Glenn on the Economic Policies Necessary to Increase Growth

Image showing scientific research generated by GTP-4o

Note: The following op-ed first appeared in the Wall Street Journal.

The Trump Economic Awakening

Traditional policies like tax cuts, targeted aid and responsible spending can deliver stronger growth.

Political scientists will debate the forces that shaped Donald Trump’s victory, but one thing is clear: Americans yearn for a change in economic policy. Voters have rejected the interventionist policies that brought inflation and high deficits. They want an economic awakening, a new way forward that uses traditional economic policies to achieve Mr. Trump’s goal of more jobs for Americans whose fortunes have been harmed by technological change and globalization.

Any economic path to a successful awakening begins with growth: the engine that powers individual income and our collective ability to support the nation’s defense, economy, education and healthcare industry. To pursue this growth, the new administration should consider at least three measures:

First, by working with Congress, it should build on the successes of the Tax Cuts and Jobs Act of 2017 to make permanent the expensing of business investment. Second, it should increase support for science and defense research, which would have significant spillover to the commercial sector, particularly in space exploration. Third, it should build on this research by constructing applied research centers around the country, linked to regional university and city hubs. Like the land-grant colleges of the 19th century, these centers would generate and distribute knowledge, improving local capabilities in manufacturing and services.

Opportunity is also a pillar of the awakening. Community colleges are an underfunded source of skill-building and mobility. As Austan Goolsbee, Amy Ganz and I proposed in a 2019 report, a modest federal block grant to support community colleges on the supply side—rather than a demand-side emphasis on financial aid—can help these schools push more Americans toward better jobs by working with local employers on skill needs and curriculum development. Targeted aid to places with depressed economic activity can help distribute opportunity to communities better than one-size-fits-all Washington-directed programs.

Corporate tax reform can play a role, too, by improving incentives for companies to settle and invest in the U.S. This can magnify opportunities for Americans, all without having to rely on costly tariffs.

Working a job doesn’t merely generate income; it also promotes human dignity. Enlisting more people into the workforce is thus another element of the economic-policy awakening. While growth and opportunity policies can boost labor-force participation, strengthening the earned-income tax credit to boost the incomes of childless workers can help attract younger people to the workforce. Maintaining the child tax credit can also provide parents with easier pathways toward economic participation.

These ideas share several important themes with Mr. Trump’s campaign and the traditional conservative playbook. They emphasize that policy ideas should be practical and workable, not merely rhetorical. Each makes use of America’s federalist system and innovative ethos. Making a priority of strong local involvement in applied research centers and community colleges and as tailoring place-based aid are more effective approaches than Washington diktats. Programs need to be held accountable for results, not simply allocated money.

This economic-policy awakening requires a clear-eyed assessment of budget trade-offs. Profligate spending with little regard for debt and inflation—à la the American Rescue Plan—contributed to Mr. Trump’s victory. It is possible to accomplish the steps above in a fiscally responsible way by offsetting spending and tax changes.

Organizing for the policy awakening’s success will be essential. Lack of communication among cabinet agencies can stymie creative ideas for expanding the economic pie for American workers. Like the president’s Working Group on Financial Markets, created by Ronald Reagan in 1988 to convene disparate agencies, the new administration would benefit from a senior executive team that can coordinate economic ideas and learn from leaders in business, labor and social services. Such a body, unlike the National Economic Council, could more adeptly cut across silos related to tax, trade, regulatory and industrial policy.

Voters have signaled they’re ready for an economic awakening. The president-elect, equipped with a new playbook and vision, should seize the opportunity.

Continue reading “Glenn on the Economic Policies Necessary to Increase Growth”

Latest CPI Report Indicates That the Fed May Have Trouble Guiding the Economy the Last 1,000 Feet to a Soft Landing

Image illustrating inflation generated by GTP-4o.

On November 13, the Bureau of Labor Statistics (BLS) released its monthly report on the consumer price index (CPI). The following figure compares headline inflation (the blue line) and core inflation (the red line).

  • The headline inflation rate, which is measured by the percentage change in the CPI from the same month in the previous month, was 2.6 percent—up from 2.4 percent in September. 
  • The core inflation rate, which excludes the prices of food and energy, was unchanged at 3.3 percent for the third month in a row. 

Both headline inflation and core inflation were the values that economists surveyed by the Wall Street Journal had expected.

 In the following figure, we look at the 1-month inflation rate for headline and core inflation—that is the annual inflation rate calculated by compounding the current month’s rate over an entire year. Calculated as the 1-month inflation rate, headline inflation (the blue line) increased from 2.2 percent in September to 3.0 percent in October. Core inflation (the red line) fell from 3.8 percent in September to 3.4 percent in October.

Overall, considering 1-month and 12-month inflation together, the U.S. economy may still be on course for a soft landing—with the annual inflation rate returning to the Fed’s 2 percent target without the economy being pushed into a recession. However, progress on lowering inflation may have slowed or, possibly, stalled. The relatively high rates of core inflation in both the 12-month and 1-month measures are concerning because most economists believe that core inflation is a better indicator of the underlying inflation rate than is headline inflation. It’s important not to overinterpret the data from a single month, although this is the third month in a row that core inflation has been above 3 percent. (Note, that the Fed uses the personal consumption expenditures (PCE) price index, rather than the CPI in evaluating whether it is hitting its 2 percent inflation target.)

