[WellSpyder]

phil_20686, on 2012-August-13, 10:16, said:

The fundamental reason that monetary policy works at all, is that prices/wages are sticky. This means that changing the rate of inflation gives you a short term boost until wages adjust. In the long run money is neutral. The existance of a neverending spiral basically implies that you do not think that raising the inflation rate will lower unemployment. If it does successfully lower unemployment, then you can lower the rate of inflation again.

I don't really want to pick up on all the points in your post, and I agree with quite a bit of what you say, but I suspect the fundamental reason why we don't necessarily agree on the appropriate policy response lies in the final sentence in your para above. How do you propose to lower the inflation rate again?? Do you think this will simply happen by the central bank reducing the rate of monetary expansion in the economy, with no consequences for the real economy?? Or is it more likely to require an increase in interest rates to reduce demand, and put downward pressure on inflation by increasing unemployment again, in order to reduce inflationary expectations again?

[phil_20686]

WellSpyder, on 2012-August-13, 11:01, said:

I don't really want to pick up on all the points in your post, and I agree with quite a bit of what you say, but I suspect the fundamental reason why we don't necessarily agree on the appropriate policy response lies in the final sentence in your para above. How do you propose to lower the inflation rate again?? Do you think this will simply happen by the central bank reducing the rate of monetary expansion in the economy, with no consequences for the real economy?? Or is it more likely to require an increase in interest rates to reduce demand, and put downward pressure on inflation by increasing unemployment again, in order to reduce inflationary expectations again?

The point is that the philips curve is not the same shape at full employment as it is during a recession, so these procedures are not symmetrical. Near full employment it is shallower, so reducing inflation by one percent near full employment will have less of an effect on employment than one percent now, where we are on the steep part of the curve.

Moreover, even if they were symmetric, you can lower it more slowly, so that you stay at full employment, and get an overall increase in net jobs. Its really just a variation on the fiscal policy argument: fiscal policy raises demand a lot now, and reduces it a little over a long period in the future, through consumption smoothing, and so stimulus during a recession does lead to a net increase in jobs. Of course, that must be true, as fiscal and monetary stimulus are essentially identical.

We can also see this through a less abstract lens: at full employment, there is a demand for labor, and generally the economy wants more workers than it has available, so small negative shifts at full employment are easily absorbed.

On final point, if inflation expectations in the long term are 2%, returning to the expected does not have any effect. What you say above is something which is true by degree. If we moved inflation expectations by having higher inflation for several decades, then lower inflation would be contractionary, but in reality a few years of higher than 2% inflation is unlikely to move the expectation.

Okay really final point here. If you are worried about longterm inflation expectations, you should be worried that expectations of inflation are already disachnchored. FOr decades the us 30 year treasuries have had an implied inflation rate between 2 and 2.5 %. But now we are seeing significant volatitility, check it out here. In late 2010, for example, implied inflation expectation for the US was down to 1%. Which is mental. The market no longer knows whether to believe that the Fed is actually targeting a 2% inflation, and the result is unprecedented volatility in long term expecations. We have already dis-anchored expectations, to the downside, which, by your own admission, is contractionary. The Fed, by having lower than expected inflation, is engaging in contractionary monetary policy, despite the high unemployment. This is a scandal.

[phil_20686]

WellSpyder, on 2012-August-13, 11:01, said:

I don't really want to pick up on all the points in your post, and I agree with quite a bit of what you say, but I suspect the fundamental reason why we don't necessarily agree on the appropriate policy response lies in the final sentence in your para above. How do you propose to lower the inflation rate again?? Do you think this will simply happen by the central bank reducing the rate of monetary expansion in the economy, with no consequences for the real economy?? Or is it more likely to require an increase in interest rates to reduce demand, and put downward pressure on inflation by increasing unemployment again, in order to reduce inflationary expectations again?

Came across this the other day, I think it shows clearly why its important to understand the differences between when policy is demand side and supply side:




I will try to find subsequent data back to the great depression and forward to now

[PassedOut]

phil_20686, on 2012-August-13, 12:24, said:

The point is that the philips curve is not the same shape at full employment as it is during a recession, so these procedures are not symmetrical. Near full employment it is shallower, so reducing inflation by one percent near full employment will have less of an effect on employment than one percent now, where we are on the steep part of the curve.

