economists use the term “market failure” to describe situations where private markets fail to produce an optimal outcome. Basically, market failure is when the structure of a market creates situations where people cannot protect themselves from costs created by other people’s actions. In this case, the market can actually incentivize people to act in a way that is deliberately costly to other people. Economists basically see market failures as something that should be corrected by the government. Now, this does not mean the government should replace the marketplace. Most economists prefer to use targeted policies to correct for problems of market failure since the government can create its own set of problems (known as Public Choice Theory - see the post on 9/ 20). The ACA is an example of policy being used to fix a market rather than replace a market.

As a policy, the ACA was designed around the reality that most people get their health insurance through their employer and are reasonably satisfied with that system, or they are already covered by some sort of government healthcare program (Medicare and Medicaid). The problem was that about 30 to 40 million people did not have health insurance, mostly because they could not afford it, or insurance companies would not cover them because of pre-existing conditions (private companies seek to avoid known losses). The ACA was designed as a patch on the existing system of health insurance to fix these problems instead of creating a whole new system (this is what would happen in a single payer system). The ACA was designed so the solution to the problem of providing health insurance to millions of uninsured people would also solve the problem of insurance companies not covering pre-existing conditions. This is important because removing one piece of the policy could cause the whole program to collapse.

In order to understand how the ACA works, it is first good to look at how insurance works. In general, insurance is a good way for people to plan to protect themselves in an uncertain world. When you buy insurance, you are paying someone else to take on your risks buy paying off the losses you suffer. Insurance works by grouping people into a “risk pool” where health outcomes are more predictable. For example, it is hard to predict if a specific person will get in a car accident in the next year. However, is it easier to predict how many people in a population of ten thousand will get in car accidents in the next year. Insurance companies group people together in a “risk pool” and charge everyone a rate based on covering the cost of paying for all of the injuries in the pool. Statistics allows insurance companies to accurately price how much each person in the pool should pay to cover all of the losses by the whole pool. Insurance means that everyone pays the same price and the money collected is paid to help the people who suffer losses. In short, the people who do not suffer losses pay to cover the expenses of the people who do suffer losses. The reason this works is because nobody knows who will suffer losses when they buy insurance.

Insurance markets begin to break down if people know whether they are more likely to suffer losses before they buy insurance. People who know they will have expensive healthcare needs will buy insurance if the price is lower than their expected healthcare costs, while people who are in good health will take the risk of not having health insurance if the price is too high. Any insurance company selling insurance at one price to everyone will be forced to raise the price - which of course drives many healthy people to drop their insurance, leaving a smaller group of less healthy people in the insurance pool. The end result is expensive insurance that only covers a few people. The insurance companies can prevent this outcome and keep the price down by denying coverage to people who are unhealthy, and expensive to insure. Prior to the ACA, insurance companies did this by denying coverage to people with preexisting medical problems.

It is important to recognize that even though health insurance would not sell to people with pre-existing conditions, that did not mean these people did not get healthcare. The reality is that hospitals still treated these people (along with anyone else without health insurance), and when they could not pay the bills, the hospitals would just charge people with health insurance a higher price for their services, which only increased the price of insurance. So, before the ACA, healthy insured people were still paying for the unhealthy uninsured people.

The ACA fixed this problem with health insurance by doing three things: stopping insurance companies from denying people coverage because of pre-existing conditions, forcing everyone to buy health insurance, and subsidizing insurance for people with low incomes. The government told the insurance companies that the trade-off for the expense of covering unhealthy people was the expansion of the insurance pool though forcing health (cheap to insure) people to buy insurance (this is the mandate). In addition, the government would pay the cost of insuring low income people (many of whom were young and healthy) so the mandate to buy insurance did not create a financial hardship. The ACA basically solved the problem by keeping a large pool of people in the insurance market which made it easier for the healthy (with government support) to pay for the coverage of the sick. The insurance companies generally saw this as good for business and supported the ACA.

The really important point is that without the government keeping people in the insurance market (more through subsidies than the mandate) then insurance companies will not cover people with pre-existing conditions. If this is taken away and the the law that prevents them from denying people coverage for pre-existing conditions stays in place, then the insurance companies will solve the problem by choosing to not sell health insurance to anyone. This is the fundamental reason no one has been able to come up with an alternative plan to Obamacare that is not a single-payer system. Basically, the choices the country has for health insurance is to go back to the way it was before the ACA (30-40 million uninsured), have a single payer system, or have the ACA (or something very similar). The problem is that the Trump administration and Republicans in Congress have been trying to end the ACA without developing a replacement policy (because they cannot). An interesting side note here is that Obamacare is basically the program that Mitt Romney implemented in Massachusetts when he was governor. Still, not having a plan has not stopped them. This fall the Supreme Court will be hearing another challenge to the ACA and there is a small, but significant, chance that it will strike down the ACA. This would be a terrible thing during a pandemic.

Economics Update - 9/ 27

The end of last week brought more news that showed the rate of economic recovery is slowing, that government policy is doing little to stop that process and that the recovery that is happening is unevenly affecting the country.

New unemployment claims for last week were 825,000, which was up from 796,000 the week before. While there is a lot of noise in this weekly statistic, the general trend over the past few weeks shows that new unemployment claims are not going down, and may be going up, which can be read as evidence that the rate of economic recovery is slowing. As I have said in previous posts, the concern with the high rates of new unemployment claims is that they represent permanent jobs losses, as opposed to the earlier "temporary" job losses experienced at the start of the pandemic. In a normal recovery, a decline in new unemployment claims would be a sign of declining unemployment because businesses typically stop laying off workers before the start to the process of hiring new workers. This week will bring a lot more information about jobs and unemployment over the past month, including the new unemployment rate which will be announced on Friday.

While most of the news this week was focused on the coming battle over the Supreme Court nomination, the Democrats in the House of Representatives did move to restart the negotiations over another fiscal stimulus package by proposing a plan for a $2.4 trillion spending package of unemployment relief, funding for states and schools and increased testing. The current White House plan calls for a spending program of $1.3 trillion. So, the two sides are still about $1 trillion apart. It seems unlikely that they will be able to make any agreement there before the election. Even though Republicans and Democrats are unable to agree on a stimulus package, they were able to pass a short term spending bill so the Federal government can avoid a shutdown on September 30th and keep operating past the election until December 11th.

While the economic recovery has been uneven, it has been very strong in the housing market. On Friday, it was announced that new housing sales are up 4.8% for August, which is the highest monthly rate since 2006 (during the peak of the housing boom). If this rate of new house sales carried on for a year, it would mean 1 million new housing sales. The rate of new house sales is depleting the supply of available new houses from 291,000 to 282,000, meaning new construction cannot keep up with demand. Limited supply of building materials is restricting the construction of new houses. The reason for the jump in new house sales is because of the combination of low interest rates and people moving from cities (largely driven by increasing ability to work from home and wanting more home space due to lifestyle choices brought about by the pandemic). In addition to this increase in demand for houses, the supply of houses has remained low because many existing home owners are not interested in selling (for many of the same reasons people want to buy). The result is that there are too few existing homes being put up for sale, which is forcing buyers into competing for the limited number of new homes.

Economics Update - 9/ 20

The death of Supreme Court Justice Ruth Bader Ginsburg on Friday has ignited a fierce political conflict in the middle of a contentious presidential election (as if the country needs any more turmoil and conflict right now). At this point, president Trump has the Constitutional authority to nominate a replacement and the Senate has the Constitutional power to approve the nominee for the vacant seat on the Supreme Court. This simple constitutional procedure will become a political fight in the Senate as the Republican majority tries to confirm president Trump's expected nominee against Democratic resistance. From a Constitutional procedural perspective, the Republicans have the stronger position in the nomination battle. However, this conflict is happening in the midst of a presidential election which means that there is a lot more at play here and the effects of this event will have a large impact on other events. Instead of getting into the political conflict over the nomination battle, today's post will focus on the economic impact of this event.

First, the expected nomination fight over replacing Justice Ginsburg on the Supreme Court means that it is unlikely that there will be another fiscal stimulus package. This fiscal stimulus package has been on hold since the previous spending package expired over the course of August. The part of the package that received the most attention was the enhanced unemployment benefits of $600 a week. Less known, but also important, the package was to give financial assistance to states struggling with large budget shortfalls, funding to schools and money to pay for more COVID-19 testing. This fiscal support will be necessary to continue the process of economic recovery. As I have described in previous posts, there is already evidence that the economic recovery is stalling far short of a full recovery. However, the combination of a strong stock market and upper income people doing financially well right now has reduced the political pressure for the government to act on this spending package. The death of Justice Ginsburg has sucked up all of Washington's attention and it will not be able to focus on any other issue - Washington does not have the bandwidth to handle more than two or three things at the same time. The reality is that short of an unexpected economic crisis in the next few weeks, which is unlikely, the poor condition of the economy will continue to be a background story, even though it is wreaking the lives of millions of people.

An economics issue that could factor into the nomination fight over replacing Justice Ginsburg on the Supreme Court is the Affordable Care Act (ACA), or Obamacare. Over the past few years, conservative groups with the support of the Justice Department have been advancing legal challenges to the ACA though the Federal court system and some of those cases are moving toward the Supreme Court's docket. Up until now, the ACA has survived Supreme Court challenges. However, a clear majority of conservative Justices could overturn the ACA. Ending of the ACA will be incredibly disruptive to a health care system already stretched thin by the pandemic and it will result in millions of people losing their health care. Just to be clear, once the ACA is gone there is no other way to provide health insurance to the whole population except for a single-payer system (I will have a future post to explain the economics of this). The Republicans do not have an alternative health care plan except to go back to the system that existed before the ACA in which up to 40 million people did not have health insurance.

There is currently a lot of analysis going on about how the nomination fight will play out. Economic theory does not give an answer to this event, but it does provide some ideas about what to watch for in how the fight plays out. There is a part of economics called Public Choice Theory that views people in the government as individuals who act on their own perceived self interest. Nobel Prize winner James Buchanan described this with the phrase "politics without romance". The insight from this perspective is to look at what is in the current personal political interest of the Senators involved in the process to approve the nominee, and ignore their party affiliation or previous statements. This means that the Republican majority in the Senate should be viewed as a collection of individuals and not a monolithic group. These senators will make a decision based on self interest, not doing the “right thing” for the group - or nation. Another thing to consider is the concept of procedural fairness. This is an idea associated with the economist Dani Rodrik, who explains that people are willing to accept losses if they believe the procedure that resulted in their loss was fair - that is they played by the rules of the game and lost fairly. Rodrik notes that when people view that the procedural process that led to their loss as not fair, then they are likely to act to change the procedure, even if that change will cause poorer outcomes for society as a whole in the future. This implies that this nomination fight could result in future changes to the Supreme Court in terms of the number of Justices on the court, establishing term limits for Justices or the process through which nominees will be appointed. There may be good arguments for all of these changes, however, there is no guarantee that a better situation will be developed.

Economic Update - 9/ 16

It has been a little while since the last economic update and with all the other things happening in the country (fires in the West, floods in the South, on-going race/ policing crisis and the on-going pandemic everywhere) the news of the economy has been pushed off the front page. Still, the economy is in turmoil and there is more evidence that the economic recovery is slowing to a stall with no real indication that it will pick up again soon. However, the stock market continues to do well. The strange situation of a rising stock market with a stalled economic recovery is a topic I covered back on 8/ 19, and that explanation still holds.

The economy has recovered significantly since the lows of the spring, but it is far from fully recovered. A good quick way of assessing the condition of the economy is the "Back-to-Normal Index" produced by CNN and Moody's Analytics (Mark Zandi, the chief economist at Moody's is a highly respected economist who was an advisor to Mitt Romney and John McCain). The Back-to-Normal Index currently says that the American economy is 80% of where it was prior to the pandemic - that is a large output gap in the economy. Economic statistics over the past couple of weeks have shown that the rate of economic recovery has slowed. New unemployment claims for the past three weeks have held constant at around 800,000 a week (and there is the concern that many of these new job losses are permanent with more companies downsizing to adjust to the new economy or going out of business). Today, it was announced that retail sales grew at 0.6% in August. This would be good under normal economic conditions. It is not good in an economy that is recovering from such a deep recession. Worse, the July retail sales number was revised downward to 0.9%, showing that the recovery then was not as strong as it was first reported. The downward trend in retail sales from 0.9% in July to 0.6% in August is a sign of the economic slowdown.

There are a number of reasons the economic recovery is slowing. The first is the failure of the Federal government to pass another economic stimulus bill. The most publicized part of this was the end of enhanced unemployment benefits at the start of August (president Trump's executive order did result in the resumption of some enhanced benefits, but it is far less money going into the economy). However, the end of Federal government stimulus spending has meant no financial assistance to states or schools - and no new money for COVID-19 testing. This could become a significant drag on the economy. The second reason for the slowing of the recovery is that many businesses cannot return to pre-pandemic levels of operation because of public health concerns - restaurants, concerts, sporting events and so forth are in this category. Third, there are a large number of failed businesses that represent economic activity that will not come back. Finally, the recovery is slowed down because it takes businesses time to adjust their operations to the pandemic economy. This adjustment process can be seen in larger companies announcing large lay-offs of workers this fall.

At this point, it would be good if the Federal government put together another stimulus package to help the economy adjust (I cover this topic more fully on 8/27). However, the politics of this (with the approaching election) are difficult and there is a good chance that there will be no additional stimulus in the next few weeks. One reason for this is that economic concerns have fallen out of the top of the news cycle - fires, floods, race/ policing crisis and other crises are taking people's attention. A second, and very important, reason is that many educated upper income Americans are doing well economically because they can work from home and have kept their jobs - this is also the population that has benefited from the recovery of the stock market. The real economic pain is being felt by lower income less educated Americans. This was true in the downturn in the spring and it is also true in the recovery. Economists have started to use the letter "K" to describe the divergence in the economic recovery. The reality that many upper income Americans do not feel the economic pain reduces the political pressure on the government to address the economic problems (in a perverse way, this situation can actually result in increased political pressure not to address the economic problems.

