ZERO CASH: ZERO PROBLEMS?

By: Adrian Pietrzak

How another recession might require some creative solutions.

Central Bankers have become awfully familiar with the concept of zero. Over the past two decades, sluggish growth and two recessions have forced central banks to slash their key interest rates to near zero. While the Fed may be cautiously nudging interest rates up, most of the developed world still has yet to budge. The ECB has yet to raise their key rates, and have continued to push its Quantitative Easing policies a full nine years after the Recession. The BOJ continues to wrestle with low inflation, and we’re not likely to see a departure from zero anytime soon.

Zero interest rates are thought of as necessary to promote economic growth after a large shock, yet, Central Bankers may be playing with fire. In the United States, the current recovery is the longest period of economic growth the economy has ever experienced. While growth rates may still be unimpressive, growth cannot and will not occur forever. If a new Recession were around the corner, Central Banks would be caught in a situation where they’ve exhausted all the tools in their toolkit. Yet, this doesn’t mean they have zero ways to encourage growth; Central Banks may simply have to be much more creative in their approach to stabilize the economy. One such method is the abolition of all paper currency. A cashless society might be able to avoid some of the perils of an economy stuck at zero.

HOARD ME NOT

The idea behind scrapping cash comes out of some classic theories of how people behave at zero interest rates, what economists call the zero lower bound. At the zero lower bound, people view holding cash and holding bonds equivalently; both earn no real returns. As a result, many simply hoard money. Holding onto money with expectations of deflation reinforces the effect; if people think each dollar they hold will be worth more tomorrow, they have little reason to spend. Central Banks try to get out of this by pushing real interests negative through inflation. But if people view cash and bonds as equivalent, no amount of money introduced into the economy will cause inflation. The economy becomes stuck in the awkward position called a liquidity trap; people hoard their cash, refusing to spend or invest, and the Central Bank is powerless to inflate.

Trying to eliminate the zero lower bound is not a new idea. In the 1930’s, many economists floated around ideas to create stamped currency, currency that would have a stamp doubling as a tax to forcibly devalue the currency. The idea was popular enough to be featured in Keynes The General Theory, however, governments were wary that the measure would be highly unpopular and that the anonymity of cash would mean nobody ever paid the tax. Such a negative interest rate would only really be feasible if all payments were made on a common ledger, such as through a commercial bank. Indeed, both the ECB and BOJ (along with other Central Banks like the Swiss Central Bank) have experimented with negative interests at their participating commercial banks. However, these banks haven’t passed on the negative rates to most customers for fears that this would cause mass withdrawals of deposits.

SORRY, CARD ONLY

Withdrawing deposits into cash is a loophole that, theoretically, a government could eliminate. In effect, government issued paper guaranteeing a zero nominal rate acts as a floor on the interest rate. Eliminating cash, and forcing all people to have their money in some online system with a common ledger would allow a Central Bank to charge a negative rate with no zero-return cash alternative.

A cashless society would be one where all money could be subject to these negative rates, and people would be forced to spend their money before its value deteriorates. However, there are many concerns with going completely scrapping paper. Quite obviously, the move would likely disadvantage those who rely on cash. The consequences are twofold. One, this may be beneficial to discourage illegal activities such as drug dealings or tax evading practices. However, this may also spell bad news for older and poorer individuals who may not be as comfortable with online currency. That said, cash transactions made up only some 24% of all transactions in the United States in 2016.

While most consumers already rely on online forms of currency, and many other consumers may simply move their cash into an online account, there are concerns that the lack of anonymity would cause some users of money to look for other ways to store their wealth. Cryptocurrencies like Bitcoin are attractive for this reason, but their lack of government backing and volatility make them impractical as legitimate currencies. During periods of negative interest rates, people may look for other stores of wealth; such as moving money around zero-fee credit cards or prepaying their taxes. While plausible, such evasion of a negative interest rate would also reduce people’s liquidity, and on-demand exchangeability is a key feature people demand from their currency.

FREE? PAY THE FEE

While the complete elimination of paper currency has its concerns, central bankers should give it a fair hearing. The next Recession might require expansionary measures in excess of the already unconventional policies we’ve recently witnessed. Rather than eliminating paper, perhaps Central Bankers should take a gentler approach. Charging commercial banks a fee for transactions occurring in cash could effectively create a negative interest rate on paper currency. The fee creates an effective exchange rate between paper and online currency; the Central Bank would guide the exchange rate depending on how it wants the interest rate to move.

When the economy sputters, the Central Bank could slash interest rates, charging depositing institutions negative rates. When depositors go to deposit or withdraw, they’d be charged a fee larger than the negative interest charged on sitting deposits in the bank. The fee would, in theory, cause differential rates in the valuation of either paper or electronic currency. And the comparative difference from the unattractive fee would encourage people to spend rather than hoard their income, increasing aggregate demand to the point where increased investment makes sense. An economy like this might be able to break away from the zero lower bound faster than otherwise.

