David Beckworth directed me to a tweet by Jeanna Smialek: A friendly shorthand for non-housing core services PCE?  How about “wages”? When nominal wages grow at about 3%/year, inflation will average 2% in the long run.  In that case, any deviations in the headline inflation rate will be transitory.  The burst in inflation that began in 2021 went from being transitory to permanent when it became embedded in wage inflation.   If you listen closely to Jay Powell, it’s pretty clear that he understands that fact.  But the Fed is reluctant to say this out loud.  It sounds bad to emphasize that the number one goal of the Fed right now is to reduce wage increases.  When the public hears that, they think in terms of real wages.  Actually, a tight money policy that slows the growth of nominal wages will tend to cause real wages to rise in the short run.  Some of the largest increases in real hourly wages occurred in years like 1921 and 1930, when nominal wage growth slowed due to tight money, but consumer prices fell much more dramatically. Goods inflation is already slowing.  Housing prices (part of services) are still rising due to the lagged effects of rent contracts signed earlier in 2022.  But the inflation rate of “spot” rents on new rental contracts has begun slowing, and overall average level of rents will eventually follow suit.  Today, the main outstanding problem is fast rising nominal wages, which is the primary factor behind non-housing service prices.  But then nominal wage inflation has always been the essential monetary policy problem, as price inflation is a misleading guide to policy that mixes supply and demand side influences.   In other words: (0 COMMENTS)

Yes. Let’s start with some data: A few comments:  1.This deflates median wages by the CPI.  Most economists believe the PCE is more accurate, and it would show much more rapid real wage gains.   2. This excludes fringe benefits, which have improved much faster than money wages. 3. On average, families are smaller, hence there are fewer children to raise. 4.  If I had used average wages, the increase would have been even greater, as top end incomes have risen faster than median wages. To summarize, this is a conservative estimate of the gains in real wages. So why the perception that it now takes two incomes for the lifestyle that one income once supported?  I see many factors: 1. In a few places such as Silicon Valley that claim is clearly true, at least for workers with median incomes.  Influential pundits often live in places where house prices have risen much faster than average. 2.  We now have higher expectations.  Suppose you are a median worker that wished to reproduce a 1960s lifestyle.  How do you do this?  You’d move into a 1200 square foot ranch house with one bath in a working class immigrant neighborhood.  To get a car as unreliable as a 1960s car, you must buy a cheap 15-year old car.  To get a TV as bad as a 1960s TV, you find one that someone left out at the curb.  You give up your cell phone.  No vacations by jet, it’s a drive down to Disneyland.  You get the idea. 3.  After the 1950s, a steadily increasing number of women began working.  As two incomes became the norm, the lifestyle that two incomes could support because the norm.  Now families wanted a 2500 square foot house with a big kitchen and three baths.  They expected a reliable car, a big flat panel TV and an iPhone.  They flew to Disney World instead of driving to Disneyland.  Humans are social animals, so the perception of “necessities” depends mostly on what sort of lifestyle you see among your friends and family.  Keeping up with the Jones. Pundits seem surprised that people now believe it takes two incomes to support a family, whereas one income would have been adequate in the 1960s.  In retrospect, however, this was inevitable once America’s married women decided to enter the labor force in large numbers.  It would have occurred even if real wages had increased 10 times faster. If you don’t believe me, you might want to study more extreme cases, such as China and South Korea, where real wages did increase at least 10 times faster.  If you speak with people from those countries, you’ll often hear claims that the birth rate has fallen to very low levels because it is too costly to raise children today. In one sense, that’s obviously nonsense.  Back in the early 1960s, South Korea was as poor as sub-Saharan Africa and (like Niger today) Korean women had roughly 6 children on average.  Today, South Koreans are vastly richer, even adjusting for the rising cost of living, and they have 0.8 children. In places such as China and South Korea there has been a radical change in expectations, in all sorts of dimensions.  Not just the number of goods that are viewed as necessities, but also the expectations for childrearing.  Far more effort is now devoted toward getting kids into the best universities.   Thus although Chinese and Korean parents are obviously not too poor to have larger families, there may be a sense in which economic factors are influencing family size.  But it has more to do with a change in acceptable lifestyles, rather than in any lack of growth in real wages. (0 COMMENTS)

