Monday, December 23, 2013

A Festivus Carol by Katy Kasriel

Festivus 2013

A Festivus Carol by Katy Kasriel
To the melody of O’ Tannenbaum

O’ Festivus, O’ Festivus,
This one’s for all the rest of us.
The worst of us, the best of us,
The shabby and well-dressed of us.

We gather ‘round the ‘luminum pole,
Air grievances that bare the soul.
No slights too small to be expressed,
It’s good to get things off our chest.

It’s time now for the wrestling tests,
Feel free to pin both kin and guests,
O’Festivus, O’ Festivus,
The holiday for the rest of us.

Wednesday, December 18, 2013

2013 Festivus Airing of Grievances – I’ve Got a Lot of Problems with You People!

December 19, 2013

2013 Festivus Airing of Grievances – I’ve Got a Lot of Problems with You People!

Paring Unemployment Insurance Benefits / Food Stamps Is Bad for the Economy

I often hear this from some of the cable news hosts and their guests. You see, according to these “economic theorists”, when the unemployed and/or lower-income populace receive various types of funds from the government, they spend these funds, thus increasing nominal aggregate spending in the economy. What could be wrong with that in an economy that is operating below its potential? Although I am all in favor of stimulating aggregate demand if it is demonstrably below potential aggregate supply, it is not entirely clear to me how increasing government transfer payments will accomplish this. The fundamental question I would ask those who make the claim that it is so is from where does the government get the funds to make these transfers?

If the funds are obtained by cutting other government expenditures, then some entities’ spending will be decreased by the amount that the recipients of the transfers spending increases. The result is no net increase in nominal aggregate spending.

If the funds are obtained by raising some entities’ taxes, then the spending of those paying the increased taxes will decrease, offsetting the increased spending of the recipients of the transfer payments. But, good Keynesians that the cable news economic theorists are, will say that those subject to the higher taxes (the RICH?) will not cut their spending fully by the increase in their tax bill, but rather will meet some of their increased tax bill by cutting back on their saving. And that won’t imply a cut back in some other entities’ spending? One man’s saving is another man’s borrowing. And most entities borrow in order to spend. If the taxpayer cuts back on his saving, this means that he is cutting back on his lending. And if he cuts back on his lending, then this means that a potential borrower/spender will remain just that, potential rather than actual. Only if the taxpayer chooses to run down his cash balances to pay some or all of his increased taxes will his or his borrower’s spending not decrease. More on this run down in cash balances will be discussed below.

If the funds are obtained through increased government borrowing, then the purchasers of this increased supply of government bonds will be curtailing their lending to other borrowers/spenders or will curtail their own spending in order to purchase the government bonds. Either way, someone else’s spending will decrease in order to fund the increased spending by the recipients of government transfer payments. The result is no net increase in nominal aggregate spending.

Now, it might be argued that the purchasers of the increased supply of government bonds used “idle” cash to pay for them. That is, it could be argued that the velocity of money increased in order to fund the government transfer payments. Perhaps. But can you be sure of this? With the elimination of Reg Q decades ago, bank deposit rates now tend to move up and down with open-market interest rates. So the interest sensitivity of the demand for deposits is not what it used to be because the interest differential is now more stable. MV ≡ PT. If PT, nominal transactions (the Price level times real Transactions), are to increase and M, the money supply, stays constant, you have to explain why V, velocity, increases.

Under another special circumstance (other than an increase in velocity of money) transfer payments can result in a net increase in nominal aggregate spending. That circumstance is when the increase in transfer payments is funded by a corresponding increase in the sum of Fed and depository institution credit, i.e., total thin-air credit. In this case, the recipients of the transfer payments will increase their spending and, by virtue of the fact that the funding of these payments is created, figuratively, out of thin air, no other entity need cut back on her/his current spending.

Why do you think unemployment insurance benefits and food stamps are called transfer payments? Because these government spending programs transfer income from certain segments of the population to other segments. If income is being transferred, it’s a good bet that spending also is being transferred. The nomenclature is a tip off that transfer payments do not, except under special circumstances, result in a net increase in nominal aggregate spending in the economy. Rather, transfer payments tend to redistribute a given amount of income and spending.
The above is not meant to be an argument against transfer payments. I believe that the arguments for or against transfer payments are largely moral and philosophical. My only problem with you people arguing in favor of transfer payments is when you try to justify it in terms of macroeconomics.