Paper currencies, while less and less common, are still a fundamental part of many people’s lives. And even if they’re not, they are often a point of national pride and a clear symbol of the credibility and power of a government. Doing completely away with paper currencies may not be the best move, however, allowing for an exchange rate between cash and online currency might help mitigate some of the perverse consequences of an economy stuck at zero interest. It’d add a powerful tool to the Central Banker’s toolkit, leaving him or her prepared to respond and make sure that economic growth is anything but zero.

Works Cited

Agarwal, R. & Kimball, M. (2015). “Breaking Through the Zero Lower Bound.” International Monetary Fund Working Paper No.15/22.

Buiter, W.H. (2009). “Negative Nominal Interest Rates: Three Ways to Overcome the Zero Lower Bound.” NBER Working Paper No. 15118.

Krugman, P. (1998). “It’s Baack! Japan’s Slump and the Return of the Liquidity Trap.” Brookings Papers on Economic Activity 1998(2): 137-187.

McAndrews, J. “Would Elimination of Currency Remove the Zero Lower Bound on Nominal Policy Interest Rates?” Presentation to the Federal Reserve Bank of New York Monetary Economics Conference, 2015.

Rogoff, K. (2014). “Costs and Benefits to Phasing out Paper Currency.” NBER Working Paper No. 20126.

Swift, A. & Ander, S. (2016). “Americans Using Cash Less Compared with Five Years Ago.” Gallup.

Concrete Jungle: There’s Some Things You Can’t Do

Facing an affordable housing crisis, it may be time for the big apple to rethink zoning.

By Adrian Pietrzak

Long before Occupy Wall Street protesters flooded the cramped concrete soapbox that is Zuccotti Park, New Yorkers’ frustrations were directed at the shadow they stood in: the imposing block-sized monolith that is the Equitable Building.

The building, aptly named for its impartial application of a seven-acre shadow, is brutally efficient, earning its nickname as the “world’s heaviest building”. But the temple to commerce brought worry to New Yorkers that their streetscape would be transformed into one of dark “canyons.” Within one year of the Equitable Building’s completion, New York became the first city in the Americas to enact comprehensive zoning reform.

Yet, the building may have more in common with modern day economic anxiety than is proximity to the epicenter of corporate disobedience. Its origins, and modern day uses, are closely linked with the City’s affordability crisis and some truly inequitable growth.

EQUITABLE GROWTH?

Over the past few decades, the changing tide of globalizing economic reality have, once again, made cities the beating heart of the American economy. After decades of urban flight, New York’s once withering population has recovered, and surpassed its 1970’s peak. And there’s few signs of that changing; the City is expected to surpass 9 Million residents by 2040. And it isn’t happenstance that people are returning to the concrete jungle. Globalization’s focus on skilled labor has concentrated key industries in areas where they can compete over the brightest workers. GDP growth has averaged stronger in the City than in the Nation. And just as more and more Americans are dropping out of the labor force, New Yorkers are putting their work boots on.

Yet, while globalization has made the city an attractive new home, living costs are anything but. The Census Bureau estimates that between 2011 and 2014, median rent rose by a whopping 3.4% after deducting inflation, with the median renter paying $1,200 per month. By contrast, the median renter only saw a 1.1% increase in their household income; leaving an increasing share of their income devoted to rent payments. And this comes in an already rent strapped city. A full one-third of renters are “rent-burdened,” meaning that they expend more than 50% of their monthly income on rent.

A rent strapped populous is more than just a trope; New Yorkers are getting the short end of the stick regarding a serious market inefficiency. The rise of housing rose some 40% relative to other goods and services since 1970, diverting New Yorkers’ money away from potentially supporting local businesses and upstarts. Moreover, increases in the relative price of housing (as renters have seen weaker gains in income than homeowners) has increased income inequality by some 25% since 1970, making an already stratified city truly separated by a canyon of wealth.

BETWEEN A PLAZA AND A PARK SPACE

Yet, higher rents aren’t so surprising. If more people demand to live in a city, it’s natural that the influx of residents will bid up the rent of a fixed level of existing housing. The issue lies with the supply of housing; developers and the local government have struggled to satiate the desire for new homes as newcomers flood into the city. While many have validly pointed to tighter credit following the 2008 Financial Crisis and Hurricane Sandy damage, New York’s housing shortage goes far beyond these temporary afflictions: the City’s regulatory and zoning codes may have produced perverse city growth patterns.

