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Inflation Reduction Act? How Can Spending Be Disinflationary?!

Well a couple of ways, but first, a quick primer on whats been going on with prices lately

Overall, inflation is a function of aggregate demand (henceforth referred to as “demand”) and aggregate supply (“supply”). Demand is the sum of Personal Consumption (C), Investment (I), Government Spending (G), and Net Int’l Trade (Exports – Imports). Supply is all the goods and service producers can supply, a function of the cost of labor (wages) and various inputs (materials, energy, etc.). Consumption accounts for by far the largest portion of the U.S. economy, roughly 70% of demand. Different markets, both in different areas and for different goods or services, realize different inflation rates (some markedly so). To keep things relatively simple, for now lets just consider overall price levels.

Early in the pandemic, savings increased (for many) due to a combination of stimulus money and restrictions on many things people typically spend disposable income on. Once vaccines came out and the economy reopened, people were flush with cash (demand increased), but supply chain issues, global events (Russia-Ukraine War, China’s Zero-Covid policy), and shortages of workers (as COVID reoriented people’s calculus on what they are willing to do and for how much), caused input shortages and increased costs for producers, some of which were passed on to customers in the form of higher prices.

Hindsight is 20/20 as to whether the government “spent too much” during COVID. In the decades preceding the pandemic, increases in demand had been absorbed by a private sector eager to increase supply in order to reap greater profits, with little impact on inflation; globalization created a seemingly endless supply of “stuff” in wealthy countries like America. It was reasonable, if ultimately wrong, to use the models of recent history to forecast what would happen going forward. Early in the pandemic the primary focus was on shoring up demand and reducing personal hardship, which is why the CARES act and subsequent extensions of enhanced unemployment insurance (UI) benefits passed with bipartisan support–inflation simply wasn’t on most lawmakers’ radars.

If the Democrats made a unilateral mistake, it was parts of their American Rescue Plan (ARP)–stimulus checks and extending enhanced UI benefits–that were no doubt politically popular at the time but may have fueled inflation by increasing demand at a time the economy couldn’t absorb it. Some parts of the ARP, particularly the expanded child tax credit and aid to state and local governments, were needed (the latter likely had little impact on inflation; more on that in a moment when we discuss the “multiplier”.) But it is fair to say that Democrats may have overreached with some aspects of the ARP.

I have focused on fiscal policy (spending) because that is the primary story with respect to inflation right now. Yes, the Fed can also impact prices by increasing interest rates (lowering consumption and business spending.) But raising rates comes at a cost to the labor market, one which the Fed didn’t want to take in 2021 when full employment seemed like the more pressing of its dual mandates (and inflation was seen as being transitory.) Furthermore, real consumption has returned to be more-or-less in line with what it would have been if COVID never happened, meaning right now inflation is primarily due to the supply-side factors noted earlier, which the Fed has little power to affect regardless of how much it chokes off growth by raising interest rates.

Not all fiscal policy is equal, that’s on purpose

Not all government spending is equal in its intended goals (obviously, specific programs are sold to the public to address specific needs.) Less obviously, not all spending is equal in its impact on inflation. The extent to which government spending impacts demand (and therefore inflation) is known as the “multiplier”–how much each dollar of government spending increases economic output.

The exact multiplier for a policy is never truly known, there are too many variables to perfectly tease it out in the short run, let alone over time. Generally speaking the multiplier is a function of how much spending affects personal consumption, which as mentioned before makes up about 70% of U.S. GDP and is the surest route to short-term economic impact.

Fiscal policy can be predominantly “counter-cyclical”, directly targeting short-term consumption and business spending. Examples include COVID era spending policies like stimulus checks, enhanced UI benefits, and the Payroll Protection Program, or tax cuts (like the Bush era tax cuts, and a surprisingly large portion of Obama’s post-Great Recession stimulus package.)

These policies main goal is to have a high multiplier–they leverage government money to try to increase demand at a time when the private sector is pulling back (hence “counter-cyclical”.) Normally, as demand rises, businesses hire more people to meet that demand (increasing supply by adding jobs), starting a virtuous cycle of growth in the economy; it goes without saying that the past two and a half years have not been normal times in any sense, including economically.