  The Bureau of Labor Statistics report on inflation that came out today shows that in November, the CPI (not inflation) rose by 0.1 percent in November. That means that in the 5 months from June to November, the CPI has risen by 0.0 percent (July) + 0.1 percent (August) + 0.4 percent (September) + 0.4 percent (October) + 0.1 percent (November) for a total of 1.0 percent. Although one should ideally compound these numbers, they are so low that compounding would make little difference. That means that the annualized rate of inflation for the last 5 months is approximately 2.4 percent. Over those same months, the CPI minus food and energy (the core CPI) rose by 0.3 percent (July) + 0.6 percent (August) + 0.6 percent (September) + 0.3 percent (October) + 0.2 percent (November) for a total of 2.0 percent. Failure to compound is a little more serious here because of the large numbers in August and September, but still not a big mistake. That means that the annualized rate of core inflation for the last 5 months is approximately 4.8 percent. I posted about the inflation rate in November after the October data had been released. (0 COMMENTS)

In late 2008, the Fed was very worried about inflation. But they also faced a financial crisis. In response, they injected liquidity into the financial system system to help banks, while simultaneously instituting a program of paying interest on bank reserves in order to prevent that extra liquidity from boosting aggregate demand. As a result, demand collapsed and we plunged into the Great Recession.   At the time, the Fed was accused of trying to rescue Wall Street without helping Main Street. It might have been better if they had done the reverse. Keep that history in mind when you read this observation from the Financial Times: Central banks could be forced to backstop crucial parts of the financial system that are vulnerable to higher interest rates, undermining their attempts to fight inflation, the Bank for International Settlements warned on Monday. The BIS, dubbed the bank for central banks, said the crisis that unfolded in UK gilt markets in September underlined the risk that monetary authorities could be forced to inject liquidity into financial markets at a time when they are trying to rein in price pressures through higher interest rates and are shrinking their balance sheets. In fairness, the BoE is aware of the issue with moral hazard: Andrew Bailey, the BoE governor, told the Lords economic affairs committee last week that it had been “imperative” to end the operation promptly. The operation constituted a “serious moral hazard problem” — since parts of the market “would love to have the Bank of England permanently offering to buy gilts” — and “was running directly counter to the operation of monetary policy”. If modern economies cannot survive 5% interest rates without triggering a financial crisis, then we need to rethink a wide range of policy issues including both monetary policy and also the various ways that previous government bailouts have tended to encourage more risk taking by financial firms. (0 COMMENTS)

Is the flat income tax revolution underway across the states enough? No, but it must be advanced.  This extraordinary feat includes four states passing a flat personal income tax in 2022 after only four did over the last century. Now 14 states have or will soon have flat income taxes. But if you consider how the nine states without personal income taxes outperform, on average, the nine states with flat income taxes in economic growth, domestic migration, and non-farm payroll employment over the last decade, more is necessary.  While flattening income taxes is important, eliminating them is best. And this should be tied to spending restraint to avoid the infamous Kansas problem of excess spending while cutting taxes. The five states always with a flat income tax were Massachusetts (1917), Indiana (1965), Michigan (1967), Illinois (1969), and Pennsylvania (1971). The next four states initially with progressive income taxes before improving to a flat income tax were Colorado (1987), Utah (2007), North Carolina (2014), and Kentucky (2019).  