As we’ve discussed in previous blog posts, Federal Reserve Chair Jerome Powell and his colleagues on the Fed’s policymaking Federal Open Market Committee (FOMC) have been closely following inflation in the price of shelter. The price of “shelter” in the CPI, as explained here, includes both rent paid for an apartment or house and “owners’ equivalent rent of residences (OER),” which is an estimate of what a house (or apartment) would rent for if the owner were renting it out. OER is included in the CPI to account for the value of the services an owner receives from living in an apartment or house.

As the following figure shows, inflation in the price of shelter has been a significant contributor to headline inflation. The blue line shows 12-month inflation in shelter, and the red line shows 1-month inflation in shelter. Twelve-month inflation in shelter has been declining since the spring of 2023, but increased in October to 4.9 percent from 4.8 percent in September. One-month inflation in shelter—which is much more volatile than 12-month inflation in shelter—increased sharply from 2.7 percent in September to 4.7 percent in October.

Chair Powell and the other members of the FOMC have been expecting that the inflation in shelter would continue to decline. For instance, in his press conference following the last FOMC meeting on November 7, Powell stated that:

“What’s going on there is, you know, market rents, newly signed leases, are experiencing very low inflation. And what’s happening is older—you know, leases that are turning over are taking several years to catch up to where market leases are; market rent leases are. So that’s just a catch-up problem. It’s not really reflecting current inflationary pressures, it’s reflecting past inflationary pressures.”

The recent uptick in shelter inflation may concern FOMC members as they consider whether, and by how much, to cut their target for the federal funds rate at their next meeting on December 17-18. Bear in mind, though, that shelter has a weight of only 15 percent in the PCE price index that the Fed uses to gauge whether it is hitting its 2 percent inflation target in contrast with the 33 percent weight that shelter has in the CPI.

To better estimate of the underlying trend in inflation, some economists look at median inflation and trimmed mean inflation.

  • Median inflation is calculated by economists at the Federal Reserve Bank of Cleveland and Ohio State University. If we listed the inflation rate in each individual good or service in the CPI, median inflation is the inflation rate of the good or service that is in the middle of the list—that is, the inflation rate in the price of the good or service that has an equal number of higher and lower inflation rates. 
  • Trimmed mean inflation drops the 8 percent of good and services with the highest inflation rates and the 8 percent of goods and services with the lowest inflation rates. 

The following figure is from the Federal Reserve Bank of Cleveland. It shows that median inflation (the orange line) was unchanged in October at 4.1 percent. Trimmed mean inflation (the blue line) was also unchanged at 3.2 percent. These data provide confirmation that (1) core CPI inflation at this point is likely running at least slightly higher than a rate that would be consistent with the Fed achieving its inflation target and (2) that progress toward the target has slowed.

Will this persistence in inflation above the Fed’s 2 percent target cause the FOMC to hold constant its target range for the federal funds rate? Investors who buy and sell federal funds futures contracts expect that the FOMC will cut still cut its target for the federal funds rate by 0.25 percentage point at its December meeting. (We discuss the futures market for federal funds in this blog post.) The following figure that today these investors assign a probability of 75.7 percent to the FOMC cutting its target for the federal funds rate by 0.25 percentage point and a probability of 24.3 percent to the committee leaving its target unchanged at a range of 4.50 percent to 4.75 percent.



Fed Tries to Thread the Needle with Today’s 0.25% Cut in the target Federal Funds Rate

A meeting of the Federal Open Market Committee (Photo from federalreserve.gov)

The Federal Reserve’s policymaking Federal Open Market Committee (FOMC) concluded its meeting today (November 7) after considering a mixed batch of macroeconomic data. As we noted in this blog post, the most recent jobs report showed a much smaller increase in payroll employment than had been expected. However, the effects of hurricanes and strikes on the labor market made the data in the report difficult to interpret. Real GDP growth during the third quarter of 2024, while relatively strong, was slower than expected. Finally, as we discuss in this post, inflation has been running above the Fed’s 2 percent annual target with wages also growing faster than is consistent with 2 percent price inflation.

Congress has given the Fed a dual mandate of achieving maximum employment and price stability. If FOMC members had been most concerned about lower-than-expected real GDP growth and some weakening in the labor market, the likely course would have been to cut the target range for the federal funds rate by 0.50 percentage point (50 basis points) from its current range of 4.75 percent to 5.00 percent to a range of 4.25 percent to 4.50 percent.

If the committee had been most concerned about inflation remaining above target, the likely course would have been to leave the target range for the federal funds rate unchanged. Instead, the committee split the difference by reducing the target range by 25 basis points. As we noted near the end of this blog post, financial markets had been expecting a 25 basis point cut. At the conclusion of each meeting, the committee holds a formal vote on its target for the federal funds rate. The vote today was unanimous.

