Yesterday, a reader asked why I thought QE3 wouldn't do much to spur the economy (specifically consumer demand). I answered that investors would lift prices on commodities (as they move to protect themselves from prospective inflation), which would ultimately raise prices on consumers, who can't react as quickly as investors can from changes in monetary policy. I want to expand upon that, because he also brought up a concept called GDP (output) gap, and it's something that really bothers me.
GDP gap is the difference between actual output (what we produce in a given amount of time) and what we can potentially produce in that same time frame. In normal times,GDP growth is considered synonymous with capital/wealth growth because there is no perceived gap in actual GDP and potential GDP. After a recession (when output contracts), immediate GDP growth is considered "catching up" to what we were previously making. Once we bridge the gap, any new growth is assumed to be more wealth creation.
The only problem is GDP gap is a terrible concept. It can't be accurately measured. Even in the best of times, there is still a theoretical GDP gap because, collectively, we could all work more hours or a greater percentage of the population could be working or both. The gap is measured by taking labor metrics (workforce participation, labor utilization, average hours worked) from a time that is considered healthy and comparing it to a time when the economy is considered to be performing poorly.
People can always work more hours. More people can join the workforce. There is always more work to be done. When you consider it from that standpoint, output gap is essentially meaningless because it doesn't measure anything that we didn't already measure before.
So how does that relate to the current state of affairs? Back in 2008, GDP stood somewhere around the range of 14.4 trillion dollars. By the end of this year, it will be around 15.6. The reason why some economists still consider our economy to be in the midst of a GDP gap is because all that growth in GDP occurred during a time when employers were slashing payrolls and making the remaining employees work harder for longer periods of time.
In other words, we increased GDP by increasing productivity faster than we decreased employment. The thinking is that we'll get back to the good times when everybody rejoins the work force at a level before September 2008 while keeping as much of the productivity gains as possible.
Other economists say "hold up a second, the labor statistics we see now seem to indicate that this is the new normal". Which is to say we can't go back to the employment and productivity numbers we saw in early 2008 (or, for that matter, 1999) because the economy has been altered permanently in some way. The old cliche rears its ugly head: the truth probably lies somewhere in between.
The reason why I say looser monetary policy (QE3) won't get us closer to 2008 is because monetary policy isn't the right tool to tackle the problems that our economy is facing. The three most consequential phenomena that occurred between 1980 and now are the diverging real savings rates between the top 10% of households and the rest of society, increasing socioeconomic stratification among emerging adults (teenagers who are past high school and twenty somethings), and the yawning gap between what most kids learn in secondary education (essentially nothing) and what is required in the modern workplace (which is actually a lot different from what you probably think it is).
Fiddling with the money supply isn't going to change any of those factors except exacerbate the first one. When the Federal Reserve buys Treasurys (real word, honest) and injects money into the financial system, the first group to be affected by it are the primary dealers (aka the large banks who make the Treasury market). The second group that it affects are the participants in the secondary Treasury market (funds of all various colors and large non-financial companies). Everybody else (small businesses and employees) feel the effects downstream, when it's too late for them to take any meaningful action.
If we've learned anything in the past, it's that Wall Street will make its money whether interest rates are low or high. They pay much more attention to monetary policy. It's their job. Everybody else learns what happened the next time they go take out a loan or fill up their car. And that's why I think QE3's effect on the broader economy is going to be minimal, at best.
Bernanke has admitted as much. But the reason why he feels compelled to act is because the Federal government won't. Policy making essentially grinds to a halt during the campaign season. And there is a lot of economic uncertainty looming (1 year away from the full implementation of the PPACA with the rules yet to be fully determined, the tax rate resets, sequestration) that is a direct result of both Congress and the President's unwillingness to act.
This is just bad macro.
ReplyDeleteThere is a structural limit to the economy which we can measure, its called NAIRU. (its not 100% precise buts its close enough to be very useful)
All the evidence suggests that we are no where near our structural limit, and there is literally zero evidence suggesting that there has been any signifigant increase in structural unemployment since 2008.
If our unemployment was largely due to a skills gap we would expect to see rapidly rising wages in certain sectors as they would bid for a small subset of workers. This in turn would incentivize others to acquire these skills in order to earn the higher wages being provided and the market would facilitate this smoothly. Thats why we like markets.
But of course we don't see that at all. We see stagnant wages more or less across the board. We see an economy not shifting production, but halting it completely. We don't see companies training new workers to fill any skills gap, we see these workers sit at home watching TV while the companies sit on a boat load of cash and do nothing.
So why are we suffering from a general glut? Easy, not enough money!
Ask yourself this question: what is a recession?
A recession is not, as commonly defined in the media, a state of contracting RGDP. It's a state where its difficult to sell goods but easy to buy them. It's the excess supply of goods and labor which becomes difficult to sell which characterizesa recession, not contracting GDP.
Now, can a barer economy suffer from a recession? The answer is no, because in a barter economy every time you sell a good you are also buying a good. They are metaphysically entangled.