Moreover, even if they were symmetric, you can lower it more slowly, so that you stay at full employment, and get an overall increase in net jobs. Its really just a variation on the fiscal policy argument: fiscal policy raises demand a lot now, and reduces it a little over a long period in the future, through consumption smoothing, and so stimulus during a recession does lead to a net increase in jobs. Of course, that must be true, as fiscal and monetary stimulus are essentially identical.

Phil, thanks much for a great sequence of posts, especially this last clarification. The problem of reversing the effects of inflation later had always been a (perhaps irrational) problem for me.

Any inflation erodes the value of the nest egg of retired people. If inflation stays at a predictable 2% or so, folks can plan accordingly. But if it spikes above the normal amount for an extended period, it hurts those folks immensely. I saw that happen in the 1970s. Perhaps one should plan for a somewhat higher than normal inflation to account for the need to pump it up on occasion.

It would be good to know the exact strategy of the central banks (and, of course, that the strategy is sound).

[phil_20686]

Ok note quite as good, but I think this will make my point:




The philips curve suggests that during a recession unemployment rises, and inflation falls, We see this clearly, following each recession (shaded bar) pre 1970, unemployment rises, while inflation falls. Moreover, generally inflation remains depressed until unemployment has returned to its natural rate. See the 1960 to 1967 period. Expansionary policy leads first to falling unemployment, and then to rising inflation.

In the 1970's we see something different. Now inflation and unemployment move together. This is indicates that the philips curve is very steep. The explanation of this lies in supply constraint. Inflation was high because demand for stuff was outstripping the rate at which the economy could expand production, due to a combination of rising working age population (the entry of women into the work force raised labour participation rates rapidly), rising competition for commodities.

Supply side issues ended in the eighties, as we got better at making more with less (productivity gains), and we returned to the business as usual of demand side recessions. Then look what happened. five years ago we had the biggest recession visible on this graph, and the FOMC has allowed inflation, and inflation expectations, to languish below trend.

Now my preferred measure of whether policy is stimulative or not is Nominal GDP, which is basically a measure of aggregate demand. Its also clear that a central bank can necessarily raise nominal GDP, (although not necessarily RGDP).




The difference between NGDP and inflation is RGDP. You can see that mostly RGDP growth has been fairly robust, so NGDP tracks inflation. Every large decline in unemployment visible on this graph, has been accompanied by NGDP growth above five percent (which is roughly the stable trend at full employment). Not only is the fed not engaging in stimulus, it is allowing NGDP to be below trend, which is contractionary, and its own estimates suggest that NGDP will not be above 5% through 2020. Moreover, the apparent decline in the unemployment rate is flattering, it is mostly caused by people dropping out of the labour force, having been unable to find a job. Particularly for those in teh fifties, it often makes sense to start claiming your pension early, even though its not your first choice, rather than having no money. Once you do that, you are no longer unemployed.

[phil_20686]

PassedOut, on 2012-August-14, 07:35, said:

Phil, thanks much for a great sequence of posts, especially this last clarification. The problem of reversing the effects of inflation later had always been a (perhaps irrational) problem for me.

Any inflation erodes the value of the nest egg of retired people. If inflation stays at a predictable 2% or so, folks can plan accordingly. But if it spikes above the normal amount for an extended period, it hurts those folks immensely. I saw that happen in the 1970s. Perhaps one should plan for a somewhat higher than normal inflation to account for the need to pump it up on occasion.

No problem:

Also, above average inflation shouldn't hurt you, what does hurt you is if you retire during below average inflation, or alternatively, if inflation rises after you retire. I realise that is counter intuitive, but basically it the argument goes like this suppose that you hold part of your retirement portfolio in bonds. Consider that you hold one year bonds in year one, and buy them at an interest rate of 8%, intending to roll them over upon maturity into more bonds. The next year, inflation expectations fall, so yields fall. This increases the capital value of your original bonds, but decreases the yield, so rolling over the capital always gives you exactly the same coupon payment that you started with. Thus, its actually best to buy bonds when inflation expectations are high, because if inflation expectations fall you benefit. So those people who saved their portfolio's in bonds through the 1970's, have made a killing as decreased inflation expectations have lowered yields. Anyway, my point is this: the yield for risk free assets should oscillate around the expected level of inflation, plus a small premium for bearing the risk of higher than expected inflation. The entire reason that yields have been higher in the past, was pretty much because the inflation expectations in thirty year bonds take a while to reset, and people had high expectations by the end of the 1970's:




