The U.S. economy wasn’t the only one to tank in the second quarter

AMERICA’S PAROCHIAL ‘LIBERALS’

Some of the reaction to yesterday’s news that the United States’ Gross Domestic Product (GDP) fell at an annual rate of 32.9 percent in the second quarter of 2020 was plain bizarre. Twitter – almost always a cesspool, admittedly – was full of people saying that the Trump administration was to blame for these horrendous numbers.

Reading such reactions I was struck, as I often am, by how American ‘liberals’, who claim to be so much more worldly than their ‘conservative’ countrymen and women, can be so thoroughly parochial themselves. Covid-19 is an international phenomenon. Indeed, that is why it is a pandemic and not an epidemic. It has killed people and crashed economies around the world.

U.S. AND EUROPEAN GDP COMPARED

Today, for example, the European Union released its preliminary estimates of GDP growth (or lack of) for the second quarter of 2020. As I wrote yesterday, the 32.9% rate of decline the U.S. reported yesterday was ‘annualized’, which means that that is how much GDP would decrease by if that rate continued for a full year. The actual decline in GDP in the second quarter was 9.5%: still horrible, but somewhat less scary. Now, as the E.U. reports:

In the second quarter 2020, still marked by COVID-19 containment measures in most Member States, seasonally adjusted GDP decreased by 12.1% in the euro area and by 11.9% in the EU, compared with the previous quarter…These were by far the sharpest declines observed since time series started in 1995.

Figure 1 shows how the decline in U.S. GDP compares to that of several E.U. member nations in the second quarter. In this admittedly grim context, the performance of the U.S. economy looks somewhat less bad. The other G7 members in the group – Germany, Italy, and France – all did worse.

Figure 1: Percentage change in Real Gross Domestic Product, Second Quarter 2020

Source: Eurostat and Bureau of Economic Analysis

Many ‘liberals’ seem to believe that Covid-19 has been a calamity unique to the U.S. owing to the supposed the incompetence/malevolence of the Trump administration. As a result, I wouldn’t expect to see them argue that the relatively less bad economic performance of the U.S. is because of a relatively less bad Covid-19 outbreak here. But, just in case, Figure 2 shows deaths per million of the population for the same countries. We do see some correlation between the severity of the Covid-19 outbreak as measured by deaths and the hit to GDP – the countries with the most per capita deaths tend to be on the same side of the chart as the countries with the worst declines in GDP. But the U.S. is a bit of an outlier. With an outbreak of comparable severity to France, as judged by per capita deaths – 458 to 464 – its economy has weathered much better, a fall of 9.5% compared to France’s 19.0%.

Figure 2: Covid-19 deaths per million

Source: Our World in Data

This is not a defense of the Trump administration’s handling of Covid-19 (neither am I attacking it). But if you want to judge how a government has responded to an international phenomenon like Covid-19, it makes sense to compare that response to that in other countries. Ignoring the evidence of other countries demonstrates parochialism and is likely to lead to sub-optimal policy.

John Phelan is an economist at the Center of the American Experiment. 

GDP tanked in the second quarter, but by how much?

This morning the Bureau of Economic Analysis (BEA) released its figures for Gross Domestic Product (GDP) in the second quarter of 2020. To nobody’s great surprise, it made for grim reading:

Real gross domestic product (GDP) decreased at an annual rate of 32.9 percent in the second quarter of 2020 (table 1), according to the “advance” estimate released by the Bureau of Economic Analysis. In the first quarter, real GDP decreased 5.0 percent.

This is bad whichever way you look at it. Still, there are some important qualifications around that number. NBC News tweeted:

The bit about GDP just isn’t true. The 32.9% decline is an ‘annualized’ rate, which means that that is how much GDP would decrease by if that rate continued for a full year, which few people think it will. The actual decline in GDP in the second quarter was 9.5%: still horrible, but somewhat less scary.

Secondly, not only is this figure ‘annualized’ but it is also ‘seasonally adjusted’. According to the BEA’s website, its:

…estimates of GDP are seasonally adjusted to remove fluctuations that normally occur at about the same time and the same magnitude each year. Seasonal adjustment ensures that the remaining movements in GDP, or any other economic series, better reflect true patterns in economic activity. Examples of factors that may influence seasonal patterns include weather, holidays, and production schedules. 

