Normative Narratives

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With Inflation Moderating in Most Sectors, the Fed Should Consider Pausing Rate Hikes

“All You Need Is Love”

Ask any kid what the necessities of life are, and they will come back with a short list including food, water, shelter, and love. As adults we also understand the importance of energy (gasoline and electricity) and money in attaining these needs, as well as the many “wants” of life.

These very necessities–food, energy, housing, and wages–are the current drivers of inflation. This stands in contrast to earlier in the pandemic recovery, when “supply chain issues” caused widespread inflation across consumer goods.

So why then, if these necessities are so important (in life and as current drivers of inflation), am I focusing on data excluding them when calling for a potential pause on rate hikes? Because their prices are less responsive to interest rates.

Most consumer prices are impacted by interest rates; as rates go up so do borrowing costs, putting downward pressure on demand and prices. Food and energy prices, however, are primarily determined on their global markets (which our interest rates have little impact on). Food and energy are also, as just noted, necessities, meaning demand is less responsive to price changes because people need them regardless of price (in economics-speak, their demand is “inelastic“). Interest rates are simply not a good mechanism for impacting food and energy prices.

Shelter is another necessity that has an interesting relationship with interest rates. As the Fed increases interest rates to combat inflation mortgage rates go up, pricing some people out of buying homes and into the rental market. Supply in the rental market is fixed in the short term (due to construction time), and slow to increase in the longer term (largely due to restrictive zoning laws). Increasing demand and fixed supply, combined with higher operating costs and the expiration of pandemic era renter protections, have recently led to large increases in rent. In other words, the Fed’s primary tool for combating inflation could actually be contributing to inflation in housing (peoples’ largest expense category regardless of income).

[Paul Krugman recently cited Jason Furman’s analysis claiming that rental prices are already moderating more than official BLS measures suggest, due to the Bureau’s methodology of tracking lease renewals in addition to newly signed leases. Newly signed leases, which in theory are more reflective of current market conditions than renewals, have been falling more steeply of late. These are two very smart people and their analysis is sound, hopefully it proves true and starts bearing out in official BLS rental indexes in the coming months.]

One Month Doesn’t Make a Trend

“Several Fed officials sought to temper investors’ enthusiasm, warning that there would need to be more evidence of slowing inflation before the Fed will let up on its campaign of rate increases.

‘It could easily go the other way in the next report, and I just don’t want to put too much weight on one month’s data,’ James Bullard, the president of the Federal Reserve Bank of St. Louis, said on Thursday.”

That’s fair, one month’s data doesn’t make a trend. But prices for “core” goods, whose supply chain issues drove inflation earlier in the pandemic, have leveled off since June. Prices for services other than rent (the remainder of what could be considered the “core”, or interest rate responsive economy) were flat in October, but inflation in the services sector has been more persistent. The provision of services is more reliant on labor than goods production is, and labor costs were still rising as of the latest September data.

Source: Bureau of Labor Statistics, Total Factor Productivity

The Producer Price Index (PPI), which tracks prices received by producers and is considered a bellwether of future consumer price movements, has also shown inflation coalescing around food and energy for about four months.

Table B represents intermediate demand goods even further up the supply chain, suggesting continued disinflation / deflation ahead for goods.

There is an element of “reading the tea leaves” when trying to determine the future trajectory of inflation, so the Fed should make use of all the high quality “tea leaves” it has at its disposal. What they show are four months of producer price data reinforcing that the current slowdown in “core” consumer inflation is not an aberration and will likely continue. Four months does make a trend in our current fast-moving environment, and the Fed will have the benefit of two more months of data before the next interest rate setting (“FOMC”) meeting (as well December labor cost data). This will also give the Fed time to see if Furman is correct about moderation in rental markets.

In June 2021 I wrote that we should “Keep Calm and let the Fed Carry On”—asserting that the Fed is an independent, expert body that knows what it is doing. The Fed is still independent and full of experts, but these experts are human and therefore need to check their biases and not be overly risk averse. Every large-scale economic policy carries risks, but the risk of the Fed waiting on rate hikes seems negligible (inflation has moderated if not yet begun to reverse), while the downside of unnecessarily raising interest rates is very real–we could still be facing a recession, especially given uncertainties in the global economy. The higher the interest rate the greater the drag on the economy, so raising rates in the name of fighting inflation–if inflation continues to be driven by markets that are not responsive to interest rates–doesn’t make much sense.