Economic Update - 8/ 27

Today's post is about where the economy stands six months into the economic crisis caused by the pandemic and what that might mean for economic policy. Six months ago, at the beginning of March, the economy was doing well and unemployment was at a record low. Then the country shut down large parts of economic activity in order to deal with the coronavirus pandemic which caused the unemployment rate to jump at a speed never been seen before. The Federal government responded to this by enacting a series of large fiscal stimulus packages and the Federal Reserve acted to support financial markets in order to give businesses the financing needed to get through the economic downturn. It is important to remember that this was all done with the expectation that the pandemic would be brought under control by the end of the spring. Government policy in the spring was based on the idea that it needed to support businesses during the time that the economy was shut down. If the crisis had lasted only two to three months, this policy would have worked very well. However, the country is now six months into this pandemic and the coronavirus is not under control and the early actions to blunt the economic impact have run their course. The country did have an economic recovery that ran from mid-April to early August, but that recovery seems to have stalled without any clear government economic policy to deal with the current economic situation. The Federal Reserve has made clear that it will continue to act to support the economy, but Fed policy tools of low interest rates and support for financial markets have very limited effectiveness in helping the economy recover. The problem is that the many parts of the economy in March no longer exist. Lots of businesses have failed or have significantly changed their operating structures in order to maintain profitability, which have involved laying off lots of workers. This means that a simple economic recovery of reopening businesses is no longer possible. The choices about economic policy now have to be about helping the economy adjust to the changes that have happened over the past few months.

The reason government policy needs to support the process of economic adjustment is because the current process of economic adjustment is causing a lot of unnecessary social dislocation and hardship. In normal economic times the economy is constantly going through a process of change and an adjustment driven by changes in technology and society and marked by the creation of new businesses and the failure of older businesses. This change generally does not need to be supported through large government policies because it involves does not widespread disruption and benefits of the disruption are greater than the cost. However, the current economic crisis is causing hardship for millions of Americans who can rightfully be considered economic victims who are unable to fix their problems due to the problems in the larger economy. This is specifically the case with the problem of unemployment which has changed from temporary lay-offs at the start of the pandemic to now becoming permanent job losses. This means that direct support to businesses, though programs like the Paycheck Protection Program, should be curtailed in favor of more direct aid for the unemployed. The Paycheck Protection Program was a good program when the expectation was that businesses needed a bridge over a short down turn. The problem with continuing to provide direct support to businesses is that a large amount of money will be spent supporting businesses that will not be viable after the economy adjustment to the pandemic. It would be better to spend that money on helping workers survive this time when it is hard to find a job because businesses not hiring while they are adjusting their business model.

The government does not need to directly guide how the economy adjusts and, in fact, there is a lot of evidence that government directed economic adjustment and growth easily goes astray because of politics and the influence of entrenched economic power of existing companies. The economist Joseph Schumpeter coined the term "creative destruction" to describe how the process of economic adjustment is about the new replacing the old. This process is an important part of any dynamic growing economy. The problem is that governments typically want to prevent the destruction part of the process for political reasons, which in turn holds back the creative part of the process. The destruction process is important because new businesses often grow by absorbing the capital and talented workers of failing businesses. The process of economic adjustment is already underway in the way people are now working from home, ordering out from restaurants and changing how they shop for everything. Some businesses are succeeding in this new economy and others are failing. These changes need to happen for the economy to do well in the future. The reality is the people in government, businesses and consumers do not have a good grasp of what that future economy will be like since the process of economic activity is the way that future will be created. For this reason, the best role for the government in this time is to help people get through this messy process.

Economic Update - 8/ 27

With all of the other important news happening these days, the news about the economy has dropped out of the top headlines. Still, the economic crisis continues as the economic recovery seems to be stalled. There have been several statistics released in the past week that signal that the economic recovery has slowed, and maybe has come to a stop. The first statistics to look at are the new unemployment claims numbers for the past two weeks. The number of new claims for unemployment last week dropped below one million, to 971,000, for the first time since March. That number when it was released seemed to be a bit of good news. However, today the new unemployment claims for last week came in at slightly more than 1 million, which indicates that the trend of weekly new unemployment claims is not really dropping, but holding at around the 1 million mark. The new claims for unemployment number is important because it can indicate two things happening in the economy. The first is that businesses are continuing to lay-off workers as they adjust to operating new long-term economic conditions. This is troubling because many of these unemployed people are not temporary lay-offs, but permanent dismissals (meaning these people will have to find new jobs to regain employment). Second, high unemployment will likely continue for a long time since companies will first stop laying workers off before they start hiring new workers. This opens up the question about how the country will deal with a large unemployed population for the next year, or more. In addition to the unemployment numbers, this week the Conference Board released the Consumer Confidence Report for August showing a drop of 6.9 points (from 91.7 in July to 84.2 in August) - the absolute number here is not important, the important part is the direction and size of the change. This is a large fast decline and it indicates a significant decline in consumer confidence in the past month (it is also the lowest reading of consumer confidence in the past six years). The reason this number is significant is because consumer confidence is seen as a leading indicator showing where the economy will be in the future. A decline in consumer confidence indicates a potential drop in consumer spending, which represents about 70% of the American economy. This could push the economy back into recession.

On the flip side, there was some good economic news this week in record numbers of new home sales - highest number since 2006 (which was during the housing bubble). Sales of new single family homes rose 14% from June to July and new home sales were up by 36% compared to home sales last year at this time. One reason for the large jump in the sale of new homes is because the supply of older homes on the market is low because many people are not moving. Basically, if you want to buy a house right now you will have to buy a new house because that is what is available. In addition, durable goods orders rose by 11.2% in July, largely because of increased car sales. Strong durable goods sales are generally tied to a good economy because people buy these expensive purchases when they are confident they will have a strong income over a long period of time (required to pay for the good if it was bought using credit).

These reports on new home sales and durable goods seem odd given the other bad economic news, but they start to make sense when they are thought of in conjunction with the reality that the pandemic has caused an increase in economic inequality. First, there are many people who are personally doing well even though the general picture in the economy is bad. Professionals who can work from home have not suffered much economic dislocation over the past six months. In addition, people with investments in the stock market have fully recovered their investment value. This population is taking advantage of the low interest rates to buy larger homes. In addition, this population may be interested in buying a house as part of a process of moving from an urban area to a more rural area (since they can now work remotely and no longer have to live so close to work).

So, the best way to think about the economy right now is that it is generally in bad shape, but there are a lot of people who are doing well.

If you are into looking at statistics, CNN and Moody's Analytics have posted an interactive index that tracks America's economic recovery based on a baseline of March 2020 that is called the Back-to-Normal Index. This link is to a video and article that explains how the index works. The index shows that the United States' economy is operating at about 78% of where it was in March. The index measures the low point of the economy as being at 60% in mid-April. By this measure, the economy has recovered half of what was lost due to the pandemic. If the recovery was continuing at the pace it had in June and July, it would take about four more months to get back to the March 2020 economy. However, if the recovery slows, or stalls, it may be more than year before the economy fully recovers.

Economic Update - 8/ 19

Yesterday the S&P 500 (representing the larger stock market) reached an all time high, erasing all of the losses from the stock market pandemic crash in March. The fact that the stock market has recovered from the pandemic crash while much of the economy is still devastated and millions are unemployed seems like a strange situation. A lot of the explanations about this seem to hang on the statement that "the stock market is not the economy." The problem with this statement is that while it is correct that the stock market is not representative of the economy, it is also incorrect because it implies that the stock market operates independently of the economy. The companies traded in the stock market operate in the economy and their profitability (the driving force in the stock market) is based on how well they do in the economy. The challenge is to explain why it makes sense that the stock market is doing well despite the significant problems in the economy.

The important point that guides any explanation of the stock market is a recognition that it is driven by expectations of future value. Now, while the economy as a whole is not doing well and expectations for the future (at least over the next few months) seems bleak, the future profitability for many companies on the stock market looks good. The stock market only represents large well established companies, not small businesses. This current economic crisis has been far more devastating to small businesses than it has been to large companies. It is expected that many large companies will survive the economic downturn and may emerge stronger because they will face less competition in the future. An example of this is the restaurant industry where many single restaurants have gone out of business while many large chains remain. In addition, many of the top stock market companies (especially in the S&P 500) are technology companies. These are the companies that have thrived during the pandemic as people moved to shopping and working from home. If these pandemic behaviors continue after the pandemic ends (and there is good reason to expect this) then these companies will continue to do well. All of this means that the stock market is doing well because it represents the parts of the economy that will emerge stronger from the pandemic, which makes the decision to invest in the stock market a rational action.

Another reason to explain the fast recovery of the stock market is that it is really the only place right now to invest money with any significant chance for a return. Most of the other investment opportunities currently offer small levels of return. Federal Reserve policy of low interest rates and liquidity support for financial markets have pushed down the rate of returns on bonds. While this policy is the lifeblood of the economy right now (think of the Fed as giving financial markets a blood transfusion), it does affect investment decisions by pushing people to more risky investments like stocks. However, this focus on stock investing is not just driven by Federal Reserve policy. Even before the pandemic, the United States stock market was doing well while other financial markets around the world were not doing well. The explanation for the strength of the stock market at that time was because the global economy seemed to be in a period of slow growth which limited the amount of good investment opportunities and this pushed more money to chase the fewer good opportunities that existed. If the global economy before the pandemic was one of small growth, then the current condition is worse, which would push more investment money into the few companies which have done well in this pandemic.

So, the stock market can do well when the economy as a whole is suffering because "the stock market is not the economy." However, before deciding to invest in the stock market, it is also important to note that in investment "the past does not predict the future" and that we are living in a world that is going through big changes, which translates to large investment risks. This means that before you invest in anything, take the time to learn as much as you can about where you are putting your money or it may not be your money for very long.

Economic Update - 8/ 18

The big story in the news right now is the post office and whether it will be able to handle the flood of mail in ballots in the November election - and whether president Trump is deliberately trying to undercut the post office for political purposes. While the political story here is important, this post will be about the economics of the post office. Critics of the post office point to the fact that the post office operates at a loss to justify plans to radically change the post office. It is true that the post office has lost money for a long time. This loss was caused by two simultaneous reasons. One is the decline in regular mail. The second the order from Congress that the post office pre-fund the health care pension fund for its workers (the process of pre-funding makes sense, but the practice is unusual). In short, the post office is facing a problem of declining revenue while managing a large expense that is not directly connected to its operations. Now, critics of the post office want it to "operate like a business", which means adjusting its operations to bring its costs back into balance with its revenue.

The problem with the view that the post office should "operate like a business" is that it is not a business, it is a government service that exists to provide social benefits that would not be provided by a private market. An important area in the study of economics is the topic of market failure which covers that range of economic situations where markets do not create outcomes that are beneficial to both individuals and the larger society. The delivery of mail is a situation where a private business would not operate a system with national reach because it would not be profitable. Yes, private mail delivery companies do exist, such as UPS, FedEx and DHL, but their services are limited. These private delivery companies actually rely on the post office for some of their operations - typically the expensive last part of the delivery process of delivering a package to homes. In urban and suburban areas the cost of delivering a package to a house is reduced on average because of the density of houses. Rural delivery is much more expensive because houses are farther apart, which means more additional cost per house delivery. The only way a private company could operate a national mail delivery system is by charging higher prices to rural customers and limiting the number of offices it has in rural areas. An important part of the post office is that it charges the same rate for the whole country and has offices in each town. The only way the country can have these benefits of standardized mail price and post offices in every town is for the postal service to be a government service. Economists classify the post office as a public good because the only way the service can be provided at a socially optimal level is through government operation. The term "socially optimal" is a vague term that could be interpreted in a number of ways, however considering that the current set up for the post office was determined in a democratic society and it is one of the most popular programs in the Federal government is an indication that is pretty close to "socially optimal" in operations.

It should be noted that the post office is more than just a mail delivery service. It provides many other useful services that are not easily accessible in many parts of the country, such as handling passport applications and money orders. It has been suggested that the post office could become financially sound by providing basic banking services to parts of the country that are not well served by the banking industry (this is again poor and rural parts of the country). The issue of poor populations in the country not having easy access to financial services is a significant issue in the causes of economic inequality. It may be better to expand the post office to help society and make the post office more financially secure.

A final note on this issue, UPS and Fed Ex are not legally allowed to accept mail in ballots for delivery.

Economic Update - 8/ 16

The failure to prepare schools to successfully reopen this fall may be the government policy failure (out of many policy failures) that causes the most long term damage to economic growth in this country, and this failure is representative of many of the policy failures in the country. Before I get into the details of this statement, I want to make clear that in saying "prepare schools to successfully reopen" I do not mean that in-person education is the measure of a successful reopening. While in-person education is clearly better than the form of remote on-line education that happened across the country last spring, a remote on-line education system that is sufficiently prepared and supported can provide a good education that could produce results equivalent to in-person education. The policy failure has been to not give schools the time and resources to plan how to provide quality education for both in-person (that meets the health consideration of the pandemic) and on-line platforms. In fact, schools across the country are being starved for resources by budget cuts just when they need more resources. The reality is that budget cuts have resulted in almost 500,000 teachers being laid-off (this does not count the teachers choosing to not return to work because of health concerns). This means that many schools are not in a good position to provide in-person education. All of this means that schools are reopening following either an in-person or on-line model that will not able to provide a good education. The sad part is that none of this is unexpected. The difficulty in opening schools during a pandemic was apparent last spring. The policy failing is that all of this time has largely been wasted.

