Covid-19 & The Federal Reserve

I remember people talking about Covid-19 in January of 2020. There had been several epidemic scare-claims from major news outlets in the decade prior and those all turned out to be nothing. So, I was not excited about this one. By the end of the month, I saw people making substantiated claims and I started to suspect that my low-information heuristic might not perform well.

People are different. We have different degrees of excitability, different risk tolerances, and different biases. At the start of the pandemic, these differences were on full display between political figures and their parties, and among the state and municipal governments. There were a lot of divergent beliefs about the world. Depending on your news outlet of choice, you probably think that some politicians and bureaucrats acted with either malice or incompetence.

I think that the Federal Reserve did a fine job, however. What follows is an abridged timeline, graph by graph, of how and when the Fed managed monetary policy during the Covid-19 pandemic.

February, 2020: Financial Markets recognize a big problem

The S&P begins its rapid decent on February 20th and would ultimately lose a third of its value by March 23rd.  Financial markets are often easily scared, however. The primary tool that the Fed has is adjusting the number of reserves and the available money supply by purchasing various assets. The Fed didn’t begin buying extra assets of any kind until mid-March. There is a clear response by the 18th, though they may have started making a change by the 11th.  One might argue that they cut the federal funds rate as early as the 4th, but given that there was no change in their balance sheet, this was probably demand driven.

https://fred.stlouisfed.org/graph/?g=JYVL
https://fred.stlouisfed.org/graph/?g=JYVy

March, 2020: The Fed Accommodates quickly and substantially.

In the month following March 9th, the Fed increased M2 by 8.3%. By the week of March 21st, consumer sentiment and mobility was down and economic policy uncertainty began to rise substantially – people freaked out. Although the consumer sentiment weekly indicator was back within the range of normal by the end of April, EPU remained elevated through May of 2020. Additionally, although lending was only slightly down, bank reserves increased 71% from February to April. Much of that was due to Fed asset purchases. But there was also a healthy chunk that was due to consumer spending tanking by 20% over the same period.

https://fred.stlouisfed.org/graph/?g=JYXj
https://fred.stlouisfed.org/graph/?g=JYYz

In the 18 months prior to 2020, M2 had grown at rate of about 0.5% per month. For the almost 18 months following the sudden 8.3% increase, the new growth rate of M2 almost doubled to about 1% per month. The Fed accommodated quite quickly in March.

April, 2020: People are awash with money

Falling consumption caused bank deposit balances to rise by 5.6% between March 11th and April 8th. The first round of stimulus checks were deposited during the weekend of April 11th. That contributed to bank deposits rising by another 6.7% by May 13th.

By the end of March, three weeks after it began increasing M2, the Fed remembered that it really didn’t want another housing crisis. It didn’t want another round of fire sales, bank failures, disintermediation, collapsed lending, and debt deflation. It went from owning $0 in mortgage-backed securities (MBS) on March 25th to owning nearly $1.5 billion worth by the week of April 1st. Nobody’s talking about it, but the Fed kept buying MBS at a constant growth rate through 2021.

May, 2020 – December, 2021: The Fed Prevents Last-Time’s Crisis

Jerome Powell presided over the shortest US recession ever on record. The Fed helped to successfully avoid a housing collapse, disintermediation, and debt deflation – by 2008 standards. The monthly supply of housing collapsed, but it had bottomed out by the end of the summer. By August of 2021, the supply of housing had entirely recovered. The average price of new house sales never fell. Prices in April of 2020 were typical of the year prior, then rose thereafter. A broader measure of success was that total loans did not fall sharply and are nearly back to their pre-pandemic volumes. After 2008, it took six years to again reach the prior peak. A broader measure still, total spending in the US economy is back to the level predicted by the pre-pandemic trend.

The Fed can’t control long-run output. As I’ve written previously, insofar as aggregate demand management is concerned, we are perfectly on track. The problem in the US economy now is real output. The Fed avoided debt deflation, but it can’t control the real responses in production, supply chains, and labor markets that were disrupted by Covid-19 and the associated policy responses.

What was the cost of the Fed’s apparent success? Some have argued that the Fed has lost some of its political insulation and that it unnecessarily and imprudently over-reached into non-monetary areas. Maybe future Fed responses will depend on who is in office or will depend on which group of favored interests need help. Personally, I’m not so worried about political exposure. But I am quite worried about the Fed’s interventions in particular markets, such as MBS, and how/whether they will divest responsibly.

