What is the government's budget deficit? It is the difference between the government's expenditures and its income in a given year. The government's expenditures must be financed--if not by income, then by borrowing. Hence, the budget deficit is the contribution that a given year makes to the public debt.
What causes the budget deficit to grow? If the government's expenditures rise, other things being equal, or if the government's income falls, other things being equal, the budget deficit increases. That's it. It is always one, the other, or both that cause the deficit to swell. Consequently, any recipe for shrinking the budget deficit must involve less expenditures, more income, or some mix of the two.
Why does the budget deficit matter? The government's savings is, like for a household, the difference between its income and its expenditures in a given year. Thus, a bigger budget deficit implies less public savings. As long as decreases in public savings do not induce equal or offsetting increases in private savings, therefore, a bigger budget deficit makes for less national savings. Less national savings either contracts the supply of loanable funds, expands the demand for loanable funds, or both, raising the natural rate of interest. A higher natural rate of interest, other things being equal, stimulates the aggregate demand for goods and services (AD).
The central bank is usually tasked with managing AD by way of managing the market rate of interest. If AD was previously on target, by the central bank's lights, then the market rate of interest will be raised in order to offset the AD stimulus induced by the swelling of the budget deficit. Thus, under normal circumstances, a bigger budget deficit raises interest rates. At higher interest rates, private borrowers do not wish to borrow as much, which means that the government's additional borrowing is "crowding out" some private borrowing. In most cases, therefore, it only makes sense to increase the budget deficit if we have reason to believe that the government's borrowing will prove to be more productive than the private investment it is crowding out.
Additionally, the government's financing need not come solely from domestic lenders. Foreign lenders who wish to buy the government's debt will first have to exchange their own currency for the domestic currency. This expands the demand for the domestic currency, causing it to strengthen in foreign exchange markets. A stronger currency makes importing from the domestic country more expensive, causing the domestic country's exports to fall. Thus, a bigger budget deficit also produces a bigger trade deficit.
There is also a question of how the debt produced by bigger budget deficits is to be retired. One option is to roll over the debt, which is to say, borrow some more to make principal and interest payments on the debt in a timely manner. This is feasible so long as interest rates on government debt remain low. Another option is to increase the government's savings, by increasing its income (collecting more tax revenues), decreasing its expenditures, or a bit of both, in order to pay down the debt. A final option is to default on the debt.
The first option is the most painless. A government's ability to service its debt depends upon its power to tax its citizens, for this is its only (significant) source of income. As a result, the higher a country's GDP, the more able it is to service its debt, for this makes possible the raising of greater tax revenues. A government's ability to service its debt, therefore, is best revealed by its debt-to-GDP ratio, rather than its debt in absolute terms. So long as the country's economy is growing as fast, or faster, than the government's debt, investors do not have cause for concern. In such cases, the government typically enjoys low interest rates, making rolling over its debt feasible (forever, potentially).
The second option is more or less painful depending on the circumstances. Economic growth raises the government's income--often reducing its expenditures on safety net programs, too--thereby increasing its savings without anyone making sacrifices. In countries with serious growth problems, or serious debt problems, though, this may not be enough. In such cases, sacrifices must be made. Either tax rates go way up, expenditures go way down, or both. The more growth-friendly the reforms, and the more slowly they're phased in, the less painful the transition. The longer a country waits to make these sacrifices, the more hurried and more extreme they have to be.
If a country's debt problems get out of hand, the result is a 'hard landing'. Investors lose confidence in the government's ability or willingness to service its debts, so they charge higher interest rates for the greater risk they're bearing. Higher interest rates, in turn, worsen the government's finances, causing investors to charge even higher interest rates, worsening the problem further, etc. Eventually, it becomes impossible for the government to service its debts through either economic growth or budget reforms (see, e.g., Greece). At that point, the choice is between explicit default, or implicit default through debt monetization. Only countries with their own currencies have the latter option, and this option usually serves to slow the aforementioned interest rate death spiral. Both courses subject economies to severe financial/macroeconomic dislocation in the short run (due to either banking panics or currency crises), and much higher borrowing costs in the long run.
There's more to say on the subject, but the short story is: maintain budget deficits when crowding out is not much of a problem (i.e., when financing productive public investments, in the midst of a recession, etc.), but maintain budget surpluses the rest of the time, so that investors chillax and the government doesn't risk a hard landing. Don't wait to fix long-term deficit problems--the more thoughtfully they're approached, and the more slowly they're implemented, the happier the outcome. And don't worry so much about future generations. Debt is indeed a burden upon them, but they'll be richer than us, so, whatever.
