So did Kuznets say it, or not?

Shekhar Aiyar and Christian Ebeke at VOX:

Despite the firm consensus that income inequality is intrinsically undesirable, its impact on economic growth is much disputed. Simon Kuznets famously argued that inequality is beneficial for economic growth at an early stage of development, since a moneyed capitalist class can undertake more investment, but is harmful at a later stage. Others have pointed to inequality as a necessary, even desirable outcome of rewards to innovation and risk-taking...

Granted, it's their opening paragraph. They're setting the stage for what they really want to say. But to me it is objectionable to speak, even in passing, to speak about inequality being "beneficial" or "harmful" or "necessary" or "desirable" without at least acknowledging that numbers or percentages or relative levels matter. There will always be income inequality, but surely there are differences between a little, a lot, and a lotta lot.

What's interesting in their quote is Kuznets's different evaluations of inequality in "early stage" and "later stage" economies. This has Cycle of Civilization implications.

Simon Kuznets famously argued that inequality is beneficial for economic growth at an early stage of development ... but is harmful at a later stage.

I had to go looking. Where does Kuznets say this? He's not listed among the VOX article references. What I've found so far is not promising:

1. The Political Economy of the Kuznets Curve by Daron Acemoglu and James A. Robinson:
   

   One of the major stylized facts about long-run processes of economic development is the Kuznets curve—the inverse-U shaped pattern of inequality. In a seminal paper, Kuznets (1955) argued that as countries developed, income inequality first increased, peaked, and then decreased, and documented this using both cross-country and time-series data.

   According to this source, Kuznets said inequality changes. I don't find him saying the benefit/harm from inequality changes.
   
   
2. How does income inequality affect our lives? from the OECD iLibrary:
   

   It’s also possible to look at the relationship between inequality and growth from the opposite direction: Does inequality affect growth and, if so, how? The Harvard economist Richard B. Freeman is one of those who believe it does. He argues that inequality is good for growth – up to a point. But after that point, rising inequality means falling growth...

   So okay, somebody said it. But I find Richard Freeman saying it, not Simon Kuznets.
   
   
3. I went to Aiyar and Ebeke's own paper, the one listed among their VOX article references: "Inequality of Opportunity, Inequality of Income and Economic Growth", IMF Working Paper WP/19/34. 23 pages. I searched for Kuznets. No matches were found. WTF.
   

I'd like to add the Kuznets and the variable benefit of inequality argument to my arsenal of evidence on the Cycle of Civilization. Unfortunately, I can't do that.

If you have a link to Kuznets making the argument, I'm interested.

Why the Economy Is Slow: A Never-Ending Story

Why do we not grow?

1. We think printing money causes inflation.

2. We think we need credit for growth.

3. Our policies restrict the growth of money and encourage the use of credit.

4. As a result, we have come to use credit for money.

5. Policy does not fight inflation by getting people to reduce their debt, so debt accumulates.

6. The increasing reliance on credit drives up embedded interest costs.

7. The cost of using money comes to compete with wages and profit.

8. Low wages and low profit lead to inadequate growth.

9. We think more access to more credit will solve the growth problem.

10. Greater reliance on credit increases the cost of using money and puts further downward pressure on wages and profit.

11. Go to step 8.

Why the economy is slow

Testimony of Chairman Alan Greenspan
The Federal Reserve's semiannual monetary policy report
Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate
July 18, 1996

... Looking forward, there are a number of reasons to expect demands to moderate and economic activity to settle back toward a more sustainable pace in the months ahead.

First, the bond markets ...

Second, the value of the dollar ...

Third, the support to economic growth provided by expenditures on durable goods, both for household consumption and business fixed investment, is likely to wane in coming quarters. Consumer spending in the past few years has been boosted as households have made up for the purchases of big-ticket items that they had deferred during the recession and the early, weaker phase of the recovery. Five years after the business-cycle trough, however, we should expect that this pent-up demand has been largely exhausted. Moreover, many households have built up sizable debt burdens in recent years, and coping with debt repayments could hold down their spending.

That last part -- repayment of debt holds down spending -- that's what I talk about all the time. I'm just thrilled to see Greenspan admit it could happen.


