10/21/2005

Daily Kos: Revolt of the Economists

Revolt of the Economists
by Stirling Newberry
Wed Oct 19, 2005 at 05:51:38 AM CDT

The Nobel Memorial Prize for economics is often an award for full dress wingnuttery - the parade of hard right economists who have taken the stage in Sweden and extolled the genius of the reactionary regime in economics is legion - Schelling, Prescott, Mundell. They did brilliant formal work, but also used the pulpit provided to go far beyond economics and into politics. The architecture of economics that they have built is centered around a simple idea: allow asset inflation, and then keep the people who roll the money over very, very, very happy. The problems of "rational expectations" economics could simply be called "the rich rent the world to the rest of us".



The rise of a new economics is at hand - one which overthrows "rational expectations" and the Friedman-Mundell economy. The first shots of that rebellion have been fired - over inflation and unemployment. And not strangely, the libertarians are selling the ammo.

An economy has to be believed to be seen. One doesn't measure most economic variables directly, but must sift them out of other observations. This means that when a new economic policy regime comes into existence, it often adjusts statistics so that it is measuring the responsiveness to its incentives. For the Friedman-Mundell economy, this has been embodied in changes to the Unemployment Rate and the Consumer Price Index which take asset inflation off the table as part of inflation. The more radical FMers argue that we should also change the way the savings rate is calculated, so that asset inflation is counted as "savings". Basically if you bought a house for 200K and it is now worth 500K, when the value of renting that house has only gone up 50%, the FMer argues that you have 200K of "personal savings".

But economic policy regimes only work so long as people believe the drift of what the numbers tell them. If unemployment feels low, and the number is low, then people think it probably is low. However, in the recovery from the 2001 recession, more and more people in the financial and economic world have openly questioned whether the current economic paradigm is measuring the world that voters and consumers live in.
The first blow to confidence was the stream of absolutely unbelievable jobs projections from the Bush executive attached to their tax cuts. In order to produce the number of jobs that they promised, American productivity would have had to crater. While productivity has taken a hit, it didn't crater. Brad DeLong was all over this one like red marks on a failed macro pop quiz.
The second was the NBER changing the rules to end the 2001 recession early. By the old rules, the recession would not have ended until May of 2003 or perhaps August of 2003. The result is that the recovery conforms to no known rules of recoveries past. No economy has produced so much "GDP" and so little employment.
And this slogging recovery lead to the first open break: namely, the unemployment rate stopped resembling what people experienced. Even as jobs were scarce, and payroll employment crept upwards, the unemployment rate sank as people took non-paying jobs, illegal immigrants were counted in jobs but not population - the UI rate marched downwards.
At the same time CPI remained nominally subdued. And this too made no sense in two key ways. First of all, energy and food are supposed to vary around the core rate of inflation in the economy - whether Keynesian or FMer - part of the economic perscription is to prevent raw material costs from climbing the curve of diminishing returns. What this means is that at a certain point, the next barrel of oil is more expensive than the last, and the one after that is more expensive still, and so on. Staying off of the steep part of that curve is important.
For some time the "core" rate of inflation has been low, while energy has spiralled upwards. This is a contradiction in terms. A "core" rate of inflation can only be "core" if removing other variables only reduces volility, and doesn't change the trend line. This is basic skedastics (study of volatility).

The other complaint was about the two waves of changes made to the CPI number - the first in the early 1980's which took out housing inflation, and the second in the mid 1990's which took out shoe leather costs and changed the basis of inflation from constant relative standard of living to constant absolute standard of living. These two changes have shaved a great deal off of inflation, and that has been used to lower social security costs, since social security is linked to CPI-U.
What should have been done was create an CPI-R, Consumer Price Index for retired people. This should not have included housing asset inflation - since retired people are cashing out, not in, to houses, but it should also have reflected the enormous gains in health inflation, since for retired people this is a larger component. This would have restrained the government from allowing health inflation.
Since January I have been using government numbers to calculate a CPI-W that reflects rising home costs - it runs almost 2% above the official number. The Mess That Greenspan Made calculates a series. The result, the recent home boom is inflationary. Combined with Greenspan's own calculations of "equity extraction", and my theory from 2004 - namely that all of the hiring in the economy is pure "Phillips Effect" - inflationary - job creation, is confirmed. We don't have low unemployment, we have high inflation for a large sector of the work force, and another large sector of the work force that is just dropping out of the cash economy and sneaking by.
In short, the reverse of the 1960's, when America was depovertized.
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The other part of the equation is the creation of a large protected economy. If asset inflation is encouraged, then, logically, we should see effort moving away from capital - and exports, and towards rent, and those forms of economic activity that are shielded from import competition. And so we have. All of the job creation has been from housing, health care and homeland security. The US has not created one net export job in this recovery.
This becomes a vicious circle - protected economy rewards people in the protected economy, which encourages people to invest in the protected economy, which creates asset inflation, and pulls in more capital to the protected economy, which means the need for more revenue reductions, and again, lower and lower expectations from export.

This vicious circle was supposed to be propped up by Iraq - steal the one thing we need export dollars for - oil, and that would allow the circle to spin a lot longer. It would also create an export target. It was a brute force attempt to create a colony as a market for goods, and as a source of raw materials. Meanwhile money would be put in the hands of the upper class which ran the military contracting apparatus.
There is a word for this in 1770 - mercantilism. The current right wing order, by focusing on the problem of keeping the privileged in the system is neo-mercantilist.
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All this may sound like inside baseball - dense with econospeak. However, what it means is explosive. The left is now on the forefront of having ideas - economic ones - which measure a different economy, and point to a different series of incentives. Instead of creating asset inflation - and with it resource inflation - to drive the economy, it points the way to shifting economic incentives away from rent and extraction and towards capital formation. The reality isn't that the right wing is capitalist against a socialist left wing, the reality is that the right wing is neo-mercantilist, against a neo-capitalist/neo-socialist left.
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So what is the bottom line. The bottom line is this - if the FM economy worked, then we have nothing to worry about - inflation is low, though with some pressures, unemployment is low, so there is plenty of room to raise interest rates, and everyone should be happy as the economy takes off for a boom phase of the expansion. But the evidence, even from the inside, is that the FM economy is not working - that instead of 5.1% unemployment and 4.9% CPI, the reality is that inflation is 7.2% and the labor slack number is 7.2%. Instead of a nice misery index of 10%, the reality is a crushing 14.4%
In line with the FM economy - the solution being proposed is taxing the consumer to pay for the privileged to profit. Better luck next life America, and thank you for playing "How to Cheat the greedy electorate".

The next year will tell, and the evidence, from wall street, the bond market and the public is, that we are about to spin the FM dial. What are we going to replace it with? The answer is complex, and it will require some examination of ideas that are more prevalent on the libertarian right than the left. You see, libertarians and liberals think about an issue which doesn't bother conservatives and reactionaries much, namely the problem of "the veil of money". And it is the question of money that is going to dominate the transition to the next century.



Daily Kos: Revolt of the Economists

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