ADDENDUM: In the United States, bigger budget deficits have not, of late, raised interest rates. The reason is that the US central bank, the Federal Reserve, would like to see lower interest rates, but its policy rate is near zero (its lower bound). As a result, the Fed has not raised interest rates in order to offset bigger budget deficits--in effect, it is having fiscal policy to do some of the work (of stimulating AD) that would normally be performed entirely by monetary policy. Nor have investors lost confidence in the US government (yet!), because they expect currently bloated budget deficits to shrink substantially as the US economy returns to full employment. The real deficit problem in the US stems from the implicit liabilities of Medicare, Medicaid, Social Security, etc. Without reform, these programs imply (under plausible assumptions) unsustainably large budget deficits that would, almost surely, shake investor confidence. Investors have been giving us quite a bit of breathing room to reform these programs, but the longer we take to do so, the more likely it is that we (or the next generation) will suffer a hard landing.
Sunday, February 5, 2012
Saturday, February 4, 2012
Misconceptions concerning inflation, Pt. II
Misconception #4: Inflation is the very same thing as printing money. Define inflation however you like--be my guest. Just note that if inflation is defined to be the printing of money, then the dominant theory of inflation, the quantity theory of money (QTM), becomes a tautology. The QTM says that x% money growth, in the long run, causes x% inflation. If inflation is the very same thing as printing money, then the QTM says that inflation leads to inflation in the long run. No shit. Let's call rises in the price level 'schminflation', then, so we can carry on.
Misconception #5: Inflation causes bubbles, which cause busts. I should begin by observing that no one has a definition of "bubble" that satisfies anyone else. Note that just as the US housing bubble was supposedly developing, home prices were appreciating in many other countries, too. While US prices eventually came crashing down, prices in many other countries (e.g., Canada) have kept on rising. Have these countries figured out ways to keep their bubbles from bursting, or should we conclude that the diagnosis of bubbles ought to be left to Captain Hindsight? Prices go up, then they go down, then up, then down, ... What insight is gained when we conclude that some one upturn followed by a downturn was a bubble, when no one can systematically identify bubbles ex ante?
In any event, below is the inflation rate during the 2000s:
And here is the Case-Shiller home price index during that same period:
Which came first, the housing bubble or the uptick in inflation? And which was first to reverse course? As for bubbles causing busts, note that the housing market began to fall apart long before the broader economy followed suit. Indeed, the collapse in the housing market didn't even accelerate once the economy went into the tank. By contrast, inflation lingered at 2.0-2.5% per year before plunging in concert with the broader economy. A prescient paper by Ben Bernanke (with a coauthor) contends that the responsibility of monetary policy is not to identify bubbles in order to burst them, but rather to keep the broader economy stable as it absorbs the shock. The economy didn't tank because the housing bubble burst; it collapsed because the Fed failed to keep AD on target. Had the Fed been aggressive enough in its response, the housing bubble would've ended with a whimper, not a bang. And it wouldn't make a difference whether we thought the movement in home prices was a bubble or not. Inflation would seem, correctly, to have nothing to do with any of it.
Misconception #5: Inflation causes bubbles, which cause busts. I should begin by observing that no one has a definition of "bubble" that satisfies anyone else. Note that just as the US housing bubble was supposedly developing, home prices were appreciating in many other countries, too. While US prices eventually came crashing down, prices in many other countries (e.g., Canada) have kept on rising. Have these countries figured out ways to keep their bubbles from bursting, or should we conclude that the diagnosis of bubbles ought to be left to Captain Hindsight? Prices go up, then they go down, then up, then down, ... What insight is gained when we conclude that some one upturn followed by a downturn was a bubble, when no one can systematically identify bubbles ex ante?
In any event, below is the inflation rate during the 2000s:
And here is the Case-Shiller home price index during that same period:
Which came first, the housing bubble or the uptick in inflation? And which was first to reverse course? As for bubbles causing busts, note that the housing market began to fall apart long before the broader economy followed suit. Indeed, the collapse in the housing market didn't even accelerate once the economy went into the tank. By contrast, inflation lingered at 2.0-2.5% per year before plunging in concert with the broader economy. A prescient paper by Ben Bernanke (with a coauthor) contends that the responsibility of monetary policy is not to identify bubbles in order to burst them, but rather to keep the broader economy stable as it absorbs the shock. The economy didn't tank because the housing bubble burst; it collapsed because the Fed failed to keep AD on target. Had the Fed been aggressive enough in its response, the housing bubble would've ended with a whimper, not a bang. And it wouldn't make a difference whether we thought the movement in home prices was a bubble or not. Inflation would seem, correctly, to have nothing to do with any of it.
