Tag: Macroeconomics

Coming Attractions: Hubbard and O’Brien Principles of Economics Updated

It’s customary for textbook authors to note that “much has happened in the economy” since the last edition of their book appeared. To say that much has happened since we prepared our last edition in 2019 would be a major understatement. Never in the lifetimes of today’s students and instructors have events like those of 2020 and 2021 occurred. The U.S. and world economies had experienced nothing like the Covid-19 pandemic since the influenza pandemic of 1918. In the spring of 2020, the U.S. economy suffered an unprecedented decline in the supply of goods and services as a majority of businesses in the country shut down to reduce spread of the virus. Many businesses remained closed or operated at greatly reduced capacity well into 2021. Most schools, including most colleges, switched to remote learning, which disrupted the lives of many students and their parents.

During the worst of the pandemic, total spending in the economy declined as the unemployment rate soared to levels not seen since the Great Depression of the 1930s. Reduced spending and closed businesses resulted in by far the largest decline in total production in such a short period in the history of the U.S. economy. Congress, the Trump and Biden administrations, and the Federal Reserve responded with fiscal and monetary policies that were also unprecedented.

Our updated Eighth Edition covers all of these developments as well as the policy debates they initiated. As with previous editions, we rely on extensive digital resources, including: author-created application videos and audio recordings of the chapter openers and Apply the Concept features; figure animation videos; interactive real-time data graphs animations; and Solved Problem whiteboard videos.

Glenn and Tony discuss the updated edition in this video:

Sample chapters will be available by October 15.

The full Macroeconomics text will available in early to mid December.

The full Microeconomics text will be available in mid to late December.

If you would like to view the sample chapters or are considering adopting the updated Eighth Edition for the spring semester, please contact your local Pearson representative. You can use this LINK to find and contact your representative.

New 09/03/21 Podcast – Authors Glenn Hubbard & Tony O’Brien discuss the recent jobs report, Fed comments, and financial stability!

Authors Glenn Hubbard and Tony O’Brien discuss the recent jobs report falling short of expectations. They also discuss the comments of Fed Chairman Powell’s comments at the Federal Reserve’s recent Jackson Hole conference. They also get to some of the recommendations of a Brookings Task Force, co-chaired by Glenn Hubbard, on ways to address financial stability. Use the links below to see more information about these timely topics:
Powell’s Jackson Hole speech: 

https://www.federalreserve.gov/newsevents/speech/files/powell20210827a.pdf 

The report of Glenn’s task force: 

https://www.brookings.edu/wp-content/uploads/2021/06/financial-stability_report.pdf 

The most recent economic forecasts of the FOMC: 

https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20210616.pdf

Menu Costs in the Digital Age

Inflation imposes a number of costs on households and firms (see our discussion in Economics, Chapter 19, Section 19.7 and Macroeconomics, Chapter 19, Section 19.7). Economists call the costs to firms of changing prices menu costs. For instance, when supermarkets raise prices, employees have to spend time changing the prices posted on shelves. 

When restaurants raise prices, they have to print new menus (hence the general name economists give to these costs). Particularly during the Covid-19 pandemic, the trend toward having digital menus rather than paper ones increased.  But even with digital menus, a restaurant incurs some costs, as this sign in a coffee shop indicates. An employee has to update the digital menu to reflect the new prices and, in the meantime, the shop may experience friction from customers who see one price on the digital menu and are charged a higher price when they pay at the register. 

H/T Lena Buonanno

WELCOME BACK! New 08/20/21 Podcast – Authors Glenn Hubbard & Tony O’Brien return to discuss delta variant & inflation!

Join authors Glenn Hubbard and Tony O’Brien as they return for a new academic year! The issues have evolved but the importance of these issues has not waned. We discuss the impact of closures related to the delta variant has on the economy. The discussion extends to the active fiscal and monetary policy that has reintroduced inflation as a topic facing our economy. Many students have little or no experience with inflation so it is a learning opportunity. Check back regularly where Glenn & Tony will continue to wrestle with these important economic concepts and relate them to the classroom!

What’s Going on with Inflation?

   The U.S. inflation rate has accelerated. As the following figure shows, in mid-2021, inflation, measured as the percentage change in the CPI from the same month in the previous year (the blue line), rose above 5 percent for the first time since the summer of 2008.

As we discuss in an Apply the Concept in Chapter 25, Section 25.5 (Chapter 15, Section 15.5 of Macroeconomics), the Fed prefers to measure inflation using the personal consumption expenditures (PCE) price index. The PCE price index is a measure of the price level similar to the GDP deflator, except it includes only the prices of goods and services from the consumption category of GDP. Because the PCE price index includes more goods and services than the CPI, it is a broader measure of inflation. As the red line in the figure shows, inflation as measured by the PCE price index is generally lower than inflation measured by the CPI. The difference is particularly large during periods in which CPI inflation is especially high, as it was during 2008, 2011, and 2021.