The four states that passed a flat income tax in 2022 were Idaho (starts in 2023), Mississippi (2023), Georgia (2024), and Iowa (2026). After a recent court decision, Arizona will also have a flat income tax in 2023 at the lowest rate in the nation at 2.5%. This will support greater economic growth as progressive personal income taxes disincentivize people to work and live in those states. This is happening in California, where even its wealthy citizens are fed up with sky-high personal income taxes that will worsen when the top marginal tax rate rises to 14.4% in 2024. According to the American Legislative Exchange Council’s 15th edition of the Rich States, Poor States report that compares the economic performance of the 50 states, the nine states already with a flat income tax rank mostly in the middle of the pack from 2010 to 2020. This includes an average overall ranking for those nine states of 24th based upon three key economic variables with average rankings of 23rd in state gross domestic product (GDP), 29th in absolute domestic migration, and 22nd in nonfarm payroll. The highest overall rankings for these states are Utah (2nd) and Colorado (6th), lowest are Illinois (43rd) and Pennsylvania (45th).  States should seek better outcomes that ultimately help people flourish. The nine states without a personal income tax are Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. These states have average rankings in ALEC’s report of 19th overall, 22nd in GDP, 14th in migration, and 21st in jobs. The highest overall rankings are Florida (3rd) and Washington (5th), with Texas (8th) and Tennessee (10th) also in the top 10, and lowest are Wyoming (41st) and Alaska (49th). Historically, the nine states with the highest personal income tax rates, including California (ranks 19th) and New York (36th), have underperformed in these economic measures and have dire outlooks ranking 48th and 50th, respectively, in ALEC’s report. Progressive, high-income tax structures produce undesirable outcomes, and states should work toward eliminating personal income taxes.  Other taxes and policies matter. The Tax Foundation’s latest report on state business tax climates shows how other taxes influence business activity, and thus economic performance.  States without a personal income tax or lower tax burdens overall rank the highest in business tax climate with Wyoming (1st), South Dakota (2nd), Alaska (3rd), and Florida (4th) leading the way. And those states with the highest personal income rates perform worst with California (48th), New York (49th), and New Jersey (50th) being last. What many of these states without personal income taxes tend to use to fund their spending are consumption-based taxes. The least burdensome form of taxation tends to be a flat final sales tax with the broadest base and lowest rate possible.  Whatever you tax, you get less of it. Taxing consumption results in less consumption but more savings, which can support greater capital accumulation and economic growth while taxing the underground economy, such as drug dealers and undocumented workers.  But the ultimate burden of government is not how much it taxes but how much it spends. Jonathan Williams, who is a co-author of the ALEC report, correctly noted, “There are nine states with no income taxes, and they spend substantially less per capita than states with an income tax.”  When there’s already heavy headwinds imposed by policymakers in Washington and across many states, it’s time to build on the flat tax revolution by cutting or even freezing state budgets, strengthening state spending limits, and eliminating personal income taxes.   Vance Ginn, Ph.D., is founder and president of Ginn Economic Consulting, LLC. He is chief economist at Pelican Institute for Public Policy and senior fellow at Young Americans for Liberty. He previously served as the associate director for economic policy of the White House’s Office of Management and Budget, 2019-20. Follow him on Twitter @VanceGinn. (0 COMMENTS)

The title of a Financial Times story looks nakedly clear: “Iran Executes 23-Year-Old Protester” (December 8, 2022). It was referring to Mohsen Shekari, condemned and hanged for allegedly wounding a praetorian and “fighting with God” during recent protests. Did Iran really do that? Is it only able to? This is far from certain. As a citizen or subject, Mr. Shekari was officially part of Iran, a set of people in a circumscribed geographic space. Does this mean that he is the artisan of his own execution, as Jean-Jacques Rousseau might have claimed? Difficult to believe. He was also part of a part of Iran made of people who obviously disagreed with another part, the latter disagreeing so strongly that it executed Shekari. “Iran” is only the part that executes others. It only represents certain Iranians, minority or majority. What “Iran” means in the Financial Times title is the state or government of Iran or, in practice, those individuals who actually run it. To speak meaningfully and not confusedly, it is the latter, a certain part of Iran, not Iran, that executed Mr. Shekari. Adding “The state of” to the story title would have been useful, as it is analytically useful to look at the social-political world in the perspective of methodological individualism as opposed to holism, organicism, or collectivism. Of