The non-seasonally adjusted GDP decline in the second quarter was 7.0%. Again, still horrible, but, as Figure 1 shows, our economy routinely experiences real terms, non-seasonally adjusted GDP declines of 3 to 4% every year from January to March for the reasons the BEA gives above. These aren’t reported because, for understandable reasons, our government and media focus on seasonally adjusted data, but we still experience and survive them.

Figure 1: Percentage change in Real Gross Domestic Product, Billions of Chained 2012 Dollars, Not Seasonally Adjusted

Source: Federal Reserve Bank of St. Louis

To repeat, these are terrible numbers and this isn’t intended to downplay in any way the scale of the economic damage our economy has suffered this year. When you shut large chunks of it down to combat a virus, that can only be expected. Other countries have experienced similar damage. We have to hope that the numbers in the third quarter are much better.

John Phelan is an economist at the Center of the American Experiment. 

Economic suppression will hurt today’s grads for years to come

This op ed appeared in the Grand Rapids Herald Review and the Crookston Times.

Times are hard for Minnesota’s graduates. Not only are they being denied their graduation ceremonies by Gov. Walz’ anti-Covid-19 measures, but their prospects beyond that look bleak. They are graduating into the worst job market in decades and the consequences of that will be severe, and linger for a very long time.

Minnesota’s unemployment rate currently stands at 9.9 percent, a record high since the data began and more than 800,000 Minnesotans have filed claims for unemployment insurance since March 16th. Minnesota job postings on Indeed.com, the online employment site, are down about 40 percent from last year and a recent survey by Handshake, a nationwide job hunting site for college students, found nearly half of students are worried about getting a job when they graduate.

This dire labor market is set to improve – the national unemployment fell in May while Minnesota’s rose – but only slowly.

In April, the Congressional Budget Office (CBO) released ‘preliminary projections of key economic variables through the end of calendar year 2021.’ For the labor market, the CBO forecast: ‘The unemployment rate is projected to average 15 percent during the second and third quarters of 2020, up from less than 4 percent in the first quarter…the unemployment rate is projected to decline to 9.5 percent by the end of 2021. Under that projection, the unemployment rate at the end of 2021 would be about 6 percentage points higher than the rate in CBO’s economic projection produced in January 2020, and the labor force would have about 6 million fewer people.’

That isn’t the end of it. A body of research shows that college graduates who start their working lives during a recession earn less for at least 10 to 15 years than those who graduate during periods of prosperity.

Recent research by economists Hannes Schwandt and Till von Wachter looked at a broader range of metrics and at those without college degrees.

It paints a grim picture. They found, first, that high school graduates and dropouts who entered the labor market during a recession suffered even stronger income losses than college graduates; second, that negative impacts on socioeconomic outcomes persist in the long run, so that, in midlife, recession graduates earned less, while working more and were less likely to be married and more likely to be childless; and, third, that recession graduates had higher death rates when they reached middle age, stemming mainly from diseases linked to unhealthy behaviors such as smoking, drinking, and eating poorly. There is a significantly higher risk of death from drug overdoses and other so-called “deaths of despair” among those who left school during an economic downturn.

There are some signs that the recession could be ‘V’ shaped, meaning a rapid recovery following the rapid collapse. The economy was strong going into this downturn and we need to maintain and advance the policies of lower federal taxes and deregulation that built that. At the state level, we need to look at pushing such pro-growth policies ourselves. Even so, it is a bleak outlook for today’s young Minnesotans and it is through no fault of theirs. What they need is as strong an economic recovery as possible.

Minnesota’s GDP shrinks by 4% in the first quarter of 2020

Over time, more data measuring Covid-19’s impact on the American and Minnesotan economy is becoming available. First was the surge in Unemployment Insurance claims cataloged by Minnesota’s Department of Employment and Economic Development. Then came the actual unemployment numbers from the Bureau of Labor Statistics. This was followed by estimates for first quarter Gross Domestic Product (GDP) growth – or shrinkage – for the U.S. economy. Today, the Bureau of Economic Analysis gave us our first look at how Minnesota’s GDP has been affected.