Of course, another cost of the Fed’s policies has been higher inflation. During the 17 months prior to the pandemic, inflation was 0.125% per month. During the pandemic recession, consumer prices dipped and inflation was moderate through November.  But, in the 16 months since April of 2020, consumer prices have grown at a rate of 0.393% per month – more than three times the previous rate. Some of that is catch-up after the brief fall in prices.

Although people are genuinely worried about inflation, they were also worried about if after the 2008 recession and it never came. This time, inflation is actually elevated. But people were complaining about inflation before it was ever perceptible. The compound annual rate of inflation rose to 7% in March of 2021. But it had been almost zero as recent as November, 2020. That March 2021 number is misleading. The actual change in prices from February to March was 0.567%. Something that was priced at $10 in February was then priced at $10.06 in March. Hardly noticeable, were it not for headlines and news feeds.

Has Economic Growth Really Slowed Since 1970?

In the post-WW2 era, by many different measures the US economy performed better before about 1970 than after. You can apparently see this in many different statistics. For example, the productivity slowdown is a well-known and well-studied phenomenon. And even given the productivity slowdown, median wages don’t seem to have kept pace with productivity growth.

I think there are good reasons to doubt these particular statistics. For example, on wages and productivity see this working paper by Stansbury and Summers.

But even considering all these criticisms of the statistics, we do observe that overall GDP growth has been slower since about 1970. Why might this be?

In an NBER summary of his research, Nicholas Muller argues that a big part of the GDP growth slowdown is because we aren’t including environmental damage in the calculation. This is not a new argument (Muller is an important contributor to this literature), and the exclusion of environmental damage is a well-known flaw of GDP, but Muller’s paper does a great job of quantifying how much we are mismeasuring GDP. The following figure is a nice summary of what GDP growth looks like when we consider environmental damage.

2021number3_muller1.jpg

If we use the standard measure of GDP, growth indeed slowed down after 1970. If instead we augment GDP for environmental damages, the period after 1970 was actually faster! The adjustment both slows down growth from 1957-1970, and speeds up growth after 1970.

There are lots of things we can draw from this, but if the results are close to accurate, there is a clear implication: environmental regulations (such as the Clean Air Act) do reduce GDP growth, as traditionally measured. So the skeptics of regulation are partially right: regulation reduces growth!

However, this seems to be a clear case where standard critiques of GDP (as you can find in just about any Econ 101 textbook — yes, really!) need to be incorporated into the complete cost-benefit analysis of the impacts of environmental regulation.

Pumpkin Spice: 15th Century Edition

It’s pumpkin spice season. That means that not only can you get pumpkin spice lattes, but also pumpkin spice Oreos, pumpkin spice Cheerios, and even pumpkin spice oil changes.

The most important thing to know about “pumpkin spice” things is that they don’t actually taste like pumpkin. They taste like the spices that you use to flavor pumpkin pie. (Notable exception: Peter Suderman’s excellent pumpkin spice cocktail syrup, which does contain pumpkin puree.)

Last week economic historian Anton Howes posted a picture of the spice shelf at his grocery store and guessed that this would have been worth millions of dollars in 1600.

Some of the comments pushed back a little. OK, probably not millions but certainly a lot. Howes was alluding to the well-known fact that spices used to be expensive. Very expensive. Spices, along with precious metals, were one of the primary reasons for the global exploration, trade, and colonialism for centuries. Finding and controlling spices was a huge source of wealth.

But how much more expensive were spices in the past? One comment on Howes’ tweet points to an excellent essay by the late economic historian John Munro on the history of spices. And importantly, Munro gives us a nice comparison of the prices of spices in 15th century Europe, including a comparison to typical wages.

As I looked at the list of spices in Munro’s essay, I noticed: these are the pumpkin spices! Cloves, cinnamon, ginger, and mace (from the nutmeg seed, though not exactly the same as nutmeg). He’s even included sugar. That’s all we need to make a pumpkin spice syrup!

Last week in my Thanksgiving prices post I cautioned against looking at any one price or set of prices in isolation. You can’t tell a lot about standards of living by looking at just a few prices, you need to look at all prices. So let me just reiterate here that the following comparison is not a broad claim about living standards, just a fun exercise.

That being said, let’s see how much the prices of spices have fallen.

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Inflation: Not Merely a Monetary Phenomenon

I’m a big fan of Milton Friedman. I’m also a big fan of easy-to-remember phrases that impart great wisdom. It honestly made me wince the first time I said the following:

Inflation is *not* everywhere and always a monetary phenomenon“.