The Fed must also avoid the common mistake of fighting the last war; after in hindsight not doing enough to combat inflation in 2021, it must resist the urge to overcorrect with unnecessarily aggressive rate hikes now. The “smooth landing” of disinflation without a painful recession we all hope for is within reach. I would argue we are currently on that path, and while factors outside America’s control could always derail us, hopefully an overly risk averse Fed does not.

Purposefully Misleading “Forward Guidance”?

My best explanation, or perhaps hope, for what I see as unnecessarily hawkish rhetoric from the Fed, is that it is using “forward guidance” in an unusual manner. “Forward guidance” is exactly what it sounds like: “a tool that central banks use to provide communication to the public about the likely future course of monetary policy.

Forward guidance is usually meant to be as straightforward as possible, but these are unusual times. The Fed may be trying to manifest the future we all want–the “smooth landing” of disinflation without a recession–by purposefully giving stricter guidance than it hopes to have to follow through on.

In other words, the Fed could be trying to impact peoples’ “inflationary expectations”. If people believe the Fed will act aggressively to keep inflation down, they may be less likely to buy more things or demand higher wages in anticipation of even higher future prices, pushing back on those sources of inflation. (It is commonly accepted by economists that inflationary expectations can have a self-fulfilling affect on future inflation rates.) As mentioned earlier, labor costs seem to be the most persistent driver of inflation that is (somewhat) in the Feds control right now, so managing inflationary expectations is a top priority for the Fed.

The Fed can always say one thing now while ultimately making policy based on not yet available data. I hope it is engaging in this tactical (and forgivable) misdirection, because if inflation continues on its current path, actually carrying out the rate hikes the Fed has been signaling would be poor policy. I am not advocating for reducing rates yet, but if two more months of encouraging consumer, producer, and labor price data come in, the Fed should pause rate hikes during the next FOMC meeting Feb 1st.


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Economic Outlook: Developing or Developed, National Investment Into “Quality” Jobs Yields Strong Returns

Original article:

Developing countries that invested in quality jobs from the early 2000s grew nearly one percentage point faster every year since 2007 and were better able to weather the economic crisis than comparable economies, according to a new report by the United Nations labour agency.

The annual report of the International Labour Organization (ILO), The World of Work 2014, focuses this year on the relationship between good jobs and national development through analysis of 140 developing and emerging nations.

Decent work opportunities for women and men help trigger development and reduce poverty,” Guy Ryder, Director-General of the ILO,” said in a news release on the launch of the report, subtitled Developing with Jobs.

“Social protection, respect for core labour standards and policies that promote formal employment are also crucial for creating quality jobs that raise living standards, increase domestic consumption and drive overall growth,” he added.

“In view of the evidence, it is essential to make decent work a central goal in the post-2015 development agenda,” stressed Raymond Torres, Director of the ILO Research Department.

Quality jobs are an important tool for escaping poverty traps. In a recent post, I said that economics is always context sensitive; this does not mean, however, that certain things–such as quality jobs–are not important in all contexts. Whether in a rich or poor country, societies poorest are unable to escape poverty traps because they do not save–they either spend their entire income on survival or short-term luxuries to distract them from life’s problems. While “extreme poverty” (living on less than $1.25 /day, adjusted for purchasing power parity) is confined to the world’s least developed countries (LDCs), relative poverty exists everywhere. While the exact income level needed to escape a poverty trap (the inflection point on the graph above) is context sensitive, the general relationship holds in all contexts.

Underpinning the universality of relative poverty is the inverse relationship between marginal propensity to consume (MPC) and income; the lower ones income, the greater percentage of it they will consume. The flip side of this is low savings–the higher one’s MPC (ranging from 0-1), the lower one’s MPS (MPS + MPC = 1). This inability to save perpetuates a vicious cycle of low productivity, low wages, and low savings resulting in inadequate investment in “human capital” (education, healthcare, etc), which is what causes the low level of productivity in the first place–a poverty trap. While different income groups in different countries have different levels of MPC/S, this general relationship between income, consumption, savings, investment and poverty holds in all contexts.

