Inflation, Budget Deficits, Monetary Policy, Climate Change, and Senator Manchin

The big news regarding the Administration’s budget proposal has been Senator Manchin’s rejection of much of the Democrat’s compromise budget proposal, including measures to address climate change. Senator Manchin claims he has been right about inflation and has indicated he will not negotiate any more about increased government spending until inflation comes down.

Journalists reporting on this have generally written that Manchin has been correct about inflation. However, the story is more complicated. In fact, reading what prominent economists say indicates considerable confusion. It could be that Manchin is using inflation as an excuse to oppose climate change measures which affect fossil fuels.

One of the arguments currently being used is that government spending generates inflation by putting more money into the economy. But let’s look at what happens. When the Treasury needs to spend more money than it has on hand, it borrows the funds it needs by selling Treasury securities. In other words, if the federal government is spending more than it is receiving, it takes money out of the economy by borrowing and puts it back in by spending. In the first instance, this is more or less a wash. 

That, though, is not the end of the story. There are models addressing how deficit spending affects the economy, with the impact dependent on what else is happening in the economy. Usually the assumption is that deficit spending increases aggregate demand, because it involves direct spending or results in transferring money to those with a high propensity to consume. If the economy is running at near capacity, the increased demand is postulated to increase inflationary pressures. However, some who were more relaxed about the spending measures during the pandemic thught the inflation risks were minimal because some of the recipients would save some of the money rather than spend it. 

Left out of much of the discussion of Manchin's and other's inflation warnings is monetary policy.  The Federal Reserve, if it decides it is appropriate, can effectively monetize the federal budget deficit by buying Treasury securities. The Fed is prohibited by buying directly from the Treasury, but if it buys roughly the same amount of securities in the market that the Treasury has issued, it has effectively monetized the budget deficit. In other words, it has replaced deficit financing with securities by creating bank reserves. (When the Fed buys securities in the open market, it credits the accounts banks have at the Federal Reserve Banks with the purchase amount. The amounts it credits the private banks are liabilities on its balance sheet and the purchased securities are assets.) The Fed was effectively monetizing much, if not all, of the budget deficit during the pandemic, and this likely has contributed to inflation. (This story can be expanded with more detail, but the details do not matter for the main point of this blog post. Suffice it to say that the effect of monetary policy has been difficult to analyze with short-term interest rates near zero and bank holdings of large excess reserves. These both are unprecdented in our modern history.)

There is a growing consensus that the Fed kept interest rates too low for too long. There may be a price to be paid for that. The Fed has now reversed course, and there is the likelihood that it will not achieve a “soft landing.” If a recession does happen, an increase in government spending would be helpful in pulling us out of it. Mancin appears to ignore this point.

In addition, the current inflation is a global problem. It is hard to make the argument that this is due to excessive U.S. government spending. There are some global factors at work -- among them, war in Ukraine, reduced global grain supplies, oil price increases, reduced production in China due to severe Covid lockdowns, and supply chain issues. What portion of U.S. inflation is due to U.S. government spending and overly loose monetary policy and what portion is due to global issues and supply shortages, rather than excessive demand, is unclear. Except for some economists who project certainty in their pronouncements, there is general uncertainty in the profession about exactly what is going on and what is likely to happen.  

While Senator Manchin may believe what he is saying about inflation, focusing the blame for inflation solely on government spending is misguided. Monetary policy needs to be factored in. No one can predict with certainty how long the current inflation will last, but it should not be used as an excuse to avoid enacting urgently, needed measures to address the growing problem of climate change. 

(This post was revised on July 22 in an attempt to make it clearer.)

Paul Krugman and Inflation

Paul Krugman, who had been on “team transitory” about the current inflation, has become more pessimistic about the outlook. In an April 12, 2022 opinion piece for The New York Times (“Inflation Is About to Come Down — but Don’t Get Too Excited”), Krugman argues that inflation may be coming down in the next few months because supply chain problems will be less of a factor and oil prices may have overshot and will come down.