While most economic theories regarding urban growth focus on proximity to city centers or other industries (in economics jargon, the monocentric city and agglomeration models), recent advances in literature have pointed to other culprits explaining high rents: zoning and urban planning regulations. The NYC Department of Planning, ironically situated in the Equitable Building, was created to mitigate the externalities of mixed land development. Plagued by pollution and poor sanitation, the city hoped to separate residential, commercial, and industrial (RCI) developments into “zones” where they are permitted to exist.

However, today, zoning regulations go far beyond just RCI; buildings must abide by strict codes such as height limits, floor-to-area ratios, and minimum lot sizes. For example, the densest of apartment towers have a height cap of 210 feet, and outside of Manhattan, these towers can only take up 40% of the lot and must supply a parking spot to at least 40% of its residents. These zoning controls have influenced some of New York City’s greatest monuments. The code allows buildings to add 20% more space if they build a park or plaza open to the public, a policy which created the famous Zuccotti Park. Towers are required to include “setbacks,” leading to the tapered form of the Empire State Building. Yet, the strictness of these regulations have only tightened. Nearly 40% of all buildings in Manhattan would not be allowed to be built today: they’re either too dense or too tall. And these noncompliant buildings define some of the greatest neighborhoods in the city; such as the fashion heaven of SoHo or foodie paradise that is the East Village.

NOT IN MY BACKYARD AND AN UNLIKELY URBAN COALITION

These regulations can have serious effects of urban welfare. Zoning helps prop up residential property values. In a sense, these regulations amount to a “regulatory tax” with sizable effects; causing Manhattan apartment prices to be upwards a full 50% higher than under a free development policy. And these impediments change the very structure of the city. Restrictions against dense residential lots make them less responsive to what economists call an “income shock,” or an influx of higher wages or wealthy individuals. As a response, construction is shifted to areas where it’s more profitable to construct small, suburban housing. This leads to a city constantly pushing its bounds: urban sprawl and gentrification in neighborhoods outside of the city core.

The cause of these restrictions are surprisingly political. Progressive reformers allied with real estate interests, one seeking to clean up urban geography and the other seeking to protect their property value. In Chicago, the president of the Chicago Real Estate Board, Ivan O. Ackley, predicted that zoning would raise his property values by over $1 Billion, or an increase of 25% of the current value. Today, regulations tend to become stricter in areas with more affluent residents or more homeowners versus renters.

City development ends up reflecting a political equilibrium that benefits a few at the expensive of the overall robustness of the city’s welfare. New research suggests that construction slows and regulations tighten in areas where the addition of new residential property does not benefit the median voter. Homeowners, affluent voters, and entrenched residents tend to be opposed to additional population growth as it imposes increased public service costs on them: more people use their subway train, sit in their park, and walk on their sidewalks. New residents may compete for existing amenities, however, strict regulations only reduce welfare. Instead of creating new amenities, strict zoning regulations tend to increase rents far in excess than the benefits existing residents receive from fewer neighbors.

AFFORDABILITY AROUND THE CORNER

Rather than constricting the will of the market to build new buildings where people want them, policymakers should instead focus on their true mandate: the provision of public goods. Local lawmakers ought to focus on building new subway and bus lines, improving public park space, and boosting local amenities through innovative policies such as urban beautification programs or tree planting. Restricting the influx of newcomers for the sake of preserving the advantages of existing residents is backwards: policy should be oriented to actively improving every resident’s welfare.

There have been some signs of hope. The De Blasio administration has proposed the elimination of the current floor-to-area restrictions with SB 5469, however, it is unclear if the amendment will pass in Albany. Some zoning reform has encouraged the construction of affordable housing (although the existence of the lottery is notoriously Soviet in style). However, zoning reform should go further. New York should embrace its self-proclaimed culture: a city bigger, taller, and more aspiring than any other. While the concerns over the Equitable Building’s imposing “canyon” creating façade are valid, and zoning is undoubtedly a useful tool of city planning, the building’s density and efficiency in land use should model the potential to solve many of New York’s rent problems. A more concrete jungle may truly be a better (and more affordable) one.