In a press conference following the meeting, Fed Chair Jerome Powell noted that: “We see the risks to achieving our employment and inflation goals as being roughly in balance, and we are attentive to the risks to both sides of our mandate.” Powell also indicated his confidence that the committee would succeed in staying on what he labeled the “middle path” that monetary policy needs to follow: “We know that reducing policy restraint too quickly could hinder progress on inflation. At the same time, reducing policy restraint too slowly could unduly weaken economic activity and employment …. Policy is well positioned to deal with the risks and uncertainties that we face in pursuing both sides of our dual mandate.”

With respect to the effect of the macroeconomic policies of the incoming Trump Administration, Powell noted that the Fed doesn’t comment on fiscal policy nor did he consider it appropriate to comment in any way on the recent election. He stated that the committee would wait to see new policies enacted before considering their consequences for monetary policy. When asked by a reporter whether he would leave the position of Fed chair if asked to do so by someone in the Trump Administration, Powell answered “no.” When asked whether he believes the president has the power to remove a Fed chair before the end of the chair’s term, Powell again answered “no.” (Most legal scholars believe that, according to the Federal Reserve Act, a president can’t remove a Fed chair because of policy disagreements, but only “for cause.”  See  Macroeconomics, Chapter 17, Section 17.4/Economics, Chapter 27, Section 27.4 for more on this topic.)

Weaker Than Expected Jobs Report Likely Due to the Effects of Hurricanes and Strikes

Image generated by GTP-4o.

The Bureau of Labor Statistics (BLS) releases the “Employment Situation” report (often called the “jobs report”) monthly.  Economists and policymakers follow this report closely because it provides important insight into the current state of the U.S. economy. The October jobs report was released this morning, November 1 As sometimes happens, the data in the report were distorted by unusual events last month, primarily the effects of hurricanes and strikes. The BLS reported the results of its surveys without attempting to correct for these events. With respect to hurricanes, the BLS noted:

“No changes were made to either the establishment or household survey estimation procedures for the October data. It is likely that payroll employment estimates in some industries were affected by the hurricanes; however, it is not possible to quantify the net effect on the over-the-month change in national employment, hours, or earnings estimates because the establishment survey is not designed to isolate effects from extreme weather events. There was no discernible effect on the national unemployment rate from the household survey.”

Economists who participated in various surveys had forecast that payroll employment would increase by 117,500, with the unemployment rate—which is calculated from data in the household survey—being unchanged at 4.1 percent. The forecast of the unemployment rate was accurate, as the BLS reported a 4.1 percent unemployment rate in October. But the BLS reported that payroll employment had increased by only 12,000. In addition, the BLS revised downward its estimates of the employment increases in August and September by a total of 112,000. (The BLS notes that: “Monthly revisions result from additional reports received from businesses and government agencies since the last published estimates and from the recalculation of seasonal factors.”) The following figure, taken from the BLS report, shows the net changes in employment for each month during the past two years.

What had initially seemed to be particularly strong growth in employment in September, possibly indicating a significant increase in the demand for labor, has been partially reversed by the data revision.

As the following figure shows, the net change in jobs from the household survey moves much more erratically than does the net change in jobs from the establishment survey. The net change in jobs as measured by the household survey for October was a decline of 368,000 jobs after an increase of 430,000 jobs in September. So, the story told by the two surveys was similar: significant weakening in the job market. But we need to keep in mind the important qualification that the job market in some areas of the country had been disrupted by unusual events during the month.

Other data in the jobs report told a more optimistic story of conditions in job market. The following figure shows the employment-population ratio for prime age workers—those aged 25 to 54. Although it declined from 80.9 percent to 80.6 percent, it remained high relative to levels seen since 2001.

The establishment survey also includes data on average hourly earnings (AHE). As we noted in this post yesterday, many economists and policymakers believe the employment cost index (ECI) is a better measure of wage pressures in the economy than is the AHE. The AHE does have the important advantage that it is available monthly, whereas the ECI is only available quarterly. The following figure shows the percentage change in the AHE from the same month in the previous year. AHE increased 4.0 percent in October, up from a 3.9 percent increase in September.

The following figure shows wage inflation calculated by compounding the current month’s rate over an entire year. (The figure above shows what is sometimes called 12-month wage inflation, whereas this figure shows 1-month wage inflation.) One-month wage inflation is much more volatile than 12-month wage inflation—note the very large swings in 1-month wage inflation in April and May 2020 during the business closures caused by the Covid pandemic.

The October 1-month rate of wage inflation was 4.5 percent, an increase from the 3.8 percent rate in September. Whether measured as a 12-month increase or as a 1-month increase, AHE is increasing more rapidly than is consistent with the Fed achieving its 2 percent target rate of price inflation.

The Federal Reserve’s policy-making Federal Open Market Committee (FOMC) has its next meeting on November 6-7. What effect will this jobs report likely have on the committee’s actions at that meeting? One indication of expectations of future rate cuts comes from investors who buy and sell federal funds futures contracts. (We discuss the futures market for federal funds in this blog post.) As shown in the following figure, today these investors assign a probability of 99.8 percent to the FOMC cutting its target for the federal funds rate by 0.25 percentage point (25 basis points) at its next meeting. Investors see effectively no chance of the committee leaving its target range unchanged at the current 4.75 percent to 5.00 percent or of the committee cutting its target rate by 50 basis point cut.

