Macro Roundup

Fed economist are presenting this at Brookings tomorrow. Supports your view of the high cost of low skilled workers, paper finds that tight labor markets boost the employment of marginal workers, "...Over our entire sample, the unemployment rates of each group we study moves in tandem with the aggregate unemployment rate. Second, like others, we also find that the fluctuations of less advantaged groups including blacks, Hispanics, and those with less than a college education are more pronounced. When the labor market weakens, these groups tend to suffer disproportionately; when it recovers, their experience improves disproportionately...."

Stephanie R. Aaronson, Mary Daly, William Wascher and David Wilcox, "Okun Revisited: Who Benefits Most From a Strong Economy?" Brookings Paper's on Economic Activity, March 8, 2019, https://www.brookings.edu/wp-content/uploads/2019/03/Okun-Revisited-Who-Benefits-Most-From-a-Strong-Economy.pdf

"....We use two variables: annual own income (sum of all earnings and all other income) and annual household income (sum of all income across all household members). All measures from the ADF are annual and refer to the years 1988 to 2017, corresponding to the calendar year preceding the survey year. In line with previous research we focus our attention on 25-64 year olds because this age group consists of individuals who are most likely to be finished with schooling and below normal retirement age. Within this group we examine the relative outcomes of historically less advantaged groups defined by race, gender, and educational attainment. We define three mutually exclusive groups for race and ethnicity: African Americans/blacks (we will use the terms interchangeably); Hispanics or Latinos (again, we will use the terms interchangeably); and whites.....A key feature evident in figure 2 is that fluctuations in the unemployment rates for African Americans and Hispanics—both males and females—are roughly synchronized with fluctuations in the unemployment rate for whites (top tier of panels). However, these rates are uniformly higher than the rates for white men and women and exhibit considerably greater amplitude. As a result, when the labor market weakens, the gaps between these rates widen markedly; they then shrink again when the labor market tightens. Compared to the unemployment rate, the labor force participation rate (middle tier of panels) is considerably less cyclically sensitive. A much greater fraction of the variation in the gaps in labor force participation rates across different races and ethnicities appears to reflect secular trends. Overall, black men have lower labor force participation rates than white or Hispanic men. Among women, Hispanic women participate at a lower rate than either black or white women. Finally, the employment-to-population ratio (EPOP), which combines the information in the unemployment rate and the labor-force participation rate, also varies considerably over the business cycle.9 In terms of levels, black men and Hispanic women have lower EPOPs than their counterparts, reflecting both their lower rates of labor force participation and higher unemployment rates....Figure 3 presents similar information for groups at different levels of educational attainment. On average, the unemployment rates (top two panels) of individuals without a college degree are more cyclically sensitive, rising by more in downturns and falling by more in expansions. At all points the unemployment rates for those without a college degree are higher than the rates for those with a college degree....On average, the unemployment rates (top two panels) of individuals without a college degree are more cyclically sensitive, rising by more in downturns and falling by more in expansions. At all points the unemployment rates for those without a college degree are higher than the rates for those with a college degree. Labor force participation rates and EPOPs (the middle and lower panels) are lower for those with less education.Similar to the results by race and ethnicity, labor force participation exhibits very little observable cyclical sensitivity. EPOPS are slightly more cyclical. The gaps in both LFPRs and EPOPs by educational attainment are large and persistent..... That said, there is very little visual evidence that the strength of the labor market affects the gaps in these variables across less-advantaged and more advantaged groups. In general, these aggregate income measures for blacks and Hispanics are far lower than the analogous measures for whites; similarly, the average incomes of those with lower educational attainment are well below those of persons with higher educational attainment....... A few observations seem clear. First, as previous researchers have shown, when the economy gets weak everyone suffers and when the economy gets stronger, everyone benefits. This is seen most clearly in unemployment rates: Over our entire sample, the unemployment rates of each group we study moves in tandem with the aggregate unemployment rate. Second, like others, we also find that the fluctuations of less advantaged groups including blacks, Hispanics, and those with less than a college education are more pronounced. When the labor market weakens, these groups tend to suffer disproportionately; when it recovers, their experience improves disproportionately. Third, inspired by Arthur Okun, we have also searched for evidence that high-pressure economies are qualitatively different, and found suggestive evidence that this is the case. A high-pressure economy does afford greater improvement for some less-advantaged groups in some key labor market variables, although the evidence is complicated by the heterogeneity observed across the various cycles. Finally, we also find suggestive evidence that these benefits persist at least for a while. All in all, the evidence presented here supports the idea that high-pressure economies are different than normal expansions, but just how different remains a topic of further study...."