Greenspan also said

While these are all good reasons to anticipate that economic growth will moderate some, the timing and extent of that downshift are uncertain.

It didn't happen in 1996. It happened in 2008, and it was hard to miss.

Look at Capacity Utilization

What I said yesterday: "Look at Capacity Utilization."

Here is Total Capacity Utilization (TCU) from FRED, with a "best performance" trend line eyeballed in:

Graph #1: Total Capacity Utilization with my estimate of a Best Case Trend Line

The best, or highest, capacity utilization that we can get shows a consistent decline since the 1960s. Where we were once near 90% utilization, we are now below 80% at best. The peaks in the data are reliably close to trend except for two brief periods which I have circled, and possibly at the near end (see arrow) where we can't say what will happen next.

The circled low peaks occur after the 1980 and 1982 recessions. Note that the circled peak following the 1982 recession is well below trend despite the uncharacteristically high growth of Real GDP at the same time. In my view the utilization peaks run low somehow because of the disturbance created by the Federal Reserve in the process of ending the so-called Great Inflation.

The circled high peaks occur in the mid and late 1990s, during the good years of the "new economy" identified by Alan Greenspan. They occur in the early years of the high productivity period which notably followed 20 years of low productivity. In my view the utilization peaks run atypically high because financial costs were atypically low. With less money going to pay for the money we use to buy things, there was more money available to buy things. That gave a boost to aggregate demand.

You could argue the point, but it looks to me that the final peak (at the arrow) is above trend. That's unusual. It leads me to wonder if perhaps the future will bring a second, equally high peak, as happened in the 1990s. It wouldn't surprise me. Because, you know, financial costs are atypically low again at present.

"It’s one of the major challenges of our time, really, to have inflation, you know, downward pressure on inflation let’s say."

The title of this post is part of a statement from Fed Chairman Powell, from a press conference, recently quoted by Tim Duy. And of course quoted by me the other day, because it was funny.

I want to say #1 that if it was me at a press conference, the quotes would be so bad they wouldn't even be funny. So I sympathize with Mr. Powell, and he has my respect.

Be surprised, I don't care. Let's consider what he said. He said downward pressure on inflation is one of the major challenges of our time.

It is. And by focusing on it, Powell was perhaps trying to bring this challenge, this downward pressure on inflation, bring it front and center.

A major challenge to explain it, I think he means. Hold that thought.


On my old econ blog, one of the first posts that I wrote was The Big T: How to prevent inflation when the Fed prints a trillion dollars. March, 2009.

In that post I had a good laugh when the Fed said they would "employ all available tools ... to preserve price stability." And I wrote

The phrase "preserve price stability" seems to mean the Fed will fight inflation. But it really means the Fed will fight deflation.

I quoted Glenn D. Rudebusch of the San Francisco Fed on "unconventional strategies":

"A transparent commitment to a positive inflation objective may help prevent inflationary expectations from falling too low, which could help forestall any excessive decline in inflation directly."

By "a positive inflation objective" Rudebusch meant keeping inflation up, not down.

That was in 2009, when Ben Bernanke was Chairman of the Fed. Ten years have gone by. What started as a "commitment to a positive inflation objective" has grown into a focus on "one of the major challenges of our time". And the attention level has moved up from Rudebusch (presently Executive Vice President and Senior Policy Advisor at the San Francisco Fed) to Jerome Powell, Chairman of the Federal Reserve.


So basically, we still have the same problem we had ten years ago: downward pressure on inflation. And as I understand Chairman Powell, we still need to explain this downward pressure.

The simplest explanation is best, right? Recall this, from Alan Blinder:

At any given moment, there is a core inflation rate toward which the actual inflation rate tends to gravitate. This rate is determined by fundamental economic forces, basically as the difference between the growth rates of aggregate demand and aggregate supply.

If Blinder is correct, then we can explain the downward pressure on inflation as a case of low aggregate demand. It is the sort of thing that might arise from a permanent policy fixation on the supply side.

How to explain the downward pressure on inflation? Maybe the economy is just slow. Slow, not since 2008, not even since 2001, but slowing persistently since the mid-1970s. Scott Sumner, for example, says: "I am not denying that growth in US living standards slowed after 1973, rather I am arguing that it would have slowed more had we not reformed our economy [in the 1980s]". And Tyler Cowen, in Stubborn Attachments, mentions "the great stagnation, a slowdown in growth which overtook the Western world starting in about 1973."