Misconceptions concerning inflation
We want a positive rate of inflation in order to keep the unemployment rate at tolerably low levels. We want a low rate of inflation in order to minimize relative price distortions due to price stickiness. Most importantly, we want a stable rate of inflation in order to facilitate intertemporal transactions (for example, almost every financial transaction). Occasionally, we may want a higher than normal inflation rate (now is one of those times) in order to lower real interest rates when nominal interest rates are stuck at zero. Normally, however, a low, positive, and stable rate of inflation is what we seek, and ever since Paul Volcker broke the back of unstable, double-digit inflation during the early '80s, the central bank of the United States, the Federal Reserve System, has more or less delivered on those inflation objectives. Why, then, do some people worry so much about inflation, and insist upon monetary regime change in order to contain an inflation problem that exists only in their own minds?
Misconception #1: Inflation hurts those who save. Recall the lending example in my previous post. If I naively lend you my savings, without taking inflation into account, then I will end up getting back less than I was expecting. If inflation is stable, however, I need only adjust the interest rate I charge you for the rate of inflation in order to get back exactly what I was expecting. In general, so long as inflation is stable, savers need not fear it, for they may simply demand higher interest rates to compensate them for it, which is what savers in fact do. (This is why high inflation is correlated with high interest rates, low inflation with low interest rates, etc.) The only savers that stable inflation hurts are those who save by hoarding cash (by stuffing it under their mattresses, for example). These people, however, have nobody to blame but themselves. Even in the context of perfect price stability (0% inflation), the rate of return on cash is inferior to equally safe alternatives (e.g., Treasury securities). And if you're really concerned about inflation, you can always buy TIPS (Treasury inflation-protected securities), which adjust Treasury yields for CPI inflation. The reality is even the most insecure people typically don't stuff a lot of cash under their mattresses; instead, they stick their cash in government-insured bank deposits. And banks, of course, adjust their interest rates for inflation. Savers have nothing to fear, therefore, besides unpredictable inflation, but everyone has a stake in keeping inflation predictable, not just the savers.
Misconception #2: Inflation raises people's cost of living. Inflation is any rise in the general level of prices. Hence, the more inflation we experience, the higher the price of gas, right? The higher the price of gas, the higher your cost of living, right? Not quite. Inflation does show up in higher gas prices, but it also shows up in higher wages. Much like savers adjust interest rates to compensate for inflation, workers adjust wages for the same reason. Even though gas prices are higher, so is your income, which means gas is just as affordable now as it was when gas prices were lower. The same reasoning applies to other commodities. Inflation raises the prices of the things you buy, but it also raises the amount of money you have with which to buy those things. It has nothing to do, therefore, with your cost of living. What does determine your cost of living? One word: scarcity. The less stuff there is, the more expensive it is to buy. If higher gas prices raise your cost of living, it is not because the Fed is printing too much money. Rather, it is because there's not enough gas out there to support the previously lower price of gas. Unfortunately, Dr. Bernanke is not known for his oil drilling skills, seeing as the only way he may lower gas prices without also lowering your wages is by drilling for more oil.
Misconception #3: The gold standard is the best recipe for keeping inflation in check. This is probably the nuttiest idea out there. The gold standard is a monetary regime in which the money supply is adjusted over time in order to keep the money-price of gold fixed. The idea is that gold's value is inherently stable, and thus the value of money would be thereby stabilized. Here's the problem: suppose miners in South Africa unexpectedly discover enormous reserves of gold. Such a discovery would sharply depress the goods-and-services-price of gold, but in order for the money-price of gold to remain fixed, the goods-and-services-price of money would have to fall sharply, too, generating a sudden burst of inflation. Sound stable to you? Or consider a historical example: just before the Great Depression, France began hoarding lots of gold, for reasons unknown to the rest of the world. This raised the goods-and-services price of gold dramatically, which under the gold standard meant that the good-and-services price of money had to rise dramatically, too. The result was that France imposed catastrophic deflation on every country on the gold standard, triggering the Great Depression. How do we know this? Countries like China and Spain, which were not on the gold standard, suffered only mild recessions, and essentially no deflation, because of the collapse of their trading partners. Every country on the gold standard plunged into depression, in the midst of historically rapid deflation. But here's the best part: the timing with which countries began to recover from the Great Depression is precisely the timing with which countries abandoned the gold standard. Here is US industrial production at the beginning of the Depression:
Guess what happened right at the trough in early 1933? FDR took the US off the international gold standard. For serious.
The last few decades show that determined central banks are perfectly capable of keeping inflation at low, positive, and stable rates, without surrendering monetary policy to the random forces at play in the gold market. Why, oh why, does anyone want to go back on the gold standard?
