The Unassuming Economist

From Econbrowser:

“Or, old fogey downloads data, finds a negative relationship, a.k.a. the Phillips Curve…

Much was made of the meeting of minds of AOC and Larry Kudlow regarding the Phillips Curve, to wit (from Bloomberg):

… Ocasio-Cortez said many economists are concerned that the formula “is no longer describing what is happening in today’s economy” — and Powell largely agreed.

“She got it right,” Kudlow told reporters at the White House later on Thursday. “He confirmed that the Phillips Curve is dead. The Fed is going to lower interest rates.”

Well, since I’ve been teaching the Phillips Curve for lo these thirty odd years, I thought I’d check to see if I’d missed something. First, it’s important to remember that while we talk about the negative relationship between inflation and unemployment, or the positive relationship between inflation and output, the actual model we use is the expectations augmented Phillips curve including input price shocks. My preferred specification is:

π_t = π^e_t + f(u_t-4 – u_n,t-4) + θz_t

Where π is 4 quarter inflation, π^e is expected inflation, u is official unemployment rate, u_n is natural rate of unemployment [ so (u-u_n) is the unemployment gap], and z is an input price shock, in this case the 4 quarter inflation rate in import prices. Each of these series is available from FRED; using the FRED acronyms, PCEPI for the personal consumption expenditure deflator, MICH for University of Michigan’s 1 year inflation expectations, UNRATE for unemployment rate, NROU for natural rate of unemployment, and IR for import prices.

Estimate this relationship using OLS over the 1987-2019Q2 period (first two months of 2019Q2 used to proxy for Q2). This sample period, after accounting for lags, spans the “Great Moderation”.”

From Conversable Economist:

“As Americans recover from our annual April 15 deadline for filing income taxes, here are a series of figures about longer-term patterns of taxes in the US economy. They are drawn from a series of blog posts by the Tax Foundation over the last few months.  The Tax Foundation is a nonpartisan group whose analysis typically leans toward side that taxes on those with high incomes are already high enough. However, the figures that follow are compiled from fairly standard data sources: IRS data, the Congressional Budget Office, and the like.

For example, here’s a figure showing what taxes are the main sources of federal income over time from Erica York. She writes: “Before 1941, excise taxes, such as gas and tobacco taxes, were the largest source of revenue for the federal government, comprising nearly one-third of government revenue in 1940. Excise taxes were followed by payroll taxes and then corporate income taxes. Today, payroll taxes remain the second largest source of revenue. However, other sources have shifted in relative importance. Specifically, individual income taxes have become a central pillar of the federal revenue system, now comprising nearly half of all revenue. Following an opposite trend, corporate income and excise taxes have decreased relative to other sources.”

 

From a new IMF working paper by Jean-Marc Natal and Nicolas Stoffels:

“We argue that strong globalization forces have been an important determinant of global real interest rates over the last five decades, as they have been key drivers of changes in the natural real interest rate—i.e. the interest rate consistent with output at its potential and constant inflation. An important implication of our analysis is that increased competition in goods and labor market since the 1970s can help explain both the large increase in real interest rates up to the mid-1980s and—as globalization forces mature and may even go into reverse, leading to incrementally rising market power—its subsequent and protracted decline accompanied by lower inflation. The analysis has important implications for monetary policy and the optimal pace of normalization.”

From an article by Christopher G. Collins (PIIE) and Joseph E. Gagnon (PIIE):

“The US economy is running hot, with a record high rate of job vacancies and the lowest unemployment rate in nearly fifty years. Yet most forecasters predict no increase at all in inflation. This combination appears to challenge the validity of the Phillips curve, a popular economic model dating from the 1950s that predicts rising inflation when unemployment is low and falling inflation when unemployment is high. In a new paper, however, we show that the relationship between inflation and unemployment has shifted twice—in the late 1960s and in the mid-1990s. The paper replicates the findings of some other researchers, who find a very flat Phillips curve since the 1990s, implying that unemployment has little effect on inflation. But we also propose an alternative hypothesis: The Phillips curve is bent when inflation is low so that high unemployment has little downward effect on inflation, but low unemployment still pushes inflation up. If we are right, inflation is likely to rise modestly over the next couple of years. We will explore what this means for monetary policy in a subsequent post.