Prices of food and energy are particularly volatile, so the measure of inflation the Fed focuses on most closely is the PCE price index, excluding food and energy prices (the green line in figure). The figure shows that this measure of inflation is more stable than either of the other two measures. For instance, during June 2021, measured by the CPI, inflation was 5.3 percent, but was 3.5 percent when measured by the PCE, excluding food and energy.

In the summer of 2021, even inflation measured by the PCE, excluding food and energy, is running well above the Fed’s long-run target rate of 2 percent. Why is inflation increasing? Most economists and policymakers believe that two sets of factors are responsible:

  1. Increases in aggregate demand. Consumption spending (see the first figure below) has increased as the economy has reopened and people have returned to eating in restaurants, going to the movies, working out in gyms, and spending at other businesses that were closed or operating at reduced capacity. Households have been able to sharply increase their spending because household saving (see the second figure below) soared during the pandemic in response to payments from the federal government, including supplemental unemployment insurance payments and checks sent directly to most households. The increase in federal government expenditures that helped fuel the increase in aggregate demand is shown in the third figure below.

Fed policy has also been strongly expansionary, with the target for the federal funds kept near zero and the Fed continuing its substantial purchases of Treasury notes and mortgage-backed securities. The continuing expansion of the Fed’s balance sheet through the summer of 2021 is shown in the last of the figures below. The Fed’s asset purchases have help keep interest rates low and provided banks with ample funds to loan to households and firms. 

2. Reductions in aggregate supply. The pandemic disrupted global supply chains, reducing the goods available to consumers.  In the summer of 2021, not all of these supply chain issues had been resolved. In particular, a shortage of computer chips had reduced output of motor vehicles. New cars, trucks, SUVs, and minivans were often selling above their sticker prices. High prices for new vehicles led many consumers to increase their demand for used vehicles, driving up their prices. Between July 2020 and July 2021, prices of new vehicles rose 6.4 percent and prices for used vehicles rose an extraordinary 41.7 percent.

Supply issues also exist in some service industries, such as restaurants and hotels, that have had difficulty hiring enough workers to fully reopen. 

Economists and policymakers differ as to whether high inflation rates are transitory or whether the U.S. economy might be entering a prolonged period of higher inflation. Most Federal Reserve policymakers argue that the higher inflation rates in mid-2021 are transitory. For instance, in a statement following its July 28, 2021 meeting, the Federal Open Market Committee noted that: “Inflation has risen, largely reflecting transitory factors.”  Although the statement also noted that inflation is “on track to moderately exceed 2 percent for some time.”

In a speech at the end of July, Fed Governor Lael Brainard expanded on the Fed’s reasoning:

“Recent high inflation readings reflect supply–demand mismatches in a handful of sectors that are likely to prove transitory…. I am attentive to the risk that inflation pressures could broaden or prove persistent, perhaps as a result of wage pressures, persistent increases in rent, or businesses passing on a larger fraction of cost increases rather than reducing markups, as in recent recoveries. I am particularly attentive to any signs that currently high inflation readings are pushing longer-term inflation expectations above our 2 percent objective.”

“Currently, I do not see such signs. Most measures of survey- and market-based expectations suggest that the current high inflation pressures are transitory, and underlying trend inflation remains near its pre-COVID trend…. Many of the forces currently leading to outsized gains in prices are likely to dissipate by this time next year. Current tailwinds from fiscal support and pent-up consumption are likely to shift to headwinds, and some of the outsized price increases associated with acute supply bottlenecks may ease or partially reverse as those bottlenecks are resolved.”

Brainard’s remarks highlight a point that we make in Chapter 27, Section 27.1 (Chapter 17, Section 17.1 of Macroeconomics): The expectations of households and firms of future inflation play an important part in determining current inflation. Inflation can rise above and fall below the expected inflation rate in response to changes in the labor market—which affect the wages firms pay and, therefore, the firms’ costs—as well as in response to fluctuations in aggregate supply resulting from positive or negative supply shocks—such as the pandemic’s negative effects on aggregate supply. Fed Chair Jerome Powell has argued that with households and firms’ expectations still well-anchored at around 2 percent, inflation was unlikely to remain above that level in the long run.

Some economists are less convinced that households and firms will continue to expect 2 percent inflation if they experience higher inflation rates through the end of 2021. The Wall Street Journal’s editorial board summed up this view: “One risk for the Fed is that more months of these price increases will become what consumers and businesses come to expect. To use the Fed jargon, prices would no longer be ‘well-anchored.’ That may be happening.”

As we discuss in Chapter 27, Sections 27.2 and 27.3 (Macroeconomics, Chapter 17, Sections 17.2 and 17.3), during the late 1960s and early 1970s, higher rates of inflation eventually increased households and firms’ expectations of the inflation rate, leading to an acceleration of inflation that was difficult for the Fed to reverse. 

