The fundamental question for the U.S. macroeconomic forecast is if the pandemic recovery can continue or if the economy is heading into a recession. This outcome will be determined largely by Federal Reserve actions during the quarters ahead. Given how long the Fed waited to fight the current bought of inflation, it is not likely they can return inflation to its target rate without monetary policy changes which would also induce a recession.

It is an open question if the Fed has the fortitude to follow-through fighting inflation. The forecast then, is either for recession, or anemic growth accompanied by continued inflation.

CERF’s baseline forecast embodies the assumption that the Fed will cease substantive hikes by December 31^st of 2022 and that the economy will not be pushed into recession. We do have one 25 basis point hike in early 2023, but no other hikes. This is a low confidence forecast, since it necessarily involves predicting the behavior of a body of political actors at the Fed.

This forecast for the Fed’s policy rate has implications for inflation. Inflation, with substantial momentum at the current time of writing, will not be much reined in by this forecast of Fed policy.

How strong is the Fed’s policy stance on inflation? The real ten-year Treasury yield was -3.1 percent using September yields with the core PCE deflator. As conventional wisdom has always argued, a negative interest rate of that magnitude indicates policy that is massively stimulative.

The presumed level of short term interest rates under this forecast scenario is that they reach 4.625 percent (based on the midpoint of the Fed’s target range) by mid-2023. By the Fed’s own analysis the rate needs to be above 6 percent in order to adequately combat inflation.

Inflation will subside, but it will not subside quickly, and the real 10-year Treasury yield will remain in negative territory for all of 2023, indicating that instead of being restrictive, the Fed’s policy will remain stimulative, for about a year.

We forecast that the Core PCE deflator will still be 4.8 percent at the end of 2022, and that it will still be 4.3 percent at the end of 2023. This is higher than the consensus forecast of 3.2 percent, but our forecast is lower than inflation expectations, such as the University of Michigan’s survey value of 4.8 percent.

This forecast is one where rates are not really that high. The chart below shows the third quarter real 10-year Treasury is still quite negative, and it shows real rates during the Volcker policy era in the early 1980s that did succeed in fighting inflation, and also pushed the economy into recession.

Because rates are not really that high, inflation will remain persistent, and, growth will be weak but positive. We do not forecast a recession in this scenario, in part because rates are not actually that high. They will not get high enough to halt inflation, and they will not be high enough to cause a recession.

CERF has argued that monetary and fiscal policy has been much too stimulative. While it is possible to justify stimulating the economy in the time of crises, policies have been a ratchet, ramping up support through payments and credit in times of crises and not subsiding thereafter. This occurred after the 2007-08 financial crises and again during the Pandemic in 2020.

Overly-stimulative policies help us understand the macroeconomic environment we are in today. Some forecasters are saying that the Fed’s impotence against inflation, with 300 basis points of hikes in seven months having failed to slow inflation momentum, has surprised almost everyone. This does not surprise CERF. The economy is overstimulated. According to CoBank estimates the U.S. household sector still has $2 Trillion in excess savings. And, we point to the most recent University of Michigan survey data, which as of October showed consumer’s expect inflation will still be 4.8 percent a year from now.

There are risks to this forecast. One alternate scenario is that the Fed does continue raising rates aggressively during 2023, sending the short term policy target well-over 6 percent. In this scenario, the real 10-year Treasury yield would surge into positive territory more rapidly, inflation would subside more quickly during 2023, and the economy would experience a recession.

Why is our baseline case that the Fed does not get in front of inflation? They have shown before that they are sensitive to markets, especially, the stock market. In October of 2018, they announced a balance sheet normalization policy that sent the S&P 500 into a 24 percent decline in just 3 months. On January 4, 2019, Fed chair Jerome Powell signaled a reversal of policy normalization, and in March of that year, stated that a multi-trillion dollar balance sheet might go on indefinitely. This of course, gave rise to the notion of QE-infinity, the idea that the Fed would never normalize policy.

The effect of significantly higher rates will have an important follow-on effect of raising the debt service costs for the U.S. This is more of an issue now, where the debt to GDP ratio is 120 percent, a historically high level for the U.S. This will be another source of pressure against further Fed rate hikes to levels above 5 percent.

CERF’s economic forecast for the next eight quarters is for growth substantially below potential. Many forecasters, including the Fed, point to demographic factors and make post-industrialized economy arguments to rationalize below potential growth. CERF disagrees. Most of the sub-par growth is driven by poor policies, policies that throw a blanket on what would be a much more healthy and robust economy.