Alternatively, fiscal policy can be predominantly structural–aimed at addressing the root causes of poverty or other structural inequalities or deficiencies in society. These policies also increase demand by increasing government spending, but their multiplier is lower than counter-cyclical “stimulus spending” because the money is going to longer-term investments in public goods and human capital, not to putting money in people’s pockets to consume more now.

So when is fiscal policy disinflationary?

Fiscal policies that increase demand typically aren’t disinflationary in the short run, but they can have essentially no impact on inflation depending on their multiplier. In the long run, some types fiscal policy can be quite disinflationary.

The Inflation Reduction Act is disinflationary for a straightforward reason–it actually lowers demand, with more tax revenue being raised than money spent. It will also help bring down the cost of prescription drugs by allowing Medicaid to negotiate directly with pharmaceutical companies.

The infrastructure bill is disinflationary in the long run because it will make us more productive. Investments in concrete infrastructure and ports will help people and products get where they’re going quickly and safely. Replacing lead waterpipes will lead to less stunted cognitive development in our youth. Investing in broadband will help bridge the “digital divide” that cuts many poorer and rural people out of the 21st century economy. The bill had a negligible impact on inflation in the short run (notice no large increase in real GDP from before it was passed in Q3 2021 till now) despite injecting a large amount of government money into the economy ($550 billion in new spending), because the money is being disbursed over a longer period of time and isn’t going directly into people’s pockets.

Even after passing the infrastructure bill, the Inflation Reduction Act, and the China-countering Chips and Science Act, many parts of “Build Back Better” (BBB) still need to be passed. 17 Nobel prize winning economists signed a letter saying that, in addition to its primary benefits, BBB would “ease longer-term inflationary pressures” despite its huge price tag. Specifically, investments in affordable childcare and universal pre-K would bring down the cost of childcare and bring caretakers back into the labor market, increasing the supply of labor and easing pressure on wages. More seats at community colleges and apprenticeships would create alternate paths to gainful employment, increasing productivity, reducing student loan debt, and driving down the cost of a four year degree. Allowing anyone to buy into a Medicaid “public option” would inject competition into the health insurance market, lowering prices. These are exactly the “kitchen table” economic policies that Democrats (and ideally some Republicans) should campaign on in 2022 and ’24.

Lawmakers should also embrace the concept of “supply-side progressivism”, another example of spending that can reduce inflation (note that it complements and synergizes with the more traditional approach of providing financial support to poorer people, it does not replace it.) Supply-side progressivism means the government actually creates the things the private sector does not supply enough of affordably. By taking ownership the government removes the need to make a profit, making the product more affordable (like Medicaid vs. private insurance.) Generally speaking profitability is of course desirable, but some markets supply things that are so important for society and the economy that affordable access is more important than profits. Removing the need to profit, and directly increasing supply, can greatly reduce price pressure in imperfect markets.

Most markets function well in the U.S. and require minimal intervention, but not all of them. Some markets, particularly those for necessities, deviate greatly from the textbook concept of “perfect competition”, and thus are prime candidates for supply-side progressivism. Housing, higher education, healthcare, and childcare–all areas where price increases have far outstripped overall inflation in recent history–are good places to start. Looking at how prices have increased for these things over the past four decades; consider the cost that has imposed on all Americans (particularly the poor), and the strain it has put on the federal budget. Clearly the status quo isn’t working.

(Value = % change since July 1982. For example, tuition, fees, and childcare have increased 926.94% over the last 40 years, compared to a 302.84% increase for all items)

Don’t get me wrong, college is still a good investment for those who graduate from a good school with a degree. But the ability to get into a good school–and then remain in until completion–has increasingly become a function of family wealth. Of course there will always be anecdotal examples of social mobility in a country as large and advanced as America, but on a macro level the “American Dream” is no longer attainable for most.

The Inflation Reduction Act, and any future spending proposed to address structural deficiencies in our society, will be attacked as reckless–“Spending?! With inflation as high as it is!” This is a gross oversimplification. For one, there are reasons to believe inflation has already peaked and will start to come down in the coming months. But more generally speaking, some types of spending–the types America has sorely needed for decades–would have little impact on inflation in the short run, and actually reduce it in the long run (in addition to all of its other primary benefits.)

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Economic Outlook: Why to NOT Raise The Social Security Retirement Age–Labor Force Participation and the “Life-Cycle of Employment”

Original article, courtesy of Politifact:

During the Republican presidential debate in North Charleston, S.C., Sen. Ted Cruz, R-Texas, took aim at the nation’s economic record under President Barack Obama.