While the wasting of time in developing policies to deal with the coronavirus pandemic has affected many government actions, the failure to prepare for school reopening could affect a whole generation's education and the long-term economic prospects for the country. There is general agreement about the loss of education caused by pandemic. The full amount of educational loss caused by this pandemic is unknown but will be easy to document through standardized test scores. Whether that amount of loss can be made up all depends on the level of education students get from this point forward. Schools that are well funded and supported should be able to make up some amount of that loss. However, those schools might be the exception. Many schools do not have the resources to do this - they had trouble providing a good education before the pandemic. The reality is that many current students will not be as well educated as students in the previous generation. Economic statistics show that there is a strong correlation between level of education and lifetime income. In short, current students may feel the effect of the pandemic for the rest of their working lives. It may be that the failure of education now could drive future increases in economic inequality since students in wealthier communities most likely go to schools that can provide educational catch up (or provide a good education during the pandemic) while students in poorer communities go to the schools that will not be able to close the educational gap. This will have an effect on the whole economy. Economist Paul Romer won the Nobel Prize in Economics for his work in endogenous growth theory which said in part that government policy for education was crucial because an educated population develops the new ideas in technology that is the core driver of economic growth. A country with a better educated population will grow its economy better than one with a less educated population. Importantly, small differences in growth rates over time become large differences in economic outcome. For example, an economy with a 1% growth rate will double in size in 70 years and an economy with a 2% growth rate will double in 35 years.

The failure to prepare schools to reopen successfully is part of a larger misunderstanding of how economics works that can also be seen in the failures in testing, unemployment benefits and other policy responses to the pandemic. Too many people see the issue as a "money problem" and not one of resource allocation. The "money problem" is making decisions based on cost alone and it is a problem framed by the size of budgets - this is the "there is not enough money for this" answer to the problem. This is a real issue for many parts of the government, but not the Federal Government. The Federal Government can always get more money through borrowing (this is the reason the political deadlock over the more financial aid to states and schools is so important). The important point is that money is not a limited resource, it is simply a tool for directing resources to schools in need. The idea that schools cannot properly prepare for reopening because there is not enough money is caused by not fully understanding the economics of the situation. The reality is that preparing schools for reopening (or any other pandemic response policy) is not a money problem, it is a resource problem. Currently, there are lots of resources available for use in education. The largest resource used in any school are the people who are teachers, administrators and support personnel. The current unemployment rate of 10% shows that there are lots of people available for schools to employ, and their time will be unused (wasted) if not put to work. In short, the education problem can be solved by supplying the money needed to match the available resources to the needs - that is hiring the unemployed to work in supporting education. Yes, this does cost money now, but the loss of future income (from lower educated workers) can also be counted in money. Being too cheap to spend the money now will result in losing money in the future - most likely more money.

There is no good reason schools do not have the resources they need to provide a good education during this pandemic and the failure to do this will have a long-term scarring effect on the economy.

Economic Update - 8/ 13

There is no one big piece of economics news today, but there are some smaller stories that can be used to track the larger issues with the economy right now. First, the statistical news for the day was the update on new unemployment claims from last week. Last week, 963,000 people claimed unemployment for the first time. Now, this is a large number (higher than anytime during the 2008 Financial Crisis), but it is the first time in 22 weeks that this number has been less than one million. On the surface, this is good news since it implies that the number of people losing their jobs has gone down. However, there are a few caveats. First, the reason new unemployment claims might be down is because the incentive to apply for unemployment has gone down by $600 a week since the start of August with the end of enhanced unemployment benefits. This means that new unemployed workers in many states will only make $200 in weekly benefits. In addition, many people might have thought that the news on the end of Federally enhanced benefits meant the end of all benefits. Second, a decline in new unemployment claims reflects decisions the businesses made at the end of July (when the economy was still doing well). The end of enhanced unemployment benefits is still less than two weeks ago, which means the economic impact of this cut in government spending has not yet been felt - that will be happening in the next few weeks. A third point to consider is that the unemployment going on now is quite different from the unemployment in the spring. The high rates of unemployment in the spring was the result of the pandemic and there was an expectation that many of the unemployed would get their jobs back when the economy recovered. In fact, that is what happened in May, June and early July. The jobs "created" during that period were really a jobs "recovery" as many unemployed returned to their previous jobs. The jobs being lost now are more likely to be permanent and the result of businesses failing and companies reducing staff to reflect the decline in business activity.

The other piece of economic news is that the Senate and the House of Representatives have gone on summer recess without any action or agreement on a new spending package. The problem is that the Republicans and Democrats are far apart in their positions (if they were closer, there would be a chance that the leadership would call the members back to Washington for a vote). There does not seem to be anything that will bring them together anytime soon. In reality, the politics of the Democratic Convention next week and the Republican Convention the following week make it unlikely that there will be a deal before the end of the month. In a brutal way, the politics of failing to make a deal gives each side a way to fire-up their supporters. This is bad news for the millions of unemployed and the larger economy.

President Trump's executive orders from last weekend have become dead letters and failed policies that are not really talked about anymore.

Economic Update - 8/ 10

Over the weekend, president Trump tried to resolve the issue of enhanced unemployment benefits by issuing an executive order that restored the enhanced unemployment benefits to $400 a week, reduced payroll taxes and suspended some evictions. The problem is that the work-around the executive orders use to avoid being unconstitutional have made the executive orders ineffective - and, worse, have made it more difficult for Congress to deal with the all of the other issues that need to be addressed, such as financial assistance to states, money for schools and funding for more coronavirus testing.

Before going into details about what the executive orders do and how they work, it is first important to recognize that the president does not have the power to authorize the spending of money and set the rate of taxation. Article One of the Constitution clearly states that only Congress has that power. More specifically, the Constitution states that all legislation must begin in the House of Representatives. In order to avoid this clear violation of the Constitution, the executive order redirects money that has already been authorized by Congress (president Trump already did a similar action to get money to build the Wall) and directs the Treasury Department to defer the collection of payroll taxes until December, and then the taxes would have to be paid (unless the payroll taxes laws are changed by Congress). So, while these executive orders may survive a constitutional test (and they very well may be unconstitutional), they may fail because of the way they have to work in order not to be unconstitutional.

First, the problems with the extension of enhanced unemployment benefits. The executive order has the Department of Homeland Security (DHS) use $45 billion of the $70 billion in Federal disaster relief money to use for unemployment benefits. The $400 of weekly enhanced unemployment benefits would be covered with $300 from DHS and $100 from state governments. It is not clear how many, or if any, state governments will be able to participate in this program. States are already short of money from fighting the pandemic (and loss of tax revenue) and the Federal government has not given them any financial support. The executive orders may fail to pay any unemployment benefits because states will not participate in the program. Another problem is that the $45 billion that would be spent is not very much money relative to the problem that exists. Assume that every state participates in the program, the Federal government would be sending $300 a week to 30 million recipients of unemployment benefits. The Federal government would be spending $9 billion a week, and the $45 billion would only last five weeks. And, all of this assumes that there is no major disaster (during hurricane season) that would need Federal action - if there is a major disaster, Congress would then have to allocate new money to deal with the disaster.

Second, the deferment of payroll taxes may not result in any reduction in payroll taxes. The idea for this policy is that the money not taken in payroll taxes would go to workers, which would effectively be a pay raise. As I described in the post on 8/ 4, there are many reasons a payroll tax cut will not be a very effective policy at this time. This executive action may not have any effect because it does not reduce payroll taxes, it just postpones the collection of the taxes. The reason this may not be effective is because businesses may continue to withhold payroll taxes because they expect they will have to pay them, in bulk, in December. Now, president Trump says that he will change the payroll tax laws once he is reelected. However, he will need both a Republican controlled House of Representatives and Senate to make this happen. Businesses, doubting this happening, will continue withholding payroll taxes to be prepared for the large tax bill in the future.

One final note on president Trump's executive order is that it further complicates the negotiations between Democrats and Republicans over the government spending package. These negotiations go beyond unemployment benefits to also cover financial aid to states, money for schools, more funding for the Paycheck Protection Program and funding for more testing. Unemployment benefits were the issue that was forcing both sides to negotiate on these other issues. The questionable program to spend $45 billion may result in hundreds of billions of additional spending being delayed, or not being spent. Without this additional spending, it will be harder to fight the pandemic and deal with many other economic problems.

Economic Update - 8/ 8

This week was the unemployment update which confirmed that the economy grew until mid-July and has started to weaken. This view of the economic situation is based on three statistical reports: the ADP monthly jobs report, the weekly new unemployment claims and the monthly jobs report from the Bureau of Labor Statistics. First, the APD jobs report, which had methodological issues, said that companies hired 167,000 people in July, which is a low number given the large number of unemployed (this would not be a good number under normal economic conditions). Second, the weekly new unemployment claims was 1.2 million. This is less than the past two weeks, but is still a large amount by any historic measure. Finally, the Bureau of Labor Statistics (BLS) reported that the unemployment rate for July dropped to 10.2% (down from 11.1%). The BLS also reported that the economy added 1.2 million jobs in July. In addition, it revised the jobs added to the economy in June up from 2.4 million to 4.3 million.

How does this data fit a story that the economy grew until mid-July and has started to weaken? First, the BLS employment survey that is used to calculate the unemployment rate is done in the middle of the month. So, Friday's job report was based on information from the middle of July when the current surge of coronavirus was starting, so it does not include any information about changes in employment over the past three weeks. In addition, while the economy had added jobs in July, it was at a much slower pace than June. This matters because with the large amount of unemployed any slowing in the pace of rehiring will only prolong the recession. Currently, the economy has only restored half of the jobs lost due to the pandemic. Second, the continuing high rate of new unemployment claims means that there are still many businesses in trouble (and some of the recent rehires have lost their jobs again). Any real recovery in the economy would begin with a decline in new claims of unemployment as companies stopped cutting jobs - rehiring or new hiring would happen after this. Third, the large divergence between the BLS numbers and ADP numbers might be an indication of a worsening economic situation in the later part of the month.

The larger problem is that enhanced unemployment benefits stopped at the end of July (one explanation for the decline in new unemployment claims may be due to the reduced benefits as unemployed workers have less incentive to apply for unemployment benefits. Currently, there are 30 million people collecting unemployment benefits and the loss of enhanced benefits should start to be felt in consumer spending this week or next week. There is a lag in time from when people collect the benefits and when they spend them. At this point, the Republicans and Democrats are far apart on any deal to extend benefits. Even when a deal is made, it will take weeks for the unemployed to receive the benefits.

The way to understand this week's jobs numbers is that they were generally good news, but it was good news about the past and it is far from clear how the good news will carry into the future.

Economic Update - 8/ 4

The political deadlock in Washington over the continuation of enhanced unemployment benefits continues without any clear resolution anytime soon. This deadlock over unemployment benefits has also stalled any additional government spending on financial assistance to states, expanded COVID-19 testing and continuing the Paycheck Protection Program. A crucial reason for the deadlock is that the Republicans in the White House and the Senate cannot seem to agree on their plan. Currently, there seems to be several proposals about what to do besides a simple continuation of the existing program. Today's post is about looking at the effectiveness of these other proposals in comparison to the recently expired program of $600 a week in enhanced unemployment benefits.

A good place to start is to cover the macroeconomic benefits of the $600 a week in enhanced economic benefits. While there are many good arguments for the unemployment benefits that are based on issues of morality, politics and social benefits, this post is going to focus on only the macroeconomic effect of this policy. Economists describe government spending as having a "multiplier effect" on the economy which means that government spending creates economic activity that is greater than the amount of government spending. The most important factor in determining the amount of additional economic activity created by government spending is how much the recipient spends of the benefit they receive. In general, the more the recipients spend, the higher the multiplier effect will be. The multiplier effect for unemployment benefits is high with each dollar in unemployment benefits creating between $1.50 and $2 in increased economic activity. This is because recipients of unemployment benefits tend to spend all of the money they receive in benefits. The enhanced unemployment benefits of $600 a week has had a significant macroeconomic impact during this economic crisis and has helped maintain consumer spending, and the larger economy. The end of this program will create an economic drag on the economy.

The problem with the other proposals about what to do instead of the $600 a week in enhanced economic benefits is that they tend to be either less effective in terms of macroeconomic impact or not easy to implement. For example, president Trump has been arguing for a payroll tax cut, which would effectively increase the pay of Americans a couple of percentage points. While this would not give that much money to individual people, collectively this could be a lot of money put into the economy. The problem with payroll tax cuts is that they do not have a high multiplier effect. In general, one dollar in tax cuts has a multiplier of around one dollar. Payroll tax cuts have been used before in economic policy because it is a simple policy that can be implemented quickly and can affect most of the country. In the current situation, the idea of doing a payroll tax cut does not make much sense because the more stimulative policy of $600 a week in enhanced economic benefits is already in place. In addition, the major problem with using payroll tax cuts in the current situation is that unemployed people get no payroll tax cut benefit. Many Republicans in the Senate want to reduce unemployment benefits to about 70% of an unemployed person's income from the job they lost. The idea with this proposal is that a high level of benefits will discourage workers from taking jobs. While there might be examples of this, most evidence does not support the view that the benefits discourage work. For example, when the economy did start to recover in June, many lower income workers left unemployment and returned to work, most likely explained by the idea that securing a permanent source of income was better than the additional money for a short period of time. Another piece of evidence against the argument that enhanced benefits discourage work is that there are currently 30 million unemployed and only 5 million available jobs. Still, reducing enhanced unemployment benefits to a percentage of previous income does create a positive economic effect. The main problem with this policy is that most states' computer systems for unemployment benefits cannot be programmed to administer this type of program. Yes, the computer systems can be replaced, but not in the next few weeks by states that are already short of money. Another idea for policy is to repeat the policy of sending checks of $1200 to Americans. Again, this can be stimulative, but has a lower multiplier effect because many recipients are likely to save the money - and this is more likely in a time of economic stress when people are worried about losing their jobs or seeing their income decline.

A proposal that could work would be to link the amount of enhanced unemployment benefits to an economic statistic like the unemployment rate or the number of unemployed, so the level of benefits would adjust to changing economic conditions. This policy would continue the benefits as long as the economy is doing badly and then reduce the amount of benefits as the economy recovers and there are more jobs available. This proposal is not currently being debated in Washington.