Investors don’t appear to believe that the acceleration in wage growth indicated by today’s jobs report will cause the FOMC to pause its rate cutting. Nor do they appear to believe that the unexpectedly small increase in payroll employment will cause the committee to cut its target for the federal funds rate by 50 basis points.

New Data on Inflation and Wage Growth Indicate that the Fed Is Still Not Assured of Hitting Its Inflation Target

Photo courtesy of Lena Buonanno.

Yesterday, the Bureau of Economic Analysis (BEA) released quarterly data on the personal consumption expenditures (PCE) price index as part of its advance estimate of third quarter GDP. (We discuss that release in this blog post.) Today, the BEA released monthly data on the PCE as part of its Personal Income and Outlays report. In addition, the Bureau of Labor Statistics (BLS) released quarterly data on the Employment Cost Index (ECI).

The Fed relies on annual changes in the PCE price index to evaluate whether it’s meeting its 2 percent annual inflation target.  The following figure shows PCE inflation (blue line) and core PCE inflation (red line)—which excludes energy and food prices—for the period since January 2016 with inflation measured as the percentage change in the PCE from the same month in the previous year. Measured this way, in September PCE inflation (the blue line) was 2.1 percent, down from 2.3 percent in August. Core PCE inflation (the red line) in September was 2.7 percent, which was unchanged from August. PCE inflation was in accordance with the expectations of economists surveyed by the Wall Street Journal, but core inflation was higher than expected.

The following figure shows PCE inflation and core PCE inflation calculated by compounding the current month’s rate over an entire year. (The figure above shows what is sometimes called 12-month inflation, while this figure shows 1-month inflation.) Measured this way, PCE inflation rose in September to 2.1 percent from 1.4 percent in August. Core PCE inflation rose from 1.9 percent in August to 3.1 percent in June.  Because core inflation is generally a better measure of the underlying trend in inflation, both 12-month and 1-month core PCE inflation indicate that inflation may still run above the Fed’s 2 percent target in coming months. But the usual caution applies that data from one month shouldn’t be overly relied on.

Turning to wages, as we’ve noted in earlier posts, as a measure of the rate of increase in labor costs, the Fed’s policy-making Federal Open Market Committee (FOMC) prefers the ECI to average hourly earnings (AHE).

The AHE is calculated by adding all of the wages and salaries workers are paid—including overtime and bonus pay—and dividing by the total number of hours worked. As a measure of how wages are increasing or decreasing during a particular period, AHE can suffer from composition effects because AHE data aren’t adjusted for changes in the mix of occupations workers are employed in. For example, during a period in which there is a decline in the number of people working in occupations with higher-than-average wages, perhaps because of a downturn in some technology industries, AHE may show wages falling even though the wages of workers who are still employed have risen. In contrast, the ECI holds constant the mix of occupations in which people are employed. The ECI does have this drawback: It is only available quarterly whereas the AHE is available monthly.

The data released this morning indicate that labor costs continue to increase at a rate that is higher than the rate that is likely needed for the Fed to hit its 2 percent price inflation target. The following figure shows the percentage change in the employment cost index for all civilian workers from the same quarter in 2023. The blue line shows only wages and salaries while the red line shows total compensation, including non-wage benefits like employer contributions to health insurance. The rate of increase in the wage and salary measure decreased from 4.0 percent in the second quarter of 2024 to 3.8 percent in the third quarter. The movement in the rate of increase in compensation was very similar, decreasing from 4.1 percent in the second quarter of 2024 to 3.9 percent in the third quarter.

If we look at the compound annual growth rate of the ECI—the annual rate of increase assuming that the rate of growth in the quarter continued for an entire year—we find that the rate of increase in wages and salaries decreased from 3.4 percent in the second quarter of 2024 to 3.1 percent in the third quarter. Similarly, the rate of increase in compensation decreased from 3.7 percent in the second quarter of 2024 to 3.2 percent in the third quarter. So, this measure indicates that there has been some easing of wage inflation in the third quarter, although, again, we have to use caution in interpreting one quarter’s data.

Some economists and policymakers prefer to look at the rate of increase in ECI for private industry workers rather than for all civilian workers because the wages of government workers are less likely to respond to inflationary pressure in the labor market. The first of the following figures shows the rate of increase of wages and salaries and in total compensation for private industry workers measured as the percentage increase from the same quarter in the previous year. The second figure shows the rate of increase calculated as a compound growth rate.

Both figures show results consistent with the 12-month PCE inflation figures: A decrease in wage inflation during the third quarter compared with the second quarter but with wage inflation still running somewhat above the level consistent with the Fed’s 2 percent price inflation target.