However, Krugman argues that there is still an inflation problem because wage increases are unsustainable. To show this, he reproduces a graph from the Federal Reserve Bank of Atlanta showing that in April 2022 wages had shot up by 6% over a year. This, he states, is an “unsustainable pace” and “won’t recede until the demand for workers falls back into line with the available supply, which probably — I hate to say this — means that we need to see unemployment tick up at least a bit.”

Krugman, though, fails to note that wages have not kept pace with inflation. The CPI in April rose 8.3% over the year. In other words, the current tight labor market shows the limit of workers’ bargaining power; their real wages have gone down. One could tell a story that the tight labor market has resulted in increased nominal wages, which led for consumer prices to increase even faster than wages. Krugman does not make that argument, and, while it might be correct, it would be hard to prove.

There are different reasons being given for the current inflation. Some blame a too expansive fiscal policy. Another reason, sometimes linked to fiscal largess, is that demand had been suppressed because of the pandemic, and now with the general impression that Covid is diminishing in seriousness, people are spending more.  Others put the blame on the Federal Reserve, which, the argument goes, kept interest rates too low for too long. And, as mentioned, supply chains and labor market tightness are also blamed. Of course, all these factors may be contributing to the current inflation; their relative importance is unclear as is the how long we will have to endure too high inflation.

The Federal Reserve is on course to raise interest rates substantially. The Fed can of course stop the inflation; the question is at what price. Paul Volcker’s judgement in the early 80s was to do whatever it takes given the high inflation of the time. The price was high; but his judgement was that leaving inflation unchecked was worse for the economy and, I am not sure he explicitly said this, the future of our liberal democracy. Most economists and others agree he made the right call, painful as it was.

As the Fed raises interest rates, economic activity will slow down, and unemployment will increase. Krugman is right about that. He seems disconcerted that workers are effectively put on the front line to fight inflation, but the Fed has no choice. The real, long-term problem for the U.S. and other developed economies is the increasing inequality in income distribution. As an IMF annual meeting a few years ago demonstrated, economists are unsure why this is happening and what to do about it. It is a pressing issue. While I cannot prove this, the appeal of the siren call of authoritarianism in the West may be linked to this growing inequality and the anger it causes, though there are likely other reasons too. In the U.S., Democratic Administrations have failed to address the income inequality issue in a meaningful way, and, while those on the right flirt with such questionable measures as protectionism, their policies have usually benefitted those with high incomes.

Florida Governor Ron DeSantis and Math Education

Florida’s Department of Education recently rejected 54 math textbooks for classes K-12. This blog post is not about the reasons given for the rejections of these books but a comment on a tweet about this from Florida Governor Ron DeSantis.

The governor’s tweet said: “Math is about getting the right answer, not about feelings or ideologies. In Florida, we will be educating our children, not indoctrinating them.”

The teaching of math is not only about getting the right answer but in learning to think mathematically. In other words, to arrive at the right answer one often first has to frame a problem in way that can be solved by using math. Specific problems and their solutions may have an emotional component.

An example of how to use math to get insight on a particular issue, in this case not ideological nor emotional, is the question of whether a rectangular television screen or a square television screen has the greatest viewing area for a given diagonal length.

The correct answer is a square, but how does one determine that? While it is fairly easy using calculus to determine that the largest area of a rectangle with a given perimeter is a square, it is more difficult to prove that a square also provides a larger area than that of any other rectangle with the same diagonal. You have to be able to think like a mathematician to prove this. Not all math is learning rote skills to get the correct answer, as DeSantis implies. (Since I don’t have the proof, I am going to resort to that statement in math textbooks which annoys math students no end: the proof is left as an exercise for the reader.)

As a final comment, in the example I gave, some may see a public policy issue. As the aspect of television screens changed to become more rectangular, television manufacturers characterized their models by diagonal size, not area. This may have misled some into thinking that a television set with an equal diagonal to their old square one had the same viewing area. This is not an issue I think is worth fretting much about, but only a way of saying that using math to get insight into real issues can have implications.

A Brief Comment on the Economy – Krugman and Summers

Paul Krugman said yesterday (April 10, 2022) on his twitter feed that he is worried about inflation due to wage pressures, even though inflation may decline somewhat in the near future because of the “bullwhip effect,” which can cause some freight and wholesale prices to decrease in the short-term. 