Monetary and fiscal policies should follow policy rules, or a logic that is guided by economic theory and analysis. Policies since 2008, especially monetary policy, have been ad hoc. They depress economic activity through the specific disincentivizing impacts they impart on investing for the future, but in addition, they depress the economy through policy uncertainty. This uncertainty doesn’t just add difficulty to forecasting, but it also reduces the ability of households, establishments, and governments to make decisions for their, and the our nation’s, future.

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The U.S. Bureau of Economic Analysis (BEA) released its annual Metro GDP dataset yesterday which provides economic growth figures for our regional economy.  The release includes a new Ventura County GDP growth estimate for 2018 as well as significant, and truly surprising, revisions to the economic history of Ventura County going back to 2002.

Plainly, this revision to the County’s economic history paints a different picture than the one that we described in our Annual Ventura County Economic Forecast publication.  Importantly, there have been significant upward revisions to the county’s economic performance over the past five years.  These are accompanied by significant downward revisions to the county’s performance during and following the Great Recession.

Below, the chart on the left shows the Sept. 2018 vintage estimates of Ventura County GDP growth and the current release, Dec. 2019.  The bar chart on the right shows the “gap” between the two vintages of estimates, calculated by subtracting the Sept. 2018 estimates from the data in the new release.

Key takeaways from the revised economic data for Ventura County are these:

Average economic growth since the Financial Crisis is somewhat weaker than previously estimated.  Average growth from 2008 to 2017 was previously estimated to be 0.8 percent.  With the latest revisions, average growth during this period is now estimated to be 0.3 percent.

The Financial Crisis and the Great Recession hit Ventura County much harder than previously thought.  Previous vintages of the County’s economic data indicated that the County experienced a single year of negative economic growth during the Great Recession.  Revised data indicate that the County experienced five years of economic hardship beginning with the Great Recession.  Average growth from 2008 to 2012, which was previously estimated to be 1.2 percent, has been revised down to -2.2 percent.  Ventura County experienced five years of economic contraction.  This is consistent with jobs data that we have been tracking since 2008. Ventura County was the last county in Southern California to recover the pre-recession number of jobs.  It was not until 2018 that this happened, an arresting figure.

The past five years no longer appear to be the weakest on record in Ventura County.  By comparison, the five years beginning with the financial crisis now appear significantly weaker.

The recession was deeper but the recovery, which began in 2011 and peaked in 2013, was far stronger and more rapid than previously understood.

The sustained decline in economic growth which Ventura County is currently enduring began later than previously thought, but the decline is more rapid than previously thought.  In the previous vintage of data, the post-Recession peak of economic growth was estimated to be in 2010.  It now appears that peak growth was reached in 2013. The decline in economic growth since 2013, which was previously estimated to be 250 basis points, is now estimated to be 290 basis points.  Because the economy was starting its slowdown from a higher growth rate, economic growth remains positive despite the more rapid slowdown.

Sectoral data indicate that Ventura County’s economy is much more dependent upon Non-Durable Goods Manufacturing (such as biotechnology) than previously thought.  Non-durable goods manufacturing, which in Ventura County is dominated by Biotechnology, is responsible for a much larger share of the County’s total economic output than previously understood.  As shown in the table below, the September 2018 vintage of data indicated that Non-durable Goods Manufacturing accounted for 15 percent of County GDP in 2007.  Revised data indicate that Non-durable Manufacturing accounted for 29 percent of County GDP in that year.  Substantial declines in Non-durable Manufacturing account for a significant share of the County’s GDP contraction in 2008.

Background Note

This year’s release also incorporates data updates and methodology revisions for all of the BEA’s GDP data programs, including national, state and local data.  This was a revision process that started with benchmark revisions to national GDP in July of this year.  Those revisions filtered down to state level GDP calculations, which were released on November 7.  The localization of the revision-process ended with yesterday’s release.

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Readers of CERF blogs and forecast publications know that CERF economists are critical of the Fed’s monetary policy, and have been for seven years now.  The Fed’s policies starting in December of 2008 were extraordinary, unprecedented, not recommended by economic theory, and have contributed to anemic growth and wealth generation for the past decade.