So the people who really get hurt are those who are retiring right now, because the way pension funds are set up as annuities essentially forces you to move all of your assets from equities into bonds (although tihs all happens behind a curtain as it were), and yields are currently low, and its the yield on the day your annuity is taken out that matters, as that has that days inflation expectation built into it. But this is the central banks fault. If should have moved aggressively to stimulate NGDP, if it had, bond yields would not have fallen below the four percent they were yielding pre crises, which was pretty much their historical floor. Barring this crisis, they would have stabilised at around four percent. No one buys safe assets at a loss unless they have to .

Of course, this is not a popular view. Obviously, in some sense, inflation `always' hurts you when you have an annuity, as people don't think "two percent of my yield is my inflation expectation, I should reinvest that in more bonds to protect myself from inflation", but that is how an economist thinks.

So the only losers here will be the people who retired 2008-now. But what can you do.

[WellSpyder]

phil_20686, on 2012-August-14, 07:05, said:

Came across this the other day, I think it shows clearly why its important to understand the differences between when policy is demand side and supply side:

A useful chart, thanks - but I think what it really illustrates is the importance of inflation expectations, not whether the economy is demand or supply constrained.

PassedOut, on 2012-August-14, 07:35, said:

Any inflation erodes the value of the nest egg of retired people. If inflation stays at a predictable 2% or so, folks can plan accordingly. But if it spikes above the normal amount for an extended period, it hurts those folks immensely. I saw that happen in the 1970s. Perhaps one should plan for a somewhat higher than normal inflation to account for the need to pump it up on occasion.

This is exactly my problem with Phil's inflation-inducing strategy. Sure, you can plan for average inflation somewhat above normal, to allow for the occasional policy-induced extra inflation. But now the policy will only work if it pumps inflation up even higher. It is only if policy-makers can exceed inflationary expectations that such a policy will work, but that means savers have lost out again. And it also means that investors will be more wary of lending to governments in the future. Any policy that is "time inconsistent" (ie wouldn't work if people had known in advance that that was going to be your policy) is unlikely to be sutainable in the long run.

[phil_20686]

WellSpyder, on 2012-August-14, 08:38, said:

This is exactly my problem with Phil's inflation-inducing strategy. Sure, you can plan for average inflation somewhat above normal, to allow for the occasional policy-induced extra inflation. But now the policy will only work if it pumps inflation up even higher. It is only if policy-makers can exceed inflationary expectations that such a policy will work, but that means savers have lost out again. And it also means that investors will be more wary of lending to governments in the future. Any policy that is "time inconsistent" (ie wouldn't work if people had known in advance that that was going to be your policy) is unlikely to be sutainable in the long run.

From what I understand, the fundamental difference in our thinking, is that you think raising the inflation rate now will necessarily change inflation expectations. I don't think that this follows. If you can promise to balance inflation to two percent over the cycle, like australia attempts to do, and still allow it to run high now. If that is the case the policy is sustainable, as you can have quite a lot of above expected inflation without changing the long term inflation much at all. Of course, this is all about time horizons, but the `inflation expectation' people talk about seems to be roughly on a ten year horizon.

It does not seem to follow that having two or three years of 5% inflation should necessarily move the ten year expectation much at all. I can show you graphs of countries, like Australia, where the implied inflation in the bond market didn't move much at all, despite a short period of high inflation. Or in the UK, where we had a short period of high inflation (although in this case not because of the central bank).

[Cthulhu D]

squealydan, on 2012-August-13, 04:58, said:

If they aren't saving their employers vast amounts of money in reduced or deferred tax payments, why are tax attorneys are the highest paid lawyers in the legal profession, and why do corporations tend to employ large numbers of them?