Congress Should not Oppose an Increase in the Minimum Wage as It Would not Involve an Increase in Government Spending or an Increase in Taxes

I heard this one on cable news, too.  As far as it goes, it is true. But, in my opinion, it does not go far enough. As I tried to illustrate in the comments above, the government has to obtain the funds it spends from some source – the nonbank public through taxes or borrowing or from the Fed and depository institutions. You might think of the government as an intermediary in the collection and distribution of funds. But just as the funding from an increase in government transfer payments has to come from somewhere, so, too, does the funding from an increase in the minimum wage. Who will get the bill for McDonald’s increased wage bill? McDonald’s customers through increased menu-item prices? McDonald’s stockholders through decreased profits. McDonald’s suppliers through decreased orders for merchandise from them. So, no, an increase in the minimum wage would not directly involve an increase in government spending or an increase in taxes. But it would involve a redistribution in income and spending away from McDonald’s customers, away from McDonald’s stockholders, away from the stockholders and employees of McDonald’s suppliers and toward McDonald’s employees. So, just as transfer payments redistribute spending and income, so does an increase in the minimum wage.

I have also heard cable news economic theorists argue that an increase in the minimum wage would result in a net increase in nominal aggregate spending. Really? Explain to me how M goes up and/or V goes up in MV ≡ PT as a result of an increase in the minimum wage. Or does P go up and T goes down? If, in fact, an increase in the minimum wage were to result in a net increase in nominal aggregate spending, then we could eliminate any shortfall in aggregate demand relative to aggregate supply by merely boosting the minimum wage to whatever level necessary to eliminate the gap. If only.

Let’s assume that the argument for an increase in the minimum wage is a moral one, not an economic one. Let’s further assume that we as a society believe that people who work are entitled to some minimum income. If their wages do not yield this minimum income, then we as a society feel honor bound to, one way or another, boost their income to the minimum. If so, as a matter of equity, why should the customers of McDonald’s, the stockholders of McDonald’s and the suppliers to McDonald’s bear the biggest burden in boosting McDonald’s employees’ income to the minimum via an increase in the minimum wage? If we as a society believe that McDonald’s employees are entitled to a minimum income, then should not we as a society be willing to have our taxes increased in order to “top off” McDonald’s employees’ market-based wages either through a wage subsidy or an increase in the earned-income tax credit?

I don’t even want to get into the economic argument as to whether an increase in the minimum wage results in someone’s loss of employment. To paraphrase an old joke, if you ask an econometrician what is the effect of an increase in the minimum wage on employment, he will answer, “What do you want it to be?”

On the Wednesday Preceding Employment Friday, It Was Reported that Private Employment Increased by X Thousand

This is not what I hear on cable “current events” news channels but on the cable financial news channels, whose producers should know better. On the Wednesday preceding Employment Friday, ADP/Moody’s releases its estimate of what it perceives the BLS is going to report as the change in private nonfarm payrolls for the prior month. The media might mention parenthetically, if at all, that this is an estimate of an estimate. Although the median absolute difference between the revised ADP/Moody’s estimate and the revised BLS estimate is only 44,000 between April 2001 and October 2013, there were 22 occasions in this timespan in which the monthly absolute difference between the two revised series was 100,000 or more. If the ADP/Moody’s estimate is that nonfarm private employment increased by 100,000 in a given month and two days later the BLS estimate is of a 200,000 increase, which estimate do you think will have the largest impact on the financial markets? If you answered as I, the BLS estimate, why does anyone care what about the estimate by ADP/Moody’s?

The (Fill in the Blank) Economic Report Showed a Change Greater than / Less than What Economists Expected

Ask an economist for a number and he will give you a number. To illustrate, some economists actually provide estimates of the ADP/Moody’s monthly employment report. Why? Because someone from the media asked.  But if the media wanted to serve a useful function, they would ask two follow-up questions when requesting a forecast from an economist. How has that economist’s past estimates of a particular economic statistic compared with the actual reported statistics? And, how did the economist arrive at his estimate? That is, what’s his model – explicit or implicit? If these follow-up questions were asked and answers obtained, I wonder if anyone would really care what economists “expected”.

Then there’s the post-release interview. Economist A’s forecast of the number was plus 100,000, but the actual number turned out to be minus 100,000. In the post-release interview, in which Economist A’s errant forecast is rarely mentioned, Economist A with great confidence can fully explain after the fact why the number turned out to be plus 100,000 and will tell you that next month’s number also will likely be near the same magnitude (it’s the chameleon method of forecasting) without missing a beat or exhibiting a hint of shame.

Along the same lines, economists shy away from giving a definitive forecast of a binary event. Rather, they like to hedge their forecast “bets” by giving a probability of a binary outcome. For example, Economist B thinks that there is a 50% probability that the Fed will announce today a tapering in the amount of securities it will purchase. Either the Fed will or will not make such an announcement today. It is not going to make a 25% announcement, a 50% announcement or a 75% announcement. It’s all or nothing!

