Economic Analysis


Why Central Bankers Are So Confused by Low Prices

 

By Peter Morici, Ph.D.

 

Aug. 10, 2017 –

Yellen Doesn’t Understand Low Inflation Will Persist because of Changes in the Economy

 

Central bankers are captive to conventional economics – faced by low inflation and low unemployment they are flummoxed about pulling back on monetary stimulus. Their dilemma lies in an incorrect reading of statistics and taking modern macroeconomic theory too seriously.

Unemployment in the European Union is at its lowest level since 2009, yet inflation across the pond drags along at about 1.3%. U.S. unemployment is at a similar trough, while headline and core inflation remain well below the Fed’s 2% target.

According to the textbooks, unemployment and inflation are supposed to move in opposite directions, not in tandem as they have. As summarized by the Phillips curve, falling unemployment should coincide with tightening labor markets and rising wages and prices, and the inverse should be true as unemployment rises.

For one thing, headline unemployment rates are proving an increasingly poor measure of what is going on in many labor markets. In the United States and Europe, large numbers of adults are on the dole and opting out of work altogether, and on both continents many university graduates are underutilized in low-paying jobs – serving coffee at Starbucks, chaperoning tours of historic venues, and the like.

For another, macroeconomic models deal poorly with the fact that entitlement programs have created large pools of contingent workers – folks who may only again participate in the labor force if wages rise very sharply. More generally, those models paper over other demand- and supply-side structural changes that are holding down prices and subverting the historically expected inverse relationship between unemployment and inflation.

Central bankers point to low oil prices, instigated by the U.S. shale revolution, but those fell last year to about to $44 a barrel in 2016 and generally have been a bit higher in 2017.

Cell phone alibi

Janet Yellen is fond of pointing to falling cell-phone subscription rates – thanks to more intense competition among the four principal carriers. However, even after pulling cell-phone services out of the core deflator for personal consumption – the Fed’s preferred measure of inflation – price increases have been slowing through 2017 and were only 1.6% in June.

The cell-phone alibi looks even weaker after considering recent weakness in inflation for apartments, air fares, autos, and apparel. All are items that should exhibit more robust price increases this late in the business cycle but in varying measure, their prices have been dampened by swelling capacity and innovation that push down costs and retail prices.

Perhaps the most compelling phenomena have been the intersection of overbuilding in the retail sector – everything from grocery to department stores – and the revolution in supply-chain management and increased competition associated with the Amazon effect.

Internet aggregators are driving down supply-chain management costs and prices for many household items and business necessities. With their share of retail at only 8.5% but growing, that downward pressure on inflation is not likely to abate soon.

Wal-Mart and Amazon are in unique positions owing to the former’s mass and the latter’s unique access to consumers’ attention – most online product and price checks begin at the Amazon site these days – to drive down suppliers’ margins. In turn, suppliers push back on workers’ wages and producers of basic materials or in the case of manufacturers in China, they can rely on very generous credit conditions and subsidies that permit selling at or near a loss.

Shifts in consumer preferences

Similarly, shifts in consumer preferences are diminishing the pricing power of major consumer- product companies like Kraft Heinz, Procter and Gamble and colleges.

Consumers are getting smarter about the false monopoly premiums once demanded by many consumer brands and educational institutions.

These kinds of structural changes – all occurring with increasing perforce – simply shift the parameters of the Phillips curve in ways conventional macroeconomic models and the bubble think at central banks cannot accommodate.

Editor’s Note: Peter Morici is an economist and professor at the Smith School of Business, University of Maryland, former chief economist at the U.S. International Trade Commission, and five-time winner of the MarketWatch best forecaster award. You can see his economic forecasts here.

 

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Why Republicans Won’t be Able to Pass a Big Tax Bill

 

By Peter Morici, Ph.D.