From the 4th quarter of 2019 to the first quarter of 2020, Minnesota’s GDP shrunk at an annualized rate of 4.0%. This is hefty, but, surprisingly perhaps, it is far from the worst quarterly performance on record. As Figure 1 shows, the state’s economy has suffered greater quarterly declines on five occasions since the data began in 2005.

Figure 1: Minnesota’s real GDP, Percent change from preceding period (annualized)

Source: Bureau of Economic Analysis

Figure 2 shows us how this compares to other states and the U.S. generally. Minnesota has done better than the U.S. as a whole, whose economy shrank by 5.0% in the first quarter of 2020. We have done better, too, than our neighbors across the St. Croix in Wisconsin, whose economy also shrank by 5.0%. But we have done less well than our neighbors to the south and west. Iowa (-3.5%), North Dakota (-2.6%), and South Dakota (-2.2%) all saw their economies weather the storm of the first quarter of 2020 better than Minnesota.

Figure 2: Real GDP, Percent change from preceding period (annualized)

Source: Bureau of Economic Analysis

This is even more striking when we look at how these states have dealt with Covid-19. All three have lower rates of deaths per 100,000 people (Iowa 23, South Dakota 11, North Dakota 10) than Minnesota with 27.

This is only a hint of what is to come. The first quarter covers the first three months of the year and the full effects of the Covid-19 pandemic did not make themselves felt until the second quarter. Forecasts for second quarter GDP for the U.S. are correspondingly grim. Sadly, there is a good chance that the record quarterly decline, currently held by the fourth quarter of 2008, will be smashed.

John Phelan is an economist at the Center of the American Experiment. 

Review: The Deficit Myth by Stephanie Kelton

This article originally appeared in luckbox magazine, July 2020.

In January, the Congressional Budget Office (CBO) released its Budget and Economic outlook for 2020 to 2030. It is horrific reading. Federal budget deficits are projected to rise from $1.0 trillion this year to $1.3 trillion over the next 10 years.

Federal debt will rise to 98% of GDP by 2030, “its highest percentage since 1946,” the CBO says. “By 2050, debt would be 180% of GDP—far higher than it has ever been.” And that was before Covid-19 hit. Now those numbers will be much, much worse.

On top of this, politicians have been announcing grand schemes for further spending: $47 billion on free college tuition, $1 trillion for new infrastructure, $1.4 trillion to write off student loan debt, at least $7 trillion on the Green New Deal and $32 trillion on Medicare for All. By one estimate, these new proposals total an estimated $42.5 trillion over the next decade.

Adding these new spending proposals to the flood of red ink the CBO projects just from following the current path, the federal government is set to face a serious fiscal crisis in the not-too-distant future.

Keep printing

Or, perhaps not. There is an idea afoot in economics that, as Bernie Sanders’ former economic advisor Stephanie Kelton argues in her new book The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy, could revolutionize the field in the same way that Copernicus did to astronomy by showing that the earth orbited the sun.

Modern Monetary Theory (MMT) states that “in almost all instances federal deficits are good for the economy. They are necessary.” That being so, we don’t have to worry about this coming deluge of red ink, indeed:

“Rather than chasing after the misguided goal of a balanced budget we should be pursuing the promise of harnessing what MMT calls our public money, or sovereign currency, to balance the economy so that prosperity is broadly shared and not concentrated in fewer and fewer hands.”

Most people would say the government taxes people to raise money to pay for the functions it performs. Not so, argues Kelton. Indeed, “the idea that taxes pay for what the government spends is pure fantasy.” Instead, “it is the currency issuer—the federal government itself—not the taxpayer, that finances all government expenditures.”

It does so by printing money. So, while you or I might have to worry about running up vast debts, “Uncle Sam has something the rest of us don’t—the power to issue the U.S. dollar,” Kelton writes.

Galloping inflation

This is hardly revolutionary. Governments and economists have known for centuries that a monetary sovereign—a body which issues the currency its liabilities are denominated in—can meet whatever liabilities it incurs simply by issuing a sufficient nominal amount of currency. The idea that a monetary sovereign, like the federal government, could go “bankrupt” is, thus, not strictly true.