Misconception #1: Inflation hurts those who save. Recall the lending example in my previous post. If I naively lend you my savings, without taking inflation into account, then I will end up getting back less than I was expecting. If inflation is stable, however, I need only adjust the interest rate I charge you for the rate of inflation in order to get back exactly what I was expecting. In general, so long as inflation is stable, savers need not fear it, for they may simply demand higher interest rates to compensate them for it, which is what savers in fact do. (This is why high inflation is correlated with high interest rates, low inflation with low interest rates, etc.) The only savers that stable inflation hurts are those who save by hoarding cash (by stuffing it under their mattresses, for example). These people, however, have nobody to blame but themselves. Even in the context of perfect price stability (0% inflation), the rate of return on cash is inferior to equally safe alternatives (e.g., Treasury securities). And if you're really concerned about inflation, you can always buy TIPS (Treasury inflation-protected securities), which adjust Treasury yields for CPI inflation. The reality is even the most insecure people typically don't stuff a lot of cash under their mattresses; instead, they stick their cash in government-insured bank deposits. And banks, of course, adjust their interest rates for inflation. Savers have nothing to fear, therefore, besides unpredictable inflation, but everyone has a stake in keeping inflation predictable, not just the savers.
Misconception #2: Inflation raises people's cost of living. Inflation is any rise in the general level of prices. Hence, the more inflation we experience, the higher the price of gas, right? The higher the price of gas, the higher your cost of living, right? Not quite. Inflation does show up in higher gas prices, but it also shows up in higher wages. Much like savers adjust interest rates to compensate for inflation, workers adjust wages for the same reason. Even though gas prices are higher, so is your income, which means gas is just as affordable now as it was when gas prices were lower. The same reasoning applies to other commodities. Inflation raises the prices of the things you buy, but it also raises the amount of money you have with which to buy those things. It has nothing to do, therefore, with your cost of living. What does determine your cost of living? One word: scarcity. The less stuff there is, the more expensive it is to buy. If higher gas prices raise your cost of living, it is not because the Fed is printing too much money. Rather, it is because there's not enough gas out there to support the previously lower price of gas. Unfortunately, Dr. Bernanke is not known for his oil drilling skills, seeing as the only way he may lower gas prices without also lowering your wages is by drilling for more oil.
Misconception #3: The gold standard is the best recipe for keeping inflation in check. This is probably the nuttiest idea out there. The gold standard is a monetary regime in which the money supply is adjusted over time in order to keep the money-price of gold fixed. The idea is that gold's value is inherently stable, and thus the value of money would be thereby stabilized. Here's the problem: suppose miners in South Africa unexpectedly discover enormous reserves of gold. Such a discovery would sharply depress the goods-and-services-price of gold, but in order for the money-price of gold to remain fixed, the goods-and-services-price of money would have to fall sharply, too, generating a sudden burst of inflation. Sound stable to you? Or consider a historical example: just before the Great Depression, France began hoarding lots of gold, for reasons unknown to the rest of the world. This raised the goods-and-services price of gold dramatically, which under the gold standard meant that the good-and-services price of money had to rise dramatically, too. The result was that France imposed catastrophic deflation on every country on the gold standard, triggering the Great Depression. How do we know this? Countries like China and Spain, which were not on the gold standard, suffered only mild recessions, and essentially no deflation, because of the collapse of their trading partners. Every country on the gold standard plunged into depression, in the midst of historically rapid deflation. But here's the best part: the timing with which countries began to recover from the Great Depression is precisely the timing with which countries abandoned the gold standard. Here is US industrial production at the beginning of the Depression:
Guess what happened right at the trough in early 1933? FDR took the US off the international gold standard. For serious.
The last few decades show that determined central banks are perfectly capable of keeping inflation at low, positive, and stable rates, without surrendering monetary policy to the random forces at play in the gold market. Why, oh why, does anyone want to go back on the gold standard?
Friday, February 3, 2012
Let's talk about inflation, baby
Inflation is a concept that many people seem to struggle with. A brief overview may be helpful.
What is inflation? Inflation is any rise in the general level of prices. What, then, is the price level? It is the average price of goods and services produced by the economy. Suppose, for example, that the price of everything doubles over the course of a year. In that case, the average price of goods and services--that is, the price level--doubles, too. The rate of inflation, in turn, averages 100% per year.
What determines the rate of inflation? The price level is determined by the intersection of the aggregate demand (AD) schedule and the aggregate supply (AS) schedule. Thus, the rate of inflation is determined by the rates of change of AD and AS.
The value of money is determined by the intersection of the money demand schedule and the money supply schedule. The prices of goods and services are quoted in units of money. As a result, it makes sense to think of the price level as the money-price of goods and services, and the value of money as the goods-and-services-price of money. These variables are two sides of the same coin. A higher price level means that one needs more money to buy the same goods and services, implying a lesser value for money. A lower price level means that one needs less money to buy the same goods and services, implying a greater value for money. The price level is thus simultaneously determined by the intersection of the money demand schedule and money supply schedule. Consequently, the rate of inflation is simultaneously determined by the rates of change of money demand and money supply.