Taken together, the PCE and ECI data released today indicate that the Fed has not yet managed to bring about soft landing—returning inflation to its 2 percent target without pushing the economy into a recession.  As we noted in yesterday’s post, although output growth remains strong, there are some indications that the labor market may be weakening. If so, future months may see a further decrease in wage growth that will make it more likely that the Fed will hit its inflation target. The BLS is scheduled to release its “Employment Situation” report for October on Friday, November 1. That report will provide additional data for assessing the current state of the labor market.

Real GDP Growth Comes in Slightly Below Expectations, Inflation Is Below Target, and the Labor Market Shows Some Weakening

Image of GDP generated by GTP-4o

This week, two data releases paint a picture of the U.S. economy as possibly slowing slightly, but still demonstrating considerable strength. The Bureau of Economic Analysis (BEA) released its advance estimate of GDP for the third quarter of 2024. (The report can be found here.) The BEA estimates that real GDP increased by 2.8 percent at an annual rate in the third quarter—July through September. That was down from the 3.0 percent increase in real GDP in the second quarter and below the 3.1 percent that economists surveyed by the Wall Street Journal had expected. The following figure from the BEA report shows the growth rate of real GDP in each quarter since the fourth quarter of 2020.

Two other points to note: In June, the Congressional Budget Office (CBO) had forecast that the growth rate of real GDP in the third quarter would be only 2.1 percent. The CBO forecasts that, over the longer run, real GDP will grow at a rate of 1.7 to 1.8 percent per year. So, the growth rate of real GDP according to the BEA’s advance estimate (which, it’s worth recalling, is subject to potentially large revisions) was above expectations from earlier this year and above the likely long run growth rate.

Consumer spending was the largest contributor to third quarter GDP growth. The following figure shows growth rates of real personal consumption expenditures and the subcategories of expenditures on durable goods, nondurable goods, and services. There was strong growth in each component of consumption spending. The 8.1 percent increase in expenditures on durables was particularly strong. It was the second quarter in a row of strong growth in spending on durables after a decline of –1.8 percent in the first quarter.

Investment spending and its components were a more mixed bag, as shown in the following figure. Investment spending is always more volatile than consumption spending. Overall, gross private domestic investment increased at a slow rate of 0.3 percent—the slowest rate since a decline in the first quarter of 2023. Residential investment decreased by 5.1 percent, reflecting difficulties in residential construction due to mortgage interest rates remaining high. Business fixed investment grew 3.1 percent, powered by an increase of 11.1 percent in spending on business equipment. Spending on structures—such as factories and office buildings—had increased rapidly over the past two years before slowing to a 0.2 percent increase in the second quarter and a decline of 4.0 percent in the fourth quarter.

The GDP report also contained data on the private consumption expenditure (PCE) price index, which the FOMC uses to determine whether it is achieving its goal of a 2 percent inflation rate. The following figure shows inflation as measured using the PCE and the core PCE—which excludes food and energy prices—since the beginning of 2016. (Note that these inflation rates are measured using quarterly data and as compound annual rates of change.) Despite the strong growth in real GDP, inflation as measured by PCE was only 1.5 percent, below the 2.5 percent increase in the second quarter and below the Federal Reserve’s 2.0 percent inflation target. Core PCE, which may be a better indicator of the likely course of inflation in the future, declined to 2.2 percent in the third quarter from 2.8 percent in the second quarter. The third quarter increase was slightly above the rate that economists surveyed by the Wall Street Journal had expected.

This week, the Bureau of Labor Statistics (BLS) released its “Job Openings and Labor Turnover” (JOLTS) report for September 2024. The report provided data indicating some weakening in the U.S. labor market. The following figure shows the rate of job openings. The BLS defines a job opening as a full-time or part-time job that a firm is advertising and that will start within 30 days and the rate of job openings as the number of job openings divided by the number of job openings plus the number of employed workers, multiplied by 100. The 4.9 percent job opening rate in September continued the slow decline from the peak rate of 7.4 percent in March 2022. The rate is also slightly below the rate during late 2018 and 2019 before the Covid pandemic.

In the following figure, we compare the total number of job openings to the total number of people unemployed. The figure shows a slow decline from a peak of more than 2 job openings per unemployed person in the spring of 2022 to 1.1 job openings per employed person in September 2024, somewhat below the levels in 2019 and early 2020, before the pandemic. Note that the number is still above 1.0, indicating that the demand for labor is still high, although no higher than during the strong labor market of 2019.

Finally, note from the figure that over the period during which the BLS has been conducting the JOLTS survey, the rate of job openings has declined just before and during recessions. Does that fact indicate that the decline in the job opening rate in recent months is signaling that a recession is likely to begin soon? We can’t say with certainty, particularly because the labor market was severely disrupted by the pandemic. The decline in the job openings rate since 2022 is more likely to reflect the labor market returning to more normal conditions than a weakening in hiring that signals a recession is coming.

To summarize these data:

  1. Real GDP growth is strong, although below what economists had been projecting.
  2. Inflation as measured by the PCE is below the Fed’s 2 percent target, although core inflation remains slightly above the target.
  3. The job market has weakened somewhat, although there is no strong indication that a recession will happen in the near future.