The U.N. report cited at the beginning of this post focuses on quality job creation in developing countries; I would like to shift the focus to America’s political economy. No politician, particularly in a democracy, would ever say they are opposed to creating quality jobs. Therefore, we must assess the different ideological / policy approaches to quality job creation, in order to determine which approach is most likely to succeed:


Invest in human capital, particularly needs-based investment (which, due to low levels of income / savings, these people cannot afford themselves) to boost worker productivity, physical capital (infrastructure projects),  and growth markets (such as renewable energy) to boost economic output and create jobs in a depressed economy (counter-cyclical fiscal policy).

Raise the minimum wage and support collective bargaining (unionization) to increase take home pay for “blue collar” workers.


Cut spending to reign in the deficit, restoring confidence in the economy so “job creators” (those who hold financial capital) will reinvest into the economy. Perpetuate a “race to the bottom” by discouraging collective bargaining and subsidizing private job creation by providing tax breaks / subsidies to private companies .

Reduce taxes and regulations as much as possible (starve the “beast”). Rely on private actors, market forces, and trickle-down economics to result in the optimal allocation of resources.

Conservatives will point to a low unemployment rate (currently 6.3%) to prove that additional stimulus spending is not needed. Liberals will counter with evidence of wage stagnation and “working poor” to argue that greater labor market intervention is needed. The question then becomes, what is a quality job? Is it simply having a job, or is a minimum salary (perhaps that inflection point) needed? Further clouding the issue is the apparent disconnect between productivity and wages, implying that simply training low wage workers–the typical remedy for escaping “poverty traps”–may be insufficient to create “quality jobs” (and hence the growing minimum wage movement).

History has resoundingly and repeatedly debunked the concept of “trickle down economics” yet it keeps coming up in mainstream political economy discussions–something Paul Krugman would call a “Zombie Idea”. The reason this “zombie idea” persists is relatively straightforward–vested interests with large levels of wealth perpetuate this view through the mainstream media. They state any additional costs (taxes, regulations, wage increases) will cause massive job loss despite record high corporate profits (after taxes) and stock values , and (relatedly) historically low corporate income tax rates.

I leave my readers with this question; which plan to create quality jobs sounds more likely to work to you? Take that answer to the voting booth with you during the 2014 midterm elections, because quality jobs are the key to sustainable human development, economic growth, and social cohesion.


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Economic Outlook: When Gauging Support for Raising the Minimum Wage, Poll its Biggest Opponents

Trend: Minimum Wage -- Real and Nominal Value, 1938-2013

There has been a strong push this holiday season (really dating much farther back) by a variety of labor groups seeking higher minimum wages. Specifically, Walmart employees, Fast-Food Workers, and most recently low-level financial sector employees have taken to the streets to make their demands for “livable wages” heard.

As one who believes in the positive externalities of a more egalitarian society, as well as a proponent of collective action, I am happy to see people using the tools at their disposal to overcome power-asymmetries that have persisted for decades. It would appear that I am not alone in this sentiment–according to Gallup polling, 76% of Americans support raising the minimum wage to $9/hr (69% support raising the minimum wage to $9/hr and indexing the minimum wage to cost of living increases).

Furthermore, the main fear associated with raising minimum wages–that it will lead to higher unemployment–has been debunked:

The idea of fairness has been at the heart of wage standards since their inception. This is evident in the very name of the legislation that established the minimum wage in 1938, the Fair Labor Standards Act. When Roosevelt sent the bill to Congress, he sent along a message declaring that America should be able to provide its working men and women “a fair day’s pay for a fair day’s work.” And he tapped into a popular sentiment years earlier when he declared, “No business which depends for existence on paying less than living wages to its workers has any right to continue in this country.”

Support for increasing the minimum wage stretches across the political spectrum. As Larry M. Bartels, a political scientist at Vanderbilt, shows in his book “Unequal Democracy,” support in surveys for increasing the minimum wage averaged between 60 and 70 percent between 1965 and 1975. As the minimum wage eroded relative to other wages and the cost of living, and inequality soared, Mr. Bartels found that the level of support rose to about 80 percent. He also demonstrates that reminding the respondents about possible negative consequences like job losses or price increases does not substantially diminish their support.

