Kamala and the Cost Tradeoff

If I read my notes correctly, Symone at MSNBC's The Weekend (1 Sept 2024, 9:30 AM±) said Kamala wants higher-paying jobs for more Americans.

Sounds good to me. We've been underpaid for decades. But K must consider and confront Republican criticism of her call for higher pay. The R will say INFLATION. You know they will. They will tie Harris to Biden. They will tie her to the so-called "Biden inflation". Trump is doing that already. The R will make harsh criticism. K will need a powerful rebuttal. 

The R view will be something like this: Labor cost is a big part of the cost of output. So an increase in wages can be expected to lead directly to an increase in the price of output. 

It's like a reflex. But there is more. In addition to labor costs, a business has "non-labor" costs. The non-labor costs consist largely of purchases from other businesses. Embedded in those costs is the cost of labor at those other businesses. Thus, business costs consist to a large extent of the sum of direct and indirect (embedded) labor costs. So the R have a very strong argument when they say K's focus on better wages will cause inflation. 

All else aside, wage increases that drive prices up are self-defeating.

Kamala needs an economic plan that can prevent the drubbing the R are more than willing to give. K also needs a way to raise wages without creating inflation. Here is my plan: To create higher-paying jobs, Kamala should take advantage of a cost tradeoff: The increasing cost of labor should be offset by reducing the cost of finance. 

Between 1949 and 1981, there was a cost tradeoff we have not yet recovered from. Corporate interest costs increased by about 6½ percent of corporate spending. During those same years, corporate compensation of employees decreased by almost 7 percent of corporate spending. This cost tradeoff was good for corporations, but not for their employees.

Employee Compensation and Interest Cost relative to Corporate Deductions

There was plenty of inflation in the 1948-1981 period, inflation that drove corporate spending up. So those numbers, the 6½ percent interest-cost increase and the 7 percent wage-cost decline, are much bigger (in dollars) than the numbers suggest.

To boost wages without causing inflation, K can engineer a cost tradeoff where increased labor costs are offset by slower growth of finance, slower growth of debt, and slower growth of interest cost. Kamala can offset the rising cost of wages by reducing the scope and cost of finance.  

The amount of interest paid, barring complications, depends on the interest rate and the size of the debt on which interest is paid. Interest paid rises and falls with the rate of interest and the quantity of debt.

Corporate interest cost, the red line on the graph, rises along with interest rates and the quantity of debt from 1948 to 1981. Since 1981, however, interest rates have been generally falling while the quantity of debt has been generally rising. So the red line tends to run flat, with lows only at extreme lows in the interest rate: 5 years in the early 1990s, 5 years in the early 2000s, and most of the time since 2008.

My plan is, and Kamala's plan must be, to rejigger economic policy in every nook and cranny so as to turn incentives-to-be-in-debt into incentives-to-pay-down-debt. The tax deduction for interest paid, for example, is good for those who are in debt. So, that tax deduction makes debt higher than it would otherwise be. We must change that tax deduction. We must replace it with a tax deduction (or a tax credit) for making extra payments against loan principal. This will help people and businesses pay down debt. It will make debt lower than it would otherwise be.

The objective is to bring debt down for people and for businesses.

By relying less on credit and more on income, businesses will reduce their financial costs. They will be able to use the freed-up funds to increase wages without increasing overall business costs, without squeezing profit, and without the need to raise prices. The change in policy will make the red line on the graph come down, so corporations have more money available to spend on wage increases, and more money left over to boost their profit.

Consumers will see living standards improve as businesses increase wages without increasing prices. In addition, the new policy of increasing reliance on income (and reducing reliance on credit) will lead to less borrowing, less debt, and smaller debt service payments for consumers. With finance taking a smaller bite out of our disposable income, more income will be available to spend and to save -- and this is in addition to our higher income arising from the business interest-cost savings.

As we come to rely less on credit and more on income, the quantity of money will have to rise. But as long as money grows at a replacement rate (as credit-use falls), inflation should be comparable to what it was for many years before the so-called Biden inflation: generally acceptable. And because income comes to us without the cost of interest, inflation should be lower than what we had for those many years before the Biden inflation. Or economic growth higher. Or both.

Kamala's new policy will augment labor share, increase aggregate demand, and boost economic growth. It will also help reduce private-sector debt, which is the necessary precondition for reducing the federal debt.

Go Kamala!