Earlier this year, Olivier Blanchard of the Peterson Institute for International Economics, formerly a professor of economics at MIT and director of research at the International Monetary Fund, raised the possibility that overly expansionary monetary and fiscal policies might result in the Fed facing conditions similar to those in the 1970s. The Fed would then be forced to choose between two undesirable policies:

“If inflation were to take off, there would be two scenarios: one in which the Fed would let inflation increase, perhaps substantially, and another—more likely—in which the Fed would tighten monetary policy, perhaps again substantially. Neither of these two scenarios is ideal. In the first, inflation expectations would likely become deanchored, cancelling one of the major accomplishments of monetary policy in the last 20 years and making monetary policy more difficult to use in the future. In the second, the increase in interest rates might have to be very large, leading to problems in financial markets. I would rather not go there.”

In a recent interview, Lawrence Summers of Harvard University, who served as secretary of the Treasury in the Clinton administration, made similar points: 

“We have inflation that since the beginning of the year has been running at a 5 percent annual rate. …. Starting at high inflation, we’ve got an economy that’s going to grow at extremely high rates for the next quarter or two. … I think we’re going to find ourselves with a new normal of inflation above 3 percent. Then the Fed is either going to have to be inconsistent with all the promises and commitments it’s made [to maintain a target inflation rate of 2 percent] or it’s going to have to attempt the task of slowing down the economy, which is rarely a controlled process.”

Clearly the pandemic and the resulting policy responses have left the Fed in a challenging situation.

Sources: Federal Reserve Open Market Committee, “Federal Reserve Press Release,” federalreserve.gov, July 28, 2021; Lael Brainard, “Assessing Progress as the Economy Moves from Reopening to Recovery,” speech at “Rebuilding the Post-Pandemic Economy” 2021 Annual Meeting of the Aspen Economic Strategy Group, Aspen, Colorado, federalreserve.gov, July 30, 2021; Wall Street Journal editorial board, “Powell Gets His Inflation,” Wall Street Journal, July 13, 2021; Olivier Blanchard, “In Defense of Concerns over the $1.9 Trillion Relief Plan,” piie.com, February 21, 2012; “Former Treasury Secretary on Consumer Prices, U.S. Role in Global Pandemic, Efforts,” wbur.org, August 22, 2021; and Federal Reserve Bank of St. Louis, https://fred.stlouisfed.org.

Glenn and Donald Kohn on the Report of the Task Force on Financial Stability

   Glenn co-chairs the Task Force on Financial Stability with Donald Kohn, now a fellow at the Brookings Institution and formerly vice-chair of the Board of Governors of the Federal Reserve. The Task Force on Financial Stability was formed by the Initiative on Global Markets at the University of Chicago and the Hutchins Center on Fiscal & Monetary Policy at the Brookings Institution to make recommendations intended to increase the stability of the U.S. financial system.

On June 29, 2021, the Task Force issued a report, which can be found HERE. Glenn and Donald Kohn discuss the reports findings in an opinion column published on bloomberg. com.

The Federal Reserve building in Washington, D.C.

Our Financial Early Warning System Is Broken

The U.S. financial system emerged from the reforms that followed the 2008 global crisis stronger than it had been going in. But the onset of the pandemic in March 2020 demonstrated how much was left undone: Although banks weathered the storm well, financial disruptions elsewhere — in money market funds, in the Treasury market — necessitated extraordinary measures to prevent an even greater economic disaster.

A group that we co-chair, the Task Force on Financial Stability, has just released a report on how to make the system more resilient. Among other things, we see the need for a structural change: Overhaul the agencies tasked with identifying and addressing threats outside traditional banks.

The Dodd-Frank financial reform of 2010 created two new entities focused on systemic risk. The Financial Stability Oversight Council, which included the Treasury Secretary and the heads of all the major financial regulatory agencies, was supposed to foster collaboration in finding and fixing dangerous buildups, wherever they might arise. And the Office of Financial Research, formed within Treasury and equipped with subpoena power, was supposed to provide the FSOC with the data and analysis needed to do the job well.

This financial early warning system didn’t operate as intended. The FSOC’s efforts to impose special scrutiny on certain systemically important non-bank institutions, such as insurance companies, ran into legal and political headwinds. Its member agencies often proved reluctant to encroach on one another’s turf, and the FSOC lacked the power to compel action. The OFR never subpoenaed anything, for fear of making enemies. Ultimately, the Trump administration deemphasized and defunded the whole apparatus.

As a result, the U.S. was much less prepared for the shock of the pandemic than it could have been. A rush to cash triggered runs on certain money-market mutual funds, threatened the flow of credit to everyone from homebuyers to municipalities, and — in a troubling departure from the usual “flight to quality” — caused the prices of Treasury securities to fall sharply. The Treasury and the Federal Reserve had to go to extreme lengths and pledge trillions of dollars to restore stability.