Summer is back on the secular stagnation beat his new paper finds that the neutral real rate for the advanced economies has declined by ~3% points over past 40 years, is slightly above 0 in real terms, would be even lower if not for increases in government debt

"....This paper demonstrates that neutral real interest rates would have declined by far more than what has been observed in the industrial world and would in all likelihood be significantly negative but for offsetting fiscal policies over the last generation. We start by arguing that neutral real interest rates are best estimated for the block of all industrial economies given capital mobility between them and relatively limited fluctuations in their collective current account. We show, using standard econometric procedures and looking at direct market indicators of prospective real rates, that neutral real interest rates have declined by at least 300 basis points over the last generation.....Our results suggest that real rate for the advanced economy block - what we call AE R* for brevity - declined by around 3pp over the past 40 years, and is currently only slightly above zero in real terms. This is consistent with the evidence presented above on the evolution of measures of long term real interest rates....We argue that these secular movements are in larger part a reflection of changes in saving and investment propensities rather than the safety and liquidity properties of Treasury instruments. We then point out that the movements in the neutral real rate reflect both developments in the private sector and in public policy. We highlight the levels of government debt, the extent of payas-you-go old age pensions and the insurance value of government health care programs have all ceteris paribus operated to raise neutral real rates..... Overall, then, we find that the rising government debt accounts for around 1.5pp (0.8pp+0.7pp) upwards pressure on the neutral real interest rate, consistent with our calculations based on the empirical elasticities.... Using estimates drawn from the literature, as well as two general equilibrium models emphasizing respectively lifecycle heterogeneity and idiosyncratic risks, we suggest that the “private sector neutral real rate” may have declined by as much as 700 basis points since the 1970s. Our findings support the idea that, absent offsetting policies, mature industrial economies are prone to secular stagnation. This raises profound questions about stabilization policy going forward. Achievement of levels of deficits and government debt generally considered desirable - especially if complemented by reductions in social insurance - would likely mean negative neutral real rates in the industrial world. Policymakers going forward will need to engage in some combination of greater tolerance of budget deficits, unconventional monetary policies and structural measures to promote private investment and absorb private saving if full employment is to be maintained and inflation targets are to be hit..... Our findings suggest that the private sector forces dragging down on interest rates are more powerful than previously anticipated, and that on average across the business cycle, equilibration of private-sector saving and private-sector investment may indeed require very low real rate of interest in advanced economies for years to come. This conclusion is consistent with findings of Oscar Jorda, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick and Alan Taylor (2017), who established that the current low levels of interest rates are not unusual in historical terms.9 It is also consistent with the Japanese experience.10 Our findings raise the possibility that the developed world is at risk of mirroring the experience of Japan, whereby the very low equilibrium rate of interest appears to be a semi-permanent feature of the economic landscape....We draw three main conclusions from the analysis in this paper. First, the neutral real rate for the industrial world has trended downward for the last generation and this is best understood in terms of changes in private sector saving and investment propensities. In the face of neutral real rate estimates, past trends in indexed bond yields, and measures of real swap yields, this conclusion seems inescapable. It is also noteworthy that current real rates appear to be quite well predicted by pre-financial crisis trends. We believe that the these trends are best analyzed in terms of changes in saving and investment propensities or equivalently in terms of trends in desired wealth holdings by consumers and desired capital accumulation by producers. While factors involving liquidity, scarcity and risk no doubt bear on levels of real interest rates we find it highly implausible that they are the main factor accounting for trend movements. The movements are too large and too pervasive across assets and the fluctuations in spreads are too small and lacking in trend for these factors to account for the observed trends in the data.Second, the neutral real rate would have declined substantially more over the last generation but for increases in government debt and expansions in social insurance programs. Both straightforward extrapolations of existing rules of thumb regarding debt and deficit impacts on interest rates and calculations using workhorse general equilibrium models suggest that fiscal policies have operated to raise real interest rates by several hundred basis points over the last generation. While this conclusion is dependent on our rejection of Ricardian equivalence, we see nothing that leads us to believe that increased government debt automatically calls for increased saving or that pay-as-you-go social security programs alter bequests for most families. The specific magnitudes are very uncertain, but open economy aspects and the possibility suggested by our analysis - that budget deficits emerge in response to excesses of private saving over private investment - lead us to think that we are more likely to understate than overstate the extent of fiscal support for real interest rates in recent years. Third, the implication of our analysis that but for major increases in deficits debt and social insurance neutral real rates in the industrial world would be significantly negative by as much as several hundred basis points suggests substantial grounds for concern over secular stagnation. From the perspective of our analysis the private economy is prone to being caught in an underemployment equilibrium if real interest rates cannot fall far below zero. Full employment in recent years has been achieved where it has been achieved either through large budget deficits as in the United States or Japan or large trade surpluses as in Germany. It is worth considering that in the United States during the period prior to the financial crisis, negative real short term interest rates, a huge housing bubble, erosion of credit standards and expansionary fiscal policy were only sufficient to achieve moderate growth. Adequate growth in Europe was only maintained through what in retrospect appears to have been clearly unsustainable lending to the periphery...."