“The millionaires and billionaires are doing great under Obama,” Cruz said. “But we have the lowest percentage of Americans working today of any year since 1977. Median wages have stagnated. And the Obama-Clinton economy has left behind the working men and women of this country.”

Cruz is on to something. One key employment statistic known as the civilian labor force participation rate is at its lowest level since the 1970s. This statistic takes the number of Americans in the labor force — basically, those who are either employed or who are seeking employment and divides it by the total civilian population.

Here’s a chart going back to the mid 1970s.

When the civilian labor force participation rate is low, it’s a concern, because it means there are fewer working Americans to support non-working Americans.

…a notable factor in the decline of the labor-force participation rate is the aging of the Baby Boom generation. As more adults begin moving into retirement age, the percentage of Americans who work is bound to decline.

…there’s another way to read Cruz’s words. He said “the lowest percentage of Americans working” since 1977, which could also refer to a different statistic, the employment-population ratio. This statistic takes the number of people who are employed and divides it by the civilian population age 16 and above.

The difference in this case is that using the employment-population ratio, Cruz’s statement is incorrect. Unlike the labor-force participation rate, the employment-population ratio has actually been improving in recent years, although it’s below its pre-recession highs.

Here’s a chart showing this statistic over the same time frame:

If you exclude the Great Recession, the employment-population ratio was last at its current rate in 1984, not 1977.  So by that measurement, he’s close.

(Note: this blog will not meaningfully address the other major labor market issue raised by Senator Cruz–stagnant wages. Nor will it discuss strategies to alter America’s aging demographic. The primary focus is labor force participation by different age groups, the relationship between older workers staying in the workforce longer and youth unemployment, and how those issues are related to America’s Social Security system.

It is not my intention to spark inter-generational warfare, but rather to point out that a “fix” commonly floated to bring America’s fiscal house in order–raising the Social Security eligibility and retirement ages–could have significant unintended negative consequences).

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A declining labor force participation rate is worrisome. Even the more positive statistic (employment-population ratio) is cause for concern.

But as important as what is happening, is why it is happening. Failure to accurately answer this question risks the wrong policy response, which would at best fail to solve the problem and at worst further exacerbate it. The conservative camp would undoubtedly focus on the welfare state and disincentives to work. The liberal camp would probably focus on economic inequality and the resulting lack of opportunity facing many poor, mostly minority youths.

I am not interested in getting into a partisan debate, although my regular readers know which side I generally fall on. What neither side is likely to consider (because it does not fit neatly into either economic narrative) is in what age ranges most of the employment to population ratio change has taken place. To shed some light on this, lets look at a recent analysis done by the Bureau of Labor Statistics (The BLS numbers use the 16 and older employment-population ratio definition. In the interest of full disclosure, I work for the BLS, but not in any employment statistics capacity. Furthermore, the views expressed in this blog are my own, and are not the views of the BLS).

Group Participation rate Percentage-point change
1994 2004 2014   1994–2004 2004–14  
Total, 16 years and older 66.6 66.0 62.9 -0.6 -3.1
16 to 24 66.4 61.1 55.0 –5.3 -6.1
16 to 19 52.7 43.9 34.0 -8.8 -9.9
20 to 24 77.0 75.0 70.8 -2.0 -4.2
25 to 54 83.4 82.8 80.9 -0.6 -1.9
25 to 34 83.2 82.7 81.2 -0.5 -1.5
35 to 44 84.8 83.6 82.2 -1.2 -1.4
45 to 54 81.7 81.8 79.6 0.1 -2.2
55 and older 30.1 36.2 40.0 6.1 3.8
55 to 64 56.8 62.3 64.1 5.5 1.8
55 to 59 67.7 71.1 71.4 3.4 0.3
60 to 64 44.9 50.9 55.8 6.0 4.9
60 to 61 54.5 59.2 63.4 4.7 4.2
62 to 64 38.7 44.4 50.2 5.7 5.8
65 and older 12.4 14.4 18.6 2.0 4.2
65 to 74 17.2 21.9 26.2 4.7 4.3
65 to 69 21.9 27.7 31.6 5.8 3.9
70 to 74 11.8 15.3 18.9 3.5 3.6
75 to 79 6.6 8.8 11.3 2.2 2.5
75 and older 5.4 6.1 8.0 0.7 1.9
Age of baby boomers 30 to

48

 40 to

58

 50 to

68

The change in labor force participation seems to have been driven primarily by:

  1. Fewer younger people working
  2. More elderly people working

In fact, the decline of prime working age labor force participation (say 25-55) over the last 20 years has been quite small.