Regulators’ objective should not be merely to put out fires once they see smoke, but to prevent the dangerous accumulation of combustible material. New threats will emerge in unexpected ways; solutions will prompt unanticipated responses. So regulation must be dynamic, requiring an ongoing assessment process, not just periodic changes. To meet that challenge, we urge a restructuring of the FSOC and the OFR.

  1. Congress should give each FSOC member agency an explicit financial stability mandate, and require each to establish a similarly focused office to inform its rule making. This would force agencies such as the Securities and Exchange Commission, the Commodities Futures Trading Commission, and the Consumer Financial Protection Bureau to consider systemic-risk issues that they can otherwise too often neglect.
  2. Only the Treasury Secretary should issue the FSOC’s annual report, avoiding the consensus-building process among member agencies that can weaken identification of risks and accountability for dealing with them. While each agency would write a separate appendix, the Secretary would bear ultimate responsibility. The report should include a look back at what risks were missed, why, and how they will be addressed. To ensure the subject gets adequate attention, a new under-secretary for financial stability should act as the secretary’s point person.
  3. The OFR should receive a clear new mandate to gather the data that policymakers need (and, today, often lack). To underscore its importance, it should be renamed the Comptroller for Data and Resilience — echoing the stature of the Comptroller of the Currency — and its head should have a voting seat at the FSOC, a level of authority that would help the government recruit talent and experience to the post.

As the pandemic begins to recede, concern over financial stability should not. We don’t know what major shock will next hit the economy and financial system. But a process to scan for risks and adapt to them should be front and center.

Glenn’s Take on the Proposal at the G7 Meeting to Impose a Minimum Tax on Corporate Profits

   The G7 (or Group of 7) is an organization of seven large economies: Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States. Only democratic countries are included, so China is not a member. At a recent meeting attended by U.S. Treasury Secretary Janet Yellen, the group agreed to adopt a uniform corporate tax rate of at least 15 percent.

Glenn discusses this decision in the following opinion column published in the Financial Times.

U.S. Treasury Secretary Janet Yellen and Paolo Gentiloni, European Commissioner for Economy, at a recent meeting of the G7.

Governments Should Tax Cash Flow, Not Global Corporate Income

From the Biden administration’s inception, US Treasury Secretary Janet Yellen has championed a global minimum tax for corporations. While the US walked back from a request for a 21 per cent rate (which was linked to an objective of raising the current US corporate tax of 21 per cent to between 25 and 28 per cent), it did lock in with G7 finance ministers a rate of at least 15 per cent. Secretary Yellen praised the move: “That global minimum tax would end the race to the bottom in corporate taxation, and ensure fairness for the middle class and working people in the US and around the world.”

It is tough to argue that corporate income shouldn’t pay its “fair share”. But the global minimum tax raises both political and economic questions.

Politics first. Approval in the US is likely to be tough. The minimum tax is estimated by the OECD to raise as much as $50bn-$80bn per year, much of it from successful American firms. Revenue to the US Treasury would be part of this amount, but small relative to the substantial expansion in spending proposed by the Biden administration. Will other governments engage their own political costs to achieve a deal that may be ephemeral if it fails to get US legislative approval? Even if the deal succeeds, might it hand a competitive victory to China? As a non-party to G7 or OECD proposals, could it not use both tax rates and subsidies to draw more investment to China?

But it is on economics that the global minimum tax draws more sensitive questions in two areas. The first is the design of the tax base. The second addresses the foundational question of the problem policymakers are trying to solve and whether the new minimum tax is the best way to do so.

A 15 per cent rate is not particularly useful without an agreement on what the tax base is. Particularly for the US, home to many very profitable technology companies, the concern should arise that countries will use special taxes and subsidies that effectively target certain industries. The US has had a version of a minimum tax of foreign earnings since the Tax Cuts and Jobs Act of 2017 enshrined GILTI (Global Intangible Low-Taxed Income) provision into law. The Biden administration wants to use the new global minimum tax to raise the GILTI rate and expand the tax base by eliminating a GILTI deduction for overseas plant and equipment investments.

For a 15 per cent minimum rate to make sense, countries would need a uniform tax base. Presumably, the goal of the new minimum tax is to limit the benefits to companies of shifting profits to low-tax jurisdictions, not to distort where those firms invest. The combination of a global minimum tax with the broad base advocated by the Biden administration could reduce cross-border investments and reduce the profitability of large multinational firms.

A still deeper economic issue is that of who bears the tax burden. I noted above that projected revenue increases are small compared to G7 government spending levels. It is not corporations who would pay more, but capital owners generally and workers, according to contemporary economic views of who bears the burden of the tax.

There is a better way to achieve what Yellen and her finance minister colleagues are trying to accomplish. To begin with, countries could allow full expensing of investment. That approach would move the tax system away from a corporate income tax toward a cash flow tax, long favoured by economists. In this revision, the minimum tax would not distort new investment decisions. It would also push the tax burden on to economic rents—profits in excess of the normal return to capital—better satisfying the apparent G7 goal of garnering more revenue from the most profitable large companies. And such a system would be simpler to administer, as multinationals would not need to set up different ways to track deductible investment costs over time in different countries.