Economic Update - 8/ 2

This is another update on the insights of economic thinking for reopening schools during the pandemic. This post adds on to the post on 7/ 26 that covered the insights of game theory on the decisions being made for reopening of schools. Game theory is an area of study that looks at how individuals make decisions in a given situation and how the decisions of many individuals can affect the outcome. The basic problem that game theory tries to deal with is how individuals making optimal decisions for themselves can result in an outcome that is less than optimal for all participants. This scene from the movie A Beautiful Mind about John Nash (who won a Nobel Prize for his work in game theory) explains the basic idea in a colorful way. One way of thinking about game theory is that it looks at how individuals' decisions are made in strategic coordination with other individuals' decisions. The process of opening schools is about developing plans that coordinate the actions of many individuals. However, a complicating factor is that the individuals are acting in their own self-interest, and the decision of too many individuals to not accept a plan can doom any plan. Specifically, the plan to reopen a school will only work if a certain number of teachers and students decide to participate in the plan - if enough of one or both groups decide to not participate, then a school cannot really function effectively. So, the question is how to develop a plan for reopening of schools that has enough participation.

Economists working in game theory have developed an area of study called Market Design Theory that can be useful in planning for school reopening. Market design theory has already been successfully applied to the regular process of school assignment in New York city, Boston and other cities. The process of planning for reopening schools is similar to school assignment because reopening plans are involve setting up a system school choice between in-person and on-line education. The way to think about this is to imagine sorting the current population of teachers and students in one school into two new schools (one in-person and one on-line). The goal is to get teachers and students into the school they want in ratios of teachers to students that works well.

The ideas of Market Design Theory are based on how markets do a good job at matching buyers to sellers based on the individual preferences of market participants. The matching of teachers to students in a set ratio of one teacher to some number of students is not all that different from the way a market connects one seller to many buyers. The issue for schools is that they are non-market institutions (it would not be possible to make a school into a market). Economists working in Market Design Theory have developed ideas about how to make non-market institutions work like markets so that individuals can act on their preferences and get an outcome that is good for participants.

Basically, economists working in Market Design Theory have focused on three issues that should be considered in school reopening plans. The first issue, mentioned above, is the idea of "thickness" or that the situation brings together enough participants to get a good outcome. In this case, the issue is to make sure that there are enough participants in in-person school and on-line school for each school to work (this involves making sure the ratio of teacher to student participation works). The second issue is the idea of "congestion" which is about participants feeling that they will have enough time to see all of their options and make a decision that works best for them (if participants do not feel they have enough time they are likely to make a choice they don't like to avoid being forced into an even worse choice). The third issue is about participants feeling that they are safe to reveal confidential information that affects their choice without that information being used to force them into a choice they do not want. Market Design Theory says that situations that are not "thick" enough, suffer from congestion or expose participants' confidential information will not produce outcomes that are beneficial to the participants - which means they will not work well.

One final insight from game theory is that any plan for reopening school should not be based on the expectation that this is a one time event. Yes, if a vaccine for COVID-19 is created in the next year, schools can reopen "normally" next year. However, the way participants feel about this year will have an impact on their willingness to participate in school next year. This means teachers choosing to continue teaching at a school or even working in the profession and parents deciding to keep their children in a school or even supporting the government financially supporting schools. So, any plan for reopening schools should take into account the ideas of market design theory to create a situation where participants feel that they can end up with an outcome that matches their preferences.

Economic Update - 8/ 1

The news this week supported the growing consensus that the economic recovery is stalling and that the expectations for the future are not good. This week it was reported that second quarter GDP declined by a record 9%. This means that the economy shrank more in the three months from April to June than it did following the 2008 Financial Crisis. Another way to think about this rate of economic contraction is that a 9% decline in one quarter would be a decline of about 33% if it went on for an entire year. This rate of economic collapse is unprecedented. The economy did shrink by more in the Great Depression, but it happened over a longer period of time. Still, this decline was not unexpected and the size of the contraction is not really surprising. It was clear back in March that this would happen because closing large parts of the economy was part of the plan for fighting the pandemic. This is the reason the government enacted the large spending programs of support for small business, enhanced unemployment benefits and direct payments of $1200 to people. These programs were meant to be a lifeline to get the economy through this pandemic without significant long-term economic damage. So, this week's GDP report was fully expected. The thing that was not expected is that the country is still fighting the pandemic and that the rates of infections and deaths are still so high. Back in March the expectation was that the second quarter would be terrible, but that by now life would be returning to some form of normal and the economy would be fully into recovery. The problem is that life is still far form any form of "normal" and that the economy is not on a track of recovery. In fact, any recovery is now in grave jeopardy.

The new unemployment claims this week was evidence of the weakening economy. Last week 1.4 million people filled for unemployment for the first time. This is the second week in a row where this number has gone up, which makes the uptick seem like the start of a trend. Next week, the new unemployment rate will be announced. This unemployment rate will be based on data collected in the middle of July and it could show that the economic recovery stalled last month. This high unemployment rate has meant really pain for millions of millions of Americans. This week the Census Bureau reported that 30 million Americans said they did not have enough to eat the week before. Essentially, about 10% of the American population is living in a state of food insecurity. This is about to become a lot worse as the enhanced unemployment benefits of $600 end, meaning that unemployed people will have a significant drop in their income. This drop in unemployment benefits could be a large drag on economic activity. Economists say that unemployment benefits have a large multiplier effect on the economy, which means that each dollar spent on unemployment benefits has a larger effect on economic activity. Economic estimates say that each dollar in unemployment benefits creates $1.50 - $2 in increased economic activity. The ending of additional unemployment benefits will cause an equivalent decline in economic activity.

This week, Congress failed to reach an agreement on the continuation of enhanced unemployment benefits (along with financial assistance to states, money for increased testing and continuation of the Paycheck Protection Program). The reality that the continuation of enhanced unemployment benefits has fallen victim to politics is a large economic problem. The Democrats proposed a $3 trillion spending program more than a month ago that was passed by the House of Representatives. However, the Republicans in the Senate did not act on it or develop their own proposal until last week. Even then the Republican plan was unclear because the Republicans in the Senate and the White House could not agree on a common plan. Disagreements between political parties about these types of spending programs is normal - and they are resolved through negotiations. However, for negotiations to work both parties have to be clear about their own plans and priorities. The lack of clarity on the Republican side means that it will take longer to reach a final agreement. So, at this point, a new spending bill for a resumption of enhanced unemployment benefits (along with financial assistance to states, money for increased testing and continuation of the Paycheck Protection Program) could be weeks away.

Links - 8/ 1

Nobel Prize winner Paul Krugman on CNBC talking about the current state of the economy and what is next.

Mark Zandi on CNBC on how unemployment benefits support the larger economy.

Economist Ken Rogoff on the PBS Newshour about the current economic situation

Economic Update - 7/ 29

Economists have started to evaluate the Republican plan for extending government spending by slightly less than $1 trillion to support the economy. The general view is that the size and scope of the plan is less than what the government needs. Particularly interesting are the views of Mark Zandi of Moody's Analytics and Ian Shepherdson of Pantheon Macroeconomics, who are both highly regarded economists (also, if political leanings are important, Mark Zandi has advised many Republican presidential candidates, but not President Trump). Zandi has described the current state of the economy as, “Everything points to the economy flatlining. It isn’t falling yet, but it won’t take much to push it over the edge.” Shepherdson's views is that “The V-shaped recovery is toast—there is no question about that,” ... ... “The Nike swoosh might also be toast soon. And the way to prevent that is for the federal government to step in and spend more.” Both Zandi and Shepherdson say that given the current condition of the economy, the amount of the spending plan should be at least $1.5 trillion.

The current economic situation is directly tied to the status of the coronavirus pandemic. The current weakening of the economy is a result of the explosion of pandemic in many southern and western states. Zandi has calculated that for every increase of 10,000 in infections, the economy will need another $100 billion in stimulus. The reason for the need for increased stimulus spending is not to deal with the specific infected people, but because the high rate of infection reduces economic activity as people pull back and businesses shut down.

An interesting additional point is one that was made by Larry Summers that the size of the stimulus is not as important as the rate of flow of stimulus money and the length of time the stimulus is in effect. Summers' point is that the structure of the stimulus spending plan to provide the economy sustained support over a longer period of time (the duration of the pandemic) are important points that need to be considered. One way to think of this (not that this is Summers' point) is that a smaller but better structured spending plan could be just as or more effective than a larger spending plan.

Economic Update - 7/ 28

Yesterday, the Republicans in the Senate released their plan for extending the government spending to support the economy during the coronavirus pandemic. There are a lot of parts of the spending program, but the most significant part is the plan to reduce the expanded unemployment benefits to $200 a month (down from the previous $600). The $600 expanded benefits are set to run out this week (however, for technical reasons, many unemployed people received their last payment last week. This reduction in unemployment benefits will be the largest point of debate between the Republicans in the Senate and the Democrats in the House of Representatives as they negotiate the actual bill that will pass into law. This debate over the amount of benefits is about differing perspectives on the effect of unemployment benefits on the unemployed and the current state of the economy.

The Republican position for reducing the amount of unemployment benefits is based on the idea that the $600 a month in expanded unemployment benefits discourages unemployed workers from returning to work because they make as much or more money from being unemployed. Now, this position makes logical sense and there could be cases of this going on in the economy. However, this position is based on the there being jobs available for workers right now in the economy. That is not the case for most unemployed workers. Rough estimates place the number of unemployed around 20 million (and maybe as high as 30 million) and the number of available job openings at 5 million. Clearly, there are not enough jobs for all of the unemployed workers and a person's willingness to work is not the deciding factor in getting a job. So, reducing the amount of unemployment benefits at this time will not bring down the unemployment rate by very much. In fact, given the resurgence of pandemic which is weakening the economic recovery and increasing unemployment (last week new unemployment claims went up), the reduction in benefits at this time will only hurt the unemployed.

This reduction in unemployment benefits will create a significant drag on the economy, and further reduce the ability of the economy to recover. While a decline of $400 a month for each unemployed person does not seem like a lot, the cumulative effect on the economy could be significant. Economists say that unemployment benefits have a large multiplier effect on the economy, which means that each dollar spend on unemployment benefits has a larger effect on economic activity. Economic estimates say that each dollar in unemployment benefits creates $1.50 in increased economic activity. This could result in a $50 billion reduction in the amount of consumer spending each month (it is estimated that the cut in benefits would have a $600 billion annual reduction in consumer spending). In addition, the reduction in benefits will affect the ability of unemployed people to pay rent, mortgage and car loans. Loan failures can result in economic problems affecting the financial system.

An additional problem is that it could take the Republicans and Democrats weeks to agree on a new spending bill (if they are able to agree at all). This gap in benefits means that the economy will start to feel the pain of lost benefits soon and that the resumption of expanded unemployment benefits may only happen after the economy has suffered significant damage. One problem that exists now, that did not exist in March when the economic problems began, is that people and businesses have significantly less cash reserves to get them through the downturn. This means that a long delay in the resumption of expanded benefits could do more damage to the economy.

Now, the continued expansion of unemployment benefits will add to the national debt and that could be a problem in the future. However, this is not really a good argument for cutting benefits for a few reasons, First, the trade off here is about real problems that will happen now versus potential problems that might happen in the future. Second, a weaker economy now will result in a smaller economy in the future, which will make the debt burden larger. So, the argument about the size of the national debt is similar to the argument about the impact unemployment benefits on people's willingness to work, the argument is logical but it does not fit the current economic situation. The problem with ignoring the current situation will make the current problems worse.

A final thought about the debate over this new spending bill is that the bill will also contain much needed financial assistance to states, money for schools and coronavirus testing. The delay in passing this bill because of a disagreement over unemployment benefits will have a number of other detrimental effects on the economy and well being of the country.

Economic Update - 7/ 26

The issue of reopening schools is one of the most important economic issues facing the country right now because it will have a large effect on the ability of significant parts of the labor force to work this fall. A haphazard reopening of schools will make it hard for parents (especially of young children) to work. Many parents, who stayed home in the spring, will find it harder to provide the support for the "school at home" model this fall. If children are put into a on-line school option again, many parents will be forced to choose between watching their children and their job. Of course, they will choose the welfare of their children, but this will come at a cost to the family's economic well being. This is not a statement that schools have to reopen for in-person education, just a reality check on the knock-on effects of school's not reopening. My reason for noting this is to emphasize the importance (besides children's' education) that the government should be putting on making sure schools can reopen safely.

The problem with discussing "safety" is that it is a vague term that holds different meanings for different people. For example, what is the safe distance between desks in a classroom? Three feet? Six feet? There is no clear answer. I bring up the issue of the distance between desks, just one of the many decisions that schools are facing in the process of reopening, to get to a larger policy point about the importance of the effect of individual agency public policy decisions, like safely reopening of schools. The distance of three feet between desks may be safe. The problem is that it may not seem safe to many people (parents, students and teachers) who are essential to the success of school. If these people feel that the policy is not safe, they will choose not to participate in school (or attend in person) and the result will be "de facto" online school. So, a school administration that adopts a three foot distance, to maximize students in the building given other financial or institutional constraints, may end up having few students in the building. Now, a school system may say that it is doing lots of cleaning of the school, but that is hard to monitor. The reality is that many parents, students and teachers, will see the three foot rule as a signal that the school administration is willing to take risks (which could be read as a willingness to take risks in other ways. In an uncertain situation with many unknowns, signals take on a more important role in affecting people's decision-making.

So, how should a school administration operate in setting a policy for reopening. Well, economic theory gives a few ideas. The first idea comes from the "Dictator Game" in Game Theory. Game Theory is the study of strategic decision-making. In the Dictator Game, two people are deciding how to divide an amount of money, say $100. The first person gets the power to set the division of the money (they are the dictator) and the second person can either accept or reject the division. If they accept the division, they will get the portion the first person gave them. If they reject the division, then neither person will get the money. Now, in a pure rational economic world, a division of $99 to the first person and $1 for the second person should work because the second person comes out $ 1 ahead. However, this does not work in the real world because the second person will reject the offer to spite the first person for making such an unfair offer. See, the second person has a lot of power (or "agency") in this situation. If the first person actually wants to get the money, they need to make an offer that the second person will actually accept. Getting back to the three foot versus six foot distance between desks, if a school offers "three feet" then parents, students and teachers may reject the offer - and schools default to on-line. So, if school administrators want to get students and teachers into school, then they should go for the six foot distance, which is less likely to be rejected. Now, a six foot distance will mean fewer students in a class, which might mean other adjustments such as the length of the school days, days in school and teacher reassignment, which are all hard choices - but it may actually mean the students and teachers are in school.