The trouble is that excessive issue of currency erodes its real purchasing power as postulated by the equation of exchange (MV=Py), one of the few genuinely useful, and universally accepted, equations in economics.

The equation of exchange states that the money supply in an economy (M) multiplied by the number of times it is spent in a given period (velocity of circulation, V) equals the price level (P) multiplied by output (y). This is a truism. It is just another way of saying that nominal spending (or aggregate demand, MV) equals nominal income (Py), or MV=Py. Because all spending is someone else’s income, this is true by definition. The equation becomes more interesting when we make assumptions about its component variables. Assume that y is fixed by real factors and V is constant (the old monetarist assumptions), it follows that any increase/decrease in M must be offset by an increase/decrease in P—inflation, in other words. These real resource constraints—the determinants of y—determine society’s standard of living. If M increases faster than y, the nation just gets more inflation and a boost in nominal GDP, not more goods and services and an increase in real GDP. This is basic economics.

Indeed, when the University of Chicago’s Booth School of Business surveyed a group of economists last year on the questions “Countries that borrow in their own currency should not worry about government deficits because they can always create money to finance their debt” and “Countries that borrow in their own currency can finance as much real government spending as they want by creating money,” not a single one of them agreed with either statement. Even Kelton acknowledges this:

“Just because there are no financial constraints on the federal budget doesn’t mean there aren’t real limits to what the government can (and should) do. Every economy has its own internal speed limit, regulated by the availability of our real productive resources—the state of technology and the quantity and quality of its land, workers, factories, machine, and other materials. If the government tries to spend too much into an economy that’s already running at full speed, inflation will accelerate. There are limits.”

This is fatal to Kelton’s claim for any great novelty for MMT. She writes: “There is absolutely no good reason for Social Security benefits, for example, to ever face cuts” because “our government will always be able to meet future obligations because it can never run out of money.” Again, technically, this is quite correct, but only in nominal terms.

If inflation kicks in then, in real terms, that money might not buy very much. The effect will be a very real cut in what a Social Security check can buy. Kelton raises this question: “The question is, What will that money buy?” But she instantly dismisses it with a boilerplate about how, “We need to make sure that we’re doing everything we can to manage our real resources and develop more sustainable methods of production as the babyboom generation ages out of the workforce.” You don’t say?

Nothing new

So, what’s the point of MMT? Where is the Copernican revolution we were promised?

There isn’t one. What we have is a list of the left’s favorite spending priorities: Social Security, education, healthcare, child poverty, infrastructure, climate change … all paid for by borrowing, which isn’t a problem because we can finance it by printing money. We are offered examples, but where Kelton’s theory is just underwhelming, her history is actively bad. We are told that:

“As a share of gross domestic product (GDP), the national debt was at its highest—120%—in the period immediately following the Second World War. Yet, this was the same period during which the middle class was built, real median family income soared, and the next generation enjoyed a higher standard of living without the added burden of higher tax rates.”

True, the federal government ran up a considerable debt defeating Nazi Germany and Imperial Japan—money well spent. But with victory over Japan in 1945, federal government spending fell sharply: by 73% between 1945 and 1948 in real terms. In seven of the 15 years to 1960, the federal government ran a budget surplus. And when there were deficits they weren’t large, averaging 1.0 percent of GDP. The economy grew faster than government so that federal government spending fell as a share of GDP from 41% in 1945 to 17% in 1960. That Golden Age that Kelton talks about was one of mostly sound federal government financial management.

We also are told that deficits “didn’t dissuade John F. Kennedy from landing a man on the moon.” Again, this is true, but these deficits were accompanied by inflation which rose from 1.4% in 1960 to 12.3% in 1974. These examples hardly support Kelton’s case for vast deficits and their essential harmlessness.

There is an old joke: What does a parrot have in common with the Holy Roman Empire? The parrot isn’t holy, Roman, or an empire. Modern Monetary Theory is much the same. It isn’t very modern; throughout history people have been saying that we would be rich if only we had more of the medium of exchange. It isn’t monetary policy so much as a way of escaping the inevitabilities of fiscal policy. And its theoretical basis is a banal truism. It is simply the latest in a long line of claims to have found a Magic Money Tree for government.

John Phelan is an economist at the Center of the American Experiment.