course, the Financial Times is far from the only one unaware of, or unsensitive to, these distinctions. One objection is that the way of speaking I criticize is not to be taken literally. It is just a figure of speech, like there are so many in ordinary language. Only mathematics and pure logic avoid them. What we are discussing is related to the “synecdoche,” a figure of speech that consists in substituting the part for the whole—a part of Iran for Iran. Interestingly, this sort of political example of a synecdoche is seldom if ever given, probably because because most people intuitively believe that, in this case, the part is the whole. The political rulers, their agents, their accomplices, and their supporters are deemed to be Iran. Note also that the synecdoche is an especially tortured figure of speech as it can also substitute the whole for the part. For sure, it is sometimes difficult to avoid popular ways of speaking. The common jargon helps being understood and “to belong.” But the problem is that the synecdoche we are talking about can reinforce a confusion about reality. Economist and Nobel laureate Friedrich Hayek complained about “our poisoned language.” It is difficult to speak of individual liberty in Newspeak (see the Appendix on “The Principles of Newspeak” in George Orwell’s Nineteen Eighty-Four). A more tricky issue is the following. To return to Rousseau, aren’t all Iranians, including Mr. Shekari, obligated by their “social contract” to support their government? Classical liberal contractarianism, as opposed to the Rousseauist brand, answers negatively. The basic idea is that a (implicit) social contract needs to be made of rules that can be unanimously consented to by rational individuals, which is not what characterizes Iran and people living under other tyrannies. (See James Buchanan and Gordon Tullock, The Calculus of Consent; James Buchanan, The Limits of Liberty; and Geoffrey Brennan and James Buchanan, The Reason of Rules, of which a review of mine is forthcoming at Econlib. An easy but incomplete book is Buchanan’s Why I, Too, Am Not a Conservative. These arguments raises many questions worth pursuing. Reading my essays on these books is better as a complement or an introduction than as a substitute.) In any liberal or libertarian perspective, the punishment of Mr. Shekari and other resistance heroes by a tyrannical government is a crime. It is not “Iran” that should be punished, but the individuals, including the political bosses at the first rank, who committed the crime. Confusing Iranians with “their” government is an unfortunate linguistic habit that blurs this normative judgement besides making positive analysis difficult. (0 COMMENTS)

In our highly polarized times, everyone seems obsessed with the truth: what is it, who has it, and which side’s got it all wrong. What we don’t seem to care about, says journalist Monica Guzman, is the truth behind perspectives other than our own. Listen as Guzman and host Russ Roberts discuss Guzman’s book I […] The post Monica Guzman on Curiosity and Conversation in Contentious Times appeared first on Econlib.

In a recent podcast with David Beckworth, Noah Smith argued that macroeconomics was still in its infancy. Smith suggested that we needed stronger microfoundations in order to develop rigorous scientific models of the economy.I have a different view. Old Keynesian economics reached a dead end in the 1970s. This led to two major innovations—the expectations revolution and the push for microfoundations. The New Keynesian economics that developed in the 1980s did a much better job of accounting for expectations of variables such as inflation. Since then, various studies have tried to develop strong “microfoundations”, which means a better explanation of how individual people make decisions to consume, save, invest, and work.Nonetheless, I don’t see much evidence for progress in macroeconomics, at least if you define macro as developing useful general equilibrium models of the macroeconomy. Instead of being in its infancy, macro seems to be suffering from senility. In my view, things have reached a dead end and further progress would be more likely to occur if we abandoned the basic Keynesian framework and adopted an entirely different approach to macro.  I’d prefer we stop trying to model consumption, investment, and the other components of spending, and move to a more monetarist approach.  I see macro as being analogous to an inefficient conglomerate than needs to be split up into two independent firms.  Here’s how I’d do the split: Macro 1:  A model of nominal variables such as the price level or (better yet) NGDP, including short run fluctuations and long run trends. Macro 2:  A model of real GDP and employment, including short run fluctuations and long run trends.  The term “nominal” means in money terms, and my proposed Macro 1 would be policy regime dependent.  