In addition, a school reopening plan also needs to be transparent about shutdown procedures should people in the school community test positive for COVID-19. Being transparent about a shutdown plan is another important signal that a school administration is taking the pandemic seriously and primarily focused on safety. This is because administrations focused on safety will have prepared for this reality and have a plan, while those that do not have a plan either are not prepared for this reality or are not very well organized.

The big point for this post is that school administrations need to design a plan for in-person education with the goal that it will be acceptably safe to the most number of parents, students and teachers. Simply coming up with a plan that they think is safe will not be sufficient because their idea of "safe" may be quite different from the other important groups needed to make a school work. If anything, school administrators need to produce a plan that is overly safe (even if it means reducing school services significantly) or there may not be enough teachers and students who are willing to go along with their plan.

Economic Update - 7/ 24

It is the last full week of July and next week the expanded unemployment benefits of $600 a week will be ending (for many unemployed this week will be their last payment). This means that more than 18 million unemployed workers will see a significant cut in their income in the next week (not to mention loss of health insurance). The large drop in income for nearly 20 million people will cause a large decline in consumer spending that will have a significant drag on economic activity. This reduction in economic activity will have a multiplier effect on the economy as the decline in spending will cause a loss in business income that will further reduce spending. Worse, the economic recovery is already starting to slow, even before the impact of reduced unemployment benefits. This slowing of the economy can been seen in the fact that 1.4 million people applied for unemployment for the first time. This is an increase from the average over the past few weeks (1.3 million). This small increase in new claims for unemployment are troubling because it could be the start of a sharper increase. It is also important to keep historical perspective on the size of the new unemployment claims. The statistic that 1.3 million people claimed unemployment in one week is a crazy high number that is much higher than any week before this pandemic - weekly unemployment claims were never this high during the Financial Crisis in 2008. The sad reality that four months into this pandemic the weekly unemployment claims are still averaging around 1.3 million should be staggering. And it would be if there were not more staggering numbers: 4 million infected with COVID-19 and about 145,000 deaths. The reason for the stalling of the economic recovery is because of the resurgence of the pandemic across large parts of the South and West. In many parts of the country the pandemic is out of control, and it does not look like the government has any plan to bring the infection under control. The leadership in the states with the highest rates of infection are resisting any official shutdown of businesses. Still, the lack of an official order may not matter as many people choose to stay at home, which will have the same effect of slowing business activity as an order to shut down. It is sad that the United States in the twenty first century is failing to successfully implement the practices for stopping infections that were used in Medieval Europe. Getting back to the main purpose of this port, the economy is starting to weaken and the reduction in unemployment benefits will only make this worse.

The problem is that there is no clear plan for an additional government spending package to help the economy. The Democrats in Congress did pass a spending bill several months ago, but that bill was not taken up in the Senate. For the past few months, the Republican position was that the economy was recovering and the pandemic was fading so there was not reason for an additional spending package. When the signs of economic weakening and the resurgence of the pandemic began a few weeks ago, the discussion began for a new stimulus package. For the past few weeks, the Republicans in the Senate and the White House have been negotiating with each other to develop their plan for the spending package, but they are not near an agreement (they say they may have a plan next week). Once the Republicans have a plan, then they will begin negotiating with the Democrats. The debate over this spending bill will be difficult and it could take weeks to reach an agreement because this debate will be about issues that sharply divide the two political parties such as the level of unemployment benefits, financial assistance to states, money for COVID-19 testing and direct payments to Americans. The political reality that the Republicans cannot agree among themselves about the spending package is a sign that this will be difficult to reach an agreement that gets enough votes, and the support of the White House, to be enacted. The fact that the presidential election is only 100 days away will make this even more difficult because of the politics involved. Even if the agreement made will be for a large spending package, the problem will be that there will be a significant gap of time from when the current spending ends and the new spending begins - this is the time period when the economy will be getting worse. In many ways, the process for creating this spending package will be very different from the fast and effective process that happened back in the spring.

Economic Update - 7/ 17

The health of the economy is closely tied to the success in fighting the pandemic. The idea that there is a choice between fighting the pandemic and having a strong economy is a false one. The only way to have a strong economy is to bring the pandemic under control. Unfortunately, the United States is far from having the pandemic under control. Yesterday, the United States had 75,000 new cases, with many states setting daily infection rates on a daily basis. Now, in general the economy seems to be doing well, or at least it does not seem to be getting worse. But that might be about to change. First, the exploding number of cases has resulted in the health care systems in many states being pushed to their limits - they are running out of ICU beds and their health care workers are being exhausted. Essentially, large parts of the country are now living through the experience that New York had earlier in the year. This rapid growth of the rate of infection and the limits of the healthcare system might force some states to return to stay at home orders to stop the pandemic. These stay at home orders will have to last several weeks to have any effect on the rate of infection. The result will be a large drop off in economic activity, similar to what was seen in the spring. For this reason, it seems unlikely that the states suffering the worst from COVID-19 (Florida, Georgia, Texas and Arizona) will return to stay at home orders. However, even without a new round of stay at home orders, there could be a large drop off in economic activity as people chose to stay at home and avoid infection.

The sad part of the current situation is that large parts of the country have gained nothing from the months spent fighting the pandemic. While there is still a lot that is not known about COVID-19, what is needed to do to fight the pandemic is well known. Many countries are successfully fighting the pandemic, and many of these countries are much poorer than the United States. An outstanding example of this is Vietnam which has had no deaths from COVID-19. The reality is that the techniques the world is using to fight the coronavirus pandemic are the same techniques in the Middle Ages. Unfortunately, the United States is failing at fighting the pandemic because it is unable to successfully return to stay at home orders in any sort of controlled process or enforce the wearing of face masks. The fact that governors of states that are at the epicenter of the pandemic are fighting local efforts to enact stay at home orders and enforce mask wearing is terrible situation. As a result, even as things are getting much worse at a rapid rate and the rate of infection seems to be out of control, there is not even a clear plan or expectation that the pandemic will be brought under control in the near future.

In the midst of the rapid growth of the pandemic, the government economic support for the economy is going away. The Paycheck Protection Program (PPP) is being phased out and the enhanced unemployment benefits of an additional $600 a month is ending. So, unless Congress acts soon, the economy is about to run off the fiscal cliff. Until now, the worst parts of the economic crisis have been avoided because of the large amounts of economic aid provided to the economy. Once that aid is gone, there will be a sharp drop in consumer spending, increases in evictions and business failures. There has been some talk of a new economic spending package, but no clear plan or program has been announced. It is not clear if any new spending package will include financial assistance to states. The problem is that the political fight over this spending package will be hard and it is unlikely to be passed quickly - and it will not be a large spending package in comparison to what is needed.

So, while the economy seems to still be doing fine (given all the problems), this may be a lull before the resumption of the economic storm.

Economic Update - 7/ 1

Three big numbers today - the new unemployment rate, new unemployment claims and the new COVID-19 cases. These numbers run up against each other and make it difficult to figure out where the economy is going - and what is the chance of any additional economic stimulus.

First, the unemployment numbers are good (but that may be misleading in the context of new COIVD-19 cases). The jobs report announced that 4.8 million jobs were added to the economy in the month of June, which is in line with expectations of the economy continuing to reopen. This put the unemployment rate at 11.1%, down from 13.3% in May. According to the Bureau of Labor Statistics 17.7 million people are still unemployed (which is a enormous number). In addition, 1.4 million people filed for unemployment for the first time last week, showing that the economy is still losing a lot of jobs each week even though it is recovering and adding jobs.

The real concern is the fact that the United States recorded a record 50,000 new COVID-19 cases yesterday and many states are either halting or reversing their plans to open up. This could reverse the economic recovery (as I noted in the last post). So, the good jobs report could turn out to be a temporary high point if the economic recovery slows or begins to reverse. If the increase in new cases was not sky rocketing, then the jobs report would be good. However, in light of the large jump in COVID-19 cases, the new jobs report might be irrelevant in terms of trying to figure out the trajectory of the recovery. Worse, the good jobs report might reduce political pressure for another economic stimulus package just as the previous stimulus packages are set to end. The result could be that the economy begins to weaken as the sunbelt states grapple with the exploding pandemic and is further weakened by the loss of economic stimulus, which ends the momentum of the economic recovery.

Economic Update - 6/ 27

This past week might mark the point where the current economic recovery began its stall, after its start of a short sharp recovery. The sudden increase in COVID-19 cases in the sunbelt states of Florida, Texas and Arizona represent a bad set back in fighting the pandemic. All three large states, along with many smaller states, have seen a steep increase in the number of COVID-19 cases in the past few days. As a result, yesterday the United States had about 40,000 new cases, more than when New York was the epicenter of the pandemic. This rapid growth in cases is bad news for a few reasons. First, the pandemic now has several large hot spots in the country, which means it will be harder to contain. Second, many of the places seeing the increases in the number of cases do not have the medical infrastructure to provide care to large numbers of people infected with COVID-19. Added to this point is the reality that these parts of the country have lower rates of people with health insurance (This week the Trump Administration also filed a brief with the Supreme Court to end the Affordable Care Act). In many places, the hospital systems are at or close to capacity. Pushing the medical systems to their limits will make the heath crisis into a medical moral crisis as hospitals have to ration health care. The lower levels of health insurance coverage could also push these hospitals into bankruptcy.

This sharp increase in the number of COVID-19 cases will also hurt, and maybe end, the economic recovery. Up until this point, the worst impact of this economic crisis has been lessened by the combination of government spending programs, that have enabled people to keep paying their bills, and Federal Reserve policies that have put a financial floor under financial markets and provided credit to major companies. These programs have served their purposes of providing a monetary bridge across the worst period of this pandemic. That is one reason this economic downturn has not been as bleak or desperate as other major economic downturns. Yes, the statistics are Great Depression bad, but the current feeling about the economy is not nearly as grim as it was during the Great Depression (or even after the Financial Crisis in 2008). After all, the stock market is mostly recovered and average income has actually increased during this recession. The problem is that this economic support will be ending in about a month. The fiscal support that the government gave the economy with the Paycheck Protection Program (PPP) and enhanced unemployment benefits (additional $600 a week) are set to run out at the end of July - and it does not look as if these programs will be renewed. The timing of these programs ending just as the pandemic begins to surge again is bad. Right now would be the best time to enact an extension of these programs because it takes a while for Congress to organize them. Unfortunately, the economic pain needed to change the politics of these programs does not yet exist.

The best way to handle the resurgence of these cases in the sunbelt is to close down the states. This is what worked well in stopping the pandemic in the Northeast. Of course, it is very costly to shut down the economy. The problem is that the leaders in these states are reluctant to do this for political reasons, and pressure from the Trump Administration is adding to motivation to not shut down the states. Unfortunately, the leadership in these states is also reluctant to support the second best option of mandating the wearing of face masks. So, there is a good chance that the explosion of cases in these states could turn into an epidemiological wildfire. The big question right now is whether the governments of these states will attempt to keep operating as if all is well as the pandemic rages around them.

At a certain point, the official decision about whether to shut down a state will have no bearing on the economic impact of the pandemic. The reality is that the fear of getting sick in a state where the hospital system is overwhelmed will cause people to shelter in their homes and effectively close the economy. At that point, the government's decision to close the economy is just a formality. As the states of the Northeast experienced a few months ago, the period of an effective lock-down is 8 to 10 weeks in order to bring down the rate of infection. The economic hit that these states will feel will be significant. They will need economic assistance to get through this process and do it correctly without being forced to reopen prematurely. Maybe the politics of an additional economic stimulus will change, given that it is Red States that are being hit, but if they do not then the financial drag on the economy will be large. It will be enough to cause the recovery to stall. Worse, if the monetary bridge of economic policy runs out during this time, many of the businesses and individuals who were just barely holding on through this crisis could fall to bankruptcy. This could turn this economic crisis into a deep recession that will feel like a recession with people losing their homes and facing prolonged unemployment will little assistance - and the road to economic recovery will be long.

Economic Update - 6/ 19

Today is the end of the school year. I have been posting on the economic crisis caused by the coronavirus pandemic since March 15th. During that time, the economy fell into recession faster than anytime in history and plummeted to a depth that is only comparable to the Great Depression. Now, the economy is in recovery. The large question that will be answered over the next two months is how quickly the economy will recover. The early part of the recovery has been fast and strong as states have allowed businesses to recover. These reopened businesses have recalled workers and consumers are getting out and buying things. Economists are watching the economy to see if this pace of recovery can continue or if it will slow due to economic damage done to businesses and changes in the structure of the economy. There is also the concern of a second wave of the pandemic or a much longer first wave as the rates of infection and hospitalizations go up in many states.

The new unemployment claims number was released yesterday and 1.5 million people claimed unemployment benefits for the first time last week. In total, 29 million people are receiving unemployment benefits. This number of new unemployment claims was higher than expected and is seen as a troubling indicator that there might be a problem of higher permanent unemployment. Basically, a lot of the unemployment created in the first few weeks of the economic shutdown were viewed as temporary, and that the unemployed would get their jobs back as the economy reopened. The jobs report released two weeks ago, that said the unemployment rate was 13%, supported this view. However, continuing high levels of new claims are not cases of people who have lost their jobs as a result of stay-at-home orders. Nor are they the result of businesses that closed with the start of the stay-at-home orders and never reopened because those workers first claimed unemployment benefits. The new unemployment claims are the result of businesses that were trying to hold on (with help from the PPP program) but went out of business in the end, and state and local government layoffs. The new unemployment claims represent a transition in the nature of the economic crisis to a more prolonged economic downturn. This change in the economic crisis does not mean the economy will fall back into recession. It more likely means a slower recovery that would be similar to the aftermath of the 2008 Financial Crisis.