Prior to December of 2008, the Fed mainly relied on one policy tool, the Federal Funds Target rate (FFRT).  During the dark days of the financial crisis, they added two more policy tools, quantitative easing (QE) and interest on reserves (IOR).  CERF is most critical of IOR.

There are a few things that economists agree on, and one of them is that financial intermediation is good for the economy.  This is the process by which banks use savings deposits as a pool of funds to extend credit to businesses and households.  The IOR reduces the quantity of loanable funds available for intermediation by taking them out of the banking system and locking them up as reserves at the Fed.  Lending falls, investment expenditures fall, growth slows, and capital accumulation and future wealth fall.  These are unmistakably bad economic outcomes compared with having those funds available and extended to households and businesses who are growing.

What’s more, it is not clear how the Fed would respond if there were a severe recession tomorrow.  If they raised IOR, this would further restrict credit.  They could reduce IOR, but in a severe recession, weak loan demand would make this less effective.

It is clear that the Fed wants to maintain a massive balance sheet, and they have documented various technical benefits.  However, it is fearful of rapidly unwinding it, and this is the real reason for the glacial reduction pace.  A consequence of the Fed’s massive balance sheet is that it destroys the Fed’s ability to control short term interest rates.  IOR, a rate that the Fed sets directly, provides the short term interest control they desire.  The interest rate on reserves may actually be the most impactful policy that the Fed is employing, but that is only because unwinding the balance sheet would wreak unknown but horrible damage to the economy.

CERF economists have also criticized the fact that the Fed’s policy statements highlight the FFRT and QE, but IOR information is no longer provided in the Fed’s main press release.  Since December of 2015, changes to IOR have been deliberately buried in a technical note separate from the press release.

At the panel, Chair Powell and former chair Bernanke stressed the Fed’s goal of being transparent.  They repeated their desire to clearly and frequently communicate their policy intentions to the world.  However, not one word was uttered about IOR at any point during the one-hour long discussion on Monetary Policy.  It was clear this was done on purpose.  Neither the press nor the economics profession have properly brought the IOR policy and the resulting economic detriment to light until recently.  In particular, the January 1^st Wall Street Journal article, The Fed’s Obama-era Hangover by Phil Gramm and Thomas Saving, highlights the powerful impact of IOR on credit.  The article also explains that the Fed is now an interest rate follower.  It is no longer setting or leading short term rates.

It is clear that the Fed’s stated transparency goal is contradicted by the reality of the Fed’s actions.

I have a theory to explain this contradiction.  As forecasters, CERF economists routinely promulgate their economic analysis and their forecasts to the press and the community.  This is a challenge.  Economics is a complicated undertaking.  There are subtleties and complexities.  It happens that we’ll interview with the Media and then read their article and wonder what went wrong because the written article miss-represents our views and/or our analysis.  This appears to be a reality of the interface between economists and non-economists.

We have tools to deal with this issue.  We tell stories as much as possible.  We try to pull back from talking about many relevant factors to focus on one key factor.  But these strategies do not always work.

It may be that the Fed does not talk about IOR because it is difficult to explain.  There is more to IOR than the financial intermediation impact, as the Gramm and Saving article reveals.  The complexities include IOR interaction with other policy tools and various aspects of the economy.  It is difficult to explain to the public, in fact, even to economists who do not follow monetary policy closely.  Perhaps more important, the Fed does not want to publicly admit they are deeply fearful of the impact of rapidly unwinding the balance sheet.  Chair Powell would loathe to discuss either the difficulties with unwinding the balance sheet, or the IOR’s impact on the economy in public.

The Fed needs to come clean.  The Gramm-Saving article is likely to generate greater commentary, more articles, and additional questions directed to the Fed about its IOR policy and its assessment of the impact of IOR on the economy.  I expect that the pressure will become large enough that the Fed will be forced to directly address its IOR policy to the public.

With greater Fed transparency in IOR, academic researchers should then contribute.  They can build theoretical models of monetary policy that postulate and analyze formulae linking IOR to reserve flows, lending, investment, economic growth, and capital formation.  Empirical papers should then be written that test and use these new theories, and in particular, they should measure the detriment that IOR has on financial intermediation, economic growth, and wealth formation.

As we await greater scrutiny of Fed policy, it is becoming increasingly clear to the CERF team that the Fed doesn’t know how to undo the mess it created during the financial crisis.  The need to maintain its massive balance sheet necessitates ever higher IOR.  It places the Fed in the position of following market interest rates rather than driving them, as highlighted by Gramm and Saving.  It jeopardizes the Fed’s activist mandate and renders it impotent if a severe recession were to occur tomorrow.  This is such a mess that we should assume the next economic contraction could be at least as bad as the last one that the Fed seeded.

