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I have been puttering around with some of the arguments from The Great Stagnation. One line that stood out to me went something like this
If the capital isn’t doing any better and labor isn’t doing any better then where is all of this supposed innovation going?
My knee jerk reaction was what about human capital. However, I decided to see whether or not capital was doing any better. One of my favorite measures the return to capital is the national dividend yield. That is, what portion of national income is paid out to the holders of US stock.
I was actually a bit shocked at the result. I had assumed that the rise in retained earning would mask some of the “real returns” to capital and that perhaps some of innovation was being sent down the tubes by a corporate bureaucracy that spent profits on empire building rather than paying them out to shareholders.
Yet, dividends as a percent of GDP are rising. That is the owners of corporations are getting paid out an ever larger share of GDP.
Part of this is because corporate profits as a percent of GDP are rising but it looks like significantly more corporate profits are actually going out of the door.
Here is dividends as a percentage of after tax corporate profits
Maybe this is coming at the expense of small business owners. Lets add in proprietors profits
Interesting. Well that warrants looking at Proprietors’ Profits on their own.
The fall in proprietors’ income up until 1980 seems to be the dominant story, the rise in dividends the dominant story after 1980.
Basically less and less on the nations income was going towards business owners until 1980 when that turned around, both for small business owners and the owners of corporate capital.
This is not a story of the owners of capital doing worse. Indeed, it might even suggest that workers wages were being boosted by the decline in income going to the owners of capital.
An obvious question is – what about interest? I am not sure how to deal with that. On the one hand those are payments to capital but they seem of the kind most likely benefiting the median household. If a working class family was going to save typically that would have been in some interest bearing vehicle.
Plus we have problems with teasing out money demand and inflation fluctuations. Though off the cuff I am not exactly sure how to treat inflation when thinking about these variables. It seems like it ought to matter even when normalizing by GDP.
A high inflation economy is one where a larger fraction of nominal GDP is paid out to bond holders to compensate them for loss in purchasing power. This in theory should depress profits. However, should it depress dividends and proprietors income after capital adjustments? I am not sure.
Inflation is confusing. The concept makes crazy people crazier. And even worse, it makes otherwise sober people disagree with eachother. Reading through the accounts of QE2 on the internet the past few days have solidified my view that inflation is a thorny enough concept that we should rid it from popular vernacular. Is inflation important? Sure…but what measure of inflation is correct? CPI-U? GDP Deflator? Your crazy uncle’s index? Does inflation help or hurt savers in the current landscape?
If there is anything that gets turned on it’s head when an AD recession hits, it is the concept of inflation. During normal times (full employment and capacity utilization), inflation is harmful as it drives up interest rates, discourages saving, and encourages misallocation of capital. However, none of those things apply to the current situation in which we find ourselves with a large output gap and high unemployment. Thus, we need higher inflation in order to close the output gap (the difference in money expenditures between where we are currently, and the trend rate from the Great Moderation…currently about -13%), but that turns everything that everyone knows about inflation backward. All of a sudden inflation is good for savers, good for the unemployed, and good for economic growth. Well, stable inflation expectations are key…but it’s hard to steer a ship, and it’s hard to get a non-confusing answer out of pundits and other commentators.
In order to square this circle, I propose we forget about inflation. And not just forget about talking about it, but forget about its use in the setting of monetary policy. Instead, we should target nominal expenditure at a steady growth rate (3% a la Woolsey, or 5% a la Sumner, Beckworth, etc.) with level targeting. What advantages does targeting nominal expenditure have? Well…
- Targeting nominal expenditure (NGDP for short) allows monetary policy to better address recessions which arise from both aggregate supply and aggregate demand shocks. David Beckworth has an excellent discussion of this point.
- NGDP is a better indicator of monetary shocks than inflation indicators like CPI. Because prices are sticky, and because measures of inflation are so problematic, a fall in NGDP won’t immediately show up in inflation numbers. Also, if there is a large price shock in something like oil, this will raise the money price of all goods and services, causing anyone focusing on inflation to miss the underlying weak economy…and thus potentially set monetary policy to be too contractionary (sound familiar?).
- NGDP allows us to broaden our focus to aggregates like MZM, asset prices, yields, excess reserves etc. We’ll relinquish our inane focus on interest rates, which are a very problematic indicator of the stance of monetary policy, and have a much better picture of the health of the economy.
- NGDP sounds better. People have an innate fear of inflation. Inflation destroys savings, after all…and we all know frugal people are virtuous. Well, how about, in the event of a recession, instead of economists clamoring against the crowd that we need inflation, they say that we want aggregate expenditures (and thus nominal income) to be at some level higher than it currently is? Money illusion is a powerful motivator. Who would argue with that?
Targeting nominal expenditure would be a beneficial step from both an economic theory perspective, and a public relations perspective. Lets take the confusing concept of price inflation out of our discourse, so that we can see the world more clearly.
P.S. We are currently 13% below the target path from the Great Moderation, and are where we were at before the crash of Sept/Oct 2008. To make that up by 2011:Q3, the Fed would have to target NGDP at $17.6bn (to continue on a 5% NGDP growth path). However, Bill Woolsey favors a 3% growth path for money expenditures, which means that the Fed would only have to target a 13.8% increase by 2011:Q3 (or $16.4bn), and then continue on with 3% growth, level targeting, from then.
Update: Found the link to Beckworth’s article!