The continuing high rate of new unemployment claims and the slowing rate of economic recovery are the strongest arguments for an additional fiscal stimulus from the Federal government that takes the form of extended unemployment benefits and economic aid to states, to prevent more job losses as states are forced to cut their budgets.

It should not be a surprise that many workers who have lost their jobs because of the stay-at-home orders will not get their old jobs back. Yes, many businesses will never recover and reopen from this crisis, especially many small businesses, and that accounts for a lot of the permanent job losses. However, that is not the full story. The reality is that many businesses have changed their operating structure as a response to the recession and the restrictions placed on businesses as they reopen. During normal recessions, businesses have to become more efficient to continue operating in a more difficult economic environment and they do this by laying off workers and have the remaining workers do more. This is normally a longer drawn out process because workers have to let go from jobs that they are working. While the way this recession has happened is different from any previous recession, the process of businesses reorganization is similar, only faster. The difference is that the closing of businesses with the stay-at-home orders was the equivalent of businesses carrying out mass layoffs, of their whole workforce, and the reopening of businesses is a process of selective rehiring only the workers that they want. The similarity is that businesses have used the time they were closed to reorganize and become more efficient (and also in response to the reopening restrictions) and now these businesses do not need all of the workers they had just three months ago. These workers will not get their jobs back, and they will have to find new jobs - which will be much more difficult when unemployment is above 10%.

While the pandemic and economic crisis have caused jobs to be permanently lost, it will also create new jobs. This process of job destruction and creation is always happening in the economy, and it is accelerated during times of economic crisis. The challenge with this process is that it is hard to see what these jobs might be and what skills workers will need to do them. A strong argument for extending unemployment benefits is that it helps unemployed workers pass through this time of job destruction and creation. Another good policy program would be to give more support to community colleges so they can provide job retraining programs for the unemployed workers. This will help workers retain their skills and develop new skills, which will hopefully help them get better jobs in the future.

Economic Update - 6/ 17

The big economic news yesterday, which helped to push the stock market higher, was the report on retail sales in May by the Census Bureau that showed that retail sales went up by 17.7% from April to May. Similar to many economic statistics, this is a record high monthly increase. This record is because the economy is recovering from the worst economic contraction since the Great Depression. As a point of reference, retail sales fell by 8.3% in March and 14.7% in April. May's large increase in retail sales shows that the economy is recovering quickly from the coronavirus pandemic shut down, but has yet not fully recovered. In fact, May's retail sales number was 6.1% below retail sales number for May 2019. Many economists see the May retail sales number as further confirmation that the economy started the recovery from the economic crisis with a strong rebound (V-shaped) recovery. The report of the 17.7% increase in retail sales and the drop of the unemployment rate to 13.3% both show the economy is in recovery, but that there is still a large gap between where the economy is at and where it was back in February, before the economic impact of the pandemic. The big question is whether this rate of recovery will be sustainable until the economy is fully recovered. This interview with economist Mark Zandi, of Moody's Analytics, describes this recession as the shortest deepest recession ever, but that the recovery will be long unless there is additional fiscal stimulus.

There are several reasons for the sharp rebound in retail sales last month that indicate that the strength of the recovery will not be sustainable unless there is additional stimulus. The first reason is that some of this buying was pent-up demand from March and April when stores were closed. People were forced to delay purchases they were planning to make until stores reopened. The result was a surge in buying that can be best seen in the 44% increase in car sales from $70 billion to $105 billion (still below the May 2019 sales of $112 billion). An even larger example of this is the 188% increase in clothing sales, which went from $2.7 billion in April to $8.4 billion in May (still well below the $23 billion in May 2019). Another reason for the sharp rebound in retail sales is the effect of the $1200 stimulus checks sent to Americans and the $600 additional monthly unemployment benefits payment. The $1200 stimulus checks were a one time payment and the $600 in additional unemployment benefits will stop at the end of July. Given that the Federal Reserve expects unemployment to remain above 10% until the end of the year, the ending of the $600 addition unemployment benefits could reduce future retail sales and slow the recovery. Of course, it is possible for the strength of the recovery to carry the economy back to full employment, but any additional fiscal drag will slow that down.

Other statistics from the May retail sales report indicate that very visual aspects of the recovery, reopened restaurants and more traffic, may not be as robust as they appear. For example, business at restaurants only increased from $30 billion to $41 billion (May 2019 was $68 billion), which can be explained by seating restrictions at restaurants and the reality that many people are still hesitant about going out for fear of infection. Gas sales increased from $26 billion to $31 billion, which is well below the May 2019 number of $46 billion. While people are eating out and driving more than they did in April, they are still well below last year.

Zoom Interviews - Over the past few weeks, I have been working with economics teachers from Lexington High School and Belmont High School to interview business people, academics and policy makers on Zoom about the economic impact of the coronavirus pandemic. These are the links for the videos of the interviews:

Interview with Mike Kennealy, Massachusetts Secretary of Housing and Economic Development, about the process for shutting down and reopening the state, how the economic crisis affected the state budget and helping businesses navigate this economic crisis. This is the link for the interview with Mike Kennealy.

Interview with MIT professor Simon Johnson (former Chief Economist of the International Monetary Fund) about fiscal and monetary policy in confronting the economic crisis, the economics of investing in scientific research (such as pandemic response) and developing policies for institutions, like schools, to deal with the coronavirus pandemic. This is the link for the video interview with Simon Johnson.

Interview with MIT professor Jon Gruber (who helped develop the Affordable Care Act) about how the effectiveness of government policy in dealing with the shutdown of the economy, the need to invest more in science and the economics of wearing masks. This is the link for the video interview with Jon Gruber.

Interview with Peter Stein, the owner of Wit's End and restaurant and bar in Cambridge about the difficulty in closing his restaurant quickly, the difficult process of trying to preserve his workforce and the difficulty he had in turning his business into an COVID-19 antibody testing site (before he was shut down by the city of Cambridge). This is the link for the video interview with Peter Stein.

Interview with Joe Rancatore, the owner of a local chain of ice cream stores - In the interview Joe describes the process of applying for the Paycheck Protection Program and how he is re-configuring his stores in preparation of reopening. This is the link to the video interview with Joe Rancatore.

Links - 6/ 17

Larry Summers on Bloomberg talking about the long road to recovery and Federal Reserve policy.

Mark Zandi on Fox Business talking about how this is the shortest deepest recession ever, but that the recovery will be long unless there is additional fiscal stimulus.

Dambisa Moyo on CNBC discussing the difficulty of getting workers back in the office and the need for policy to give workers more certainty about the economy.

Paul Solmon on the PBS Newshour on coronavirus pandemic affected African American businesses.

Financial Times video on how coronavirus has affected global shipping routes.

Wall Street Journal video on how black owed businesses have survived without stimulus.

Wall Street Journal video on why more women have lost jobs during the coronavirus pandemic.

Economic Update - 6/ 11

It was a tough day for the stock market, which was down around 6%, after coming so close to getting back to the level it had before the coronavirus pandemic. Earlier this week I was planning to write about what was happening with the stock market and how it could be going up while the rest of the economy was so deep in recession, or what has been described as the difference between "Main Street and Wall Street". Surprisingly, today's sharp decline in the stock market has not really changed what I was planning to say. Basically, this post will explain what has been driving the stock market up, while the rest of the economy is limping along, and why the stock market dropped so much today.

Before I get into the details of what has been happening in financial markets, I want to first make clear that nothing I am about to say should be taken as investment advice. Investment decisions need to be made based on a full understanding of investment choices, an evaluation of personal goals and realization of the level of risk a person is comfortable taking

A good place to start with thinking about the recent moves of the stock market is to first cover the two basic theories of what drives financial markets. One theory holds that financial markets are rational and accurately price stocks and other investments. The basic idea behind this theory is that prices in the stock market reflect all available information since traders act on any information advantage they have and the price changes resulting from their actions is the way the information is "priced into the market". This theory holds that while no trader has all of the information about the market, their collective action in the market creates prices that reflect their collective knowledge. So, if the market seems to behave strangely, it is not the market, it is you and your limited knowledge. An example of this view was the surprising news of the unemployment rate at 13% last Friday which seemed to justify the rise of the stock market over the past few weeks. The other theory is that financial markets can behave irrationally because people make investment decisions based on emotion without thinking rationally. This theory is supported by a large amount of research in behavioral economics, behavioral finance and neuroeconomics (how brain structure affects economic decision-making) that say that financial markets can have wild swings that can cause speculative bubbles and financial crashes. This theory is used to explain many of the events in the 2008 Financial Crisis. Which is correct? The best answer is probably both, and which is correct best depends on the range of time that you are thinking about. Over the long-run, markets seem to be rational and prices are appropriate. But, within the short-run, a lot of market movement seems to be irrational and driven by emotion.

The stock market has gone through a bad crash and recovery in just a few weeks. If you remember back to late February when the news of the caronavirus pandemic began to get people's attention, the stock market was at an all time high. Then, in a few weeks, the market lost about a third of its value as the economy ground to halt. Then, a combination of action by the Federal Reserve lowering interest rates and starting trillions of dollars of emergency lending and the Federal government enacting trillions of dollars in fiscal stimulus stopped the stock market free-fall. Then, over the past two months the stock market staged a recovery that lasted until the beginning of this week. During that time, the rest of the economy continued to suffer as millions of people lost their jobs and businesses filed for unemployment. There are a number of explanations for the stock market rally while the rest of the economy suffered. These are three of the more convincing reasons for this disconnect between the stock market and the economy:

• • The Federal Reserve put a floor under the market that convinced investors that no major companies would fail. The Federal Reserve’s policy decision to buy corporate debt to prevent a financial crisis allowed large companies to restructure their debts and borrow money (and put off any bankruptcy). Traders interpreted this as a signal that companies with low priced stocks (like airlines and cruise ships) were safe bargains, at least in the short-run, because they could not go out of business. This resulted in traders buying up stocks and raising the market to get short-term price gains.

  • The stock market represents large companies which look like they will be the winners from this economic crisis. This is the real "Main Street vs. Wall Street" story. The stay-at-home orders were financially devastating to small businesses, especially retail stores and restaurants. Many of these businesses either have been driven under or will not be able to survive the recovery, with social distancing. Large companies, in contrast, have been able to survive the shutdown (because they had access to banking credit), or were able to keep functioning throughout the crisis. This reason says that stock prices are up because these companies now have less competition, so they will be more profitable in the future.

  • The stock market is forward looking and the high stock market value is because investors were looking beyond a short sharp recession to a stronger economy in a year or two. If the economy recovers to its previous level, then the crash in stock prices represented a real stock shopping opportunity. Once the stock rally got going, the more investors piled on because they did not want to be left behind (or already regretted missing the opportunity). It should also be noted that lots of small investors have been active in the stock market in the past three months (some people say this is because there have been no sports to bet on). More money in the market will push prices higher.

The basic justification for the stock rally is that it was driven by a combination of thinking that nothing could fail (thanks to the Federal Reserve) and that the future was going to be great (especially as the country reopened). Then the stock market rally turned into a rout today because news yesterday has dampened that optimism. First, yesterday, Jerome Powell, Chairperson of the Federal Reserve, held a press conference where he said the Federal Reserve expected the economy to stay weak, with high unemployment, well into next year - and the Federal Reserve would keep its current policies in place until the recovery happened. Now, the news of continued Federal Reserve support was good, but the larger story of a weak recovery means that many stocks are currently overvalued. Second, the rate of COVID-19 hospitalization are increasing in many southern and western states (this is not a second wave - this is the first wave for many of these places). Epidemiological models now estimate the country will suffer 200,000 COVID-19 deaths by early September. The reality is that the country still has a long way to go in this pandemic, and might still have localized shutdowns, which means that the economic recovery will be slower - and companies will be less profitable (or more likely to fail). In addition, this morning the number of last week's first time unemployment claims was reported at 1.8 million. This is down from previous weeks, but is still an absurdly high number. Worse, these claims might indicate longer term jobs losses due to failed businesses or permanent job cuts. Finally, investors are starting to think that the combination of high stock market values and lower than expected unemployment rate will reduce the pressure on Republicans in Congress to pass another large stimulus package. Without this aid, many state and local governments will need to lay off workers, which will add to the economic drag on the economy, and prolong the recession. People who cover financial markets often call sudden down days, like today, a "correction". This means that the euphoric optimism of Wall Street was corrected to see the harsh reality of Main Street.

Now, with all that said, the market may go up tomorrow and continue to climb to new highs. Or, it might continue to fall. Trying to guess where the market is going in the short run when there is so little good information, and a lot of contradictory information, is really only guessing. Right now investors on the stock market are trading more on emotion than information.

Economic Update - 6/ 5

The new jobs report released by the Bureau of Labor Statistics (BLS) caught almost everyone (including myself) by surprise. The BLS reported the unemployment rate to be 13.3% and said that 2.5 million jobs were added to the economy in May. This is good news and it comes at a time when we need some good news. Still, it is important to keep the good news of today's job report in perspective. An unemployment rate of 13.3% is really bad by any measure and we have a long way to go to get back to the 3.5% unemployment rate that existed in January and February of this year.

The new unemployment rate and number of jobs added to the economy reflect both the rehiring that has happened with the reopening of the economy and the slow down in rate of job losses. A deeper dive into the details of the jobs report shows that 1.4 million of the new jobs were rehires in the restaurant industry. These were workers who lost their jobs at the start of the pandemic as restaurants closed and have been returned to work as restaurants have opened. Another half million hires were in construction work. Both of these are industries that had hard shutdowns, were fast to lay off workers and are in person jobs. So, any recovery there was bound to result in a lot of rehiring. A major question for both industries is whether they will continue rehiring at this pace in the next few months. Curiously, one of the largest job creators (accounting for 10% of hires) was dentist offices (I guess people want clean teeth as much as they want haircuts).