It is true that once you get to the older age brackets (especially 60+), the group represents a smaller percentage of the overall population (see Table 1), so you cannot compare different groups percent changes directly. But even factoring in percentage of the total population, increases in elderly workers have had a significant impact on overall employment. As America’s population continues to get older, it will have an even greater impact:

age distribution over time

Furthermore, according to BLS Employment Projections (2014-2024), these age related labor trends are expected to continue into the future:

The labor force participation rate for youth (ages 16 to 24) is projected to
     decrease from 55.0 percent in 2014 to 49.7 percent in 2024. The youth age
     group is projected to make up 11.3 percent of the civilian labor force in
     2024 as compared with 13.7 percent in 2014. In contrast, the labor force
     participation rate for the 65-and-older age group is projected to increase
     from 18.6 percent in 2014 to 21.7 percent in 2024. This older age group is
     projected to represent 8.2 percent of the civilian labor force in 2024 as
     compared with 5.4 percent in 2014.

One could argue that older and younger people generally do not occupy the same job. Sometimes this is true, sometimes it is not. Furthermore, any given firm could have an older person making a lot of money in a position they intend to fill with more than one entry level worker. This is all anecdotal–without doing more research the exact relationship between older and younger workers and job openings is unknown–but surely there is some relationship (probably one that varies greatly by industry).

Next time a politician talks about raising the Social Security eligibility and retirement ages, consider:

  1. Poorer people (who rely on Social Security the most) are not living longer.
  2. Keeping people working longer means less jobs available to younger people. This also contributes to the exploding student loan debt problem in America (even those who do graduate college have a difficult time getting good paying jobs, at least partially because of competition from older, more qualified workers).

Both of these related issues–youth un(der)employment and student loan debt–create a drag on the economy, as younger people delay starting their “adult lives” (starting families, buying homes, etc.). This drag on the economic growth leads to–you guessed it–less job creation. Based on the BLS numbers, we clearly need to make youth employment a greater priority, as ignoring the problem compromises both current and future economic growth.

When we consider raising the Social Security eligibility age, we must consider unintended consequences. To responsibly increase the eligibility age, the government would have to launch a youth employment program. This could offset most (if not all) of the savings associated with raising the retirement age. Perhaps instead of raising the eligibility age, we should consider making social security a needs-based program, eliminating the cap on taxable income, or both. This may not be “fair” to people who have paid the most into the program (or those who have been more financially conservative throughout their lives), but it would make the Social Security system more financially sustainable, without the unintended negative consequences.

America does not  have to enact policies that exacerbate youth unemployment and/or discomfort poorer elderly people in order to save a few bucks. Our strong financial system and global faith in America’s creditworthiness ensures we can continue to finance important programs (for people of all ages) with long term economic implications. But this global faith in America’s creditworthiness is predicated on the belief that we can correctly identify and address our structural economic problems (and thus continue to grow and repay our debts). To preserve this faith, we must work across the partisan divide to responsibly and sustainably address these problems, not recycle stale partisan arguments that are largely unrelated to the problems at hand.


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Economic Outlook: Of Minimum Wages and Employment (Revisited)

Another hot button topic during the 2014 midterm election season are candidates stances on increasing the federal minimum wage.

This past February, the CBO released its analysis of the effects of a federal minimum wage increase on economic growth, employment, and poverty. Those on the political right seized on the reports projection that raising the minimum wage could result in 1 million fewer jobs in America.

I found Jared Bernstein’s Economix blog on the subject pretty even-handed (click here to see my previous blog on the topic):

It is important to recognize that there is a very wide range of estimates from which the budget agency can choose, as shown in the chart below, which plots results of the employment effect from dozens of studies (from a recent set of slides from the White House Council of Economic Advisers).  This wide range does not imply that the budget office made a mistake, though it looks to me as if it applied a higher job-loss estimate than is the current consensus among economists who’ve closely studied the issue.