I’ll give three quick examples: Gold standard:  Back in 1985, Robert Barsky and Larry Summers modeled the price level under a gold standard.  Here’s the abstract: This paper provides a new explanation for Gibson’s Paradox — the observation that the price level and the nominal interest rate were positively correlated over long periods of economic history. We explain this phenomenon in terms of the fundamental workings of a gold standard. Under a gold standard, the price level is the reciprocal of the real price of gold. Because gold is a durable asset, its relative price is systematically affected by fluctuations in the real productivity of capital, which also determine real interest rates. Our resolution of the Gibson Paradox seems more satisfactory than previous hypotheses. It explains why the paradox applied to real as well as nominal rates of return, its coincidence with the gold standard period, and the co-movement of interest rates, prices, and the stock of monetary gold during the gold standard period. Empirical evidence using contemporary data on gold prices and real interest rates supports our theory. A greatly underrated paper. Fixed exchange rate regime:  Under a fixed exchange rate regime, global shocks can impact the equilibrium real exchange rate.  If the nominal exchange rate is fixed by the government, then the domestic price level must move to generate the appropriate move in the real exchange rate.  This model applies to Hong Kong in the post-1983 period.   Unconstrained fiat regime:  This is the one that most of us care about.  I prefer the market monetarist model, where Fed policy determines the path of nominal aggregates such as NGDP.  Even if not directly targeting NGDP, achievement of the dual mandate requires fairly stable growth of NGDP, at roughly 4%/year.  Large fluctuations in NGDP growth are caused by monetary policy errors (except in the rare case where much lower employment is desired, i.e., the spring of 2020.)  The Fed determines the trend rate of NGDP growth, which means that undershoots like 2008-09 and overshoots like 2021-22 are caused by Fed policy mistakes.  Consumption, investment, fiscal policy, trade, animal spirits, etc., play almost no role in determining the path of NGDP.  It’s all about monetary policy targets and policy mistakes. After completing a course in macro 1, students can move on to macro 2.  The path of NGDP then becomes an input into the determination of real variables such as RGDP and employment.  Due to sticky wages and prices, NGDP shocks affect real variables in the short run, but not the long run.  Other “real” shocks (wars, Covid, oil embargoes) can also affects RGDP in the short run.  Only real factors such as population and productivity growth explain RGDP growth in the long run. What’s left to be done?  To achieve a better monetary policy, we need to develop financial instruments linked to the key macro variables such as NGDP, traded in highly liquid markets.  These real time market forecasts can then guide monetary policymakers. How about the real side of macro?  How to we make progress in that area?  Here I’d emphasize that we cannot make progress on understanding real shocks until we can measure them.  And we cannot measure real shocks until we can eliminate nominal shocks.  For instance, Noah Smith believes that 2008-09 was a real shock—a severe financial crisis caused the Great Recession.  I believe it was a nominal shock—a tight money policy by the Fed caused NGDP growth to fall from its 5% trend to negative 3%.  In my view, the financial crisis was 75% endogenous.  Until we get a monetary policy that produces stable NGDP growth, we’ll never be able to figure out who’s right.  We won’t be able to determine how much of the business cycle is real and how much is due to nominal shocks.  Take away the nominal shocks and what’s left of the cycle is real. Macro will have grown up and become a mature field when all we teach is real business cycle theory.  Not because RBC theory is correct (it’s currently false), rather because it will have become correct. PS.  Smith rightly mocks the NeoFisherians for suggesting that a low interest rate policy is a tight money policy.  But the Keynesians are equally guilty when they claim that a low interest rate policy is an easy money policy.  If Turkey refutes NeoFisherianism, doesn’t Japan refute Keynesianism?  Interest rates are not monetary policy.  Never reason from a price change.  PPS.  You might wonder if I have any empirical evidence to support my thesis that macro should split into two fields.  If I am correct, then the Phillips Curve should apply to the gold standard and to Hong Kong, but not to the post-1968 fiat money regime in America.  And that’s exactly what we find.  Phillip’s study looked at the relationship between inflation and unemployment during a period where the price of gold was mostly fixed.  