REFERENCES:
Albouy D., Ehrlich G., & Liu Y. (2016) “Housing Demand, Cost-of-Living Inequality, and the Affordability Crisis.” NBER Working Paper No. 22816.
Glaser E.L., Gyourko J., & Saks R.E. (2006). “Urban Growth and Housing Supply.” Journal of Economic Geography, 6: 71-89.
Gobetz, W. (Photographer). (2008, March 22). NYC Financial District: Zuccotti Park – Joie de Vivre, [digital image]. Retrieved from https://www.flickr.com/photos/wallyg/172900664
Gyourko J. & Molloy R. (2014). “Regulation and Housing Supply.” NBER Working Paper No. 20546.
Helsley, R.W. & Strange W.C. (1995). “Strategic Growth Controls.” Regional Science and Urban Economics, 25: 435-460.
Hilber C.A.L & Robert-Nicoud F. (2013). “On the Origins of Land Use Regulations: Theory and Evidence from Us Metro Areas.” Journal of Urban Economics, 75: 29:43.
Hilber C.A.L., Rouwendal J., & Vermeulen W. (2014). “Local Economic Conditions and the Nature of New Housing Supply.” SERC Discussion Paper No. 164. Available at SSRN: https://ssrn.com/abstract=2516055
Mills E.S. (2005). “Why Do We Have Urban Density Controls?” Real Estate Economics, 33.3: 571-585.
New York City Department of City Planning. (2013). “New York City Population Projections by Age/Sex & Borough, 2010-2040.”
New York City Department of City Planning. (2016). “Zoning Resolution.”
New York City Department of Housing. “Housing New York, A Five-Borough, Ten-Year Plan.” Retrieved at: nyc.gov/housing
New York City Office of the New York City Comptroller. (2015, May). “NYC Quarterly Economic Update.”
Ortalo-Magne F. & Prat A. (2014). “On the Political Economy of Urban Growth: Homeownership versus Affordability.” American Economic Journal: Microeconomics, 6.1: 154-181.
SB 5469, State of New York 2015-2016 Regular Session (2015).
Shertzer A., Twinam T., & Walsh R.P. (2016). “Zoning and the Economic Geography of Cities.” NBER working Paper No. 22658.
United States Bureau of the Census. (2014). “New York City Housing and Vacancy Survey.”
United States Department of Housing and Urban Development. (2015). “Comprehensive Housing Market Analysis, New York City, New York.”

Gilded Age 2.0

With inequality at record highs, the consequences of economic inequality should be thoroughly examined.

By Adrian Pietrzak

NOVEMBER 2016

When newly elected United States President Donald Trump appeared on PBS’ Sixty Minutes, the debut to his administration was overshadowed by more than just his stark ideological differences relative to his predecessor. America tuned in to witness its new President seated in a gold-leaf ordained throne, surrounded by the gilded décor of his private residence in Midtown’s notorious Trump Tower. The man of the Midwestern auto-worker, the Pennsylvania coal miner, and the Wisconsin union worker framed himself in a manner as far disconnected from the forgotten man as one could imagine. In perhaps the most perfect of caricatures (riddled with irony), President Trump has come to symbolize the gulf that divides Americans–the crisis in income inequality that marks what may be the dawn of America’s second Gilded Age.

HOOVER’S RETURN

Since 1970, income inequality in the United States has reached its Gilded Age peak. When (tariff-loving) President Hoover left office in 1933, the top 10% of Americans accrued some 45.6% of all income. Today, that number stands at 50.47% (compare that to its low of 33.7% in 1962). Perhaps even more striking is how much money is concentrated at the very top. In 1979, the top 1% of Americans held 10% of all income. When Occupy Wall Street took to the streets, they held some 22%. To put this into perspective, if the top 1% were to hold the same fraction of income as they did in 1979, households in bottom 99% today would make, on average, $7107 more per year (a significant increase of 14% versus median household income).

And there seems to be no end in sight. In addition to abysmal recovery rates since the Great Recession, nearly all the benefits of economic growth have been concentrated at the top of the economic hierarchy. Since 2009, the real growth in income for top 1% of America has been a whopping 37.4% increase, compared to the bottom 99%’s paltry 7.6%. While this does somewhat represent a slowdown in the trend, conditions are still not cheery for egalitarianism.

VOTRE CAPITAL

But why should anyone care? After all, inequality is necessary for the preservation of incentives. Motivation to work would evaporate in a truly equal society. Yet, changing economic dynamics suggest that high levels of income inequality are more than just a regrettable social phenomenon. Inequality may seriously harm economic growth.

In industrializing nations, where physical capital accumulation is the primary engine of economic growth, inequality channels resources towards those who saved more. This makes high levels of inequality not only justifiable, but even desirable for long-run growth. However, in an age of weak demand for investment coupled with a glut of savings, this model may no longer hold. Estimates suggest that, between 1890 and 2000, the contribution of human capital (the knowledge and skills of the labor force) to economic growth doubled. In developed nations, physical capital is no longer the primary engine that spins the cogs of the machine; the digital age is fueled by the educated.

Under such an economy, high levels of inequality may truly raise a red flag. An increasing body of research shows that being born into a lower income household creates perverse incentives behind schooling. Many disadvantaged youths end up choosing the short term benefits of immediate work, and the economy becomes more stratified between the well-to-do and the have-nots. Along with disparities in the quality of healthcare and primary education, the lottery of birth becomes incredibly important. In the long-run, this stratification can lead to depressed investment in human capital as a whole, since large swaths of the population neglect the importance of education and vocational training. Such neglect costs an economy tremendous potential for future growth.