The employee compensation data comes from BEA Table 1.13 row 4:
    Domestic Business: Corporate Business: Compensation of employees

The data on interest paid comes from BEA Table 7.11 row 3:
    Monetary interest paid: Domestic Business: Corporate business

The data for total deductions of active corporations comes from several sources.
Recent data from three sources:

• Tax Policy Center: Corporate Tax Items, 1998 to 2020
• Tax Policy Center: Corporate Tax Returns, 1990 to 2013
• IRS: Statistics of Income, SOI Tax Stats - Table 5 - Returns of active corporations

Older data from multiple sources:

• Historical Statistics (Bicentennial Edition), Series V 132, 1948-1970 
• Statistical Abstract, various editions: SA1976-06 Table 844, SA1980-06 Table 948, SA1984-05 Table 907, SA1988-05 Table 846, SA1992-05 Table 834, SA1996-17 Table 835

The most recent data on corporate deductions at IRS (as of 5 Sept 2024) is for 2020.

My Excel Spreadsheet: Corporate Cost Components (7 Sept 2024).xls at Google Drive

Compound loss upon compound loss

You've heard of compound interest: You get interest on your money, plus you get interest on the interest. Gosh! Debtors are remarkably generous to creditors. What a lovely world this must be.

My topic here is compound loss: It works like compound interest, but in the other direction: Less instead of more, and less on top of less. It isn't about the money we get. It's about the money we don't get.

You've heard of "Potential GDP". Brookings defines it as

an estimate of the value of the output that the economy would have produced if labor and capital had been employed at their maximum sustainable rates—that is, rates that are consistent with steady growth and stable inflation.

Note, however, that "maximum sustainable" employment does not mean we all have to work 80 hours a week. I have seen people say "economic equilibrium" occurs when no one wants to change the existing conditions. No one wants more profit, for example, and no one wants to work less hours. That concept probably applies to Potential GDP.

Whatever. I just call it "best-case GDP". Here is the graph:

Graph #1: Potential GDP

It goes up. The graph shows a pretty smooth upward curve, except it goes up faster than usual in the latter 1990s.

Here's the same data, shown as "Percent Change from Year Ago" values:

Graph #2: High on the Left, Low on the Right: Potential GDP Growth is Slowing!

To my eye, two things stand out on this graph. One is that conehead-looking high spot in the latter 1990s. That's how the good years of the latter 1990s look, when you look at Potential GDP growth.

The other thing that stands out on this graph is the strong downhill trend. Except during the latter 1990s, it is all downhill from start to finish: From above 5 percent annual growth in the early 1950s, to above 4 percent in the 1960s, to 2 percent or less in recent (and future) years. Best-case GDP is not as good as it was 50, 60, 70 years ago.

You might think economists would spend their lives studying the latter 1990s to learn everything they could learn about those years, so as to duplicate that high-performance era and, well, avoid that wide gray recession bar and the lower-than-usual low that came a decade after the conehead high. That's pretty much what I do. Study the economy. Not economics, but the economy. This, my hobby. This, my life.

 

Here is a graph of Real GDP as a percent of Potential GDP:

Graph #3: It goes up and down, but the overall trend is down.
In other words, GDP is growing even more slowly than Potential GDP.

Real GDP is sometimes higher, sometimes lower than Potential. But the overall trend is down: As time goes by, Real GDP comes out to be less and less of Potential GDP. The growth of Potential, today, is half what it was in the 1960s, and Real GDP cannot even keep up with that. This is compound loss.

A linear trend line on this data in Excel shows Real GDP growth close to 1 percent faster than Potential GDP growth in the early years. In recent years, Real GDP growth is almost 2 percent slower than Potential. This relatively small loss means Real GDP growth has slowed 2.58 percent more than Potential GDP growth, which has fallen by 50 percent since the 1960s.

GDP is a measure of income. The slowing growth of Potential GDP is the slowing growth of best-case income. Best-case income growth today is half what it was in the 1960s. Real GDP growth cannot even keep up with that. And Real GDP growth is Real Income growth. 

As time goes by, we get less and less of the income we would have in a "best-case" world. The income growth in our less-than-perfect world decreases even faster than the income growth of our best-case world. This is compound loss.

And speaking of income, the next graph shows Compensation of Employees as a percent of GDP. Remember, Potential GDP growth is slowing, and GDP growth is slowing even faster. But on this graph, employee compensation has fallen rapidly as a share of GDP, for more than half a century:

Graph #4: Employee Compensation: Wages, Salaries, and Benefits as a Percent of GDP

From a high of 58 percent of GDP in 1970, it is all downhill to less than 52 percent today. Well there is the one big increase there, in the latter 1990s. But it did come back down right quick. 

We're getting paid 6 percent less of GDP now than we got in 1970. And GDP doesn't keep up with Potential GDP. And Potential GDP is growing at half the rate it was growing in the 1960s. We are dealing here with compound loss upon compound loss.