The same sort of relationship holds for Hong Kong post-1982: But the relationship doesn’t hold for the US in recent decades.  The Fed has been trying to eliminate demand shocks, making real shocks relatively more important:    Again, never reason from a price (level) change. 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Like many other people, I have enjoyed giving prompts to ChatGPT, an AI chatbot created by OpenAI. ChatGPT will respond to a wide range of prompts, often in amusing ways, yet often in ways that are surprisingly impressive.  I have seen many of my fellow academics express concern that students will use this type of AI to cheat. I can understand their concern. The AI wrote some material that I could imagine grading favorably. For example, at one point I asked the AI to write a Christopher J. Coyne article. It did not write an article Chris would write. However, it did write a fairly good summary of his excellent book After War: The Political Economy of Exporting Democracy.  However, as OpenAI directly warns users, ChatGPT “may occasionally generate incorrect information.” This is certainly true on economic topics. Every time I have asked ChatGPT about the Alchian-Allen effect, the AI has talked about different economic phenomena, never about the Alchian-Allen effect itself. I imagine the same is true for at least some other economic concepts. Students should be careful about using ChatGPT as a substitute for real research and studying. They certainly should not treat it as though it’s “better than Google” for finding factual information. Instructors concerned about students using ChatGPT to cheat should try directly asking ChatGPT to answer the same questions they ask students. The instructors might be pleasantly surprised by how ineffective cheating using ChatGPT would be. Or they may choose to drop questions that the AI answers too reliably. Does ChatGPT have implications for economic education beyond the academic integrity concerns it raises? Perhaps! I have been having fun asking ChatGPT to write song lyrics. So far I’ve had it write songs about a variety of economic topics, including microeconomics, public choice, and Elinor Ostrom. These types of whimsical prompts could offer educators new and memorable ways to present material, though students might find the results more cringeworthy than appealing.  That said, faculty should also be careful to fact check any educational materials they try to create using ChatGPT. Just as the AI’s errors could cause trouble for unscrupulous students, they might embarrass us too if we’re not careful!   Nathan P. Goodman is a Postdoctoral Fellow in the Department of Economics at New York University. His research interests include defense and peace economics, self-governance, public choice, institutional analysis, and Austrian economics. (0 COMMENTS)

A streetwise analyst does not expect the typical politician to profess a consistent economic theory. The summits reached by Vladimir Putin in this area would be a matter of analytical wonder if they did not also remind us of the lower peaks where our own political rulers stand–as well as of the poor level of general economic literacy. The readers of yesterday’s Financial Times got two good examples in a single story (“Vladimir Putin Threatens to Cut Oil Output After G7 Price Cap,” December 9, 2022). Putin is quoted as saying: If someone agrees at some point that the consumer determines the price, then the whole industry will collapse, because the consumer will always insist on a lower price. Since the consumer always wants to pay the lowest possible price (“insists on a lower price”), one wonders why all industries don’t collapse. Another pearl reported in the Financial Times story (paraphrasing and then quoting Putin): If buyers do manage to get lower prices for oil, “prices will go down, investment will be reduced to zero, and in the end prices will go through the roof.” This is what, in a previous EconLog post, I called the yo-yo economic model. A simple confusion between supply and quantity supplied, and between demand and quantity demanded, leads to this sort of reasoning: if demand decreases, prices will go down; if prices go down, demand will increase; if demand increases, prices with go up (“go through the roof”); and the cycle will repeat. “What goes up must go down.” The confusion is between a move along the demand or supply curve and a shift in the whole curve. (Incidentally, one advantage of a mathematical representation of supply and demand is that one sees that immediately.) In defense of Mr. Putin in both cases, if we can call this a defense, he may have been speaking of the consumer or producer as a nation or country, for he cannot imagine anything else, even as an ideal, than a collective consumer and a collective producer. Run-of-the-mill protectionists fall in the same collectivist trap. (1 COMMENTS)