From thinkprogress.org : "U.S. corporate taxes that were actually paid (the effective rate) fell to a 40 year low of 12.1 percent in fiscal year 2011, despite corporate profits rebounding to their pre-Great Recession heights."

The single best corporate tax evasion scheme is Ikea. Ikea is a charity dedicated to the advancement of furniture design (I'm not joking at all), and is run as a not for profit corporation. The profits are extracted via a licensing fee charged by an off-shore corporation in Bermuda.

It is the best thing.

[phil_20686]

squealydan, on 2012-August-13, 04:58, said:

From thinkprogress.org : "U.S. corporate taxes that were actually paid (the effective rate) fell to a 40 year low of 12.1 percent in fiscal year 2011, despite corporate profits rebounding to their pre-Great Recession heights."

This is one of those annoying `small truths' that isn't exactly false but paints a completely false picture.

The fundamental reason this number is falling is that co-corporations are earning more of their money abroad. If you are a co-orporation, you should be paying US corporation tax only on those profits relating to operations in the US.

Instead, you require corporation to be paid on foreign earnings, so US subsidiaries operating in England, will pay UK corporation tax, but if they pay their profits back to the US parent company they are expected to pay a second round of corporation tax on repatriated earnings.

However, the US allows earnings deferral, so the parent company does not have to pay corporation tax on its foreign earnings if they are held abroad, and never returned to the US. The result is that companies hold much of their profits abroad indefinitely until they are ready to invest somewhere abroad.

By contrast, the UK always avoids double taxation, and taxes foreign profits only if they were not taxes in the host country, or if they were taxed at a lower rate in the host country, we make up the difference. Since corporation tax rates are similar in most of Europe, there is no great benefit to going through the hassle of deferring.

These figures are created by taking at the declared world wide earnings of corporations, and then looking at US taxes paid. Which is obviously a ridiculous thing to do. Why should the US government be entitled to tax profits made by (say) British workers, working in British factories, using British infrastructure to transfer their goods to British consumers, just because their parent company happens to be incorporated in the US, rather than (almost) any other country in the developed world .


PS: I actually think corporation tax should be zero. Economy is made up of people consuming things. So tax people, when they are paid, and when they consume. Taxing corporations, rather than the people they employ and the people they pay the money to, is weird, and it mostly happens because people don't know who is being taxed when you tax a faceless corporation, and so they don't know who is paying, and that always makes it politically feasible to have high corportation taxes.

[barmar]

phil_20686, on 2012-August-15, 07:29, said:

PS: I actually think corporation tax should be zero. Economy is made up of people consuming things. So tax people, when they are paid, and when they consume. Taxing corporations, rather than the people they employ and the people they pay the money to, is weird, and it mostly happens because people don't know who is being taxed when you tax a faceless corporation, and so they don't know who is paying, and that always makes it politically feasible to have high corportation taxes.

But as the Supreme Court pointed out in the Citizens United case, corporations are people.

But as to the "weirdness" of taxing corporations -- who and how much to tax is mostly arbitrary. It's no more weird to tax corporations than to have different tax rates on food purchased at a restaurant than at a grocery (in MA, we have a meals tax, but no tax on groceries). Dividing up the tax burden is mostly political -- taxes either implement public policy (increasing taxes on activities you want to discourage, like smoking), or are done in ways least likely to hurt one's political career (corporations don't vote, and they have lots of money, so it's safer to tax them).

[mycroft]

phil_20686, on 2012-August-15, 07:29, said:

This is one of those annoying `small truths' that isn't exactly false but paints a completely false picture.

The fundamental reason this number is falling is that co-corporations are earning more of their money abroad. If you are a co-orporation, you should be paying US corporation tax only on those profits relating to operations in the US.

Agree, but:

Quote

These figures are created by taking at the declared world wide earnings of corporations, and then looking at US taxes paid. Which is obviously a ridiculous thing to do. Why should the US government be entitled to tax profits made by (say) British workers, working in British factories, using British infrastructure to transfer their goods to British consumers, just because their parent company happens to be incorporated in the US, rather than (almost) any other country in the developed world .

If you are a U.S. Citizen, you pay U.S. tax on foreign earnings, when living in the foreign country, and employed by a foreign company (there are bigger "standard deductions", because they do realize that the foreign country wants *their* taxes, but it still happens, and it happens even if the money never enters the U.S). Why should other entities that pay tax be any different?