Krugman is now beginning to agree with Larry Summers and has quit what had been called “team transitory.” Both now agree that the Fed needs to increase interest rates; Summers has called for, among other things, an increase in immigration to alleviate wage pressures.        

However, there may be some differences in view. Summers has criticized the Fed for keeping monetary policy loose for too long and the Administration and Congress for too much spending to counteract the effects of the pandemic. Krugman has not as of now been critical of these government actions and has praised the good job growth in the economy which he says the media has underplayed. The data, though, compel him to recognize the inflation risk. 

Both Krugman and Summers are old enough to remember the stagflation of the 1970s and what Paul Volcker felt compelled to put the economy through to end a dangerous inflation cycle. Out of control inflation can be deeply corrosive to both the economy and the political system. Krugman and Summers do not want to relive any part of that again. For now, they are both correct; the Fed has to keep inflation in check even if that means some economic pain in the next couple of years. 

What is missing, though, is an explicit long-range model of the economy. Do they both really believe that the labor must be constantly subdued to keep inflation in check? Both are Democrats and should have some progressive ideas of how to deal with income inequality and not just at the margin (taxing a few billionaires more is probably justified but does not address the problem of growing income inequality). As far as their politics are concerned, I mention in passing that Krugman is the more progressive of the two, but Summers has been more active politically. 

Krugman is currently the more modest in his predictions, given that he felt compelled to leave team transitory. Also, to those who know him or follow him, it is no surprise that Summers is less than modest when giving his opinions, but he is almost always worth listening too, even if one does not fully agree. 

No one fully understands the economy, not even these two, and unpredictable events (there are those among us who thought Putin was bluffing to destabilize the west and get some concessions) can have an enormous effect. For example, Europe, too, is struggling with inflation under very different institutional setups than the U.S., different government policies, and dependence on Russian fossil fuels. Europe’s struggles undoubtedly will affect the U.S. both politically and economically.

Comment on the FDA and the CDC and Second Covid Boosters

Public health officials and agencies need to cultivate and maintain credibility in order to be fully effective. Unfortunately, there have been some missteps at the federal level. For example, remember the initial recommendation not to wear masks, which was subsequently changed. Also, recall the advice that the J&J vaccine was about as good as the mRNA vaccines, though anyone paying attention knew that this was likely not the case. Now the way the federal government has handled the approval of a second Covid vaccine booster makes one wonder what is going on in the federal health agencies.

On March 29, 2022, the FDA authorized the use of a second booster shot for individuals over 50. The CDC on the same day issued a media release, entitled “CDC Recommends Additional Boosters for Certain Individuals.”

The FDA took this action without consulting its Advisory Committee on Vaccines and Related Biological Products, even though the committee’s next meeting is on April 6. Why did the FDA not wait a few days and ask the committee for its advice on second boosters before taking regulatory action? Regardless of what the FDA officially says, my guess is that FDA officials thought they might get advice that was contrary to what they wanted to do. It is not clear that would have been the outcome, though, a prominent member of the committee, Dr. Paul Offit, has expressed skepticism of the need for second boosters for everyone over 50.

With regard to the CDC’s media release, its headline is misleading. The text of the statement does not recommend additional boosters. Rather, it says: “Following FDA’s regulatory action today, CDC is updating its recommendations to allow certain immunocompromised individuals and people over the age of 50 who received an initial booster dose at least 4 months ago to be eligible for another mRNA booster to increase their protection against severe disease from COVID-19. Separately and in addition, based on newly published data, adults who received a primary vaccine and booster dose of Johnson & Johnson’s Janssen COVID-19 vaccine at least 4 months ago may now receive a second booster dose using an mRNA COVID-19 vaccine.”

This wording is strange. It recommends that a broader group be "allowed" to get a second booster, though the CDC does not have the authority to do this. It reads as a recommendation to the FDA to do what it had already done a few hours previously.

The wording looks like a hasty bureaucratic compromise among government officials who probably are not in total agreement. There is disagreement in the medical community about this. The government's handling of this issue does not inspire confidence and is a further example of less than good public relations by public health authorities.

I do not know whether second boosters are necessary or a good idea for everyone over 50. I would like to see whether any consensus is achieved among the experts.