FALLIBLE CONSUMPTION AND DISCONNECTED INVESTMENT

But the can is not just being kicked down the road. For those who believe in the impending doom in the long-run economy, exceptionally weak short-term demand may be also tied to inequality. Weak aggregate demand may be due to stratification; those in the top 5% consume far less than those in the bottom 95%. In an unequal society, such disparity may contribute to weak demand in a still recovering economy. Moreover, this dynamic may even be linked to the cause of the Great Recession. High consumption by the bottom 95% in the face of squeezed wages and rising inequality made the class quickly become overleveraged, helping to form a bubble with an eventual catastrophic pop.

High levels of inequality may also not bode well for investment. Weak recovery rates since the Great Recession have led to speculation that low rates of growth are here today, a theory known as “secular stagnation.” The economy experiences a glut of savings over weak investment demand, one that is so weak that the economy must operate at negative interest rates to sustain itself. Yet, rising income inequality may only serve to exacerbate this condition. The current value of excess reserves banks hold over the Federal Reserve’s requirement stands at $2 trillion: money that is not being used for growth-creating investment. Large companies like Google and Apple have more reserves than they know what to do with. The rich’s propensity to save seems only to be collecting dust in the vaults.

TRAPPED IN THE THIRD ESTATE?

Beyond its effects on growth, inequality is enigmatic as it may perpetuate itself. Higher levels of income inequality are associated with lower levels of economic mobility. Those born poor are more likely to stay poor, even in the face of the popular beliefs surrounding mobility and the American Dream. Even more, political institutions can bend to the increasing influence of the top. But we have been here before. Unfortunately, it took a Depression and World War to end the last scourge of economic inequality.

This, however, is not to say that there is no hope. Governments can do plenty to help mobilize the cogs of the new model for economic growth. But they should also tread carefully; punitive taxes (like those targeting CEO’s) for the sake of face-value equality are unlikely to solve the underlying causes. Instead, reform should target these causes with precision.

For one, governments ought to focus on education. As the skill premium between high school and college graduates increases to record high due to an inability for education to catch up with technological progress, it is up to a strong education system to satiate the globalized world’s demand for skilled workers. A focus on early development issues is a must, as newly born children are being increasingly stuck in their initial conditions. Investments in infrastructure and high-return science and energy projects are promising, especially if targeted at disadvantaged neighborhoods.

Firm size should be another area of concern. A wave of high-profile merges and a steady drowning out of firm-on-firm competition has allowed firms to markup the wages of their employees. Higher firm concentration may be responsible for a large part of the increases in income inequality. As a result of larger firms’ ability to replace the unskilled with machines and to suppress middling wages through the promise of corporate opportunity, increased firm concentration may be responsible for higher inequality. Regulators should be wary with regards to new mergers. However, legislators may also want to take the initiative by promoting small business growth before a new age of monopolies and oligopolies becomes ubiquitous.

Targeting some of the political causes is also a start. Cracking down on campaign contributions, which may have polarized political parties, can help alter the incentives stacked against sensible redistribution policies and inequality targeted initiatives. Moreover, limiting the influence of lobbying may help curb the influence of rent-seeking firms.

While none of these changes alone would help reverse the trend of rising inequality, it does not mean that efforts are in vain. Even modest reforms will help curb the trend not only for the sake of inclusive growth, but also for robust growth. As Occupy Wall Street-invoked leftists and protectionist or nativist right-wingers have displayed, the United States is not immune to dangerous populist waves. Unequal gains from growth will certainly not help quell their anger. America needs to rethink the way it approaches inequality, and, perhaps only then, can the gold embellished orifices of haute-America spread to the forgotten man.

 

REFERENCES
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Bell B., & Reenen J.V. (2016) “CEO Pay and the rise of Relative Performance Contracts: A Question of Governance?” NBER Working Paper No. 22407.
Cyamon, B.Z., & Fazzari, S.M. (2015) “Inequality, The Great Recession, And Slow Recovery.” Available at SSRN: http://ssrn.com/abstract=2205524
Galor, O. (2011) “Inequality, Human Capital Formation, and the Process of Development.” NBER Working Paper No. 17058.
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Image: http://modernchairs.eu/luxury-dining-chairs-from-donald-trumps-nyc-penthouse/

Below Zero: Cold Growth

With interest rates at or near zero across developed economies, concerns increase over the effectiveness of monetary policy to prop up ailing economies.

By Adrian Pietrzak

JULY 2016

    Amidst the financial calamities of 2007 and 2008, many quickly foresaw a recession of historic proportions. While historic the downturn was in size, The Great Recession’s lasting bad taste is its’ real claim to fame: recovery rates have been abysmal. Too was the crisis unique in its response; divided and debt-laden governments’ defaulted to central bankers, who did much of the heavy lifting. Yet, their effectiveness may be diminishing.