The Amazing Rise of Nvidia

Nvidia’s headquarters in Santa Clara, California. (Photo from nvidia.com)

Nvidia was founded in 1993 by Jensen Huang, Chris Malachowsky, and Curtis Priem, electrical engineers who started the company with the goal of designing computer chips that would increase the realism of images in video games. The firm achieved a key breakthrough in 1999 when it invented the graphics processing unit, or GPU, which it marketed under the name GeForce256. In 2001, Microsoft used a Nvidia chip in its new Xbox video game console, helping Nvidia to become the dominant firm in the market for GPUs.

The technology behind GPUs has turned out to be usable not just for gaming, but also for powering AI—artificial intelligence—software. The market for Nvidia’s chips exploded witth technology giants Google, Microsoft, Facebook and Amazon, as well as many startups ordering large quantites of Nvidia’s chips.

By 2016, Nvidia CEO Jen-Hsun Huang could state in an interview that: “At no time in the history of our company have we been at the center of such large markets. This can be attributed to the fact that we do one thing incredibly well—it’s called GPU computing.” Earlier this year, an article in the Economist noted that: “Access to GPUs, and in particular those made by Nvidia, the leading supplier, is vital for any company that wants to be taken seriously in artificial intelligence (AI).”

Nvidia’s success has been reflected in its stock price. When Nvidia became a public company in 1999 by undertaking an initial public offering (IPO) of stock, a share of the firm’s stock had a price of $0.04, adjusted for later stock splits. The large profits Nvidia has been earning in recent years have caused its stock price to rise to more than $140 dollars a share.

(With a stock split, a firm reduces the price per share of its stock by giving shareholders additional shares while holding the total value of the shares constant. For example, in June of this year Nvidia carried out a 10 for 1 stock split, which gave shareholders nine shares of stock for each share they owned. The total value of the shares was the same, but each share now had a price that was 10 percent of its price before the split. We discuss the stock market in Microeconomics, Chapter 8, Section 8.2, Macroeconomics, Chapter 6, Section 6.2, and Economics, Chapter 8, Section 8.2.)

The following figure from the Wall Street Journal shows the sharp increase in Nvidia’s stock price over the past three years as AI has become an increasingly important part of the economy.

Nvidia’s market capitalization (or market cap)—the total value of all of its outstanding shares of stock—is $3.5 trillion.  How large is that? Torsten Sløk, the chief economist at Apollo, an asset management firm, has noted that, as shown in the following figure, Nvidia’s market cap is larger than the total market caps—the total value of all the publicly traded firms—in five large economies.

Can Nvidia’s great success continue? Will it be able to indefinitely dominate the market for AI chips? As we noted in Apply the Concept “Do Large Firms Live Forever?” in Microeconomics Chapter 14, in the long run, even the most successful firms eventually have their positions undermined by competition. That Nvidia has a larger stock market value than the total value of all the public companies in Germany or the United Kingdom is extraordinary and seems impossible to sustain. It may indicate that investors have bid up the price of Nvidia’s stock above the value that can be justified by a reasonable forecast of its future profits.

There are already some significant threats to Nvidia’s dominant position in the market for AI chips. GPUs were originally designed to improve computer displays of graphics rather than to power AI software. So, one way of competing with Nvidia that some startups are trying to exploit is to design chips specifically for use in AI. It’s also possible that larger chips may make it possible to use fewer chips than when using GPUs, possibly reducing the total cost of the chips necessary to run sophisticated AI software. In addition, existing large technology firms, such as Amazon and Microsoft, have been developing chips that may be able to compete with Nvidia.

As with any firm, Nvidia’s continued success requires it to innovate sufficiently to stay ahead of the many competitors that would like to cut into the firm’s colossal profits.

Want a Raise? Get a New Job

Image generated by GTP-4o of someone searching online for a job

It’s become clear during the past few years that most people really, really, really don’t like inflation. Dating as far back as the 1930s, when very high unemployment rates persisted for years, many economists have assumed that unemployment is viewed by most people as a bigger economic problem than inflation. Bu the economic pain from unemployment is concentrated among those people who lose their jobs—and their families—although some people also have their hours reduced by their employers and in severe recessions even people who retain their jobs can be afraid of being laid off.

Although nearly everyone is affected by an increase in the inflation rate, the economic losses are lower than those suffered by people who lose their jobs during a period in which it may difficult to find another one. In addition, as we note in Macroeconomics, Chapter 9, Section 9.7 (Economics, Chapter 19, Section 19.7), that:

“An expected inflation rate of 10 percent will raise the average price of goods and services by 10 percent, but it will also raise average incomes by 10 percent. Goods and services will be as affordable to an average consumer as they would be if there were no inflation.”

In other words, inflation affects nominal variables, but over the long run inflation won’t affect real variables such as the real wage, employment, or the real value of output. The following figure shows movements in real wages from January 2010 through September 2024. Real wages are calculated as nominal average hourly earnings deflated by the consumer price index, with the value for February 2020—the last month before the effects of the Covid pandemic began affecting the United States—set equal to 100. Measured this way, real wages were 2 percent higher in September 2024 than in February 2020. (Although note that real wages were below where they would have been if the trend from 2013 to 2020 had continued.)