Gramm P. and T. Saving, The Fed’s Obama-Era Hangover, The Wall Street Journal, Jan. 1, 2019 https://www.wsj.com/articles/the-feds-obama-era-hangover-11546374393?mod=mhp

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There are no surprises in our California forecast.  There aren’t any changes either.  We expect California to continue plugging along as it has for several years now.  The growth on average will be slow, but the Bay Area will do better.

We don’t see much upside potential.  That is, we would be very surprised if California’s economy did a lot better than the forecast.

We see plenty of downside potential.  New regulations and taxes will have a negative impact, but we would not expect to see an immediate or dramatic drop.  Instead, we’d expect to see California’s economy slowly lose vigor.

A national or global financial—it’s possible, leverage is high and banks are stressed worldwide, particularly in Europe—crisis would have more direct impact.  The immediate impact would be a large fiscal deficit at the state level.  The State’s response would likely be as always.  Taxes would go up.  Transfers to local governments would go down.  Debt would go up.

California’s financial situation has improved during Brown’s two terms, but California has not made the fundamental changes necessary to increase the budget’s resiliency.

Making California’s budget less susceptible to business cycles would require a major tax restructuring, reducing the reliance on a wealthy few while broadening the tax base.  It would also require that the State’s pension obligations be brought under control.

Is Sacramento likely to make the changes necessary to strengthen California’s budget?  Probably not, but now seems like an excellent time to do so.

A one-party state provides opportunity.  While the required changes would help most Californian’s, some groups would be hurt.  Those groups are part of the ruling party’s coalition, government employees and those who despise the existence of wealthy people.  The opportunity comes from the fact that these people have no place else to go.  They will not vote Republican.  The worst they could do to Democrats is sit out the election, but the party could easily retain power if that happened.

California’s Democrat Party now dominates California’s politics to such an extent that it has a unique opportunity to confront California’s long-standing issue without paying a political price.  It’s a perfect time for Governor Brown to cement a legacy.

The post California Forecast appeared first on Center for Economic Research and Forecasting.

A decade of slow or declining economic and job growth has been accompanied by fundamental changes in America’s job composition.  Those changes have caused profound disruptions in the lives of millions of workers, primarily low-educational-attainment workers, and their families.

The situation is not improving.

Economic growth (GDP) appears to have slowed, even from its previously anemic pace.  Job growth has been weak too, but it’s a little better than economic growth.  Weaker economic growth than job growth implies declining or very weak productivity growth, and we’ve recently seen quarters with each.

Declining productivity doesn’t necessarily mean that individual workers productivity has declined.  It could.  If demand fell and businesses were slow to lay off workers, perhaps because of the cost of firing and hiring, individuals’ productivity would fall.

That’s not what we’re seeing now.  Instead, we’re seeing the impacts of changing job composition.  We’ve lost, and continue to lose, high-productivity jobs.  Our job growth has been in low-productivity sectors.  Naturally, high productivity jobs pay more than low-productivity jobs.

Combined, Mining, Construction, Manufacturing, and Wholesale Trade are still down over 2.5 million jobs since their pre-recession highs.  Other sectors have seen strong growth over the same period.  The generally very low paying Leisure and Hospitality sector has grown by over two million jobs.  The surprisingly low paying, on average, Education and Health sector has been our fastest growing sector.  It’s up 3.9 million jobs, almost all of which are in health care.

Technological change, increased trade, poorly incentivized safety net programs, regulation, and slow economic growth are all claimed to contribute to the change in job composition.

Technological change is an appealing explanation, but the past decade has been characterized by low business investment and slow productivity growth.  This is not what we’d expect if we were going through a generalized technological revolution.  As it is, the most visible gains from advancing technology have been in oil and gas exploration and production.  Oil prices are consequently down, but many governments, organizations, and people are doing all they can to limit or erase the gains from these technologies.

People have worried about technological change’s impact on employment since the dawn of the industrial revolution.  Time and again, those worries have proved unfounded.  I do believe, though, that the spread of electricity throughout the economy and the adoption of tractors in agriculture contributed to the persistent unemployment of the Great Depression.