Note:

As the chart shows, the employment impact from this “meta-analysis” clumps around zero, which is why the report finds that the policy is a significant net plus from the perspective of low-wage workers: Many more workers get a raise from the policy than are displaced from their jobs.” (Jared Bernstein, Economix blog)

There is no policy I can think of that generates only benefits without any costs, and policy makers always have to weigh the two sides. In the case of the minimum wage, on the benefits side of ledger, the budget office shows that 16.5 million low-wage workers would directly get a much-needed pay increase at no cost to the federal budget.

16.5 million workers will benefit from a $10.10 minimum wage by 2016, 900,000 will be raised out of poverty, with negligible effects on the federal budget.

—

The CBO report was a projection. What have minimum wage “experiments”, carried out in America’s “laboratories of democracy” (states and municipalities), revealed?

The White House told us they were referring to the seasonally adjusted growth of non-farm jobs since December 2013. So we crunched the numbers for state-level employment data, which is collected by the Bureau of Labor Statistics.

The comparison involved nine states that increased their minimum wage automatically early in the year to keep pace with inflation (Arizona, Colorado, Florida, Missouri, Montana, Ohio, Oregon, Vermont and Washington) plus four more states that passed new laws to hike the wage (Connecticut, New Jersey, New York and Rhode Island). The other side consisted of 37 states that didn’t boost their minimum wage at all.

Using the second method — the one that gives greater weight to high-population states — we found that job growth over that eight-month period averaged 1.092 percent in the wage-raising states, compared to 1.090 percent in the non-wage-raising states. That’s a higher rate of job growth in the minimum-wage-raising states — but by the almost comically narrow margin of 2/1,000ths of one percent.

From this 8-month comparative analysis, we can see that minimum wage changes have had essentially no impact on employment levels. The meta-analysis seems to have been vindicated–I guess economists are good for something after-all.

What does this mean? Which stance on minimum wage increases has been vindicated? I would say it has to be the pro-minimum-wage-increase side of the debate.

Increasing the federal minimum wage is not meant to be a “job-creating” policy; its primary purpose is to redistribute income from the top of the economic pyramid (wage payers) to the bottom (wage earners). It is a “market” solution that does not require taxation and welfare spending, so money would not go to those “lazy welfare recipients” (this is not my view, however a significant proportion of Americans do view welfare recipients this way, and it is necessary to consider alternative perspectives when trying to pass legislation in a democracy).

One may think such an inequality / poverty reducing solution would be agreeable to proponents of “small government”, and one would be wrong. Since opponents of increasing the minimum wage cannot assail deficit spending going to undeserving recipients, they have relied on the “jobs lost” argument. Fortunately, this argument becomes less and less viable the more it is challenged and disproven.

Raising the minimum wage does not just address the “symptoms” of inequality / poverty–there are important long term / inter-generational implications of minimum wage increases. Having more money enables people to build their skills, take more entrepreneurial risks, and provide better upbringings for their children (which obviously affects their earning capacity later in life).

—

“Meta-analysis” of the effects of minimum wage increases on employment clustered around zero, and these findings have been backed up by the non-partisan statistics produced by the Bureau of Labor Statistics (in the interest of full disclosure, I should mention that I work for the BLS, although my job has nothing to do with employment statistics).

The mechanism by which minimum wage increases raises poorer peoples income is straightforward. How people would choose to use their new-found income is less straightforward–some will predominately invest in into their and their families futures, while others will use the majority for instant gratification. While not as targeted as a welfare program, raising the minimum wage is the most politically viable solution to America’s inequality problems.

Contemporary American political discourse is dominated by the related themes of “equality of opportunity” and “social mobility”. Raising the federal minimum wage would bring immediate relief to America’s poorest workers, while moving closer to the utopian goal of “equality of opportunity”. Furthermore, it would accomplish these goals without any meaningful impact on employment rates or the federal budget.

Some redistribution of income in necessary; inequality is a drag on economic growth, and poverty is a root cause of many other societal ills. History has proven over and over again that “trickle-down” economics does not work. Minimum wages should also be linked to the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), periodically (once per year?) increasing to reflect changes in cost of living.

If our federal government continues to fail in this regard, leaders at the state and municipal level must step-up–this is a matter of both present and future socioeconomic justice.