It’s Another Festivus Miracle!

Festivus (celebrated on the evening of December 23, i.e., erev Christmas Eve, how’s that for ecumenicism?) is not only a time for the airing of grievances, but also a time of miracles. And as Festivus 2013 approaches, the Kasriel household has observed two miracles. The first miracle is that our daughter, who has one more semester of law school left, has actually received an employment offer from a well-respected law firm. What is miraculous about this is unrelated to our daughter’s qualifications – they are excellent (thanks to her mother’s genes) – but is related to the depressed nature of the employment market in the legal profession. The other miracle is the recovery in one of our kitties’ health. After twice-weekly hydrations for kidney failure over a nine-year period (again, thanks to my miraculous wife), our otherwise healthy little Dee took a sudden turn for the worse last week. Now, miraculously (and with stepped up hydration) she seems to have rallied back to her lovable, quirky, independent self.

Happy Festivus everyone,
Paul L. Kasriel
Econtrarian, LLC
Sturgeon Bay, WI 54235

Tuesday, December 10, 2013

Q3:2013 Flow-of-Funds Report – ‘Tis the Season to Be Jolly

December 10, 2013

Q3:2013 Flow-of-Funds Report – ‘Tis the Season to Be Jolly

I know that being a Debbie Downer gets more face time on cable news, but after looking at the Fed’s latest Financial Accounts of the U.S. report, formerly known as the Flow-of-Funds report, I cannot contain my optimism about the economy’s prospects in the New Year. First and foremost, the report shows that combined Fed and depository institution credit creation is not only accelerating, but is growing at a relatively high rate. Secondly, household balance sheets continue to improve, which implies that depository institutions will be more favorably disposed to lend in 2014. Thirdly, part of improvement to household balance sheets is related to the upward trend in the value of residential real estate. Fourthly, the reduction in federal government spending/borrowing is resulting in “crowding in” of spending/borrowing by other sectors. Thus, the wringing of hands and the gnashing of teeth by unreconstructed Keynesians (i.e., The Consensus) over the deleterious effect of budget sequestration on the pace of economic activity is not occurring. And lastly, federal government borrowing relative to the size of the economy is less than its post-WWII median value.

Okay, let’s go to the charts. Plotted in Chart 1 are the year-over-year percent changes of quarterly observations of the sum of Fed and depository institution credit and nominal Gross Domestic Purchases. Fed credit is defined here as the Fed’s holdings of securities obtained by outright purchases as well as repurchase agreements. The sum of Fed and depository institution credit is advanced by one quarter because the historical relationship between the two series suggests that changes in this particular credit aggregate lead changes in nominal Gross Domestic Purchases. Notice that year-over-year growth in the sum of Fed and depository institution credit has been accelerating since Q4:2012, which is when the Fed’s third round of quantitative easing (QE) commenced. Year-over-year growth in this credit sum reached 8.7% in Q3:2013, the highest since Q2:2006. The median year-over-year growth in this credit sum from Q1:1953 through Q3:2013 is 7.2%. The recent relatively rapid growth in this credit sum suggests that growth in nominal domestic spending will be gaining strength over the next couple of quarters.
Chart 1
Chart 2 shows that the growth acceleration in the sum of Fed and depository institution credit starting in Q4:2012 was due to Fed QE actions. Growth in depository institution credit alone has been decelerating. But with the Fed expected to start “tapering” the quantity of securities it purchases by the end of Q1:2014, won’t the sum of Fed and depository institution start to decelerate then with negative implications for the growth in nominal domestic spending? Not if growth in depository institution credit picks up. Chart 3 shows that starting in this past October and continuing through November, growth in commercial bank credit, the principal component of depository institution credit, has been accelerating. In the eight weeks ended November 27, bank credit increased by almost $58 billion. If this pace of bank credit increase were maintained, it would more than compensate for the anticipated decline in Fed securities purchases early in 2014.
Chart 2
Chart 3
Which brings us to the balance sheet for households. Plotted in Chart 4 are quarterly observations of total liabilities of households and nonprofit organizations as a percent of their total assets. This ratio reached a post-WWII record high of 20.2% in Q1:2009. As of Q3:2013, this ratio had declined 520 basis points to 15.0%, the lowest since Q2:2001. This sharp decline in household leverage in combination with the sharp decline in the debt burden of households (see Chart 5) should make households appear more creditworthy in the eyes of depository-institution lenders.
Chart 4
Chart 5
An improving residential real estate market has played an important role in the improvement of household balance sheets. Chart 6 shows the leverage of owner-occupied residential real estate. After reaching a post-WWII record high of 63.5% in Q1:2009, leverage has fallen to 49.2% in Q3:2013, the lowest since Q2:2007. The rise in the value of residential real estate in the past two years and the absolute decline in mortgage debt following the bursting of the housing bubble are responsible for the leverage decline in owner-occupied residential real estate. Again, this improves the creditworthiness of households. The rise in residential real estate values also reduces mortgage loan write-offs by depository institutions, which should increase their willingness to put new loans on their books.
Chart 6