But we don't live in a barter economy, we live in a monetary exchange economy where the act of buying goods and selling goods are distinct because theres a third commodity in between each transaction; money.
I just looked up NAIRU, and I have to say it sounds ridiculous on its face. It's a theoretical concept. Nobody can prove what NAIRU is. It's just a target that people want to hit.
DeleteIf economic output was solely measured by the amount of cartwheels the country performed, you could always get more people to perform more cartwheels or make people perform cartwheels for longer periods of time.
And, for the record, there is definitely a skills gap in certain sectors of the economy. Software developers (I am one) are in extraordinary demand. From an anecdotal perspective, I can tell you that demand for my skills has been extremely high the past few years and my wages have risen well above inflation.
From a statistical perspective, we can see that the wages for them are high across the board and that companies are currently bidding against each other to acquire more and more developers. You can google "Silicon Valley talent wars" to find out the extent of the shortage.
The jobs that are hardest to fill require specialized skills that not everybody has. It takes a long time to acquire them (it wouldn't take me that long to become a business analyst but it would take a business analyst a lot longer to become a halfway decent developer) and because of that, companies are unwilling to spend vast amounts of money training unproven candidates and more willing to splurge on proven talent.
So during a recession it becomes more difficult to sell goods for money and easy to buy goods for money, because theres an excess demand of money! So how to solve this, well easy, print more of it!
ReplyDeletehttp://research.stlouisfed.org/fred2/series/BASE/
DeleteWe've already printed a bunch of money. M0 has increased by almost 2 trillion dollars (over 200%) since the start of the recession but M2 has grown maybe 20%. There's a reason why.
Non-financial companies in the S&P 500 are sitting on at least 1.3 trillion dollars in cash and cash equivalents and the big banks have 1.6 trillion dollars sitting at the Fed.
Money is easy to come by if you're already rich. But nobody's doing anything with it. Everybody (who matters) is still in capital preservation mode. If this is a money demand problem then I'm a monkey.
Again, open market operations affect the big banks, funds, and corporations first. They're the institutions that the Fed is pumping money into, even when they're already sitting on ridiculous amounts of cash. How exactly is QE3 going to juice up our economy?
"I just looked up NAIRU, and I have to say it sounds ridiculous on its face. It's a theoretical concept. Nobody can prove what NAIRU is. It's just a target that people want to hit."
ReplyDeleteWhy is it ridiculous? Just keep easing policy until inflation takes off and then you know you've hit the natural rate. Theres a structural limit to how much we can make people work until wage demands and prices begin to skyrocket. So claiming that we can always make people work more is simply untrue. There is a structural limit, and its at NAIRU, and the evidence strongly suggests that we are not even close to it.
"And, for the record, there is definitely a skills gap in certain sectors of the economy. Software developers (I am one) are in extraordinary demand. From an anecdotal perspective, I can tell you that demand for my skills has been extremely high the past few years and my wages have risen well above inflation."
Of course theres a skills gap. There was a skills gap before the recession and there will be one after it. But if structural employment via mismatch was driving our unemployment we would expect to see a few booming industries and a few declining ones, with the rest more or less untouched. Booming sectors would lure labor by offering rapidly increasing wages and training. There wouldn't be 5 years of depressed output and high unemployment.
In 2006 housing construction took a nose dive, but unemployment barely rose a blip and GDP kept chugging along. Why? Because this was completely offset by a declining dollar which set off an export boom. The market shifted workers and resources smoothly to other sectors because THATS HOW MARKETS WORK AND THAT IS WHY WE USE THEM.
Notice how the recession didn't come until the Federal Reserve let NGDP crash, and when NGDP did crash we saw just about every single sector shed jobs.
"http://research.stlouisfed.org/fred2/series/BASE/
ReplyDeleteWe've already printed a bunch of money. M0 has increased by almost 2 trillion dollars (over 200%) since the start of the recession but M2 has grown maybe 20%. There's a reason why."
Don't look at M2, look at NGDP and inflation. We've already been over this on PBN.
"Again, open market operations affect the big banks, funds, and corporations first. They're the institutions that the Fed is pumping money into, even when they're already sitting on ridiculous amounts of cash. How exactly is QE3 going to juice up our economy?"
While the demand to hold money balances fluctuates wildly and, as is the case now, rises extremely high, in the long run the demand for money is exactly 0. Thats because money is a hot potato. The only thing anyone wants to do with it is get rid of it in exchange for other goods. Printing up a bunch of money and giving it to people is a 100% surefire way to raise nominal growth, and consequently (in a state of disequilibrium) real growth.
However people aren't stupid. They know the federal reserve wont let inflation run too high (decreasing the incentive to hold money) which is why QE1 and QE2 only had temporary effects.
But thats where QE3 is different. Instead of saying "we will buy x amount worth of assets blah blah blah" they're changing peoples expectations of future policy by saying "we will CONTINUE to buy assets until employment improves" and "interest rates will stay at zero well after recovery."