Although increases in wages do keep up with increases in prices, many people doubt this point. In Chapter 17, Section 17.1, we discuss a survey Nobel Laurete Rober Shiller of Yale conducted of the general public’s views on inflation. He asked in the survey how “the effect of general inflation on wages or salary relates to your own experience or your own job.” The most populat response was: “The price increase will create extra profifs for my employer, who can now sell output for more; there will be no increase in my pay. My employer will see no reason to raise my pay.”

Recently, Stefanie Stantcheva of Harvard conducted a survey similar to Schiller’s and received similar responses:

“If there is a single and simple answer to the question ‘Why do we dislike inflation,’ it is because many individuals feel that it systematically erodes their purchasing power. Many people do not perceive their wage increases sufficiently to keep up with inflation rates, and they often believe that wages tend to rise at a much slower rate compared to prices.”

A recent working paper by Joao Guerreiro of UCLA, Jonathon Hazell of the London School of Economics, Chen Lian of UC Berkeley, and Christina Patterson of the University of Chicago throws additional light on the reasons that people are skeptical that once the market adjusts, their wages will keep up with inflation. Economists typically think of the real wage as adjusting to clear the labor market. If inflation temporarily reduces the real wage, the nominal wage will increase to restore the market-clearing value of the real wage.

But the authors of thei paper note that, in practice, to receive an increase in your nominal wage you need to either 1)ask your employer to increase your wage, or 2) find another job that pays a higher nominal wage. They note that both of these approachs result in “conflict”: “We argue that workers must take costly actions (‘conflict’) to have nominal wages catch up with inflation, meaning there are welfare costs even if real wages do not fall as inflation rises.” The results of a survey they undertook revealed that:

“A significant portion of workers say they took costly actions—that is, they engaged in conflict—to achieve higher wage growth than their employer offered. These actions include having tough conversations with employers about pay, partaking in union activity, or soliciting job offers.”

Their result is consistent with data showing that workers who switch jobs receive larger wage increases than do workers who remain in their jobs. The following figure is from the Federal Reserve Bank of Cleveland and shows the increase in the median nominal hourly wage over the previous year for workers who stayed in their job over that period (brown line) and for workers who switched jobs (gray line).

Job switchers consistently earn larger wage increases than do job stayers with the difference being particularly large during the high inflation period of 2022 and 2023. For instance, in July 2022, job switchers earned average wage increases of 8.5 percent compared with average increases of 5.9 percent for job stayers.

The fact that to keep up with inflation workers have to either change jobs or have a potentially contentious negotiation with their employer provides another reason why the recent period of high inflation led to widespread discontent with the state of the U.S. economy.

Acemoglu, Johnson, and Robinson Win the 2024 Nobel Prize in Economics

Daron Acemoglu and Simon Johnson (Credit: Acemoglu, Adam Glanzman; Johnson, courtesy of MIT, from news.mit.edu)

James Robinson (photo from news.uchicago.edu)

Many economic studies have a relatively limited objective. For instance, estimating the price elasticity of demand for soda in order to determine the incidence of a soda tax. Or estimating a Keynesian fiscal policy multiplier in order to determine the effects of a change in federal spending or taxes. (We consider the first topic in Microeconomics, Chapter 6, and the second topic in Macroeconomics, Chapter 16.)

Other economic studies consider much broader questions, such as why are some countries rich and other countries poor? As the late Nobel laureate Robert Lucas once wrote: “The consequences for human welfare involved in questions like these are simply staggering: Once one starts to think about them, it is hard to think about anything else.”

Today, the Royal Swedish Academy of Sciences awarded the 2024 Nobel Prize in Economic Sciences to Daron Acemoglu and Simon Johnson of MIT, and to James Robinson of the University of Chicago for “for studies of how institutions are formed and affect prosperity.” Acemoglu, Johnson, and Robinson (AJR) have published work highlighting the key importance of a country’s institutions in explaining whether the country has experienced sustained economic growth. Their work builds on earlier studies by the late Douglas North of Washington University in St. Louis, who received the Nobel Prize in 1993.

The institutional approach to economic growth differs from other approaches that focus on variables such as temperature, prevalence of disease, ethnic fragmentation, resource endowments, or governments adopting flawed development strategies in explaining differences in growth rates in per capita income across countries.

Two of AJR’s most discussed papers are “The Colonial Origins of Comparative Development: An Empirical Investigation,” which was published in the American Economic Review in 2001 (free download here), “Reversal of Fortune: Geography and Institutions in the Making of the Modern World Income Distribution,” which was published in the Quarterly Journal of Economics in 2002 (available here). In these papers, the authors argue that the institutions European countries established in their colonies helped determine economic growth in those countries even decades after colonization.

As with any analysis that covers many countries over long periods of time, AJR’s analysis of the effect of colonialism on economic growth has attracted critiques focused on whether the authors have gathered data properly and whether their data may be better explained with a different approach.