Most analysts expected the new rate of unemployment to be about 20%, which leads to the question of why did they get it so wrong. There are two explanations for this, and they work together. First, most of the employment statistics that are reported are about job losses. An example of this is the weekly new unemployment claims( this statistic is also fuzzy because many people who lost jobs in this downturn filed for unemployment several times because the unemployment systems in some states were responsive). There are not any good weekly hiring numbers. So, the data tends toward unemployment. Second, the speed and the size of the downturn is unprecedented. Even in the darkest days of the 2008 crisis, the economy was only losing several hundred thousand jobs a month. This downturn has involved millions of jobs each week. Normally, economists (with more time and better statistics) can make reasonable predictions.

It would best to describe the shock of today's job report as one of timing of the recovery, instead of the expectation of the recovery. Most analysts expected the unemployment rate to peak this month and then improve for the next month. So, the unemployment numbers show that the recovery began before most people were expecting it. The strength of the recovery at this point is not really a surprise. Most economists expected the recovery to start strong. The workers that have been rehired are the easiest ones to bring back. The question, that is still unanswered, is whether the recovery can continue at a strong pace.

I would argue that today's jobs report is a clear sign the early government action with economic stimulus was a successful policy. Back on 3/18, I made an analogy of the economy to an airplane to explain how policy makers in shutting down the economy were trying to do a controlled crash landing of the economy. The goal was to land the economy with the least amount of damage so that it could take-off and fly again after dealing with the pandemic. The economic stimulus (enhanced unemployment benefits and financial aid to businesses) was meant to help the economy structurally hold together during this process. Now, we are on the other side of that process and today's jobs report is that the policies generally worked as intended. The fact that businesses are still in place and are rehiring workers is crucially important to the economy's recovery. At a 13.3% unemployment rate, we still have a long way to go - but we are headed in the right direction.

The big question now is whether the economy is strong enough (with the previous stimulus) to recover on its own strength or if it will need additional stimulus to fully recover. This is where things will get tricky for policy makers, and the process becomes much more political. One part of the economy that did suffer large job losses last month was local governments because of reduced tax collection and the need for states and cities to balance their budgets. These job losses will continue without another stimulus from Congress. Another issue is that enhanced unemployment benefits are going to stop at the end of July, which means that people who are still unemployed will have less money. Both the additional job losses and lower unemployment benefits will be a financial drag on the economy. The point of debate will be whether that drag is greater than the power of the recovery. It is hard to tell at this point. A good way to frame the debate over additional stimulus is to go back to the airplane analogy. When a plane takes off, if the pilot throttles up the engines at a higher rate it will help the airplane become airborne faster, and the engines can be throttled back once the plane is in the air - the only cost is some fuel. If the pilot does not throttle the engine up enough, the plane may run out of runway before it becomes airborne, which is a more significant problem. Basically, spending additional money to have the economy recover faster is a good use of money.

The bad news in today's jobs report is that unemployment for African Americans and Hispanic Americans went up in May, and is significantly higher than the national average (unemployment for African Americans is at 16.85% and Hispanic Americans is at 17.6%). These numbers only reinforce the reality of inequality and demonstrate that the economic crisis has fallen harder on those parts of American society. This is a reminder that the protests are about more than the criminal justice system. The economic inequality is a large reason these parts of American society have suffered more from the coronavirus pandemic and at the hands of the criminal justice system.

Economic Update - 6/ 2

Today I am writing in response to questions I have received about how the economic crisis is affecting local government budgets and what this could mean for government spending on things like schools, fire and police departments and other government services. No surprise that, like the rest of the economy, local government finances are being hit hard by the economic crisis caused by the coronavirus pandemic. However, before I begin to explain this, I want to note that the issue of state and local government finances are going to be a big national issue in the next two months as Congress debates another stimulus package, and it is not yet clear how this will be resolved (I will return to this point toward the end of this post). In this post, I do use Bedford as an example to illustrate points so as to give a sense of perspective on the numbers I am using in the post. Also, as a warning, some of what I am about to say is pretty bleak.

A good place to start is with explaining the different types of taxes that are used to finance government (this is a simplified explanation that is ignoring many of the smaller sources of revenue for government). Town governments largely fund themselves out of local property taxes on residential and commercial property. The Massachusetts state government finances itself with an income tax and a sales tax. The Federal government finances itself with an income tax and payroll taxes (such as Social Security). Now, while each level of government funds most of its operations with the taxes it collects, the Federal government provides funding to states and states, in turn, provide funding to local governments.

If you want an idea of what this looks like for a local government, you can look at the visual of the Bedford town budget on the town web page. This interactive visualization of the budget is really useful (and a great teaching tool). The top visual on the page is the town budget. The second visual is for the town's revenue. This visual makes it clear that most of the revenue for Bedford comes from property taxes - $76 million out of a total collection of $110 million (the town does not collect sales tax). State aid represents $9 million of the revenue. So, state aid is significant, but only represents 8% of the town's revenue (many towns and cities receive state aid that equals 20% of their budgets). In addition, the town does have a stabilization fund of about $6 million and free cash of $8 million. Looking simply at Bedford's revenue sources, it would seem that Bedford is insulated against a sudden economic hit. However, the economic hit of the coronavirus pandemic is affecting the whole economy and, even with insulation, it will affect well financed towns like Bedford (poorly financed towns are going to be devastated - many towns are already laying off workers).

The economic hit from the coronavirus will fall like a one-two punch on the state budget. The first hit is to the sales tax. The shutting down of many businesses with stay-at-home orders have crushed sales tax revenue, with April tax revenue down about 18%. The second hit will be to income taxes. Curiously, this will have a bigger effect later in the year since many people who have lost their jobs are getting unemployment benefits equal or greater than their wages (income was up 10% in April) - unemployment benefits are taxable. On a side note, Massachusetts is one of the states that has successfully paid out unemployment benefits during the crisis (Florida has been a disaster). In total, the state currently faces a shortfall of $830 million (the state budget is about $43 billion). This is a significant hit and it limits the ability of the state to currently aid cities and towns. Also, keep in mind that the state, cities and towns have all had to pay money to fight the pandemic.

While the current budget situation is not good, next year will be bad - the next year for the state budget begins July 1st. Even with reopening the economy, sales tax revenue will be low because the level of economic activity will still be low (Track the recovery places current consumer spending at 16% less than it was in January). The high level of unemployment will also reduce income tax revenue. Current estimates place the state revenue shortfall to be between $4 billion and $6 billion (this is for a budget that is currently about $43 billion). The state cannot do deficit spending to finance its operation budget over any length of time (it can borrow for terms less than a year). This means that the state is looking at a 10% revenue shortfall which has to be made up with cuts somewhere - either in state government or aid to cities and towns. Keep in mind that this is happening at a time when there are (and will be) great demands placed on government services. The state legislature has not figured out how this will be handled - there is even talk of it passing a one-month budget for August to buy time to figure things out. Now, the state does have a significant rainy day fund of $3.5 billion to cushion the financial hit. While this might seem like the "smoke'm if you got'em" time, the financial pain from this downturn might be longer than a year which means that it would be unwise to spend the whole rainy day fund next year. My guess about what this means for Bedford (and similar towns) is that state aid will be cut substantially. Part of this is because there is less state money and part is due to the fact that there are a lot of towns more dependent on state aid, and will be devastated without the aid. In short, the state will send the aid to the places where it is most needed. Property tax revenue should hold at least for a year - but could become a big political issue, especially commercial real estate if many businesses fail.

This state and local government budget problem is the same across the country (in some ways, Massachusetts is better positioned than many other states). The benefit of a national problem is that it puts more pressure on the Federal government to act to stop this problem. The Federal government, unlike states, can borrow to fund its current operations (I explained this back in the post on 3/ 19). Quite simply, the Federal government could borrow $500 billion and give it to the states (this is the total amount the National Governors Association asked for) to fill the hole in their budgets created by the economic crisis caused by the pandemic. Currently, this legislation is tied up in Washington politics. However, it is expected that this will be part of another stimulus package - or at least will be part of the debate. It is expected that Congress will be forced to move toward another stimulus package by the end of July because that is when the current unemployment benefits expire. Unemployment is at a record high - 40 million people or about 25% of the workforce (new numbers will be out on Friday). So, it is expected that this (during an election year) will move Congress will put together one more stimulus bill - and hopefully, states will be included in this stimulus.

Economic Update - 6/ 1

It seems a bit strange writing about economics given the days of anger and nights of rage in the streets of so many cities, but the pandemic and economic crisis also are still engulfing the county. The trifecta of crises now hitting the United States is making this year one of the worse in American history. In several ways the three crises are connected. People of color who have suffered under police brutality have also been affected badly by the pandemic, having much higher infection rates, and have also suffered some of the worst unemployment (and poverty) created by the economic crisis. This year is showing the harsh inequalities in the country. Hopefully, this trifecta of crises will move the country to act to end these different forms of inequality.

In terms of economics, unemployment is the major economic story right now, and it definitely will be at the end of the week with the new unemployment numbers released on Friday (expectation is around 25% unemployment). However, there has not been much discussion of the other major issue in macroeconomics: inflation. I wanted to take the opportunity at the start of this week to talk a bit about prices and inflation. News coverage recently has focused on price increases in food (April grocery prices were up by 2.6% - with eggs up by 16%), and there has been some talk about the specter of inflation. So this is a good teachable moment to make it clear that price increases do not mean inflation. Inflation is a sustained increase in the price level. The question is whether the price increase in groceries can result in future inflation. The short answer is no, but even if it is, it will not be the worst problem.

Before getting to inflation, it is first important to consider the cause of price increases in food that is happening right now. The changes in food prices are the result of how markets operate and adjust to shifts in supply and demand. Over the past three months, the economy has gone through sudden and deep shocks that have affected food supply chains and food demand. The shutting down of meat processing plants and the increased demand caused by people eating at home more often represent significant shocks to food markets. The price mechanism is how markets allocate resources and signal for changes in production. So, the price increases in certain food items is not a surprise - and has actually prevented shortages. Consider that while eggs are more expensive, they are still available in stores - the same cannot be fully said for toilet paper (still hit or miss at my local supermarket - watch the video microeconomics to explain the shortage of toilet paper).

The increase in food prices are not representative of prices across the economy. While the price of food was going up in April, the price of most other things in the economy went down, by an average of 0.4%. When considering inflation, economists use the term "headline" inflation for the Consumer Price Index (CPI) and the term "core" inflation to describe the CPI for all goods less food and energy. So, the increase in food prices are not seen in other prices across the economy. The Federal Reserve when tracking inflation for the purposes of policy focuses on core inflation.

One argument for future inflation is the large increase in government spending and the large amounts of money put into the economy by Federal Reserve policy. The simple quantity theory of money equation would imply that these policies should cause inflation. However, increased government spending and Federal Reserve "printing" of money are a necessary but not sufficient condition for inflation. That means these things could cause inflation, but not by themselves - other things also have to happen to make inflation happen. Those other things are not happening. For example, there has been a drop in consumer spending and business investment - government policy has been filling those voids. Now, if the economy comes roaring back to life, then there could be inflation. But at this point, we could only be so lucky.

Inflation means a sustained increase in prices across the economy - and this can only happen through a sustained increase in demand (greater than supply) or a rise of energy prices. That does not seem to be the cards right now, but things could change. When thinking about inflation, it is important to be able to tell a story that explains how it is caused and why it would be sustained.

An important thing to consider with inflation is that it is not the worst economic problem. One reason people talk about inflation as if it is a bogie man is because most people do not have much real experience with significant inflation. The United States has not had significant inflation for forty years. As a result, most people think of inflation in terms of hyper-inflation and think of people with piles of money in Germany back in the 1920's. That is not going to happen in the United States. Basically, the problem of hyperinflation is the result of a dysfunctional government. Zimbabwe and Venezuela suffered hyperinflation because they have terrible and inept governments that could only finance themselves by printing money. Despite all of the terrible news these days, the American government continues to work well, and we are a long way from the dysfunction in the countries dealing with hyperinflation. The reality is that inflation is a slow moving economic problem that does its damage over a long period of time - it is like the slow moving lava that takes a day to consume a house. Yes, it is bad, but there are many other things that are worse. The problem with inflation is that it creates price distortions and bad investment that slows economic growth over time - which makes a country poorer than it otherwise would have been. In comparison to other economic problems inflation is not so bad. For example, high unemployment can be worse and more destructive (especially if combined with high inequality). The important point is that sometimes government policy has to make choices between "not so bad" and "really bad" problems. Right now, inflation is a "not very likely problem and not a bad problem".

One final note about inflation - the Federal Reserve is very good at stopping inflation. The last time the United States had problems with inflation was in the 1980 and it was stopped by the Federal Reserve raising interest rates to 19.5%. In fact, having inflation would be good because it is a problem that policy-makers know how to solve.

Links for 6/ 1

Economist video on why the condition of the economy might be worse than it appears.

Wall Street Journal video on how GDP is measured and how it shows the economy is in a recession.

Paul Solman on the PBS Newshour on how the pandemic could result in a new era of working from home.

Wall Street Journal video on how the government creates money.

CNBC video on the reasons the medical supply chain failed during the coronavirus pandemic.

Interview with Mark Zandi of Moody's Analytics on the current state of the economy and the forecast of a long recovery.

Interview with Mary Daly, president of the San Francisco Federal Reserve on the PBS Newhour about why economic policy needs to support all Americans.

Economic Update - 5/ 27

The issue of wearing a face mask to deal with the coronavirus pandemic has gone beyond being a public health issue to a political issue. This has been visible this week in the back-and-forth between president Trump and former vice-president Biden. This dispute is being argued as one between the people who prize the science of public health against those that claim to champion personal liberty. This can be a debate that often involves people arguing from a point of view based on values in which they argue past each other - and even devalue each other. I thought that today, because the United States passed the grim milestone of 100,000 deaths from COVID-19, it would be a good time to look at the economics of wearing a mask and what that might mean for effective public policy.