The economic function of inflation is to concurrently equilibrate the market for goods and services (AD and AS) and the market for money (money demand and money supply). Suppose, for illustration, that the government creates some extra money, with which it buys things. This expands the money supply, putting downward pressure on the value of money, which in turn puts upward pressure on the price level. The result, in equilibrium, is inflation. Another way of seeing this play out is as follows: when the government buys these things, it puts extra money in the hands of people who were previously satisfied with their money balances. Not needing to add to their money balances, they spend the money instead, expanding AD, putting upward pressure on the price level. Again, the equilibrium result is inflation. The reverse experiment, contracting the money supply, puts downward pressure on the price level, the equilibrium effect of which is deflation (the opposite of inflation).
Why does the rate of inflation matter? First, in the short run, prices are sticky. The higher the rate of inflation, the faster each price must adjust in order for relative prices to remain the same. Price stickiness means that some prices may not keep up with the rest, altering relative prices, causing resources to be misallocated.
Second, inflation instability undermines intertemporal transactions. Suppose I lend you $100, to be paid back in one year at a 10% per year interest rate. A year from now, you will pay me back $110. If, in the interim, the rate of inflation averages 20% per year, then $110 in next year's dollars is equivalent to $91.67 in this year's dollars. You'll pay me back less, in real terms, than I intended. If instead I charge you a 32% per year interest rate, then a year from now you'll pay me back $132, which is equivalent to $110 in this year's dollars. By modifying the interest rate that I charge, I may nullify the effects of inflation. I can only do this, however, if the rate of inflation is predictable. If it isn't, then I do not know how much I will be paid back, regardless of the interest rate I charge; hence, I will be discouraged from entering into this transaction in the first place.
Third, there is a short-run tradeoff between inflation and unemployment. More AD/money supply, in the face of sticky prices, boosts employment at the expense of higher inflation, while less AD/money supply contains inflation at the expense of lower employment.
Ergo, the dual mandate of macroeconomic policymaking: maximum employment (enough AD/money supply to fully employ the labor force) and stable prices (not so much AD/money supply as to produce high and/or unstable inflation). The question, then, is which regime is most conducive to fulfilling this dual mandate. I believe the answer is NGDP targeting, but either way the above is most everything you need to know about inflation. In my next post, I'll try to put to rest some misconceptions about inflation. (E.g., inflation is bad for savers, inflation raises people's cost of living, the gold standard is the best policy for managing inflation, etc.)
What is inflation? Inflation is any rise in the general level of prices. What, then, is the price level? It is the average price of goods and services produced by the economy. Suppose, for example, that the price of everything doubles over the course of a year. In that case, the average price of goods and services--that is, the price level--doubles, too. The rate of inflation, in turn, averages 100% per year.
What determines the rate of inflation? The price level is determined by the intersection of the aggregate demand (AD) schedule and the aggregate supply (AS) schedule. Thus, the rate of inflation is determined by the rates of change of AD and AS.
The value of money is determined by the intersection of the money demand schedule and the money supply schedule. The prices of goods and services are quoted in units of money. As a result, it makes sense to think of the price level as the money-price of goods and services, and the value of money as the goods-and-services-price of money. These variables are two sides of the same coin. A higher price level means that one needs more money to buy the same goods and services, implying a lesser value for money. A lower price level means that one needs less money to buy the same goods and services, implying a greater value for money. The price level is thus simultaneously determined by the intersection of the money demand schedule and money supply schedule. Consequently, the rate of inflation is simultaneously determined by the rates of change of money demand and money supply.
The economic function of inflation is to concurrently equilibrate the market for goods and services (AD and AS) and the market for money (money demand and money supply). Suppose, for illustration, that the government creates some extra money, with which it buys things. This expands the money supply, putting downward pressure on the value of money, which in turn puts upward pressure on the price level. The result, in equilibrium, is inflation. Another way of seeing this play out is as follows: when the government buys these things, it puts extra money in the hands of people who were previously satisfied with their money balances. Not needing to add to their money balances, they spend the money instead, expanding AD, putting upward pressure on the price level. Again, the equilibrium result is inflation. The reverse experiment, contracting the money supply, puts downward pressure on the price level, the equilibrium effect of which is deflation (the opposite of inflation).
Why does the rate of inflation matter? First, in the short run, prices are sticky. The higher the rate of inflation, the faster each price must adjust in order for relative prices to remain the same. Price stickiness means that some prices may not keep up with the rest, altering relative prices, causing resources to be misallocated.