I also note that the attempt to manipulate press accounts on this subject have not been fully successful because of dissenting voices among experts. For example, here is an excerpt from a recent New York Times article, “Should you get another Covid booster”:

Many scientists are dubious about today’s decision.

The F.D.A.’s authorization allows anyone over 50 to receive a second booster. But experts pointed out that the limited research so far supports a fourth shot only for those older than 65 or who have underlying conditions that put them at high risk.

The most compelling data comes from an Israeli study that found that adults older than 60 who got a fourth dose were 78 percent less likely to die of Covid than those who got only three shots. The study was posted online last week and has not yet been reviewed for publication in a scientific journal.

“The Israeli study, in terms of mortality rate, is decisive,” said Dr. Robert Wachter, chair of the Department of Medicine at the University of California, San Francisco.

But that study, while it offers the only evidence, is deeply flawed. The participants all volunteered to get a fourth shot — and are likely to be people who are naturally careful about their health, said Dr. Paul Offit, director of the Vaccine Education Center at Children’s Hospital of Philadelphia and an adviser to the F.D.A.

It will be interesting to see what happens at the FDA advisory committee meeting on April 6.

Book Review: "Cadillac Desert: The American West and its Disappearing Water" by Marc Reisner (Revised and Updated version)

Cadillac Desert by Marc Reisner is a long book about the history of water construction projects in the western United States. The book is well written and tells fascinating stories about the building of dams and aqueducts. Unfortunately, because of its length, I think many readers will not get all the way through it, but it is worth it. 

The book, originally published in 1986 with a revised version appearing in 1993, is written from an environmental point of view. At one time, Reisner worked for the Natural Resources Defense Council. However, Floyd Dominy, the longtime head of the Bureau of Reclamation, granted the author extensive access, resulting in a long chapter devoted to his career. Also, the book is nonpartisan; Democratic politicians are skewered for their support of non-economically justifiable water projects. The Democrats did control the House of Representatives for most of the period the book covers, and opposing water projects, the author demonstrates, could result in ostracization in Congress. 

Whether one is a confirmed environmentalist or not, the book is an eye-opener for all who read it. The amount of research the author did is stupendous. Disasters, such as the collapse of the Teton Dam in Idaho, are described in detail, as well as the remaking of California by providing enormous amounts of heavily subsidized water for agriculture in the Central Valley. Projects along the Colorado River are also discussed in detail, including both the Hoover and Glen Canyon dams. 

There is, though, one omission in the book. The author obtained extensive information about the Bureau of Reclamation, but much less about the Army Corps of Engineers, which was also heavily involved in water projects. There is one chapter about the rivalry of the two agencies, with each trying to get the right to build the same projects, but there is much less about the personalities and motivations of those who worked at the Army Corps of Engineers. 

All the easily justifiable and many not justifiable water projects have been built. There are few remaining good sites for major projects; in fact, the Glen Canyon Dam, which creates Lake Powell, is the last major dam built in the U.S. Construction on it started in 1956 and it was officially opened in 1966. It reached its targeted fill in 1980. 

The current problem is, of course, climate change, which has become a much more pressing issue since the book was written. One wonders what will happen to agriculture if there is less water for the Central Valley and farmers are forced to change the crops they grow. There could be a wholesale change where crops are grown and animals are raised, with attendant economic effects. The discussion in the book about California and the Colorado River made this reader think about these issues, which are briefly discussed in a postscript to the book written and added to the book by Mr. Reisner’s widow, Lawrie Mott, in 2017. 

Finally, as a native San Franciscan, I cannot resist repeating a story in the book about Governor Pat Brown (Jerry Brown’s father). Whatever one thinks of the Pat Brown, the major projects he pushed through (including the California Water Project and the California Master Plan for Higher Education), and his questionable methods and tactics (discussed in the book), he was obviously effective. In an interview for the University of California Bancroft Library Oral History Program, Brown talked about the California Water Project. The book recounts: 

...Brown suggested another motive that had made him, a northern Californian by birth, want so badly to build a project which would send a lot of northern California’s water southward: “Some of my advisers came to me and said, ‘Now governor, don’t bring the water to the people, let the people go to the water. That’s a desert down there. Ecologically, it can’t sustain the number of people that will come if you bring the water project in there.’