FOMC Inflation Predictions, 2021 & 2022

The gray line that reaches 9 percent inflation shows the CPI monthly since March 2020, the same month the Fed reduced the interest rate to zero to help fight covid. The black line that almost reaches 7 percent is the PCE Price Index (FRED series PCEPI) shown at quarterly frequency. The other 8 lines show inflation predictions made by the Federal Open Market Committee:

Graph #1: Click the image to see it bigger, or click "Graph #1" to see it at ALFRED

The four lines that start in 2021 show the four sets of predictions made by FOMC during 2021. I'm using the same color sequence that FRED uses:

• Color 1: Blue: Here represents the March prediction set.
• Color 2: Red: Here represents the June predictions.
• Color 3: Green: Here represents the September predictions.
• Color 4: Purple: Here represents the December predictions.

The four prediction sets made during 2022 use the same colors in the same sequence.

The Fed calls them projections, not predictions. The notes explain a lot:

Projections of personal consumption expenditures (PCE) inflation rate are fourth quarter growth rates, that is, percentage changes from the fourth quarter of the prior year to the fourth quarter of the indicated year. PCE inflation rate is the percentage rates of change in the price index for personal consumption expenditures (PCEPI).

The FRED Notes identify the FRED PCEPI dataset. So I went with that dataset for the black line on the  graph above, even though it is their monthly series. I changed the frequency to quarterly using average aggregation; of the available options, this made the best match to FRED's quarterly series PCECTPI.

I didn't quote the whole Notes text. You can see it in the flesh at FRED or ALFRED.

Each prediction set includes 3 or 4 data values, one for the year of reporting and the rest for the following years. You'll notice that no matter the value of the first prediction, in subsequent years the predictions typically move toward the Fed's 2 percent inflation target. I suppose "projection" is a better word for this than "prediction".

The CBO does something similar when it figures Potential GDP:

CBO assumes that any gap between actual GDP and potential GDP that remains at the end of the short-term (two-year) forecast will close during the following eight years.

That's from a 20-year-old CBO paper. It may be out of date. But the methodology for both CBO and the FOMC seems to be Fret not. Things will go according to plan.

And yes, that methodology works surprisingly well in a normal economy. But when the economy downshifts from 3 percent annual growth to 2 percent annual, and there is financial crisis, and people start talking about "the new normal", well, that's when better methodology is needed.

The transcript of Jerome Powell's 17 March 2021 press conference (where he repeated his inflation warning of 4 March 2021) has Powell saying:

The median inflation projection of FOMC participants is 2.4 percent this year and declines to 2 percent next year before moving back up by the end of 2023.

That sentence has been stuck in my head since I first read it. So I dropped what I was doing this morning when the series title "FOMC Summary of Economic Projections for the Personal Consumption Expenditures Inflation Rate, Central Tendency, Midpoint" turned up in FRED search results for federal spending. (Hey, I didn't put it there. I found it there!)

Looking for that Powell quote just now in the transcript, I found "FOMC" four times:

• "Today the FOMC kept interest rates near zero..."
• "... forecasts from FOMC participants for economic growth this year..."
• "FOMC participants project the unemployment rate to continue to decline..."
• "The median inflation projection of FOMC participants..."

The FOMC covers a lot of ground. 

 

So anyway: The last of the four 2021 projections -- December -- was for 5.35% PCE inflation in the fourth quarter of 2021. FRED's PCEPI data for the fourth quarter was 5.86%. The monthly PCEPI for December 2021 was 6.18%. The monthly CPI for December 2021 was 7.18%. And the Federal Funds interest rate was zero.

The first data value from each of the 8 FOMC projection datasets on the graph is shown in this table:

Year:	2021	2022
March:	2.30	4.40
June:	3.3	5.15
Sept:	4.15	5.50
Dec:	5.35	5.7

Note: In the table, the first data value in the March 2021 projection is given as 2.30 percent. Jerome Powell in the 17 March 2021 transcript gives the value as "2.4 percent this year". Maybe the difference is a typo. The FOMC projection Powell describes is the same March 2021 projection presented in the table.

Every projection in 2022 was higher than the corresponding projection in 2021. And in both years, the March projection is the lowest, and each subsequent projection is higher than the one before. The Federal Open Market Committee apparently did not think inflation would go down. 

It is their job to make inflation go down. But they did not think inflation would go down. This irritates me. They were right, of course: Inflation did not go down until they started raising the interest rate. But remember, it was in March 2021 that Chairman Powell warned of inflation, and it was a year later, in March 2022, that the Federal Open Market Committee finally started raising the interest rate.

The PCE measure started coming down after Q2 2022. And the CPI measure started coming down after June 2022. In both cases, inflation was coming down since midyear. And still the FOMC projections, even the September and December projections, were for rising inflation all thru 2022. I don't understand their thought process.

It almost looks like they wanted inflation raging.

Human nature

When you have a drink, the first thing you lose is your resistance to having another drink.

The second thing you lose is your resistance to blogging about it.