Speaking of residential real estate, it still looks attractive as an investment, but not as attractive because of the increase in its value and the rise in mortgage rates. Plotted in Chart 7 are quarterly observations of the imputed yield on owner-occupied housing, the effective mortgage interest rate and the differential between the two. The imputed yield on housing is calculated by dividing the Commerce Department’s estimate of the nominal dollar value of imputed shelter services produced by owner-occupied houses by the Fed’s estimate of the market value of residential real estate (then multiplied by 100 to put the ratio into percentage terms). If the imputed yield on housing is higher than the mortgage rate, then one can purchase an asset that currently is yielding more than the cost of financing it. From Q1:1973 through Q3:2008, there has been only one instance in which the imputed yield on housing was above the mortgage rate – in Q2:2003, when the differential was a mere 0.04 percentage points. But after the bursting of the housing bubble, the market value of residential real estate plummeted, boosting the imputed yield on housing. The rise in the imputed yield on housing in combination with the plunge in mortgage rates brought the differential into positive territory starting in Q4:2008, where it has remained through Q3:2013. This positive differential, after having reached its zenith of 3.7 percentage points in Q4:2012, has drifted down to 2.3 percentage points in Q3:2013. At first blush, the narrowing in the positive differential between the imputed yield on housing and the mortgage rate might suggest that the pace of the current expansion in residential real estate would moderate in 2014. But if depository institutions “loosen” their mortgage qualification terms due to the improved balance sheets of households, then “effective” demand for owner-occupied housing could increase.
Chart 7

Remember how the sequestration-induced federal government expenditure cuts and the increase in the marginal tax rate for upper-income households were going restrain nominal total spending in the economy? Well, they didn’t because of “crowding in”. The reduction in federal government spending in recent years along with increased tax revenues has reduced federal government deficits. Those entities that had planned to lend to the Treasury had its deficits been larger, now have some excess funds on their hands. They can either lend to some other entity that will spend – a household, a business, a state or local government, a furiner – and/or they can spend these funds themselves. Either way, the decrease in spending caused by the decline in federal government expenditures and the increase in taxes is offset by increases in other nonfederal government spending. So, as the federal government borrows less, other nonfinancial entities save less, i.e., spend more. This is what is meant by the term “crowding in”. “Crowding out” is the opposite – the government borrows more, other nonfinancial entities save more, i.e., spend less.
This is shown in Chart 8. Notice that as federal government net borrowing decreased precipitously in the second and third quarters of 2013, net lending by the remaining entities in the nonfinancial sectors also fell precipitously. Conversely, as federal borrowing surged in 2009, in part due to the fiscal stimulus, nonfinancial sector net lending also surged. This is an example of “crowding out”. In analyzing the macroeconomic effects of changes in fiscal policy, it is a good idea to “follow the money”.  The funds have to come from somewhere to finance an increase in government expenditures and/or a decrease in taxes. Unless there is a net increase credit created by the Fed and the depository institution system, i.e., unless there is a net increase in thin-air credit, it is likely that the funds will come from the nonfinancial sector, which means that the stimulus to demand emanating from the government sector will crowd out spending that otherwise would have emanated from other nonfinancial sectors. And when government spending is cut and/or taxes increased, the fiscal drag on spending emanating from the government sector will crowd in spending from other nonfinancial sectors. Think of the extra money that otherwise would have gone to purchase government bonds “burning a hole” in the pockets of the otherwise lenders.

Chart 8

Lastly, for all you fiscal hawks out there, Chart 9 should make you jolly. Plotted in Chart 9 are quarterly observations of seasonally adjusted at annual rates (SAAR) net lending / net borrowing by the federal government (obtained from the Fed’s Financial Accounts report) as a percent of SAAR nominal GDP. The median percentage from Q1:1953 through Q3:2013 is minus 3.2%. In the second and third quarters of 2013, this ratio was minus 1.3% and minus 1.9%, respectively. With some help from the Fed in getting thin-air credit back up to a more normal post-WII growth rate in order to stimulate nominal GDP, some restraint in federal government spending along with some tax increases and voilá! the federal government deficit relative to the size of the US economy looks quite reasonable in an historic context.
Chart 9

I hope to send out my airing-of-grievances Festivus letter next week. I have a lot of problems with you people!