In the debate leading up to the 2017 US tax law changes, Congress considered a version of this idea in a destination-based cash flow tax. Like a value added tax, this would tax corporate profits based on cash flows in a given country. The reform, which foundered on the political desirability of border adjustments, limits tax biases against investment and boosts tax fairness.

Returning to the numbers: countries with large levels of public spending relative to gross domestic product, as the Biden administration proposes, fund it mainly with value added taxes, not traditional corporate income taxes. A better global tax system is possible, but it starts with a verdict of “not GILTI.”

Glenn Is Interviewed by the Financial Times

The Financial Times recently interviewed Glenn. Here is an edited version. The full interview can be found here.

Financial Times (Gillian Tett, editor-at-large for the United States): Gross domestic product data show that the economy is rebounding very fast from the pandemic; the Federal Reserve just said that it doesn’t intend to raise rates any time soon; and President Joe Biden has pledged a massive fiscal package. So what is your forecast for the American economy?

Glenn:  Re-opening as the virus recedes would always lead to a very significant pop in GDP growth. So the near-term is not really the big question. There will certainly be a transitory increase in inflation. But I think the Fed on balance is correct, that boost is likely to be transitory. My worry is when I hear the Fed talk, as its chair Jay Powell has done, about wanting to watch for labor market “re-healing” to finish. The problem in the labor market is [largely] structural. Just running the economy hot by the Fed doesn’t fix that.

On fiscal policy, this is not just a “boost”.… The American Rescue Plan was intended as stimulus. But the American Jobs Act, the American Families Plan, those are really a remaking of the size of government. It has to be paid for and arithmetically can’t be paid for by taxes on the rich. There’s just not enough there. So the honest conversation with the American people is a matter of public choice: if you want a big government that does what President Biden wants [it to do], you’ll have to pay for it. 

GT: How confident are you that inflation pressures are transitory?

GH: One can never be completely confident, but I think if the Fed had a clearer policy story I could be confident that commodity price increases are transitory. What worries me is the Fed thinking it can lean against structural changes in the labor market with monetary policy. One might worry a bit about inflation risks in the long-term—some of the structural headwinds against inflation to do with demography and growth in the emerging world, particularly in China, are going away. 

GT: Do you think that the Fed should be indicating that it’s willing to raise rates if inflation rises?

GH: I think the Fed is unlikely to do that. [But] one of the reasons you are seeing implied volatility in rates and credit markets so high relative to equities, is the fear in the bond market that, maybe, the Fed is saying one thing but if backed into the corner could do another. Remember that the Fed bought around half of Treasury issues last year, and owns 40 per cent of all of the outstanding 10-year plus maturity treasuries, so the Fed’s thoughts there, which aren’t really clear to the bond market, are very, very important. 

GT: Larry Summers has said this is way too much [stimulus], way too fast and will create inflation risks. You and Larry don’t often agree, but would you agree on this? 

GH: I would agree on the risk, but it’s [not] the problem that is worrying me the most. What worries me even more is [in trying to] create a government that large . . .  if you want a government that does those things, tax burdens will have to be higher.

If you look at the math on the tax burden, the [proposed] corporate tax increase or capital gains tax increase are not remotely large enough. The other structural thing that worries me is that I do see productivity reductions and investment reductions as a result of these large tax increases. 

GT: Biden said if you are earning less than $400,000 a year you will not see your taxes go up. 

GH: Well, it’s just not true, [neither] in the near-term [nor] the long-term. Take the corporate tax. Many economists have concluded that much of the burden of the corporate tax is borne by workers. In the 1970s and early 1980s, we thought it was capital that bore the burden of the corporate taxes. [But] that is not what economists believe today. So you simply cannot say that people who make less than $400,000 aren’t going to bear a part of the burden of the tax. 

Likewise with capital gains, the president says: “I’m only going after 0.3 per cent of taxpayers,” meaning [those] that make more than a million dollars a year and have capital gains. But those individuals don’t have 0.3 per cent of the capital gains—they likely have the bulk of them. So if there are any effects on risk-taking, on saving and investment, the [risks] are very large.

Those effects are borne by the economy, not by the top 0.3 per cent …. And in the longer term … if you look at the budget math here, there’s going to be a large revenue hole. Somebody has to pay for it. 

GT: Well, what about that “somebody” being companies? 

GH: Let’s put the tax changes into two buckets. On the rates, I don’t think we want to go as high as the president is proposing, certainly not back to the old rates. On the base, president Biden is proposing a tax increase by base broadening—it’s a very, very big change. I expect companies will acknowledge they need to pay some minimum level, but the math isn’t going to add up.

GT: What about taxes under the guise of climate change action, such as a fuel tax or value added tax?