Look at Capacity Utilization: trending down since the start of the 1974 recession; but flat or possibly up-trending before that recession. What better measure can there be, of the difference between the growth rates of aggregate demand and aggregate supply?

The economy slowed after 1973, and would have slowed more in the 1980s if not for Reaganomics. It slowed more after the 2001 recession, and slowed more again after the 2008 recession. Oh, and there was one brief burst of vigor in the latter 1990s.

The economy is just slow. Think about it: With all this great new technology we have, and with the people who don't like it mostly retiring out of the workforce, shouldn't "the new economy" be giving us more of the high productivity and low inflation that Alan Greenspan observed in the 1990s? With all that technology, shouldn't we reliably be getting 4% annual growth, or better? Well, we're not. The economy is slow, and has been slowing for something like 45 years.

Our economy is just slow. Aggregate demand is down. That's the reason we have not been getting the inflation economists expect. That's the reason there is "downward pressure on inflation". That's the simple explanation.

Alan Greenspan, circa 1995

Dueling "recession probability" indicators

In chronological order...

  •  1 March 2019: James Hamilton, The long expansion continues

The Bureau of Economic Analysis announced yesterday that U.S. real GDP grew at a 2.6% annual rate in the fourth quarter of 2018. That’s below the 3.1% average for the U.S. economy over the last 70 years, but better than the 2.2% average rate since the recovery from the Great Recession began in 2009:Q3...

The solid growth numbers kept the Econbrowser Recession Indicator Index at 1.5%, among the lowest levels we ever see. That means the U.S. economic expansion has now been under way for 9-1/2 years, 2 quarters shy of the longest expansion on record (1991:Q2-2001:Q1).

GDP-based recession indicator index.
The plotted value for each date is based solely on information as it would have been publicly available and reported as of one quarter after the indicated date, with 2018:Q3 the last date shown on the graph. Shaded regions represent the NBER’s dates for recessions, which dates were not used in any way in constructing the index, and which were sometimes not reported until two years after the date.

  •  24 March 2019: Tim Duy's Fed Watch, Fed Needs to Get With The Program

Everyone has their pet recession indicator; many are probability models based on some combination of yield spreads and other leading indicators. Most will be raising red flags like this estimate of the probability of recession in six months based on the 10s2s and 10s3mo spreads and initial unemployment claims:

... The risk of recession has risen to levels that demand attention from the Federal Reserve. In the two cases of similar spikes in the 1990s, a recession was avoided by the rapid response of the Fed in the form of rate cuts. The times that response was lacking, a recession followed.

So now I switch from analyst to commentator: The above leads me to the conclusion that the Fed needs to get with the program and cut rates sooner than later if they want to extend this expansion.

Once again I took Duy's graph, erased the background, and used it as an overlay. This time I didn't erase the recession bars on his graph. I used his recession bars to resize and position his graph over Hamilton's.

This is probably not the must useful graph I ever made, but I wanted to see it:

Graph #3: Hamilton's (black) and Duy's (blue) Recession Probabilities

Duy's three light gray recession bars hide Hamilton's recession indicator during the recessions. But you can see it on the first graph. And anyway, I'm more interested in recession probabilities when we're not already in recession.

The interesting piece of the graph is the right end, where Duy indicates recession and Hamilton does not. Hamilton's data ends before Duy's; as Hamilton notes, "The GDP data were a month late being released due to the government shutdown." Another month or two, or three, we'll see what happens on Hamilton's graph.

My first thought was that when the data's available, Hamilton's graph will show an increasing recession probability because of the interest rate spread, as Duy's does. But Hamilton's index isn't based on the interest rate spread. As described in The Econbrowser Recession Indicator Index, it is based on GDP growth rates and the probability (based on experience through 2005) that a given GDP growth rate occurs during a recession or during an expansion.

It's a different and, as Hamilton says, an objective approach. And it has nothing do do with interest rate spreads. So there is a chance Hamilton's graph will not spike upward as Duy's does. Ooh, this just got interesting.