Tuesday, April 19, 2005

Fact checking Krugman, or: Remembering the Clinton Stagflation

Paul Krugman in yesterday's column warns us that stagflation -- the combination of too-high inflation with weak economic growth -- is returning to the economy.
What few seem to have noticed, however, is that a mild form of stagflation - rising inflation in an economy still well short of full employment - has already arrived.
Stagflation is bad because if the Fed raises interest rates to contain inflation then weak employment will become even weaker, while if it doesn't then high inflation will rise even higher. See the 1970s.

Of course, labor is the loser here, Krugman says, since the employment market is worse than "it was in the 1990's" and "before the 2001 recession" -- and as the Fed raises interest rates from here it will only get worse yet.

But wait a minute ... There was an historic economic boom in the 1990s, just "before the 2001 recession", and the economy is just coming out of that recession now.

And everybody who knows economics knows that one fairly compares economic performance during different business cycles at the same point in each cycle.

To instead compare a low point of one cycle with an historic high point of another (such as "just before the 2001 recession") is, on the contrary, the sort of cherry picking one engages in to produce whatever predetermined result one wants.

The latest current data, which Krugman is writing about, is for March 2005 -- 40 months after the trough of the 2001 recession. The previous recession occurred in 1991, and 40 months after its trough was July, 1994, well into the Clinton years.

So let's review the data that Krugman cites looking at the same 40-month-after point in time -- March 2005 versus July 1994 -- to compare conditions at the same point of the two business cycles. Following Krugman...
"Let's start with the jobs picture. The official unemployment rate is 5.2 percent"
3/2005: 5.2%
7/1994: 5.5%

Things are better today, although just at the margin of error for the unemployment rate.

By the way, the average unemployment rate for the prior 30 years was 6.4% -- things are much better today than that. And we might note that in 1996 Krugman himself declared the lowest sustainable unemployment rate to be in the 5.5% to 6.0% range -- higher than today's rate.
But unemployment statistics only count those who are actively looking for jobs ... A lower fraction of the adult population is employed
Employment rate
3/2005: 62.4%
7/1994: 62.3%

A higher fraction of the adult population is reported employed today, though the small difference isn't meaningful.
the average duration of unemployment - a rough indicator of how long it takes laid-off workers to find new jobs - is much higher
Duration of unemployment
3/2005: 9.3 weeks
7/1994: 9.0 weeks

Not "much higher" but only two days higher, again not a meaningful difference. (The 1994 number would shortly rise to a full 10 weeks.)
... wage increases have been minimal, and haven't kept up with inflation ...
This seems rather disingenuous since Krugman surely knows, while his average reader probably doesn't, that "wages" exclude benefits, which are a rapidly rising portion of total pay (as liberals insist they should be!) -- and that including benefits total pay has in fact continued to rise faster than inflation, as was noted here previously.

The implication that pay hasn't kept up with inflation is false and misleading -- seemingly intentionally so.
Why, then, has the Fed been raising interest rates? Because it is worried about inflation.
OK, let's look at both inflation and the Fed's presumed worries about anticipated inflation as embodied in its interest rate policy.

Inflation, prior 12 months
3/2005: 3.0%
7/1994: 2.8% -- not a significant difference

Inflation anticipated by the Fed as seen in interest rate policy...

Real interest rate (fed funds rate minus 12-month inflation reading)
3/2005 - 0.37%
7/1994 +1.46

The Fed's current real interest rate is negative -- which is stimulative in anybody's book. The real rate in 1994 was positive and much higher. This is a meaningful difference.

Moreover, the Fed had started increasing interest rates rapidly in 1994 -- they'd risen by 1.34 points in since their low (versus a 1.6 point increase in 3/2000) but were about to be raised by another 1.75 points in just another eight months. I don't think anyone is talking about the Fed raising the rate that fast today.

So if Krugman is right that a higher and rising interest rate is a measure of the Fed's concern about inflation, then it was much more concerned in 1994 than 2005.

A negative real interest rate such as today's cannot be sustained forever. It must rise. Perhaps this is the simple reason for why it finally is rising? Krugman would not have us consider this.

And, finally, an essential to "stagflation" is the stagnation half of it -- below par economic growth.

GDP growth rate, 12 months
3/2005: 3.9%
7/1994: 4.3%

These compare to average real GDP growth for the 30 years through 2004 of 3.1% real. Hey, you can't have stagflation with above average growth!

For that matter, it's hard to claim stagflation with well below average unemployment too -- 5.2% versus 6.4% over 30 years.

For a refresher on what stagflation really looks like, let's recall the numbers for 1975...

Unemployment: 8.5%
Employment rate: 56%
Inflation: 9.1%
GDP growth: 2.5%

Now that's stagflation -- and 1994 and 2005 are not anything like that.

However, 1994 and 2005, both at the same distance from the prior recession, are very much like each other.

And if anything, the employment numbers are marginally better in 2005 while the real interest rate (anticipated inflation) numbers are significantly tougher for 1994.

So if Krugman truly believes his warning today that "stagflation" has arrived in 2005, just where were his warnings about the Clinton Stagflation of 1994??

Look, what's really going on here is two things:

(1) Both 1994 and 2005 show economic growth that is faster than average as part of the normal course of recovery from a recent recession, with interest rates of course moving up amid the higher growth from their recessionary lows. Nothing could be more natural. Indeed, what else is possible?

(2) Krugman can't write a column without blaming Bush for something or warning about something ominous happening on W's watch -- and if he doesn't have anything real, he just makes it up.

But "stagflation" means "stagnation and inflation" -- low growth and high inflation. 1975 was stagflation. You can't have stagflation with above average growth and low inflation. To say we do as Krugman says here is to change the meaning of a word for political purposes, which is, ahem, "Orwellian."

Krugman's described tradeoff between between growth/employment and inflation in fact exists every single time the Fed decides whether or not to raise or lower interest rates -- for growth and employment are never as strong as we would prefer them to be, and the risk of future inflation is always present. The tradeoff is always there.

This does not mean the economy exists in a permanent state of stagflation.

Stagflation was 1975.