Also, if you see for example Microsoft Ireland, it's amazing how much U.S. business is done "by european workers, in a european office, using european infrastructure."

On your note about corporations and their taxes, I already work with several corporations who are co-workers. Removing any non-consumable taxes on corporations will simply encourage everybody, rather than those that are willing to deal with the hassle, to self-encorporate. And then where are you? Also, if people get taxed when they get paid, why shouldn't corporations? And if not - if we only tax people or institutions on consumption - we avoid all this hassle about "marginal income tax rates", but for all the reasons I've outlined before (specifically the "shrinking incremental value of money") that can (and therefore will, if those that have the money have the say, and they usually do, at least for a while) lead to the same issues we had in Dickensian Victoriana and Robber Baron U.S.

Faster than we're currently going, that is.

[phil_20686]

barmar, on 2012-August-15, 09:35, said:

But as the Supreme Court pointed out in the Citizens United case, corporations are people.

which is completely ridiculous. And your legislature should move immediately to change this.

barmar, on 2012-August-15, 09:35, said:

But as to the "weirdness" of taxing corporations -- who and how much to tax is mostly arbitrary. It's no more weird to tax corporations than to have different tax rates on food purchased at a restaurant than at a grocery (in MA, we have a meals tax, but no tax on groceries).

Except that US corporation tax is set up to create weird incentives. For example: it is cheaper for a US company like google to acquire foreign start ups than US start ups, as it can acquire foreign investments without paying corporation tax. A tax system that makes it inefficient to invest in your own country does not seem like a winner to me.

Also, I don't think taxes when you cannot predict the tax incidence are a good idea. I like predictable taxes and transparency. The incidence of corporation tax changes depending on the state of global competition, (they will pass on the tax to consumers unless constrained by global competition) so it is either a competitive handicap or a tax paid by consumers. The first thing isn't a good thing, and the second is a sales tax dressed up to look like something else.

[phil_20686]

mycroft, on 2012-August-15, 09:49, said:

Agree, but:
If you are a U.S. Citizen, you pay U.S. tax on foreign earnings, when living in the foreign country, and employed by a foreign company (there are bigger "standard deductions", because they do realize that the foreign country wants *their* taxes, but it still happens, and it happens even if the money never enters the U.S). Why should other entities that pay tax be any different?

This is also ridiculous. This penalises US citizens for working abroad, which handicaps US corporations from being able to send their best people to work abroad.

mycroft, on 2012-August-15, 09:49, said:

Also, if you see for example Microsoft Ireland, it's amazing how much U.S. business is done "by european workers, in a european office, using european infrastructure."

Its unclear what you mean by "us buisness".

mycroft, on 2012-August-15, 09:49, said:

On your note about corporations and their taxes, I already work with several corporations who are co-workers. Removing any non-consumable taxes on corporations will simply encourage everybody, rather than those that are willing to deal with the hassle, to self-encorporate. And then where are you? Also, if people get taxed when they get paid, why shouldn't corporations?

Tax systems should not allow you to avoid tax by self incorporation. That is, you should not be able to get the money out of the corporation and into your greedy paws without paying income tax.

[onoway]

Perhaps people would be more comfortable with corporations not paying much (or any) taxes if they weren't ever given preferential treatment / subsidised/ bailed out/ with taxpayer money.

Aside from that, why should corporations not be required to give something back to the community? Don't they also use the infrastructure that the taxes supposedly are paying for? Roads, police, septic systems and so forth? Education systems which prepare their workers for them? Roads would last a whole lot longer if big heavy trucks weren't trundling over them, and a whole lot of civil servants would be unnecessary if too many corporations didn't try to get away with what is basically antisocial behaviour.

Reasonable behaviour has too often gone by the wayside by companies who pollute and cut corners re safety and generally disregard anything but their own bottom line as having any importance.

Such behaviour means that society has to have something in place supposedly to protect the citizens from corporate misbehavour. Why shouldn't corporations be held responsible for paying for such things? People have to pay taxes for schools even if they have no kids, so why should corporations not have to pay their share as well?