TRAPPED

    December’s interest rate hike marked the Federal Reserve’s first increase in over nine years. Comparatively, this is expedient. One month later, the Bank of Japan lowered rates to negative 0.1%, despite nearly 17 years of stimulus at zero. Likewise, the European Central Bank has expressed no interest in raising its already negative rates. These negative rates are bold; they signal a strong desire to stimulate the economy at the possible expense of private banks. While unprecedented, the question still begs -why is it so hard to leave zero?

     In short, central banks are trapped. Liquidity trapped, specifically. In a liquidity trap, monetary policy loses its bite as the headline rate nears zero. No matter how much cash the central bank injects into the economy, it is to no avail – the money will be hoarded.

     For central bankers, this is quite awkward, as they lose much of their ability to generate inflation; the mechanism that pushes real interest rates negative. Central banks have tried to circumvent this trap with increasingly aggressive “unconventional” policies, such as quantitative easing or the negative headline rates introduced by the BOJ and ECB. Despite some indications of success, growth continues to fail already lowered expectations; US potential growth has already been revised downwards a full 5%.

COLD GROWTH

     The newest iteration of liquidity trap theory is the dismal view that that poor growth is here to stay; “secular stagnation” in economics jargon. Rather than just a temporary downturn, long run pressures may have pushed real interest rates permanently negative.

     Since 2009, growth in the US has averaged 2.3% – disappointing by historical standards. Between 2004 and 2014, labor productivity growth slowed to an abysmal 0.54%. Moreover, the US’s near brush with zero rates post 2001 indicate that the nation hasn’t enjoyed healthy growth in over 17 years. While unemployment statistics seem promising, it is unclear if the US economy is reaching full employment or if a flood of discouraged workers will re-enter the labor market. The Fed too acknowledges these fears; Chairman Yellen in her June address halted any rate increases due to “mixed” economic indicators and anticipation that low rates will be needed to “keep the economy operating.” With long run (ten-year) inflation expectations dropping to less than 2%, and the Fed failing to meet its 2% target, it is unclear if December’s rate hikes will succeed.

     The suspected causes of this stagnation range, but the basic premise holds; there is an excess of savings over depressed investment demand. Declines in population growth may be reducing growth expectations, and likewise investment return rates. Growing firm sizes have left companies like Google and Apple unsure over what to do with all their excess money. Rising inequality corresponds with larger rich populations who save more. Furthermore, developing economies have accumulated massive reserves, further increasing the glut of savings.

LAND OF THE RISING SUN

     Permanent demand weakness is not an unheard of condition; Japan has suffered a “lost decade” of poor growth it has struggled to escape. For nearly 20 years, Japanese growth has averaged under 1% and the economy has suffered from an average deflation rate of 0.3%. Despite low unemployment – only 3.2% of the island’s population is searching for work – economic futures are still not cheery.  

     Aggressive monetary policies in Japan have proved largely unsuccessful in increasing inflation, which dropped to negative 0.4% in May. Let this be a lesson to Western onlookers. Some monetary policy efforts, namely forward guidance, the concept that a central bank will clearly communicate its plans to keep interest rates low, have been successful in increasing inflation expectations. However, if central banks are to end stagnation alone, they would have to convince the public that they’ll behave incredibly recklessly.

     It is time for reluctant governments to step up. In Japan, Prime Minister Shinzo Abe’s reforms dubbed “Abenomics” have provided hope. In the US, low interest rates provide Congress ample opportunity to invest in high return infrastructure, science, and technology projects. Shoring up possible causes – namely increasing firm sizes and income inequality – may also help in the long run. At worst, these projects will amount to more debt at zero interest. At best, the economy will finally thaw.

REFERENCES
Image Source :NBC News  at http://media3.s-nbcnews.com/j/newscms/2014_10/230331/140305-fed_1441_dc38836bcb851acdc8c0f2e556f3c2b3.nbcnews-ux-2880-1000.jpg
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Populist Headwinds

GLOBALIZATION’S POLARIZING EFFECTS ARE NOW CAPITALISMS NEWEST CRISIS

By Adrian Pietrzak

      When Donald Trump announced his candidacy back in June of 2015, insensitive remarks and a deviation from standard political decorum should have been the most anticipated addition to the already noisy political ruckus. Few foresaw that the billionaire who has reaped the rewards of global economic liberalization would turn against his golden-egg laying goose. In a dramatic (and well documented) turn of events, Donald Trump has transformed the party of free trade and entrepreneurship into the one defined by protectionism, skepticism towards globalization, and reversion to an old order of economic production: a role traditionally reserved for union-loving, “fair trade” Democrats. A political void emerges, and few are willing to publicly support globalization.