Paul L. Kasriel
Econtrarian, LLC
1 920 818 0236

Monday, December 2, 2013

Response to Gulliver Travails’ Comment on “Unless the Fed Goes Cold Turkey …”

December 2, 2013

Response to Gulliver Travails’ Comment on “Unless the Fed Goes Cold Turkey …”

Notice that my definition of TOTAL thin-air credit is the SUM of Fed credit and depository institution (bank) credit. This is important when analyzing the effect of a Fed purchase of securities FROM the banking system. So, let's start with that scenario -- the Fed purchases $X of securities from the banking system. If the banking system then uses the reserves created by the Fed to replace the securities sold to the Fed by acquiring $X of loans/securities from the nonbank sector, then Fed credit will have increased a net $X and banking system credit will be unchanged (it sold $X of securities to the Fed and purchased $X of loans/securities from the nonbank sector). In this case, the SUM of Fed and banking system credit increases a net $X. If the banking system has made a new loan to some entity, then presumably, that entity makes a new purchase of something -- a good, service and/or asset. If the banking system acquires a newly-issued security, then the security issuer -- a household, business and/or government, makes a new purchase of something. If the banking system purchases a "seasoned" security, then the seller of that security might purchase a newly-issued security, which, again, presumably would lead to new spending on goods/services in the economy. The seller of the security to the bank, might purchase another "seasoned" security. That's still another transaction resulting indirectly from the Fed's purchase of securities. Alternatively, the seller of the "seasoned" security to the bank might decide to use the proceeds to purchase a good/service, especially in a low interest rate environment when the inducement to postpone current consumption is so low.

Now, if the banking system purchases a "seasoned" security from the nonbank public and the seller of that security to the banking system chooses to simply hold more banking system deposits, then the Fed's purchase of securities will NOT result in a net increase in spending on SOMETHING by the nonbank public. But if the nonbank public has an increased demand for deposits TO HOLD, and the Fed had NOT, purchased securities, which enabled the banking system to purchase "seasoned" securities from the nonbank public, then the net change in spending by the nonbank public would have been NEGATIVE, rather than zero. That is, if the VELOCITY of bank deposits were decreasing and the SUPPLY of bank deposits were constant, then nominal transactions would have to fall according to the
identity: MV = PT.

Now, suppose again that the Fed purchases $X of securities from the banking system. But this time, the banking system does NOT replace these securities with new acquisitions of loans/securities. Rather, the banking system chooses to hold an extra $X of (cash) reserves. In this case, the net change in the SUM of Fed and banking system credit is ZERO. Fed credit increases by $X; banking system securities decrease by $X. In this case, there is no net change in spending by the nonbank public resulting from the Fed's purchase of securities. This is akin to the decline in velocity of deposits mentioned above. In this case, there is a decline in the velocity of RESERVES. I.e., the banking system desires to hold more reserves.

If the Fed purchases securities directly from the nonbank public, then the analysis is the same as the Fed purchasing securities from the banking system and the banking system using the newly-created reserves to acquire "seasoned" securities from the nonbank public. The only difference is that "middleman", the banking system, is eliminated from the sequence. Only if the nonbank seller of securities to the Fed desires to hold more deposits, i.e., there is a decline in the velocity of deposits, will there be no net increase in spending on SOMETHING in the economy.

Now, immediately after the failure of Lehman Bros., there undoubtedly was an increased demand for federally-insured bank deposits, i.e., a decline in the velocity of deposits. I would argue that to the degree that the Fed's first round of QE increased the SUPPLY of deposits as the DEMAND for deposits was increasing, QE cushioned the negative impact on nominal spending in the economy resulting from the decline in velocity. I suspect that now, five years after the onset of the crisis, the demand for deposits is gradually decreasing. So, an increase in the SUM of Fed and bank credit would likely result in increased net nominal transactions.

I have no doubt that the increased SUM of Fed and bank credit resulting from QE has played an important role in boosting the prices of risk assets. Would it be preferable for growth in nominal spending on goods/services to be weak AND the prices of risk assets be weak, too?

Although Fed QE may now be on the edge of creating excessive growth in the SUM  of Fed and bank credit, I would argue that if the Fed had NOT engaged in QE after the 2008 crisis, economic performance would have been weaker than it has been. To those who argue that QE does NOT promote faster growth in nominal spending, I would counter that without QE, growth in nominal spending would have been even weaker.

Paul L. Kasriel
Econtrarian, LLC