THE EVOLVING US PHILLIPS CURVE

Alban Phillips (1958) developed the original curve bearing his name. It related the rate of wage inflation to the unemployment rate in the United Kingdom over the period 1861–1913. Olivier Blanchard (2017, chapter 8) showed that a similar downward-sloping curve in terms of price inflation and unemployment was apparent in the United States in 1900–1960. Our paper confirms Blanchard’s finding that the rising inflation of the late 1960s led to the unmooring of expectations of inflation from the stable low levels that had prevailed before then and a shift in the Phillips curve to a relationship between the change in the rate of inflation and the unemployment rate. The return of inflation to a very low and stable level led to a second shift in the Phillips curve in the mid-1990s, back to a relationship between the level of inflation and the unemployment rate.

In addition to this shift in the persistence of inflation, many researchers have found that the Phillips curve has been very flat since the 1990s, so that changes in unemployment have little effect on inflation. This was most dramatically demonstrated in the aftermath of the Great Recession of 2008–09, when unemployment remained very high for years and yet inflation barely dipped. We show, however, that another hypothesis fits the data equally well: The Phillips curve may become bent when inflation is low, with a flat portion for high unemployment and a steeper portion for low unemployment.”

Continue reading here.

From a VoxEU post by Davide Furceri, Swarnali Ahmed Hannan, Jonathan D. Ostry, Andrew Rose:

“It seems an appropriate time to study what, if any, have been the macroeconomic consequences of tariffs in practice. Using a straightforward methodology to estimate flexible impulse response functions, and data that span several decades and 151 countries, this column finds that tariff increases have, on average, engendered adverse macroeconomic and distributional consequences: a fall in output and labour productivity, higher unemployment, higher inequality, and negligible effects on the trade balance (likely owing to real exchange rate appreciation when tariffs rise). The aversion of the economics profession to the deadweight loss caused by protectionism seems warranted.

 

One of the most pressing issues on the international agenda these days is protectionism. The US’ trade war with China has created international tension that is infecting stock markets worldwide, exacerbated by other disputes such as the renegotiation of NAFTA, Brexit, and US steel and aluminium tariffs. One ingredient curiously absent from this turbulence is disagreement among the experts on the merits (or lack thereof) on the underlying issue. Indeed, more than on any other issue, there is agreement amongst economists that international trade should be free.¹

Economists have been aware of the senselessness of protectionism since at least Adam Smith. In general, economists believe that freely functioning markets best allocate resources, at least absent some distortion, externality or other market failure; competitive markets tend to maximise output by directing resources to their most productive uses. Of course, there are market imperfections, but tariffs – taxes on imports – are almost never the optimal solution to such problems. Tariffs encourage the deflection of trade to inefficient producers and smuggling to evade the tariffs; such distortions reduce productivity, income and welfare. Further, consumers lose more from a tariff than producers gain, so there is ‘deadweight loss’ as well as inequality (if production tends to be owned by the rich).  The redistributions associated with tariffs tend to create vested interests, so harms tend to persist. Broad-based protectionism can also provoke retaliation which adds further costs.  All these losses to output are exacerbated if inputs are protected, since this adds to production costs.

Discussions of market imperfections and the like are naturally microeconomic in nature (Grossman and Rogoff 1995). Accordingly, most analysis of trade barriers focuses on individual industries. International commercial policy tends not to be used as a macroeconomic tool, probably because of the availability of superior alternatives such as monetary and fiscal policy. In addition, there are strong theoretical reasons that economists abhor the use of protectionism as a macroeconomic policy; for instance, the broad imposition of tariffs may lead to offsetting changes in exchange rates (Dornbusch, 1974). And while the imposition of a tariff could reduce the flow of imports, it is unlikely to change the trade balance unless it fundamentally alters the balance of saving and investment. The findings of recent studies on the impact of trade would imply that tariffs could hurt output and productivity (Feyrer 2009, Alcala and Ciccone 2004). Further, economists think that protectionist policies helped precipitate the collapse of international trade in the early 1930s, and this trade shrinkage was a plausible seed of WWII. So, while protectionism has not been much used in practice as a macroeconomic policy (especially in advanced countries), most economists also agree that it should not be used as a macroeconomic policy.

The here and now

Times change. Some economies – notably the US – have recently begun to use commercial policy seemingly for macroeconomic objectives. So it seems an appropriate time to study what, if any, the macroeconomic consequences of tariffs have actually been in practice. Most of the predisposition of the economics profession against protectionism is based on evidence that is either a) theoretical, b) micro, or c) aggregate and dated. Accordingly, in our recent research (Furceri et al. 2018), we study empirically the macroeconomic effects of tariffs using recent aggregate data.”

Continue reading here.