GH: I think it’s a great idea. For years I have supported a carbon tax because I do believe that it is one of the best ways to deal with climate change. I’m very skeptical of subsidies in green things but if you put a price on carbon, businesspeople will rush around and innovate and do it efficiently and it does not have to be regressive .…

About [a value-added tax] VAT—there is no question that if we want the government President Biden is suggesting, you absolutely have to have a VAT.

European states that have much bigger [state sectors] than the American state as a share of GDP are not financed with taxes on capital. In fact, in many European countries capital taxes are lower than they are in the United States. They’re financed by consumption taxes [such as the VAT]. 

…

GT: Why do you think Biden’s package is undermining productivity? 

GH: Let me just take one step back. Some discussions of secular stagnation come from insufficient aggregate demand. Another school of thought thinks that structurally we have a problem with productivity growth, in terms of the supply side of the economy and the economy’s potential to grow. That is where I’m coming from. The tax plans are definitely anti-investment, as the lack of capital deepening explains low productivity growth and capital gains tax increases can affect risk-taking. There’s certainly nothing to enhance productivity [in Biden’s plans] and a lot to discourage productivity. 

It is not just the tax policy. I worry about a monetary policy that could lead to zombification of firms—an environment of very low interest rates that sustain low-productivity firms. To President Biden’s credit, pieces of what he’s proposing that are true infrastructure could, in fact, raise productivity, but that is a small part of what he’s actually calling infrastructure. 

GT: Are you concerned about a future debt crisis?

GH: Well, we are the reserve currency country, and we are borrowing in our currency, so I think a slow and steady malaise is more likely. To give a practical example, the Medicare trust fund could run out of money within a year or so, social security within five or so years. That will force discussions in Washington as to whether the public may wish to have a government this size. 

GT: So you don’t expect a debt crisis per se because of the reserve currency status?

GH: [Not] at the moment.

GT: Should Republicans be co-operating to create a bipartisan bill? 

GH: You could get bipartisan support for a new “GI bill” to prepare workers to adjust from the Covid world. For example, support in community colleges.

I’m not talking about free community college but supply side support—increasing their capacity to train people. Where you won’t get bipartisan support is [for] the notion that we need to move away from a work-supported social insurance system to a broader cradle-to-grave safety net.

The administration really fuzzed that up by calling it an infrastructure bill. Infrastructure doesn’t have to be just roads and bridges and airports—it could be broadband. But not healthcare. 

GT: Are childcare support and elderly support part of “infrastructure”?

GH: No—those are social spending. 

GT: One of the interesting ways you frame this debate is with the contrast between Keynes and Hayek, i.e. whether you’re trying to prop up the current system or encourage more rapid transformation. What do you mean?

GH: You could think of Covid [in terms of] a Keynesian response — we have a collapse in demand. The Keynesian response is not fanciful. But Hayek would say the new world after Covid isn’t going to look like the old world, so why support every single business? Both are right. We did a good job in policy on the Keynesian part. [But] we’ve done less well [thinking about Hayek]. 

GT: What do you think about Larry Summer’s concept of secular stagnation? 

GH: There’s a scene in Dickens’ A Christmas Carol, when Scrooge asks, [something like] “are these the shadows of things that are or might be?”. I feel the same way about Bob Gordon’s descriptions of the American economy — Larry and Bob are talking about the shadows of things that could be if we have bad enough public policy, going back to the anti-productivity story. But I don’t think they’re inevitable. 

Every businessperson with whom I speak is pretty optimistic about the technology frontier in productivity. If there’s a reason for pessimism, it’s more about the political system’s ability and willingness to let that productivity growth [run free].

GT: Do you think that the Republican party knows what it stands for with economics?

GH: … [An] approach Republicans could take is to go past the neoliberalism to liberalism (with a small L), to Adam Smith. He was anti-mercantilist—that’s what got him angry in The Wealth of Nations—and he was very interested in the ability of everybody in the economy to compete.

So a new Republican agenda might do more to help people compete—that sounds more like Lincoln, or like Roosevelt’s GI bill. In that lies a new agenda. But I don’t see the party really moving in that direction. 

GT: What about the second book of Smith’s, The Theory of Moral Sentiments?

GH: Smith referred to “mutual sympathy”, which today we would call empathy. Forward-leaning businesspeople and business leaders think that way. I don’t see [the environmental, social, and governance] ESG [approach to investing] as somehow an enemy of shareholders—this isn’t Milton Friedman versus socialism—it’s more a matter of what really is in the long-term interest of the firm.

Remember, Smith railed against the British East India Company, which he thought of as a cancer. He thought you had to be very careful in the social framing of corporations. Businesspeople today need to understand the corporate structure is a social gift. In fact, capitalism is a social gift. If the public doesn’t want it, it won’t happen. 

GT: I have a book coming out in a few weeks’ time that stresses this social and cultural aspect of business and finance and economics, and argues that business leaders need to move beyond tunnel vision to use lateral vision. Do you agree with this? 