The Great Depression and the Great Recession share some similarities.  So, we can’t reject the possibility that technological change is contributing to persistent unemployment, low investment and productivity growth notwithstanding.  If so, its impact is relatively minor.

Increased trade, combined with an ineffective safety net, has contributed to persistent unemployment.  This is a bit sacrilege for an economist.  If there is anything approaching a consensus among economists, it is that trade is good.  The proofs are elegant and convincing.  I have no doubt that countries that voluntarily trade are better off.  But, this ignores distributional issues, and distributional issues can be important.

As a free-trade enthusiast, I’ve argued, and deeply believe, that the benefits of free trade are sufficient to allow us to protect the workers, and the families of workers, displaced by the increased trade.  But, we don’t.  Maybe we shouldn’t expand trade until we do?

Our safety net is so bad that it actually contributes to persistent unemployment.  Means-tested welfare programs create cliffs, where small amounts of new income cause the loss of thousands of dollars in benefits.  So, why work?  Extended unemployment benefits encourage workers to be idle long enough that their skills atrophy.

Our regulatory environment is increasingly onerous, and contributes to persistent unemployment.  Perhaps the worst example is coal.  Our government has declared war on our coal industry, with the avowed goal of eliminating the industry, and by extension the livelihoods of the industry’s workers and their families.

Other regulations may be well meaning, but they are laced with pernicious consequences.  These include minimum wages, licensing requirements, and mandated benefits.

Recently, we’ve adopted more reckless ways to increase our economy’s regulatory burden.  Sarbanes-Oxley, Dodd-Frank, and the Affordable Healthcare Act are examples of massive regulations that were written in a short time in response to a perceived crisis and passed with insufficient consideration and debate.  Unemployed workers and their families pay a disproportionate share of costs of the poorly-considered regulations.

These regulations have performed one service.  For those willing to see, it’s clear that micromanaging markets by politicians and their bureaucratic lackeys is a terrible idea.

Slow economic growth contributes to persistent unemployment.  Unfortunately, it’s becoming increasingly fashionable to accept slow economic growth, or even argue that slow economic growth is good.  This is terrible thinking.  Our low and declining labor force participation rate, is one result of slow economic growth.  The fact remains that the best opportunity for a low-productivity worker exists with higher-productivity workers are employed.

How do we know when the higher productivity workers are employed?  The unemployment rate won’t help.

Unemployment numbers are distorted by labor force participation rates.  If a worker becomes discouraged and stops looking for a job, the unemployment rate falls.  The media, who engage in only the shallowest analysis, report this as if it were good news!  They say the world is better, when what really happened was that a person gave up looking for a job.  The once proud and self-sufficient worker surrendered to the soul-crushing life of a ward of the state.

The correct measures of economic vigor are labor force participation rates, new jobs as a percentage of the population, and per-capita GDP growth.  By those measures we aren’t doing very well.

What to do?

Lots of economists would say increase trade and public capital investment.  I disagree with both.  My arguments against public capital investment are here.

My reluctance to increase trade are not because I doubt the gains from trade.  Trade will increase the wealth of both trading partners.  Instead, it’s based on our inability to protect those displaced by increased trade.

Over the past year, I’ve had the opportunity to meet many men who lost their jobs because a factory moved to Mexico.  Yes, everyone was a man, and every factory moved to Mexico.

In every case, the impacts were devastating and long lasting.  Sure, some have bounced back and are now doing relatively well, but they bear the scars of divorce, destroyed families, extended unemployment, and reduced living standards.  More aren’t doing well, having slipped into a mind-numbing life of drug abuse and round-the-clock television.

We’re back to what to do?

One thing we need to do is completely revamp our safety net, in a way that always provides an incentive to work, to keep at least some of that next dollar earned.  Replacing our existing system with a negative income tax would do the trick, and save billions in administrative costs.  It would improve economic growth.  It would save families and lives.

We need to completely revamp our regulatory regime, reducing the compliance burden on businesses, embracing market-oriented solutions, and subjecting new regulation to rigorous cost-benefit analysis.

Just these two things need to be done.  Revamping our safety net and our regulatory environment would release Americans to do what they have always done: work hard, create wealth, and create opportunity.  We would see a sustainable boom, one like we haven’t seen in decades.

The post The United States Economy appeared first on Center for Economic Research and Forecasting.