Second, inflation instability undermines intertemporal transactions. Suppose I lend you $100, to be paid back in one year at a 10% per year interest rate. A year from now, you will pay me back $110. If, in the interim, the rate of inflation averages 20% per year, then $110 in next year's dollars is equivalent to $91.67 in this year's dollars. You'll pay me back less, in real terms, than I intended. If instead I charge you a 32% per year interest rate, then a year from now you'll pay me back $132, which is equivalent to $110 in this year's dollars. By modifying the interest rate that I charge, I may nullify the effects of inflation. I can only do this, however, if the rate of inflation is predictable. If it isn't, then I do not know how much I will be paid back, regardless of the interest rate I charge; hence, I will be discouraged from entering into this transaction in the first place.
Third, there is a short-run tradeoff between inflation and unemployment. More AD/money supply, in the face of sticky prices, boosts employment at the expense of higher inflation, while less AD/money supply contains inflation at the expense of lower employment.
Ergo, the dual mandate of macroeconomic policymaking: maximum employment (enough AD/money supply to fully employ the labor force) and stable prices (not so much AD/money supply as to produce high and/or unstable inflation). The question, then, is which regime is most conducive to fulfilling this dual mandate. I believe the answer is NGDP targeting, but either way the above is most everything you need to know about inflation. In my next post, I'll try to put to rest some misconceptions about inflation. (E.g., inflation is bad for savers, inflation raises people's cost of living, the gold standard is the best policy for managing inflation, etc.)
It's morning in America
US economy grows 243,000 jobs in the month of January. In other news, Obama is looking to be a safer bet for re-election everyday.
Addendum: I should explain what I think is happening. In part two of my series on the jobs crisis, I said that too-high (cyclical) unemployment is due to interest rates being too high. To be more precise, there is a so-called "natural" rate of interest, which is the interest rate that would equate planned savings and planned investment, keeping aggregate demand on target. Aggregate demand management involves moving the market rate of interest to keep up with movements in the natural rate of interest. The Fed has been keeping its policy rate near zero since late 2008, so why is the (cyclical) employment situation improving? My view is that the natural rate of interest is rising, which effectively makes the Fed's unchanged stance more expansionary than it was previously.
Why is the natural rate of interest rising? Well, folks haven't been spending a whole lot (hence weak aggregate demand). Consumer durables (e.g., cars) only work for so long. At some point, you cannot delay that new car purchase any longer, so, you have to borrow more (more planned investment) and consume more (less planned savings). Together, that makes for a higher natural rate of interest. In other words, when a recession hits, consumers delay a lot of discretionary purchases until they're more comfortable with their financial circumstances, but you can only delay such purchases for so long. This crisis has been going on so long, and Americans are sufficiently impatient, that they're starting to go ahead with those purchases anyway. And that means that the Fed is effectively stimulating aggregate demand more than it was before, even if its interest rate policy is effectively the same (though they have been dragging out the first projected rate hike for some time, so that probably helps, too). If enough people begin to replenish their consumer durables, a self-sustaining recovery may be underway, as long as the Fed doesn't prematurely strangle it. Hence, it's morning in America...I think. (Buy stocks, sell bonds).
P.S. Matt Yglesias agrees with me to an eery extent. In fairness I generally see things the same way he does...
Addendum: I should explain what I think is happening. In part two of my series on the jobs crisis, I said that too-high (cyclical) unemployment is due to interest rates being too high. To be more precise, there is a so-called "natural" rate of interest, which is the interest rate that would equate planned savings and planned investment, keeping aggregate demand on target. Aggregate demand management involves moving the market rate of interest to keep up with movements in the natural rate of interest. The Fed has been keeping its policy rate near zero since late 2008, so why is the (cyclical) employment situation improving? My view is that the natural rate of interest is rising, which effectively makes the Fed's unchanged stance more expansionary than it was previously.
Why is the natural rate of interest rising? Well, folks haven't been spending a whole lot (hence weak aggregate demand). Consumer durables (e.g., cars) only work for so long. At some point, you cannot delay that new car purchase any longer, so, you have to borrow more (more planned investment) and consume more (less planned savings). Together, that makes for a higher natural rate of interest. In other words, when a recession hits, consumers delay a lot of discretionary purchases until they're more comfortable with their financial circumstances, but you can only delay such purchases for so long. This crisis has been going on so long, and Americans are sufficiently impatient, that they're starting to go ahead with those purchases anyway. And that means that the Fed is effectively stimulating aggregate demand more than it was before, even if its interest rate policy is effectively the same (though they have been dragging out the first projected rate hike for some time, so that probably helps, too). If enough people begin to replenish their consumer durables, a self-sustaining recovery may be underway, as long as the Fed doesn't prematurely strangle it. Hence, it's morning in America...I think. (Buy stocks, sell bonds).