GH: Yes. When I teach students political economy, I remind them that great thinkers like a Friedman or Hayek or Smith wrote [for] the times in which they lived. Friedman and Hayek were writing in response to a very slovenly and inefficient corporatist economic system and were horrified by fascism. If Ronald Reagan were with us today, I don’t think he would be the 1980s Ronald Reagan. If Friedman and Hayek were with us today, they might have a different view. Context shifts.

GT: Friedman was also operating when people assumed that they could outsource the difficult social decisions to government and when there wasn’t radical transparency and customers, clients and employees couldn’t see exactly what firms were doing. Does that matter?

GH: Yes. If Friedman were here he might correctly remind us that there are big social externalities no one company can fix. But there is no reason businesspeople can’t be leaders. When the Marshall Plan was passed, that was not because Congress in its great wisdom decided to do something. It was because the business community came together and said: “Good Lord, we are going to have communism in western Europe and what’s that going to do to our economic system?” They pushed Congress. I understand that [today business is] afraid. But it’s not an excuse not to act. At many companies, their own employees are going to put pressure [on them to act]. 

GT: You are starting to see a level of company collaboration which was unimaginable when we had Thatcherism and Reaganism. Will this last? 

GH: I do [think so] and Hayek would have celebrated this co-ordinated response because it bubbled up from the bottom. If you compare the production of vaccines, which was largely a private-sector activity, to the distribution of vaccines, which was more a public-sector activity, I think we know which one seemed to work better.

There are things that could help that—imagine if Biden put applied research centers all around the country that were linked with universities. That might help companies fix localities, as well as solving big problems like vaccines. 

…

GT: Are you concerned that we have an ESG bubble?

GH: I am, in several aspects. We are running the risk of industrial policy and rent seeking, with just subsidizing “green things.” I also worry about how CEOs can deal with this—you don’t want the CEO spending half of his or her day responding to social concerns.

GT: What about protectionism? Can the Republicans present an alternative voice on this? 

GH: I hope so, but I’m not sure. Like almost all economists … I believe in free trade. So why is something that is obvious in Econ 101 not so popular with the public?

I think for two reasons. One is whenever your Econ 101 professor talked about the gains from trade, he or she always [had] the idea that there would be losers, but compensation would somehow occur—and it hasn’t.

[Second] free trade is one of those examples, like the old classical gold standard, of a system that’s outside-in. You have to sign up for the rules of the game and then you just adjust. I think we need to go back to a period that says, look, we do need to understand domestic constituencies. That could mean much more support for training, it could be wage insurance, it could be lots of things rather than just saying free trade. 

GT: So it’s about trying to talk about free trade with both parts of Adam Smith. 

GH: Yes, exactly. Even Smith, who was the champion for openness, would not have countenanced whole areas just being left behind. Smith talked a lot about places—he said something like a man is a sort of luggage that’s hard to move, meaning you really have to look after places, not just jobs . . . its culture. 

GT: Hey, anthropology can mingle with economics! 

GH: Exactly—two social sciences, peas in a pod. 

GT: So what’s happening to the economics profession? With issues like [the debate around Larry Summers’ criticism of Biden’s policies] are we seeing a tribal warfare break out between economists? Is there a rethink of economics? Is Biden moving away from them?

GH: Well, let me start with some good news: the young stars in the [economics] profession today tend to be people who are talking about big problems with new tools and techniques, ranging from development to monetary policy to labor markets. I think that’s entirely healthy. 

I think the government needs people who have big macro views [too]. If I were in Janet Yellen’s shoes, I’d want to be talking to economists who could continue to give me that perspective, but also get micro perspectives from labor and financial markets. So there needn’t be a war. [But] I do worry from the way the Biden administration is talking about policies that economists just aren’t very involved at all. That’s not the first administration I’ve seen that happen—but it is a concern for the economics profession. 

Deciphering the April Employment Report

On Friday May 7, 2021, the Bureau of Labor Statistics (BLS) released its monthly “Employment Situation Report.”  The BLS estimated that nonfarm payroll employment had increased by 266,000 from March to April. The average forecast of the Wall Street Journal’s panel of economists was for a much higher increase in employment of  1 million. The unemployment rate increased from 6.0% to 6.1%, rather than falling to 5.8% as economists had forecast.  

Keep in mind that employment data is subject to revisions. What does this employment report tell us about the state of the economy and the state of the labor market?  First, it’s always worth remembering that the BLS revises its employment estimates at least three times in subsequent months as more complete data become available. (The unemployment rate estimates are calculated in a separate survey of households and are not revised other than as seasonal adjustment factors change.)

Employment data gathered during and immediately after a recession are particularly subject to large revisions. In the principles textbook, Chapter 19, Section 19.1 includes a discussion of the substantial revisions the BLS made to its initial employment estimates during the 2007–2009 recession.  Today’s report noted that the increase in employment from February to March, which had originally been reported as 916,000 had been revised downward to 770,000.