First, the science of mask wearing can quickly get tricky with the different types of masks and how the virus is spread. There are the very effective N95 masks (if worn properly), but these are really for people on the front-line of this health crisis where there is a strong likelihood of regular exposure to coronavirus. Most of the masks, even home-made ones, that most people are wearing are not as effective, but are still sufficiently good for infrequent exposure to coronavirus. The reason they are sufficiently good is that they stop most airborne water particles that could have the virus. It is important to note that masks are effective in stopping the spread of the coronavirus by both blocking most of the water particles a person breaths out and also blocking most of the water particles that another person breaths in. This is the reason wearing a mask protects both the wearer and the people around them. Public health experts say that having infected people wear masks is very effective in stopping the spreading the spread - and given that many infected people are not aware that they are infected, this mean most people should wear masks to protect others.

The collective benefit of wearing masks can be significant. Studies have shown that if 80% of a population wears masks then the transmission of the coronavirus could be effectively halted. The problem is getting a large majority of the population to wear masks. This is where the science of public health needs to look to economics for ideas. A good analogy for wearing masks would be turning on headlights when driving in the rain during daylight hours. While turning on your headlights might make it easier to drive, the real benefit is that it alerts other drivers to your car which make both you and them safer on the road.

Economists tend to view people as individual agents who act in their own self interest. Now, the simple effectiveness of masks should encourage most people to wear them. However, if a large majority of people are already wearing masks (80%) then person could get by reasonable safely without wearing a mask - economists call this the free rider problem. An example of the free rider problem are the people who do not get vaccinated (largely for anti-science reasons) and do not have to worry about getting sick because everyone else provides them with herd immunity. The problem of free riding is that the incentives are for everyone to free ride, which means that the number of people in the protective herd goes down and the chance of infection then goes up (this has been shown by the measles problem in the past few years caused by too many people choosing not to get vaccinated). Policy should be aimed at reducing free riding to get to the goal of having 80% of the population wear masks.

Public policy to deal with the free rider problem in public health can take the form of punishment to discourage free riding or incentives to encourage people to adopt healthier behavior. When deciding on a public policy it is important to keep in mind what is needed to achieve the policy goal and the effectiveness of punishments and incentives in reaching the goal. In terms of getting people to wear masks, the goal should be to get at least 80% of the population wearing a mask - an effective policy does not need 100% of the population wearing masks. This is an important point because getting to 100% will be difficult and expensive. In deciding whether to get to the 80% mask wearing level through punishments and incentives it is important to consider the cost and benefits of each policy. Punishments like fines can be useful, but only to a point. On-line articles report how some communities are setting $1000 fines for not wearing a mask. This is a lot of money and it is intended to get attention, however, it is not clear how many people (if anyone) would be given this fine because it is so expensive. A fine that seems so out of line with the offense is unlike to be imposed - which means it is not really effective (especially once people see it not being imposed on violators). Worse, it encourages people violate it in order to make a "statement". It this way, a smaller fine that is imposed on a regular basis (like a parking violation) can be more effective as a punishment that gets to the policy goal. It should be noted that parking tickets are more about forcing compliance than raising revenue. However, it may be more effective to offer incentives that make it easier for people to comply, such as making masks freely available in lots of places, which reduces the ability of people to use excuses for not wearing a mask ("I forgot it at home"). Yes, this costs money, but it may be a cheaper way to get to the 80% goal than paying the police to ticket people (a police officer writing a ticket is a police officer not doing something else). The reality is that a mix policy of fines and freely available masks would be the most effective (and probably cheaper) way to get to the 80% goal.

There may be another way to use economics to encourage people to wear masks. One of the problems in the coronavirus pandemic is the issue of asymmetric information. People are wary of dealing with each other because they are unsure about the other person's health situation. Asymmetric information is a common problem in many economic transactions. The classic example is buying a used car. The seller knows the car's problems and the buyer does not - which makes the buyer reluctant to pay full price for a car. Car dealers try to convince buyers that the used cars are good though having fancy showrooms and offering money back guarantees. Economists call these actions "signals" because they are simple visible ways a seller can show the buyer that they can be trusted. Masks work as a type of signal in the mists of the cornonavirus pandemic. It is a fast and simple way to signal other people that you care about your health and their health - which would imply that you are less likely to be infected. Importantly, wearing a mask is a cheap signal (it is easy for people to adopt) which means more people will be likely to adopt it simply to gain the social trust of other people they meet as they go about their daily business. More importantly, it is easy to not interact with people not wearing masks, which raises the economic cost of not wearing a mask - lost daily business. The reality is that somebody can shout all they want about their person freedom - and just as real, everyone else can use their personal freedom to avoid that person. Free societies use social pressure to encourage people to behave in a way that is socially beneficial (yes, this can be problematic - but it is a reality of how societies function). After all, there are many things that are legal to do, but will also leave a person who does them friendless. In a way, maybe we should be glad that people who treat their health so casually can be so easily identified and avoided. That is until they decide they would rather be part of a society and accept the practices everyone else uses to keep society safe.

Links 5/ 27

Austan Goolsbee, professor at the University of Chicago, explains the basic economic concepts in the coronavirus pandemic. This a good basic video that provides a lot of economics insight without using much complex economics.

Harvard Business Review animated video on the basic concepts for explaining how coronavirus has affected the economy - again, simple video that quickly gets at a number of complex economic ideas.

Five Thirty Eight reports on its survey of macroeconomists about the economic recovery - these experts are saying it could take years to have a fully economic recovery.

Links - 5/ 22

Wall Street Journal video on the effect of coronavirus on higher education.

CNBC video on how schools are handling the disruption caused by coronavirus.

PBS Newshour video on how the coronavirus pandemic has pushed retail business to the point of collapse.

CNBC video on the reason farmers are destroying their crops.

CNBC video on how the United States is opening up.

CNBC video on what a second wave of the coronavirus pandemic would look like.

Bloomberg video on the Rise and Fall of Global Trade.

WBUR interview with Harvard economics professor Ken Rogoff.

New York Times interview with Paul Krugman about the reopening of the economy.

The New York Times Upshot column explains how economic statistics based on percentage change can be deceiving.

Economic Update - 5/ 21

The new unemployment claims for today were released and they showed that another 2.4 million workers filed first time claims for unemployment last week. This brings the total number of people who lost their jobs and filed for unemployment over the past nine weeks up to 38 million. This would make a rough estimate of unemployment rate at about 24%, which is comparable to the highest points of the Great Depression. The good news in this is that the rate of people losing their jobs has decreased and the bad news is that it is still continuing at a significantly high amount. In addition, the Census Bureau today released a household survey showing that 47% of adults say that either they or a member of their household have lost a job.

While unemployment is the headline story, another large and related story is the large numbers of people who have lost income over the past few weeks even though they still have a job - these people could be considered underemployed. A survey from the Pew Research Center survey reports that 33% of workers have had to take a pay cut. The Census Bureau also reported that 39% of people expected their households to earn less money over the next four weeks. The combination of unemployment and underemployment has pushed up the percent of people who will not be able to pay all of their bills to 33%.

The unemployment and underemployment information is important because the people represented by these statistics are not in a good position to get out an spend money to drive the economic recovery. In addition to the financial pain felt by lost income, there is a level of economic insecurity that comes will losing a job, which will result in higher levels of savings to pay off debts and to protect against future job losses. All of which is evidence of a slow recovery.

You can check out the rate of the economic recovery for the whole country and by specific states through the on-line economic tracker. Shown below are two graphs from the sight - the one on the top is a comparison of consumer spending in Georgia and Massachusetts - it is a bit interesting that a state that has been open for several weeks has a spending recovery similar to a state that is only now starting to open. There is a difference between the two states in terms of small business. The second graph is hours worked in small business and the third graph is the revenue at small businesses - clearly here Georgia has recovered more than Massachusetts. Still, the graphs show that even when businesses reopen, the rate of recovery is still slow and has a long way to go to a full recovery. This recovery data in addition to the continuing unemployment information is an indication that additional economic stimulus is needed to aid the recovery.

Links for 3/15

Neil Irwin of the New York Time's Upshot column writes about One Simple Idea that Explains Why the Economy is in Great Danger. He starts the column with starting point for explaining the depth of the economic downturn in the next few months is "One person’s spending is another person’s income. That, in a single sentence, is what the $87 trillion global economy is."

David Leonhardt, who writes for the New York Times, says that this crisis will be "More Severe than the Great Depression". In the article he quotes University of Chicago economist Austan Goolsbee saying, “Anything that slows the rate of the virus is the best thing you can do for the economy, even if by conventional measures it’s bad for the economy.” The article describes a number of creative ways economic policy could be used to deal with the crisis.

John Cassidy in the New Yorker describes his interview with Ian Sheperdson of Pantheon Macroeconomics (one of the top economic forecasting firms). Two points that Shepherdson makes are "It’s going to be catastrophic... This is an economy built on discretionary consumption.” and in terms of stimulus, "I am in the one-trillion-to-two-trillion-dollar camp, preferably by dinner time."

Tyler Cowen of George Mason University has posted his idea for a economic plan against coronavirus.

Important Economic News for 3/ 16

Forecasts about the American and Global economies are very messy at the current time because of the speed at which the economic shock of COVID-19 is now hitting both the United States and European economies. Obviously, current predictions for the near-term impact, described as Quarter Two, look to be very severe. Goldman Sachs said that it expected that Quarter Two growth could fall by as much as 5% (annualized rate). Economic data from China for January and February describe a Quarter One contraction of 6% - this is the worse economic situation in China since 1976. It should not be a surprise if the decline in the United States is equivalent to that. The Chinese economy is recovering from COVID-19 and factories are opening again. However, the factories are running at 50-60% capacity.

The longer term forecast is murkier at this point because the type of economic shock now hitting the United States and the global economy is unprecedented. Without the example of a similar event, it makes it hard to develop a model for this event. The current thinking is divided into two camps. The first camp argues that there will be a lot of pent up demand from people sitting at home for weeks and that this demand will drive a strong economic recovery in Quarters Three and Four. This view is described as seeing the recession and recovery as "V" shaped - steep downturn and steep recovery. The second camp argues that the recovery will be slow because the downturn in business means a large decline in incomes that will be permanently lost (especially in the service sector - people are not going to get twice as many haircuts when the economy gets back to normal) and that it will be hard to get many businesses back up to full speed quickly. The result is that the recession could last through the rest of the year. This view is described as seeing the recession as "U" shaped - steep downturn and slow recovery. At this point, both sides have good arguments. However, the longer the shutdown of large parts of the economy continues, the likelihood of a "U" shaped recession becomes stronger.

Financial markets, like the stock market, have been very volatile because of the large amount of unknowns in both public health and the larger economy. Markets have been dropping because of the generally bad economic news, but have been going up when news of government action is announced. Today's drop of about 12% fits within the general pattern that has been going on for the past few weeks. Today's decline is the largest on record, but it also follows on a positive gain last Friday. Basically, it is hard to judge the market on one-day observations. It is better to think of the stock market is seen as a forward looking indicator of the economy. While the downward trend is seen as an indication of a recession, the more important piece of information is the volatility (large daily moves) that is an indication that most investors do not have a clear idea of the future. Forecasting the future swings of the financial markets is murky, like economic forecasts, because there is really no experience with type of downturn.

The House Bill passed on Friday is currently working its way through the Senate. There seems to be a hold-up on the Senate action for two reasons. First, Republican Senators are objecting to the two-week paid sick leave because it will be hardship on small business (this is not clear since the Federal government will be footing the bill for this). Second, several Republican Senators are arguing for $1000 being send to every American. The Senate will reconvene on Monday night, but it is not clear where there will be a vote on the House Bill.

The general view among economists is that Federal Reserve monetary policy can provide stability to the financial sector, and help the larger economy manage debts, but that the only way to respond quickly to the downturn is through some sort of large fiscal policy stimulus program. It would not be surprising to see a stimulus package in the range from a low end of $500 billion to a high end of $1 trillion. It is a lot of money and it will add to the overall debt of the Federal government. Two important points for a fiscal stimulus package, even with the current large debt, is that the current interest rate on a 30-year government bond is 1.33% - which means it is cheap for the government to borrow. Second, the large downturn in businesses will cause a large decline in state and local tax revenue. State and local governments are limited in borrowing to meet these funding shortfalls. The Federal government will most likely need to give money to states to cover their revenue shortfalls and prevent cuts in state and local services.

Links for 3/16

Neil Irwin, writing in the Upshot column in the New York Times, explains the sharp policy moves the Federal Reserve made over the weekend with cutting the Federal Funds Rate to 0-0.25% and buying $700 billion in Treasury Securities and Mortgages.

Important Economic News for 3/ 15

The Federal Reserve System is cutting the Federal Funds Rate to a range of 0-0.25%. The Federal Funds Rate is the interest rate that banks lend to each other in the over-night lending market. The Federal Funds Rate affects all other interest rates in the economy. This was the same interest rate in the period following the Financial Crisis in 2008. In addition, the Federal Reserve is planning to buy $500 billion in Treasury securities (government bonds) and $200 billion in mortgage backed securities. All of these actions are designed to provide money to financial institutions to prevent problems in the financial system by giving financial companies (and banks) the ability to extend emergency credit to customers and to avoid having customers defaulting on debts. At this point Monetary Policy cannot have much immediate effect on the economy (typically it takes 12-18 months for monetary policy to have its full effect).

The House of Representatives passed an Emergency Spending Bill that will provide free testing for Corona virus, "paid emergency leave with two weeks of paid sick leave and up to three months of paid family and medical leave", expand federal funding for Medicaid and provide up to $ 1 billion in food assistance. The Senate will be taking up this Bill on Monday. This Bill is in addition to the $8.3 billion that Congress passed last week for the COVID-19 crisis. This should be seen as a spending bill that helps support the goal of keeping sick workers at home and for giving states more funds to support their medical systems. This is not a major economic stimulus program. That said, helping slow the spread of COVID-19 will have benefits for the economy. In addition, it is expected that there will be a full economic stimulus package as the full economic impact becomes more clear.

Links for 3/15

Greg Mankiw's Thoughts on the Pandemic - Greg Mankiw is a professor of economics at Harvard University who has authored one of the best selling economics textbooks and served an an economic adviser to George W. Bush

Alex Tabarrok at Marginal Revolution has a proposed A 21st Century Jobs Program - Alex Tabarrok is a professor of economics at George Mason University.