It is therefore not a surprise that when they have been given a choice, voters in red and blue states alike have consistently supported, by wide margins, initiatives to raise the minimum wage. In 2004, 71 percent of Florida voters opted to raise and inflation-index the minimum wage, which today stands at $7.79 per hour. That same year, 68 percent of Nevadans voted to raise and index their minimum wage, which is now $8.25 for employees without health benefits. Since 1998, 10 states have put minimum wage increases on the ballot; voters have approved them every time. But the popularity of minimum wages has not translated into legislative success on the federal level. Interest group pressure — especially from the restaurant lobby — has been one factor.

The social benefits of minimum wages from reduced inequality have to be weighed against possible costs. When it comes to minimum wages, the primary concern is about jobs. The worry comes from basic supply and demand: When labor is made more costly, employers will hire less of it. It’s a valid concern, but what does the evidence show?

For the evidence, lets turn to Dr. Krugman, who succinctly explains the evidence against this valid concern, and how “good” this evidence is:

Still, even if international competition isn’t an issue, can we really help workers simply by legislating a higher wage? Doesn’t that violate the law of supply and demand? Won’t the market gods smite us with their invisible hand? The answer is that we have a lot of evidence on what happens when you raise the minimum wage. And the evidence is overwhelmingly positive: hiking the minimum wage has little or no adverse effect on employment, while significantly increasing workers’ earnings.

It’s important to understand how good this evidence is. Normally, economic analysis is handicapped by the absence of controlled experiments. For example, we can look at what happened to the U.S. economy after the Obama stimulus went into effect, but we can’t observe an alternative universe in which there was no stimulus, and compare the results.

When it comes to the minimum wage, however, we have a number of cases in which a state raised its own minimum wage while a neighboring state did not. If there were anything to the notion that minimum wage increases have big negative effects on employment, that result should show up in state-to-state comparisons. It doesn’t.

So a minimum-wage increase would help low-paid workers, with few adverse side effects.

But what do these “egg-heads”, in their “ivory-towers” know? They are out of touch with the real world! The person who suffers from minimum wage increases is not the academic, or even the large corporation. It is the small business owner who suffers–Mom and Pop! Well, Gallup polled small business owners on their thoughts of minimum wage increases, and responses were not as overwhelmingly negative as one would think:


They were also polled on the effects of a minimum wage increase on how they invest back into their business:


The majority of small business owners responded they would not reduce their current workforce (64%) or reduce worker benefits (60%) if the minimum wage was increased. The largest negative effect would be a reduction in capital spending (38%). However, in the context of a divergence of worker compensation from productivity, and a declining share of income going to labor (in favor of capital), perhaps such a re-balancing is not such a bad thing.

Small business owners are not thrilled about the prospect of a minimum wage increase–they are not expected to be. However, the fact that nearly half support raising the minimum wage says something about small business owners.

Perhaps they recognize peoples purchasing power is tied to their wages, so increasing wages will eventually lead to higher sales (especially considering minimum wage employees have a much higher marginal propensity to consume than wealthier people). Or perhaps these people are simply more in touch with what happens in the communities they live in than their big-business contemporaries. They know people living on the minimum wage aren’t lazy people waiting for a government handout; they are their friends, family, and customers. Perhaps they believe that more egalitarian communities are friendlier, safer places, and are willing to pay a little extra in order to achieve that goal. 

Increasing the minimum wage is overwhelmingly popular, and more popular among small business owners than one would expect. Furthermore, it would save billions of dollars in Welfare programs by ending an implicit subsidy for businesses who pay non-livable wages and stimulate the economy by redistributing income to people who are more likely to spend it.

The time to act has come; people are literally taking to the streets. It is also important to index the minimum wage to cost of living increases, so we do not experience the declining real minimum wage we have had for the past 4 decades. Indexing also avoids a political battle every-time the cost of living changes (which it constantly does).

I for one am interested and excited to see the myriad benefits that decreasing poverty rates and reversing the trend of increasing income inequality have on American society as a whole.