P.S. Matt Yglesias agrees with me to an eery extent. In fairness I generally see things the same way he does...
Thursday, February 2, 2012
A guide for IT contractors
Contracting is the oldest form of outsourcing and it's on the up and up yet again. Let's face it, companies don't want real employees any more; they want proper semicolon use and people that they can say adios to at a moment's notice. Budget cut? No problem, just unload the contractors to close the gap. Sudden multimillion dollar integration project for only a year- zing, bring on 10 contractors to cover the new work load. Hey don't get me wrong, if you're a contractor it's a great way to make some dough - I left a full time position at a stagnate mom-and-pop consultanting firm for a 8 month contract and a 60% pay raise. (Then again I was getting screwed over at the other job).
If you're a first time contractor, taking that first step is like trying to swallow Oprah Winfrey without gnawing on her first - it's not easy even if you cover her in delicious jam. It's a world of uncertainty but you're highly rewarded for it, right? When I made the leap I was concerned with one thing - how much was I getting paid versus what I was currently making. The choice was simple - take the higher pay and be happy for 8 months and worry about it later. Heck, in IT there is always another opportunity if your IQ falls above 75 and can string together buzz words.
The part no one prepared me for was the perception that I was just a warm body. A no-name individual, sitting in a sea of cubicles, doing some generic task that could be farmed out easily. The weird thing was, it was everyone that interacted with me - even themoney laundering err, pass-through company that was actually paying me. You'd hear grumblings about contractors associating with employees or how bad the job market was (from your recruiter) and not to even bother looking. Everything was glum, heck it felt like the Great Depression other than the fact that I was raking in the bennies. Nothing that TeknologySystems (name changed to protect their identity - haha eff you guys) did for me was beneficial to me. The account manager always talked about the lack of margin on the account - come to find out later that the margin was actually 40% which in my book is awesome given they provide nothing to the contractor other than funnel money. I even had to watch my paycheck every week, on 8 different occasions did they under pay me for hours worked.
Maybe it was my hatred of car salesmen and the fact that the account manager acted like his was the only shop in town. Or maybe it was the lack of communication on how long I actually had a job for (he was notorious for asking the contractor if they were extended or not - isn't the the role of the account manager?). Something lead me to get out and stick it to the man. Knowing that giving 2 weeks notice would leave him in a tight spot never felt so good. Knowing that he'd be put in a room with managers reaming him out on how he could let the warm body fly away. The kicker was, I left the contracting job to work for the same company I was contracted out to...take that one MB. The final straw in the loving relationship was 6 months after I left for the perm position, after running into the account manager in the hall and the first words out of his mouth being "You still have a job here?" Reliving that moment, consistently is the onset of tears of joy - knowing that somehow, by me simply finding a job elsewhere made his life miserable for a few, however short, moments.
Alright, enough personal attacks. Working as a contractor isn't all that bad. You have a certain bit of uncertainty for the future but you're compensated in the form of a fat pay check. Don't expect to get any benefits or lovey-dovey hugs from the ones that are pimping you out - to them you are a warm blob of genetic material. Use contracting as a way to break into new markets - in my case I got a salary position for the same amount I was contracting for (pretty sure I was getting ripped off - well I know I was but the opportunity made up for it). Bottom line, if this is your first time giving it a try, ask around on what an average pay rate is for that type of position otherwise you'll get burned. Might also steer away from certain pimp firms as they are notorious for only caring about themselves even if their facade tells you otherwise.
If you're a first time contractor, taking that first step is like trying to swallow Oprah Winfrey without gnawing on her first - it's not easy even if you cover her in delicious jam. It's a world of uncertainty but you're highly rewarded for it, right? When I made the leap I was concerned with one thing - how much was I getting paid versus what I was currently making. The choice was simple - take the higher pay and be happy for 8 months and worry about it later. Heck, in IT there is always another opportunity if your IQ falls above 75 and can string together buzz words.
The part no one prepared me for was the perception that I was just a warm body. A no-name individual, sitting in a sea of cubicles, doing some generic task that could be farmed out easily. The weird thing was, it was everyone that interacted with me - even the
Maybe it was my hatred of car salesmen and the fact that the account manager acted like his was the only shop in town. Or maybe it was the lack of communication on how long I actually had a job for (he was notorious for asking the contractor if they were extended or not - isn't the the role of the account manager?). Something lead me to get out and stick it to the man. Knowing that giving 2 weeks notice would leave him in a tight spot never felt so good. Knowing that he'd be put in a room with managers reaming him out on how he could let the warm body fly away. The kicker was, I left the contracting job to work for the same company I was contracted out to...take that one MB. The final straw in the loving relationship was 6 months after I left for the perm position, after running into the account manager in the hall and the first words out of his mouth being "You still have a job here?" Reliving that moment, consistently is the onset of tears of joy - knowing that somehow, by me simply finding a job elsewhere made his life miserable for a few, however short, moments.