 

Aug. 7, 2017 –

If you think tax reform will be easy, I have a bridge I want to sell you

 

If anything should unite red-blooded Republicans, it’s tax cuts and reform. Sadly, the Trump administration and GOP congressional leaders are unwilling to face facts and make the tough choices necessary to get it done.

As evidence, I cite the Joint Statement on Tax Reform issued by the Big Six: Treasury Secretary Steven Mnuchin, National Economic Council Director Gary Cohn, Speaker Paul Ryan, Majority Leader Mitch McConnell, Senate Finance Chairman Orrin Hatch, and House Ways and Means Chairman Kevin Brady.

The document repeats campaign promises to lower taxes for working families and small businesses, boost investment, and encourage U.S. companies to bring back jobs from abroad. And to make tax reform permanent without imposing a broad-based consumption tax-read value-added, carbon- use or some other energy tax as advocated by the IMF.

That’s really great sounding stuff but hardly possible – at least not all together.

Democrats in the Senate are not likely to go along with a tax package that substantially reduces revenue and domestic spending together, and any tax package passing with less than 60 votes in the Senate, under reconciliation, must either not add to the deficit or sunset after 10 years.

Hence to make any tax changes permanent, 50 of the 52 Republican senators plus Vice President Mike Pence must agree to a package of tax and sustainable spending cuts.

Entitlements

Entitlements now consume more than 60% of the federal budget and along with interest payments, are likely to grow to 100% over the next decade.

The successful efforts of Sens. Shelley Moore Capito, Lisa Murkowski and Susan Collins of welfare-dependent West Virginia, Alaska and Maine – and others – to block Medicaid reform, as part of any plan to repeal or replace Obamacare, illustrate that the GOP talks a good game on entitlements reform but lacks the political courage to effect it.

Hence, offsetting spending reductions to finance tax cuts must come from discretionary spending.

That is made extraordinarily difficult by the fact that the overall budget package must also accommodate Republican promises to increase defense spending to rebuild the military, which has been stressed by years of war and prior cuts in appropriations for modernization of equipment and research imposed during the Obama years.

Defense spending increases must be counted in with revenue lost from tax cuts in calculating the necessary overall spending cuts to pass through reconciliation.

President Donald Trump has mused he is willing to raise taxes on upper-income Americans to provide tax relief for other Americans but the top 25% of income earners already pay 89% of the personal income tax, and most small businesses and many large ones are pass-through entities that pay taxes through the personal income tax code.

Coupled with provisions that phase out deductions and state and local taxes, many high-income individuals and limited-liability corporations are paying marginal tax rates of close to or exceeding 50%.

Small businesses

The number of small businesses has not recovered to pre-financial crisis levels, and it’s hard to see how Trump, pursuing a tax-the-rich policy to finance lower- and middle-class tax cuts, could do anything but further disadvantage small businesses, investment, and American competitiveness.

On the corporate side, revenue-neutral reform is not politically possible-eliminating deductions and credits to lower rates overall would raise taxes on at least as many companies as it would benefit. Chairman Brady proposed to lower corporate taxes overall by raising about $100 billion a year by applying corporate taxes on imports and rebating those on exports.

The latter instigated huge opposition from Wal-Mart, other retailers and manufacturers dependent on imported materials and components, even though the competitive effects would be minimal. All businesses would face the same taxes on imports and options to source more goods domestically.

Still the White House nixed border tax adjustments in the Joint Statement.

All this said, the Big Six have promised to come of up with a tax plan that simplifies the tax codes, cuts the tax burden overall, and pass it through Congress under “regular order” of legislative drafting, committee hearings, and voting procedures.

If you believe that one, well, I was born and raised in New York City and actually can sell you the Brooklyn Bridge. It’s a great piece of American history, with tolls a potentially enormous money maker, such a deal …..

 

Editor’s Note: Peter Morici is an economist and professor at the Smith School of Business, University of Maryland, former chief economist at the U.S. International Trade Commission, and five-time winner of the MarketWatch best forecaster award. You can see his economic forecasts here.

 

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