Łukasz Rachel and Lawrence Summers, "On Falling Neutral Real Rates, Fiscal Policy, and the Risk of Secular Stagnation,"Brookings Papers on Economic Activity, March 6, 2019, https://www.brookings.edu/wp-content/uploads/2019/03/On-Falling-Neutral-Real-Rates-Fiscal-Policy-and-the-Risk-of-Secular-Stagnation.pdf

Found Brad DeLong's thoughts on some of his takeaway from Summer's paper on the ERP interesting

"...Economic and finance professors continue to attempt to understand this large equity return premium as somehow reflecting some market-maker somewhere's attitude toward risk. They fail. They will continue to fail. The gap between the risky discount rate and the safe interest rate is5.5%-points today, was 1%-point 20 years ago, was 7.5% 40 years ago, and was 4% 50 years ago.Most of the time since the development of stock markets that were more than grifter cons for insiders 150 years ago, this gap has been vastly in excess of any rational assessment of the extra risk born from investing in a diversified portfolio of stocks rather than in safe government bonds. But sometimes—1998, when the risk associated with investments in stocks was not low but was unusually high—it is not....tempted by the following narrative to account for the past 20 years' moves in the equity return premium:The end of dot-com irrational exuberance that drives the equity premium up from 1998-2002 with no effect on the *safe interest rate. The financial side of the China shock 2002-2008 that greatly increases the demand worldwide for safe assets.Political risks in emerging markets and economic risks of stalling emerging-market growth greatly increased demand for safe assets like U.S. Treasuries: it seems sensible to hold U.S. Treasuries for that portion of your portfolio which will be the only thing left if the balloon goes up and you have to flee your country in the Learjet, or in a rubber boat. This drives the equity premium up further. The financial crisis's destruction of confidence that any organization besides Global North governments is or will be in the business of providing AAA assets eliminated AAA and near-AAA private close substitutes for Treasuries.This drives the equity premium up still further.The natural conclusion I am tempted to draw—which Łukasz Rachel and Lawrence H. Summers do not—isThe world economy today desperately wants to hold its wealth in claims on Global North sovereigns with exorbitant privilege issuing reserve currencies. A well-functioning economy creates things of value. The Global North sovereigns with exorbitant privilege issuing reserve currencies can create a lot of value. They should do so: governments should run up their debts until they satisfy demand with an equity return premium at a value we think is sensible and "normal"...."