Explaining the slow increase in employment. So, the estimated employment increase the BLS reported today may well end up being revised upward. But the revisions will almost certainly leave the increase far short of the forecast increase of 1 million.  We can discuss two types of explanations for this relatively disappointing employment increase: 1) factors affecting the demand for labor, and 2) factors affecting the supply of labor.

The demand for labor.  During the recovery from a typical recession, increases in labor demand may lag behind increases in production, limiting employment increases and causing temporary increases in the unemployment rate.  Employers may be reluctant to hire more workers if the employers are uncertain that the increase in demand for their products will be maintained. During a recession, firms also typically reduce employment by less than they reduce output because searching for workers during a recovery is costly and because they may fear that if they lay off their most productive workers, these workers may accept jobs at competing firms. As a result, during the early months of a recovery, firms are in position to increase output by more than they increase employment. That this outcome occurred during the first months of 2021 is indicated by the fact that productivity increased 5.4% during the first quarter of 2021, as firms increased output by 8.4% but hours worked by only 2.9%.

The recession caused by the pandemic was unusual in that many businesses decreased their supply of goods and services not because of a decline in consumer demand but because of government social distancing requirements. During March 2021, as more people became vaccinated against Covid-19, state and local governments in many areas of the country were relaxing or eliminating these requirements. But upsurges in infection in some areas slowed this process and may also have made consumers reluctant to shop at stores or attend movie theaters even where such activities were not restricted. Finally, partly due to the pandemic, some U.S. manufacturers were having trouble receiving deliveries of intermediate goods. In particular, automobile companies had to reduce production or close some factories because of the difficulty of obtaining computer chips. As a result, during April 2021, employment declined in the motor vehicle and parts industry despite strong consumer demand for cars and light trucks.

The supply of labor. In the weeks leading up to the release of employment report, the media published many articles focusing on firms that were having difficulty hiring workers. BLS data for February 2021 (the most recent month with available data) showed that the estimated number of job opening nationwide was actually 5% higher than in February 2020, the last month before the pandemic.

That employment grew slowly despite a large number of available jobs may be an indication that labor supply had declined relative to the situation before the pandemic. That is, fewer people were willing to work at any given wage than a year earlier. There are several related reasons that the labor supply curve may have shifted: 1) Many K-12 schools were still conducting instruction either wholly or partially online making it more difficult for parents of school-age children to accept work outside the home; 2) although vaccinations had become widely available, some people were still hesitant to be in close proximity to other people as is required in many jobs; and 3) under the American Rescue Plan Act proposed by President Biden and passed by Congress in March 2021, many unemployed workers were eligible for an additional $300-per-week federal payment on top of their normal state unemployment insurance payment. These expanded unemployment benefits were scheduled to end September 2021. In the case of some low-wage workers, their total unemployment payment during April was greater than the wage they would have earned if employed.

These three factors affecting labor supply were potentially interrelated in that the expanded unemployment insurance benefits provided the financial means that allowed some workers to remain unemployed so that they could be home with their children or so that they could avoid a work situation that they believed exposed them to the risk of contracting Covid-19.

That at least some firms were having difficulty hiring workers seemed confirmed by the fact that average weekly hours worked steadily increased from February through April, indicating that employers were asking their existing employees to work longer hours. 

Summary. It’s never a good idea to draw firm conclusions about the state of the economy from one month’s employment report. That observation is particularly true in this case because April 2021 was a period of continuing transition in the U.S. economy as vaccination rates increased, infection rates declined, and government restrictions on business operations were relaxed. All of these factors made it likely that during the following months more businesses would be able to resume normal operations, increasing the demand for labor.

In addition, by the fall, the factors affecting labor supply may have largely been resolved as most children return to full-time on-site schooling, increased vaccination rates reduce fears of infection, and the supplementary unemployment benefits end.

The three figures below show: 1) total nonfarm private employment; 2) the employment-population ratio for workers aged 25 to 54; and 3) the unemployment rate. Together the figures indicate that in April 2021 the recovery from the worst effects of the pandemic on the labor market was well underway, but there was still a long way to go.

NEW! – 04/16/21 Podcast – Authors Glenn Hubbard & Tony O’Brien discuss monetary policy and the tools available to the Federal Reserve.

Authors Glenn Hubbard and Tony O’Brien follow up on last week’s fiscal policy podcast by discussing monetary policy in today’s world. The Fed’s role has changed significantly since it was first introduced. They keep an eye on inflation and employment but aren’t clear on which is their priority. The tools and models used by economists even a decade ago seem outdated in a world where these concepts of a previous generation may be outdated. But, are they? LIsten to Glenn & Tony discuss these issues in some depth as we navigate our way through a difficult financial time.

Just search Hubbard O’Brien Economics on Apple iTunes or any other Podcast provider and subscribe! Today’s episode is appropriate for Principles of Economics and/or Money & Banking!

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