A RUST BELT PARADOX: EVERYONE LOSES

     From above, disassociation from the globalist consensus that has held in centrist politics seems bizarre. A slew of new technologies, cheap consumer goods, and product differentiation has led to massive aggregate welfare gains. Supporters of trade liberalization look with awe upon consumer advances. Consumers today can purchase smartphones with more computing power than the computers which put man on the moon, all with a price less than the first VCR players. Few economists dispute that the benefits of trade liberalization far outweigh the costs. In some sense, this consensus is so ubiquitous that it is assumed as a fact; one of the primary assertions of nearly every economics textbook is some notion of trade making everyone better off.

     Indeed, this assertion still holds. But it is blind of the political consequences. Whereas economists tend to think in terms of long run welfare, politicians’ horizons are often limited to their next re-election cycle. Angry voters who are threatened by globalization will most certainly punish their politicians accordingly. Increasing import competition and employment vulnerability have been linked with lower support for incumbent candidates. Moreover, populist parties, especially on the right, gain from this uncertainty. And somewhat surprisingly, this phenomenon is not just limited to those most directly affected. Voters are three times more likely to respond to their local environment over their own financial situation. As globalization disproportionately impacts small cities with concentrated manufacturing industries, even the illusion of uncertainty can create dramatic pressure for politicians to deviate from their initial stance.

POLARIZED ECONOMY, POLARIZED POLITICS

      As politicians shift to protectionism, it becomes all too easy to discount such moves as simply opportune.  While globalization certainly has short term effects on those laid off and the community around them, globalization may exaggerate broader economic trends. For one, while globalization may encourage more productive allocations of production due to foreign competition, it may also lead to the reverse effect in the long run. Initial improvements in welfare due to increased competition may lead to only a select number of firms getting ahead over their competitors. These firms, growing too large, become inexplicably linked to national welfare. They become the classic case of “too big to fail,” and, through either market or governmental exploitation, may end up eliminating any welfare gains they initially produced.

     Not only are bigger firms problematic for welfare in the realm of consumer pricing: they are also linked to more polarized wages. Globalization has been partially to blame in a slew of phenomenon associated with income inequality. For one, workers’ wages may be polarized due to vertical specialization. Globalization pressures firms to specialize in highly skilled labor, outsourcing the rest. Moreover, fast changing technological needs are creating a huge markup between the skilled and unskilled, as the educational system struggles to fill the labor market with enough skilled workers to satiate demand. As the wages of a new, skilled, and urban class are pushed upwards and the rest downwards, wages are increasingly retreating from the middle. And a hollowing out of the middle class is not just an inconvenient trend; it may pose as a serious threat to future economic growth.

CAPITALISM’S NEWEST IDENTITY CRISIS

     These developments are not just new challenges; they may present themselves as Capitalism’s newest crisis. Populists have increasingly proven that globalism makes for a good political scapegoat. Moderates, out of fear of political retribution, have fled from the center. Yet, this political polarization carries the threat of destroying the current economic order. The June 2016 Brexit vote proves that the demands of the fringes are not to be taken lightly. Just as authoritarian and populist groups seized governments following the Great Depression, today’s populists may pose the same threat to a globalizing world.

     Just as Keynes was once concerned with anti-capitalist sentiments, so must we be with the anti-globalists. For one, we must acknowledge that there are indeed winners and loser to increasing trade liberalization. Moreover, in order to adapt, governments must take aim by promoting reeducation programs, especially for those most affected by losses in the manufacturing sector. Governments should help promote globally oriented economy through science and infrastructure investment. Yet, we must also control the dangers of increasing market power. It is not enough to simply repeat that trade makes everyone better off. In the short run, we must redistribute the skewed gains of globalization for its long run benefits to truly come to fruition.

REFERENCES
Acemoglu D., Gancia G., & Zibiotti F. (2015) “Offshoring and Directed Technical Change.” American
Economic Journal: Macroeconomics, 7(3); 84-122.  
Goldin, K., & Katz, L.F. (2015) “The Race Between Education and Technology: The Evolution Of U.S.
Educational Wage Differentials, 1890 to 2005.” NBER Working Paper No. 12984.
Mueller, H.M., Ouimet, P.P., & Simintzi, E. (2015) “Wage Inequality and Firm Growth.” NBER Working Paper No.
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Krugman P. (2008) “Trade and Wages, Reconsidered.” Brookings Papers on Economic Activity, Spring 2008; 103-   
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U.S. Presidential Voting.” NBER Working Paper no. 21899.
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Market Power.” NBER Working Paper no. 21994.
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Behavior.” NBER Working Paper no. 21812.
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Brace: Orlando
Heino, A.J. (2016) “Timbro Authoritarian Populism Index.”