First, some presenters documented empirically that real interest rates since 1860 has had episodes, some of which lasted many decades, of very different behavior.  Not only has the level changed significantly in both directions, but the volatility has changed over time.  Of relevance for the current economy, it has recently been very low, oftentimes negative.

Some researchers discussed a variety of reasons why the real interest rate is so low, including the rate of time preference, fed policy, and other factors, but they did not mention the incremental productivity of equipment and structures.  This is probably because it is not intuitive that the incremental productivity of a computer, forklift, or a warehouse has fallen dramatically over time.

In Macroeconomic theory we relate real interest rates to the incremental productivity of equipment and structures via a formula.  However, when we go to the data, the latter is not observable.  To obtain a measure of the real interest rate, we must go to financial markets data and subtract inflation from a bond rate.  In thinking about a productive economy, a reasonable bond rate to deflate is the corporate bond rate.

Some researchers postulated the idea that the low real interest rate is the reason for the low performance of the US Economy.  I prefer the idea, promulgated by John Taylor, John Williams, and others, that the low real interest rate has been caused by other factors, in particular, fiscal policy uncertainty and costly regulations.  I worry that there is a wedge, partly policy driven, that has inserted itself between the after tax incremental productivity of equipment and structures, and the deflated corporate bond yield.  Another way of saying this is that while equipment and structures are themselves roughly as productive as before, but the productivity net of these recently higher costs is lower because the costs have risen substantially.

With this idea, we see that there are other factors, fiscal policy uncertainty and regulations, that have caused both slow economic growth as well as historically low real interest rates.  It is at least a possible that long-term trends in the regulatory environment have partly contributed to the long-term evolution of the real interest rates since the 1860s.

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Liftoff has market watchers glued to their monitors for a number of important economic reasons. Because the rate is related to other longer-term interest rates through the Term Structure, and the longer-term rates are used to discount cash flows, this affects net present value (NPV) calculations, making more investment projects appear profitable. Aside from new projects, lower corporate bond rates bring down a firm’s borrowing costs, raising their net income.

The argument for low rates in late 2008/early 2009 was a good one. We had faced a serious financial crises and were in the middle of a serious recession, one that appeared at the time to be the second greatest economic contraction since 1929. Many financial entities faced a liquidity crunch, where short-term credit had vanished. Firms shelved positive NPV projects. Households were upside down on their homes. Because the housing market was so decimated the lower mortgage rates were thought to be needed to help resurrect home sales activity and promote refinancing which in some cases could help a household remain as a homeowner.

The Fed’s dual mandate of price stability and economic growth, argue in a conventional way against raising rates at this time. Historically, rates were raised as a way to cool down an economy with rising inflation or dropped as a way to spur economic growth. However, inflation and economic growth continue remain low compared with postwar U.S. history.

Despite this, I think the Fed should immediately begin the process of raising rates toward historically normal levels. The abnormally low interest rates were probably justified by the double feature of a financial crises and a large economic contraction back in late 2008/early 2009, but they do not have that justification now. The canonical Taylor rule formula as published by FRED at the St. Louis District Federal Reserve bank calls for a Federal Funds Target rate of 2.44 percent.

It is safe to say that financial markets, consumption activity, and savings and investment decisions are being distorted by the low interest rates. As one example, household balance sheet rebuilding was and still is important for the long-term economic health of the U.S. A higher return to savings would aid and incentivize this activity.

The economy should be able to grow with interest rates at normal levels. If it cannot, then it needs to relearn this ability. If this process ends up taking some time, we should begin it sooner rather than later. An imminent financial crisis does not seem to be a high probability event at this time. However, if one did happen now, being at the zero lower bound would be an inconvenient reality indeed.

The post Federal Funds Rate Policy appeared first on Center for Economic Research and Forecasting.

Phelps does more than that, though.  He discusses the philosophical differences between those who are most concerned with opportunity (That would include me.) and those who are most concerned with equality.

Phelps proposes two possible causes of the decline in flourishing:

The first is suppression by those with a strong interest in the status quo:

What then caused this narrowing of innovation? No single explanation is persuasive. Yet two classes of explanations have the ring of truth. One points to suppression of innovation by vested interests. Their power has risen enormously in Western Europe and finally America over the postwar decades. Invoking corporatist notions of economic control and social contract originating in the corporazioni of ancient Rome, some professions, such as those in education and medicine, have instituted regulation and licensing to curb experimentation and change, thus dampening innovation.