 

“I weighed this very, very thoughtfully before I started going all out for the water project. Some of my advisers said to me, ‘Yes, but people are going to come to southern California anyway.’ Somebody said, ‘Well send them up to northern California.” I knew I wouldn’t be governor forever. I didn’t think I’d ever come down to southern California and I said to myself, ‘I don’t want all these people to go to northern California.’” 

While dated, this book is essential reading for those interested in the past and future economic and environmental challenges of water policy or for those interested in the history and politics of water projects in the western United States.

The Economist and “Wokeness”

The September 4^th issue of The Economist has an editorial (“leader”) and article on “the threat from the illiberal left” in the United States. These articles are particularly irritating because they exaggerate the influence of the far left in the U.S., buy into the right’s hysteria about wokeness, and minimizes by implication the real threat to liberal democracy from the far right, both in the U.S. and in Europe.

The editorial, while putting forth high-minded ideals of “classical liberals” (with which I agree), is amazingly fact free in making its case for its subtitle – “ Don’t underestimate the danger of left-leaning identity politics.” The article in the “Briefing: the illiberal left” – “Out of the Academy: How did a loose set of radical idea leap from campus to American life? – is a mishmash of ideas and facts. It is difficult to discern a coherent argument.

The article appears to be mainly a complaint about an emphasis, misguided in its estimation, on diversity in academic faculties and the media and implies that systemic racism is not the problem that some think it is. It also posits that “special favors” for the systemically disadvantaged is not good policy, but it assumes that is obvious rather than making an argument for this point of view. It also does not seem happy with efforts of corporations to deal with racism and gender discrimination, without ever quite saying why this is wrong.   

The article begins and ends with the San Francisco School Board, which is an easy target. The Board’s effort to rename schools were widely derided, and no less a liberal than Laurence Tribe joined a legal effort to stop the Board. It so happens that Mr. Tribe, a retired Harvard Law School professor, attended Lincoln High School in San Francisco and objected to it being renamed. The mayor of San Francisco, an African-American woman by the name of London Breed, also criticized the School Board for focusing on renaming schools which were empty due to the pandemic rather than figuring out how to get the schools reopened. At one point the City and County of San Francisco was threatening to sue the school board because of its slowness in reopening the schools.

While San Francisco is hardly the obvious pick for demonstrating a political trend in the U.S., the example does not work. The article admits that at the end, when it notes: “There are some signs of a backlash. Three members of San Francisco’s board of education, including its president, are under threat of a recall election.” Then the article concludes: “however, the underlying engine—the questionable ideas of some academics, and the generational change they are rendering—is not shutting off. America has not yet reached peak woke.”

The article does not make a case that the ideas of the academics are dangerous or even describe in any detail what they are. It also does not make the case that left-wing academics are having an increased role in making public policy. Why the writer or writers think that the U.S. “has not yet reached peak woke,” whatever that is, remains, as math textbooks annoyingly often say, an exercise left to the reader.

While the author(s) of this article seem unhappy at what they perceive to be a left-wing turn in public discourse, they might usefully look at the New York Times nonfiction bestseller list, on which right-wing books are well represented. They might also consider the popularity of Fox News and its current brightest star, Tucker Carlson.

Yes, the American left sometimes has crazy ideas and demonstrates political stupidity. That does not mean that it poses any real danger to liberal democracy at the current juncture, though, it admittedly may make certain people in certain milieus uncomfortable. One suspects that is the case with those responsible for this article. The real danger to liberal democracy in the U.S., as it has been in the past (remember the Palmer Raids or the McCarthy era?), is from the right not the left, as anyone who has been paying attention should know, though I continue to be optimistic that the current influence of the right will fade in time.

The problem for The Economist in publishing silly articles such as these is that it hurts its credibility. The U.S. is its biggest market; its American circulation is larger than that of the U.K. While many subscribers probably may be more interested in its foreign coverage, which is not easily found elsewhere, simplistic, biased, and poorly argued articles about the U.S. may create some skepticism about the fairness of articles about less familiar parts of the world.