The authors, writing both separately and jointly, have explored many issues beyond the effects of colonialism on economic growth. The wide scope of their research can be seen by reviewing their curricula vitae, which can be found here, here, and here. The announcement by the Nobel committee can be found here.

CPI Inflation Running Slightly Higher than Expected

Image illustrating inflation generated by GTP-4o.

This morning (October 10), the Bureau of Labor Statistics (BLS) released its monthly report on the consumer price index (CPI). As the following figure shows, the inflation rate for September measured by the percentage change in the CPI from the same month in the previous month—headline inflation (the blue line)—was 2.4 percent down from 2.6 percent in August. That was the lowest headline inflation rate since February 2021. Core inflation (the red line)—which excludes the prices of food and energy—was unchanged at 3.3 prcent. Both headline inflation and core inflation were slightly higher than economists surveyed by the Wall Street Journal had expected.  

As the following figure shows, if we look at the 1-month inflation rate for headline and core inflation—that is the annual inflation rate calculated by compounding the current month’s rate over an entire year—we see that headline inflation (the blue line) decreased from 2.3 percent in August to 2.2 percent in September. Core inflation (the red line) increased from 3.4 percent in August to 3.8 percent in September.

Overall, we can say that, taking 1-month and 12 month inflation together, the U.S. economy may still be on course for a soft landing—with the annual inflation rate returning to the Fed’s 2 percent target without the economy being pushed into a recession—but the increase in 1-month core inflation is concerning because most economists believe that core inflation is a better indicator of the underlying inflation rate than is headline inflation. Of course, as always, it’s important not to overinterpret the data from a single month, although this is the second month in a row that core inflation has been well above 3 percent. (Note, also, that the Fed uses the personal consumption expenditures (PCE) price index, rather than the CPI in evaluating whether it is hitting its 2 percent inflation target.)

As we’ve discussed in previous blog posts, Federal Reserve Chair Jerome Powell and his colleagues on the FOMC have been closely following inflation in the price of shelter. The price of “shelter” in the CPI, as explained here, includes both rent paid for an apartment or house and “owners’ equivalent rent of residences (OER),” which is an estimate of what a house (or apartment) would rent for if the owner were renting it out. OER is included to account for the value of the services an owner receives from living in an apartment or house.

As the following figure shows, inflation in the price of shelter has been a significant contributor to headline inflation. The blue line shows 12-month inflation in shelter and the red line shows 1-month inflation in shelter. After rising in August, 12-month inflation in shelter resumed the decline that began in the spring of 2023, falling from 5.2 percent in August to 4.8 percent September. One-month inflation in shelter—which is much more volatile than 12-month inflation in shelter—declined sharply from 6.4 percent in August to 2.7 percent in September. The members of the FOMC are likely to find the decline in inflation in shelter reassuring as they consider another cut to the target for the federal funds rate at the committee’s next meeting on November 6-7. Shelter has a smaller weight of 15 percent in the PCE price index that the Fed uses to gauge whether it is hitting its 2 percent inflation target in contrast with the 33 percent weight that shelter has in the CPI.

Finally, in order to get a better estimate of the underlying trend in inflation, some economists look at median inflation and trimmed mean inflation. Median inflation is calculated by economists at the Federal Reserve Bank of Cleveland and Ohio State University. If we listed the inflation rate in each individual good or service in the CPI, median inflation is the inflation rate of the good or service that is in the middle of the list—that is, the inflation rate in the price of the good or service that has an equal number of higher and lower inflation rates. Trimmed mean inflation drops the 8 percent of good and services with the higherst inflation rates and the 8 percent of goods and services with the lowest inflation rates. 

As the following figure (from the Federal Reserve Bank of Cleveland) shows, median inflation (the orange line) declined slightly from 4.2 percent in August to 4.1 percent in September. Trimmed mean inflation (the blue line) was unchanged at 3.2 percent. These data provide confirmation that core CPI inflation at this point is likely running at least slightly higher than a rate that would be consistent with the Fed achieving its inflation target.

The FOMC cut its target for the federal funds rate by 0.50 percentage point (50 basis points) from 5.50 percent to 5.25 percent to 5.00 percent to 4.75 percent at its last meeting on September 17-18. Some economists and investors believed that the FOMC might cut its target by another 50 basis points at its next meeting on November 6-7. This inflation report makes that outcome less likely. In addition, the release of the minutes from the September 17-18 meeting revealed that a significant number of committee members may have preferred a 25 basis point cut rather than a 50 basis point cut at that meeting:

“However, noting that inflation was still somewhat elevated while economic growth remained solid and unemployment remained low, some participants observed that they would have preferred a 25 basis point reduction of the target range at this meeting, and a few others indicated that they could have supported such a decision.”

Investors who buy and sell federal funds futures contracts expect that the FOMC will cut its target for the federal funds rate by 0.25 percentage point at its November meeting. (We discuss the futures market for federal funds in this blog post.) As shown in the following figure, today these investors assign a probability of 80.3 percent to the FOMC cutting its target for the federal funds rate by 0.25 percentage point and a probability of 19.7 percent to the committee leaving its target unchanged.