The reasoning is as plain as day. Consider the quantity equation:

MV=PY

For the uninitiated, M is the money supply, V (velocity) is the average number of times dollars transacts during a period, P is the price level, and finally Y is real output during a period. This equation is often called the “equation of exchange” or “the quantity equation”. Strictly speaking, it is an identity. It is a truism that cannot be violated. All economists agree that the equation is true, though they may disagree on its usefulness.

Inflation is simply the percent change in price. We can rearrange the quantity equation, solving for price, in order to see the relationship between the price level and its determinants.

P= MV/Y

What does this mean? It means that more money results in more inflation, all else held constant. It means that higher velocity results in more inflation, all else held constant. It means that less output results in more inflation, all else held constant.

Why would Milton Friedman say that inflation is always caused by changes in the money supply if it is clear that there are two other causes of the price level? When Milton Friedman said his famous quote, output growth was relatively steady. Velocity growth was relatively steady. For his context, Milton Friedman was right. The majority of price and inflation volatility was found in changes in M. See below.

Strictly speaking however, Milton Friedman knew better and he knew that the statement was not strictly correct. Friedman was a public intellectual and he was a great simplifier. He taught many people many true things. At the time, people were blaming inflation on a great variety of things: taxes, fish catches, and unions, to name a few. Arguably, Friedman got them closer to the truth.

Now, there are economists that are pointing to total spending as the driver of inflation. After all, both sides of the equation of exchange describe NGDP (a.k.a. – Aggregate Demand or Aggregate Expenditure). Replacing M and V in the equation with NGDP yields:

P=NGDP/Y

What does this mean? It means that higher NGDP results in more inflation, all else held constant. It means that less output results in more inflation, all else held constant.

But economists dismissing M in lieu of AD are committing the same oversimplification. Y can also change! Maybe economists figure that our recent history is full of relatively stable Y growth and that we ought not pay attention to it. And indeed, unsurprisingly, RGDP growth has been less than NGDP growth.

But what is driving the current bought of inflation?

Pardon the crude image. The pink lines are eye-balled trend lines on natural logged data for AD, Y, and P. Prices are up. Is it because of exceptionally high NGDP? Nope. Total spending is back on pre-2020 trend. Does Y happen to be down? Yep, it sure is.

Right now, assuming the previous trend was anywhere close to potential output, inflation is not being driven by excess aggregate demand. It’s being driven by inadequate real output. The news tells the story. There have been supply-chain bottle-necks, difficulty employing, lockdowns, and fear of covid. Right now we have an output problem and higher prices are a symptom. We do not have an aggregate spending problem.

PS – In fact, it is my belief that the Fed successfully avoided a debt-deflation aggregate demand tumble that would have been catastrophic. Inflation is expected when supplies of goods decline.

GDP Losses and COVID Deaths (6 month update)

Back in March of this year, I wrote blog posts providing data on GDP losses and COVID-19 deaths for 2020, both for selected countries and US states. Since we’ve now had another 6 months of GDP data and the pandemic continues to take lives, I thought it would be useful to update that data.

I will update the data for US states in a future post, but here is the most recent data for about 3 dozen countries (mostly European and North American countries, since they have the most believe COVID data).

*indicates that the GDP data is only through the first quarter of 2021
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Are Poor Americans Really as Rich as Average Canadians?

Have you seen this chart? I certainly have. It floats around on social media a lot. The chart seems to indicate that poor Americans are better off than the average person in most other rich countries. Roughly equal to Canada and France, and better off than Denmark or New Zealand.

When I’ve asked for sources in the past, people usually aren’t sure. They remember downloading it from somewhere, but they can’t recall where.

But I think I found the source: it’s this article from JustFacts. After seeing how they calculated it, I’m skeptical that it provides a good comparison of poor Americans to other countries.

Here’s what the chart does. For most countries, it uses a World Bank measure of consumption per capita. They then convert that to US dollars using PPP adjustments. For the poor in the US, they use a consumption estimate for the bottom 20% of households (Table 6), and then divide by the average number of people per household. For the poor in the US, the average consumption for 2010 was an amazing $57,049, more than double the poverty line! That’s about $21,000 per poor person.

How is this possible?

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The Impact of the Pandemic on US States: GDP and Deaths

Following up on my recent post on country GDP growth rates and mortality in 2020, we now have the first look at state GDP growth rates for 2020 from the BEA.

As with the national data, I would look to caution against over-interpreting this data. I’m presenting it here to give a picture of how 2020 went for states (including a few months of 2021 for morality data). One thing you will notice is that there appears to be little correlation with the raw data between GDP declines and mortality. Lots of important factors (policy, behavior, demographics, weather, luck) aren’t controlled for here. Still, I think it’s useful to see all the data in one picture, given how much many of us have been following the daily, weekly, and monthly releases.