I know someone who owns shopping malls and 100+ apartment complexes and at least one car dealership in Canada and the US and pays NO income tax at all. Hasn't for many years. And now you are saying that his companies ALSO should pay no taxes? That's a pretty hard sell, I think.

[phil_20686]

onoway, on 2012-August-15, 13:38, said:

Aside from that, why should corporations not be required to give something back to the community? Don't they also use the infrastructure that the taxes supposedly are paying for? Roads, police, septic systems and so forth? Education systems which prepare their workers for them? Roads would last a whole lot longer if big heavy trucks weren't trundling over them, and a whole lot of civil servants would be unnecessary if too many corporations didn't try to get away with what is basically antisocial behaviour.


Such behaviour means that society has to have something in place supposedly to protect the citizens from corporate misbehavour. Why shouldn't corporations be held responsible for paying for such things? People have to pay taxes for schools even if they have no kids, so why should corporations not have to pay their share as well?

I know someone who owns shopping malls and 100+ apartment complexes and at least one car dealership in Canada and the US and pays NO income tax at all. Hasn't for many years. And now you are saying that his companies ALSO should pay no taxes? That's a pretty hard sell, I think.

Because corporations are "things" and so they don't "pay". If you tax a corporation, it is people somewhere who are paying. Either the consumer in higher prices, or the employees in lower wages, or the owner in lower profits. If you tax a corporation one of these three groups is paying. So why not tax them directly? I am arguing that you should set up your tax law in such a way that people get taxed.

Moreover, we have no idea who pays for corporation tax in general. Is it a tax on rich people or poor people? How can we decide how redistributive a tax system is when we have no idea who is paying one of the major taxes?

Also, your example cannot possibly be true. But even if it is mostly true, in the sense that he pays much less than the legislature intended, it only tells you that you should be rewriting your income tax law. Finally, you are assuming that the rich guy is the one who loses from corporation tax. It could very well be that it is actually his tenants who are paying the tax through higher rents. Corporation tax incidence is very complicated.

[barmar]

mycroft, on 2012-August-15, 09:49, said:

Agree, but:
If you are a U.S. Citizen, you pay U.S. tax on foreign earnings, when living in the foreign country, and employed by a foreign company (there are bigger "standard deductions"

Are you sure they can't take a credit for the foreign taxes paid? I don't know about taxes on wages, but that's how it works for taxes on investments.

[Cthulhu D]

onoway, on 2012-August-15, 13:38, said:

Aside from that, why should corporations not be required to give something back to the community? Don't they also use the infrastructure that the taxes supposedly are paying for? Roads, police, septic systems and so forth? Education systems which prepare their workers for them? Roads would last a whole lot longer if big heavy trucks weren't trundling over them, and a whole lot of civil servants would be unnecessary if too many corporations didn't try to get away with what is basically antisocial behaviour.

You're forgetting that Isaac Newton's quote "If I have seen further it is only by standing on the shoulders of giants" is seen as an indictment of capitalism/endorsement of socalism by the US Republican movement. Just look at the sheer number of hilariously bad political cartoons sledging the 'you didn't build that' remark.

The bottom line is that your statement is self evidently true, but it runs contrary to the de jure republican/protestant line that man can pull himself up by his own bootstraps, everything government does is bad, and everything would be better if there was no government. Given the dissonance, they have to reject one position and for some reason that eludes me, they pick yours.

[mike777]

Actually I think the real debate is over the theory/question: are free markets the best antipoverty program?



That's the way the free market system distributes the fruits of economic progress among all people. That's the secret of the enormous improvements in the conditions of the working person over the past two centuries.”
― Milton Friedman, Free to Choose: A Personal Statement

[Cthulhu D]

mike777, on 2012-August-15, 19:26, said:

Actually I think the real debate is over the theory/question: are free markets the best antipoverty program?



That's the way the free market system distributes the fruits of economic progress among all people. That's the secret of the enormous improvements in the conditions of the working person over the past two centuries.”
― Milton Friedman, Free to Choose: A Personal Statement

Except that the US has higher inequality and more poverty than, say, Finland on a per capita basis. Is there any data amongst the OECD to suggest that this is the case?