The "base year"

I have a good feel for what a "base year" is. It is used a lot when "nominal" (actual-price) data is  converted to "real" (the-prices-never-change) data. For example, I use it when I divide the rising price level out of nominal GDP to get the "real" values -- values that exist because the economy actually grew, not because prices happened to go up. The "base year" is the year where the real GDP and the nominal GDP are the same. There is always one year like that for "real" data. If you look at a FRED graph of inflation-adjusted data (like Real GDP)  the vertical axis will be labeled something like "Billions of Chained 2017 Dollars". 2017 is the base year for that data. On a graph that shows both "real" and "nominal" GDP, the lines cross in the base year, because the values are equal in that year.

So I have a pretty good feel for the base year, but it comes from doing arithmetic. When I wanted a definition in words, I looked it up. The featured snippet comes from Investopedia, and it says "A base year is the first of a series of years in an economic or financial index."

The first of a series of years. I wish! If the base year was the first year for real GDP, the graph would show real GDP hanging low while inflation pushes nominal GDP up and up and up, like this:

Graph #1: The blue line is real GDP. The red line shows the result of inflation.

To make this graph, I took the shows both "real" and "nominal" GDP graph noted above, divided the real values by 1191.124 (the 1929 value of Real GDP in the FRED data), and multiplied the real values by 104.556 (the 1929 value of nominal GDP in the FRED data. Basically, I took the real data and scaled it down to make the first value -- the 1929 value -- equal to the nominal 1929 value.

Yes, I think the base year should, as a rule, always be the first year of the data on a graph. But that seldom happens. In fact, for Real GDP they move the base year frequently. At ALFRED they list the "units" used for the Real GDP in their archive:

• Billions of 1987 Dollars
• Billions of Chained 1992 Dollars
• Billions of Chained 1996 Dollars
• Billions of Chained 2000 Dollars
• Billions of Chained 2005 Dollars
• Billions of Chained 2009 Dollars
• Billions of Chained 2012 Dollars
• Billions of Chained 2017 Dollars

There is a move to a more recent base year every three to five years. Actual low prices become a more and more distant memory. This is how economists work. Standard practice, apparently.

The search that turned up the Investopedia definition also turned up one that I like better: this one, from  europa.eu:

In the calculation of an index the base year is the year with which the values from other years are compared. The index value of the base year is conventionally set to equal 100.

the year with which the values from other years are compared: yes.
the first of a series of years in an economic or financial index: no.

the base year is conventionally set to equal 100: yes
it is typically set to an arbitrary level of 100: no.

Oh, and both Investopedia and the europa (EuroStat) site think in terms of the price index having a base year. I think in terms of inflation-adjusted data having a base year. They are right. The data does have a base year, but it inherits the base year from the price index used to strip inflation out of the numbers. I can live with that.

Real GDP per Capita

Looked up Real GDP per Capita annual at FRED. Got 1225 search results.

Filtered for Geography Type: Nation and for Geographies: United States of America. Now, 7 search results.

Omitting the results that pertain to subsets

• Real DPI per Capita
• Metropolitan Portion
• Consumption Share
• Investment Share, and
• Government Consumption Share

I am left with two datasets:

Constant GDP per capita for the United States and

Real GDP per Capita in the United States (DISCONTINUED) 

The one is in 2010 dollars and the other is in 2011 dollars, so I can't even compare them easily. And I hafta start by comparing them. So I put em on a graph.

The discontinued series ends in 2011, and both of them start in 1960. I was 11 years old in 1960. We should what, ignore those early years? WTF. 

So I looked up an old post of mine and read:

At FRED, this Real gross domestic product per capita page links to Table 7.1, which identifies FRED series B230RC0Q173SBEA as the relevant population measure for the per capita calculation. FRED calls that measure "Population". But when I search FRED for population, I get 107,803 results. So I call it "B23". I checked my arithmetic. Yes, that's the right population data for per capita GDP.

I took FRED's Real Gross Domestic Product series and divided it by the "B23" population measure, then corrected the units, and got my own version of Real GDP per Capita, with data that goes back to 1947. FRED offers 824,000 datasets from 114 different sources, and I have to make my own Per Capita GDP.

Maybe there's some detail I don't know about, a detail that explains why the data before 1960 is not valid. But I don't know about any such detail, so I'm good for now. I put my version on the graph with the others. Here's the graph:

Graph #1: Three Measures of GDP per Capita. Mine is the Green one.

Usually I make the lines thicker before I reduce the image size to fit the blog. Didn't do that this time because the green and red lines are so close together. To see the graph bigger click the image. Or click Graph #1 in the caption to see it at FRED.

The Covid Time

Graph #1: Household Borrowing (blue) and the CPI

Graph #2: Nonfinancial Corporate Business Profit (blue) and the CPI

Graph #3: Federal Spending (blue) and the CPI