Brad DeLong, "On Falling Neutral Real Rates, Fiscal Policy, and the Risk of Secular Stagnation,"Grasping Reality, March 7, 2019, https://www.bradford-delong.com/2019/03/which-interest-rate-on-on-falling-neutral-real-rates-fiscal-policy-and-the-risk-of-secular-stagnation.html

Bloomberg quotes from a David Kostin (GS) note on buybacks,

"...Goldman found that firms with EPS-linked incentive compensation actually spent a greater portion of their cash on dividends than those without, even though executives in the first category would have had financial incentives to prefer repurchases. Further, the report said, evidence suggests buybacks aren’t crowding out capital investment. The pace of growth investment may even be accelerating. “Corporates are generally efficient allocators of capital,” Goldman wrote. “We find some evidence that the companies that are able to generate the highest returns on assets are also those that invest the most in growth capex and R&D,” while “firms that generate lower asset returns may find the economics of cash return to shareholders to be superior to investing for growth.”..."

Joanna Ossinger, "Goldman Rips Into U.S. ‘Misconceptions’ About Share Buybacks,"Bloomberg, March 8, 2019, https://www.bloomberg.com/news/articles/2019-03-08/goldman-says-public-discourse-gets-it-wrong-about-buybacks

"...we examine possible explanations for the decline in labor-force participation among less-educated men.....wages have not declined consistently over the sample period while labor-force participation has. Moreover, the uncompensated elasticity of labor supply necessary to align wage changes with participation changes, during periods when both were declining, is implausibly large. We then examine two oft-discussed developments outside of the labor market: rising access to Social Security disability insurance (DI), and the growing share of less-educated men with a prison record. Rising DI program participation can account for a non-trivial share of declining labor-force participation among men aged 45-54, but appears largely irrelevant to declining participation in the 25-44-year-old group. Additionally, we document that most non-participating men support themselves primarily on the income of other family members, with a distinct minority depending primarily on their own disability benefits.The literature has not progressed far enough to admit a reasonable quantification of the impact of rising exposure to prison on the labor-force participation rate, but recent estimates suggest that sizable effects are possible. We flag this as an important area for further research. The existing literature, in our view, has not satisfactorily explained the decline in less-educated male labor-force participation. This leads us to develop a new explanation. As others have documented, family structure in the United States has changed dramatically since the 1960s, featuring a tremendous decline in the share of less-educated men forming and maintaining stable marriages. We additionally show an increase in the share of less-educated men living with their parents or other relatives. Providing for a new family plausibly incentivizes a man to engage in labor market activity: a reduction in the prospects of forming and maintaining a stable family, then, removes an important labor supply incentive. At the same time, the possibility of drawing income support from existing relatives creates a feasible labor-force exit.We suspect that changing family structure not only shifts male labor supply incentives independently of labor market conditions, but also moderates the effect of a male labor demand shock on labor-force participation. Since male earning potential is an important determinant of new marriage formation, a persistent labor demand shock which reduces male earning potential exerts an impact on male labor-force participation which operates through the marriage market....'

Ariel Binder and John Bound, "The Declining Labor Market Prospects of Less-Educated Men,"National Bureau of Economic Research, February 2019, https://www.nber.org/papers/w25577.pdf

"... This consensus is wrong: The budget deficit does not cause the trade deficit. In fact, changes in America’s budget deficit have historically been canceled out by changes in the saving behavior of U.S. households and business. The U.S. trade balance is affected by foreign behavior at least as much as by the saving and spending decisions of the government and domestic private sector. (The same holds true for the current account balance, which is a broader measure of cross-border payments that is less affected by corporate tax avoidance.) Yet many hold the unreasonable assumption that America’s external economic relationships are “wholly determined by domestic forces,” as the economist Michael Pettis has put it.....Americans are not “living beyond their means”—there is ample spare capacity and no sign of excess inflation. The problem is that the rest of the world refuses to spend. Producers in Europe and Asia rely on U.S. consumers to absorb their excess output, even as their consumers suffer from shortages of goods, services, and investment. Workers and machines lay idle even as material needs remain unmet...."

Matthew Klein, "Who’s Really to Blame for America’s Trade Deficit,"Barron's, March 8, 2019, https://www.barrons.com/articles/whos-really-to-blame-for-americas-trade-deficit-51552048201