Concentrated Grievances

by Adrian Pietrzak

June 13th, 2016

Americans have always had a certain level of reverence towards their entrepreneurs. Their success is the classic American tale. Nearly every iteration of “The American Dream” will include the Horatio Alger rags-to-riches self-made man. Many still dream of being their own boss, starting their own company, and “making it.” Yet, this dream may be just that, a dream. Over the past 20-30 years, the American economy has faced widespread consolidation that has led to a concentration of capital and labor amongst fewer and fewer firms. America, the land of dynamic free enterprise, now has a serious competition problem. Everyday Americans are experiencing this concentration in their paychecks, career paths, and political system.

DAVID VERSUS GOLIATH, AN ALTERNATIVE ENDING

Today, the average American works for a Goliath. Gone are the days of “mom and pop” shops, welcome to the era of retail-chains and multinational conglomerates. Firms with over 500 employees, only 0.3% of all firms, accounted for 45.5% of all employment in 1988. In 2011, that figure rose to 51.5%. In 2011 the top 0.016% of firms (those employing over 10,000 workers) accounted for a whopping 27.8% of all US employment.

And it’s not just employment. Many other measures of firm concentration point to the same trend. The Economist calculates that nearly two-thirds of some 900 industries have become more concentrated between 1998 and 2012. Moreover, the average market share of the top four firms across these markets has increased from 26% to 32%. A recent wave of high-profile mergers hasn’t helped matters – markets are increasingly being held by the few.

A NEW ERA FOR STARTUPS

Having bigger companies isn’t always bad. Concentration which takes advantage of economies of scale may improve productivity and growth, ultimately leading to lower prices and a more robust economy. However, recent research links bigger companies with less dynamic growth. Since 2000, there has been a marked decline in business dynamism and entrepreneurship – normally one of America’s most desirable qualities.

A decline in startups (despite the popular perception of a ubiquitous Silicon Valley Golden Age) can have serious economic consequences because smaller firms disproportionately create jobs compared to their larger competitors. Furthermore, high-growth startups, not larger firms, are responsible for high levels of productivity growth, such as that witnessed in the 1980s and 90s. Ultimately, a lack of startups and small firms leads to lower productivity and growth, which does not bode well for a sluggish economy.

(NOT) CHURNING AND CHURNING IN THE WIDENING GYRE

Less dynamic businesses, less dynamic workers. Job-to-job flows, the rate at which workers and business exchange jobs, declined by roughly 47% between 1998 and 2010. The rate of hiring and separation both fell as well, with 10% and 38% declines, respectively. Strikingly, over one quarter of this decline can be linked back to increasing firm size and age.

On the surface, falling employment dynamics could mean that employees are experiencing more job stability or that workers are finding better career matches. However, more job reallocation has been associated with higher growth, while less movement can be indicative of a less flexible labor market. Job movement is also important for people’s wages, as switching jobs usually leads to higher salaries, especially for young people.

DEPRESSED WAGES AND A DEPRESSED CENTER

Stagnating wages have plagued the average American for decades. A widening wage gap has caused a return to Gilded Age levels of income inequality. While globalization causing changes in skill demands is thought to be the main driver, large companies may also exacerbate inequality. Large companies effectively suppress wages, as they replace routine jobs with machines or foreign labor. Middle-skill workers are worst off, paying a premium to work at large companies in exchange for possible promotion. Meanwhile, large companies compensate their executives lavishly. Moving from a small to large company increases the wage of the top employee by 280% compared to the wage of the lowest employee.

This phenomenon has helped thin out an already ailing middle class. High inequality may dampen demand, and certainly dampens political stability. The retreat of centrist candidates has been shown by the surge of economic demagogues. Americans feel that their economy is rigged – and it may very well be. But few proposals from both the left and right would help. Scapegoating outsourcing, the rich, or immigrants is ineffective – what America needs are smaller firms and more competition.

References

Cyamon, B.Z., & Fazzari, S.M. (2015) “Inequality, The Great Recession, And Slow Recovery.” Available at SSRN: http://ssrn.com/abstract=2205524
Decker, R.A., Haltiwanger, J. Jarmin, R.S., & Miranda, J. (2015) “Where Has All The Skewness Gone? The Decline In High-Growth (Young) Firms In The U.S.” NBER Working Paper No. 21776.
Goldin, K., & Katz, L.F. (2015) “The Race Between Education and Technology: The Evolution Of U.S. Educational Wage Differentials, 1890 to 2005.” NBER Working Paper No. 12984.
Hyatt, H.R., & Spletzer, J.R. (2013) “The Recent Decline In Employment Dynamics.” Washington, DC: Center for Economic Studies (U.S. Census Bureau).
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Neumark, D., Wall, B., & Zhang, J. (2011) “Do Small Businesses Create More Jobs? New Evidence For The United States From The National Establishment Time Series.” The Review of Economics and Statistics, 93(1), 16-29.
“Too Much Of A Good Thing.” (2016, March). The Economist.