Here is the data. Below I’ll explain more how I created this chart, especially the excess mortality data.

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Working Hard for the Money

40 hours. That’s what we think of as a typical workweek. 8 hours per day. 5 days per week. Perhaps the widespread practice of working from home during the pandemic (as well as the abnormal schedule changes for those unable to work from home), has led some to rethink the nature of the workweek. But the truth is that the workweek has always been evolving.

Take this chart, for example. It comes from Our World in Data (be sure to read their excellent related essay as well), and the historical data comes from a paper by Huberman and Minns. I’ve singled out 4 countries, but you can add others at the OWiD link.

The historical declines are dramatic. This is especially true in Sweden. The average Swedish worker labored for over 3,400 hours per year in 1870. Today, that’s down to 1,600 hours. In other words, the typical Swede works less than half as many hours as her historical counterpart. Wow! The decline for the US is not quite as dramatic, but still astonishing: a US worker today labors for only about 57% of the hours of his 1870 predecessor.

It’s tempting to focus on the differences across countries today: the average worker in the US works about 250 hours more than the average French worker. That’s 6 weeks of vacation! And as recently as 1980, the US and France were roughly equal on this measure. We might also wonder why these historical changes happened. For a very brief introduction to the research, I recommend the last section of this essay by Robert Whaples.

But still, the historical declines are dramatic, even if we in the US haven’t seen much improvement in the past generation (and those poor Swedes, working 100 hours per year more than 40 years ago).

I think another natural question to ask is whether GDP data is distorted, at least as a measure of well being, given these differences in working hours. The answer is partially. Let’s look at the data!

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The Luck (?) of the Irish

Poor Ireland. Long oppressed by the Brits. Losing 25% of their population in the Great Famine due to both deaths and emigration. Today, there are possibly 10 times as many Irish Americans as there are residents of Ireland. There are as many Irish Canadians as there are residents of Ireland.

Poor Ireland.

And indeed, Ireland used to be literally very poor, at least in an economic sense. In 1960, their GDP per capita was about half of the United Kingdom. As recently as 1990, they were still only at about 70% of the United Kingdom and the rest of Western Europe. That’s all according to the latest Maddison database figures, which are probably as close to accurate as we can find. But after 1990, we probably shouldn’t use those figures, for reasons peculiar to Ireland.

Today? Ireland is much wealthier. But how much wealthier? It’s tricky. Ireland’s GDP is inflated significantly due to a lot of foreign investment. And possibly some tax evasion/avoidance. You see, Ireland is a tax haven. It has one of the lowest corporate tax rates in the world. That means we have to interpret the data with care, but only because it is such a great place to invest.

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GDP Growth in 2020

Last year was a historically bad year for many reasons, but to economists that badness is most visible in our widest measure of the economy: Gross Domestic Product. All issues with GDP aside, especially as a perfect measure of relative living standards, the annual real (inflation-adjusted) growth rate of GDP gives us a good picture of how much national economies were harmed by the pandemic, private behavior changes, and government restrictions (disentangling these three effects is hard — I will leave that to the academic journals rather than a blog post).

While GDP is reported with a lag of several months and is subject to revision, many countries have now reported full GDP data for 2020. For those that don’t follow GDP very closely, for a developed country an annual rate of growth of about 2% is pretty normal and respectable. For further context, in the US recent recessions had declines of -2.5% in 2009, -0.1% 1991, and -1.8% in 1982 (the 2001 recession never had an annual decline, only a few quarterly declines). While it is unusual for countries to go more than 10 years without a decline, it does happen. For example, Australia’s last annual decline was in 1991, when it declined -1.3%. But that’s unusual.

This chart shows the 2020 GDP growth rates (mostly negative, with one exception — Taiwan) for 2020 for most countries were I could find data. What this number shows us is the total amount of economic activity in 2020 compared with the total amount of economic activity in 2019 (adjusted for inflation, of course). I believe this is a better measure than others you might see, such as data that compares the level in the 4th quarters of 2020 and 2019 (a country could have had a terrible 2nd quarter but still gotten back close to the prior year level, and a simple Q-over-Q measure would miss that decline). As I did for the 3rd quarter data, this chart also plots the cumulative COVID-19 death rates on the vertical axis.

GDP data comes from government statistical agencies and media reports. COVID-19 death data is from Our World in Data.

What can we learn from this data?

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