The second is repression by families and schools:

The second explanation points to a new repression of potential innovators by families and schools. As the corporatist values of control, solidarity, and protection are invoked to prohibit innovation, traditional values of conservatism and materialism are often invoked to inhibit a young person from undertaking an innovation. Schools are doing less to expose the young to the great books of adventure and personal development. Parents teach their children from infancy to be careful and stay close to the family. There is discussion now of the overprotected child: the need for a return to “free range” children who are allowed to explore, to try things and take chances.¹⁴ Parents urge their children upon graduating to take a secure job with high pay, not a job at a startup. Many universities are now teaching courses in “responsible investing” but nothing on venturesome investing.

I think this paragraph hints at another cause, risk aversion.  As a society, we have become increasingly risk averse over the post WWII period.  Phelps points out the change in child rearing, from free range to helicopter parents.

There is more to it than how we raise children.  Our nation, which once sent men to the moon, no longer has a large-scale public space program.  Our government has become larger and more bureaucratic.  Our business have become larger and more bureaucratic.  Even smaller institutions, pressed by regulation and potential law suits, have become more bureaucratic.

Bureaucracies tend to  crush innovation, because it’s disruptive.  They also tend to punish Type I errors and not Type II errors.

I’ll step back and give a working definition (Warning. Statisticians won’t like this, but I’m not trying to be precise or exactly correct.  I’m trying to keep it simple.):  A Type I error is one that results in an obvious loss:  A loan goes bad.  A spacecraft explodes.  A new drug kills some people.

Type II errors are not so obvious:  A loan that should be made isn’t made.  A perfectly good spacecraft isn’t launched.  A drug that could save thousands of lives isn’t approved.

In each of my Type I examples, there would be hell to pay for the error.  Lots of loan officers have lost their jobs for making bad loans.  Few, if any have lost their jobs for not making a good loan.

Because of the incentives, we minimize Type I errors and ignore Type II errors.  This shows up as risk aversion, and it limits innovation.  We probably won’t regain Phelps’ flourishing until we embrace at least some risk.

The post Risk Aversion and Flourishing appeared first on Center for Economic Research and Forecasting.

“It’s no longer legal to say, ‘We don’t want African-Americans to live here,’ but you can say, ‘I’m going to make sure no one who makes less than two times the median income lives here,’” Jargowsky told me.

The above quote is from an Atlantic article on the resurrection of American slums.  I recommend the entire article.  It highlights the cycle that our slums have gone through over the past 25 years or so.

However, the quote succinctly tells a story that I’ve been trying to tell for the past 15 years.  California is now dominated by a wealthy elite, an elite that has molded policy to advance their preference.  Those preferences are all about the elite’s consumption.  They are nothing about opportunity for the less fortunate.

By implementing policies that limit opportunity, the elite are ossifying our society, limiting socioeconomic mobility.  The New York Times has an article on the correlation between a person’s parents’ income and their own.  Here’s the money quote:

I hear from people who say something like: I grew up poor, but I worked hard and I made it. If other people tried, they could, too. Bravo! Sure, there are extraordinary people who have overcome mind-boggling hurdles. But they’re like the N.B.A. centers with short parents.

Too true.

Bloomberg has noticed that our young people aren’t working summer jobs as much as they used to, but they get it all wrong.  Our young people aren’t lazy.  The decline in teen jobs is not exogenous, or an act of God.  Immigrants may be taking some traditionally teen jobs, but policy is the reason there aren’t enough to go around.

Each of these three articles highlights some results of policies optimized for the elite’s consumption rather than economic opportunity.  California, of course, is the nation’s forerunner in policy optimized for the elite.  The results are sometimes beautiful cities.  Santa Barbara, Monterey, and Malibu are excellent examples.  Just as often, the results are ugly cities.  Consider that San Bernardino has the second highest poverty rate among large U.S. cites, second only to Detroit.

The ugly results on people are not so obvious, but these three articles show that they are starting to become unavoidable.  Now, if people would take them as serious as a dead lion, we’d be getting someplace.

The post Ugly Outcomes of Elite Policy appeared first on Center for Economic Research and Forecasting.

Productivity dropped for the second consecutive quarter, and hiring slowed.

It appears that a weak global economy and the United States increasingly onerous regulatory environment is more than offsetting and stimulus from lower oil prices.

The post U.S. Economy Weak and Fragile appeared first on Center for Economic Research and Forecasting.