Alright, enough personal attacks. Working as a contractor isn't all that bad. You have a certain bit of uncertainty for the future but you're compensated in the form of a fat pay check. Don't expect to get any benefits or lovey-dovey hugs from the ones that are pimping you out - to them you are a warm blob of genetic material. Use contracting as a way to break into new markets - in my case I got a salary position for the same amount I was contracting for (pretty sure I was getting ripped off - well I know I was but the opportunity made up for it). Bottom line, if this is your first time giving it a try, ask around on what an average pay rate is for that type of position otherwise you'll get burned. Might also steer away from certain pimp firms as they are notorious for only caring about themselves even if their facade tells you otherwise.
Issue #1: Unemployment in America, Pt. III
The recipe for a lower unemployment rate, then, is lower interest rates. Why isn't the US government delivering? Well, the Federal Reserve, the central bank of the United States, which is responsible for setting interest rate policy, lowered its policy rate to essentially zero in late 2008, in response to the bottom falling out of the US economy. But why didn't it lower it some more? Why didn't the Fed go negative?
Suppose you have cash on hand. Your decision is whether to lend it to others or not. The Fed has pushed interest rates below zero. What do you do? I dunno about you, but I'd hang onto my cash. Why? Simple--cash earns (nominal) interest at a rate of precisely 0% per year. Zero sounds pretty bad, but I'd prefer zero to, say, negative three. Thus, if the Fed tries to push its policy rate into negative territory, folks will just hoard their cash, which does nothing for the unemployed.
What, in that case, can the Fed do for the unemployed under these circumstances? The Fed may no longer be able to lower interest rates today, but don't forget about tomorrow. Interest rates won't remain at zero forever, so there is surely a time at which the Fed is expected to raise interest rates. What the Fed can do today is to convince the public that it will not raise interest rates until there is enough aggregate demand to fully employ America's labor force.
Here is a picture of aggregate demand, as measured by nominal gross domestic product (NGDP) over the last decade:
Notice that when NGDP plunged, so did employment. Notice also that even though it has stopped plunging, we never caught up with the pre-crisis trend. That's why unemployment has remained so stubbornly high.
What the Fed ought to do is to make a commitment to keep interest rates near 0% until NGDP recovers to its pre-crisis trend level. In short, the solution to high unemployment is NGDP targeting. Think I'm pulling this out of my ass? Here's Goldman motherfucking Sachs. (Note that I was totally on this first--Jan Hatzius, bow to your sensai.)
That, my fellow Americans, is what I would do to put you back to work. Just hang in there for 13 years.
Next up: fossil fuels, deforestation, global warming, etc...
[Earlier posts in this series:
Announcing my bid for the US presidency
Issue #1: Unemployment in America
Issue #1: Unemployment in America, Pt. II
]
Suppose you have cash on hand. Your decision is whether to lend it to others or not. The Fed has pushed interest rates below zero. What do you do? I dunno about you, but I'd hang onto my cash. Why? Simple--cash earns (nominal) interest at a rate of precisely 0% per year. Zero sounds pretty bad, but I'd prefer zero to, say, negative three. Thus, if the Fed tries to push its policy rate into negative territory, folks will just hoard their cash, which does nothing for the unemployed.
What, in that case, can the Fed do for the unemployed under these circumstances? The Fed may no longer be able to lower interest rates today, but don't forget about tomorrow. Interest rates won't remain at zero forever, so there is surely a time at which the Fed is expected to raise interest rates. What the Fed can do today is to convince the public that it will not raise interest rates until there is enough aggregate demand to fully employ America's labor force.
Here is a picture of aggregate demand, as measured by nominal gross domestic product (NGDP) over the last decade:
Notice that when NGDP plunged, so did employment. Notice also that even though it has stopped plunging, we never caught up with the pre-crisis trend. That's why unemployment has remained so stubbornly high.
What the Fed ought to do is to make a commitment to keep interest rates near 0% until NGDP recovers to its pre-crisis trend level. In short, the solution to high unemployment is NGDP targeting. Think I'm pulling this out of my ass? Here's Goldman motherfucking Sachs. (Note that I was totally on this first--Jan Hatzius, bow to your sensai.)
That, my fellow Americans, is what I would do to put you back to work. Just hang in there for 13 years.
Next up: fossil fuels, deforestation, global warming, etc...
[Earlier posts in this series:
Announcing my bid for the US presidency
Issue #1: Unemployment in America
Issue #1: Unemployment in America, Pt. II
]
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