Known Unknowns

Hello,

Welcome to Known Unknowns, a newsletter that apparently still believes in the Philips Curve[*].



Paying for all of this debt

We’re currently running up the biggest debts in American history, and the Fed can’t monetize debt forever. The big debts are necessary right now, but we eventually have to ask who will pay for it. Biden says it won't be people who make less than $400,000, but that is not realistic. But that won’t stop people from trying to put all of the higher bill on the rich. So, I anticipate that the wealth tax, a tax on fortunes that are more than millions of dollars, will soon come back into the conversation.

I highly suggest that you read my interview with Wojciech Kopczuk, a leading scholar on inequality and taxation (and a member of my dissertation committee!). He explains why a wealth tax would be so hard to implement and would lead to undesirable economic behaviors.

He says many interesting things, but one I point I’d never thought of before is that a wealth tax encourages people to keep their companies private, since private companies are harder to value, and that makes it easier to evade taxes. Keeping companies private worsens inequality, since the average guy then can’t buy shares of the best companies. Though we’ll also know less about the extent of inequality, because information will be less transparent and under-reported. This is one reason why lots of people think that there’s less inequality in Europe—to some extent, the equality is an illusion, because more firms are private.

So, wealth taxes can actually worsen inequality, but actually make us think that it has gotten better instead. Wojciech points out that that could mean a more productive discourse, but if we actually want to raise revenue and reduce inequality, wealth taxes are a bad idea.


Unemployment

Unemployment rates are terrible. The official rate is nearly 15%, but the real rate could be more than 20%. Many households have both earners out of work as well.

But, as terrible as this is, this time is different from previous ones. Unemployment rates just don’t have the same meaning as they used to. Unlike prior recessions, high unemployment is the result of a deliberate policy to shut the economy down and pay people through the unemployment insurance program. As the economy re-opens, many of these people will go back to work. Normally all new unemployment represents job destruction. That is not entirely true now, some jobs are just on pause.

But just how many will go back is the big question. And this will depend on things we can’t control, like whether a spike in the virus comes back, or if people are still afraid to go out and spend. It also depends on things that policymakers can influence, like how generous unemployment benefits are relative to employees’ normal pay. I’ve heard it argued that we need bigger UI benefits, because that will make people spend more—and apparently this will bring the economy back. What can I say? Some people really fixate on demand, and I get it—every recent recession has been mostly demand-driven. And demand may become an issue later.

But what we currently face is a supply issue, and if we can get a grip on that, demand will be less of a problem. So let’s give supply a shot first. If we pay people higher benefits than their wages, they won’t go back to work. Where does that leave employers struggling to reopen? I worry mostly about small businesses that exist on a tight margin and will face bigger costs and fewer customers even before paying elevated wages. But large and medium firms will struggle, too.

I don’t understand the obsession that we’ve developed with who gets government money and that they must spend it only on payroll. As firms reopen, they will have to be nimble. Some will have to lay off workers in part because there will be less demand, and also, in lean times, firms often do long overdue restructuring. A requirement that any firm that accepts government support can't do lay-offs seems short-sighted. It made some sense when we thought we could switch the economy back on like a light switch, but now we need to focus on supporting firms to weather the upcoming year.

I think of government support now as a kind of insurance. We pay taxes in part so that we can have a government that steps in when a big unforeseen and uninsurable event happens. This is not socialism, or a call for permanent government intervention—it is actually just efficient. If everyone lived as if large tail risks were about to happen, we’d have much less growth and dynamism. An insurance company normally does not take over your life and hobble your rebuilding when there’s destruction; rather, it bails you out and gets out the way. However, your premiums will probably be higher in the future—and so will your taxes.

If we want employment to come back, we must stop hating on big firms, medium and small firms, or any business owner. There is no “Wall Street versus Main Street versus households” going on here. They all need each other, and in the coming months, we need to let them do whatever it takes to survive.

Inflation

In the last recession, people who worried about inflation because of QE were mocked and sent to the pundit Bad Place. But now, inflation-could-be-a-thing again people are coming out of the woodwork. And I think that’s fair. The outlook is still unknown, and anything is possible.

Most people agree that deflation is the bigger problem in the near term. But both Martin Wolf and Clive Crook are concerned that debt monetization and high debt loads could mean a high, uncertain inflation future. Because it has in the past. I know it didn’t in Japan, but are we staking everything on one outlier case? I think the real reason to think that this time could be different is the fact the Fed pays interest on reserves, which gives them another lever with which to control inflation, and it changes the transmission mechanism.

However, that doesn’t mean we don’t need to worry about inflation. I think it’s possible in the medium- to long-term for two reasons. One is that less trade means higher prices. Like it or not, cheap labor and global supply chains explain why we’ve gotten so much new stuff for cheap. We can wax nostalgic for the good ol’ days when we actually made stuff, but we also had inflation then as well.

Secondly, the Fed is less credible now. Can you see them clamping down on a recovery because of inflation? I can’t—especially now that many people can’t even conceive of high inflation anymore. That means, as we economists like to say, that “inflation expectations could become unanchored.” Or, if inflations starts, that it will be very hard for the Fed to stop it without sacrificing growth.

More on the future

One thing that I find odd is how quick everyone is to declare the world forever changed. The line goes the pandemic has showed how wonderful working from home, online classes, and Zoom happy hours are, so we’ll adopt this new technology even when we don’t have to. I guess some people have enjoyed seclusion, but I reckon that many people miss conferences and seeing people—even their co-workers.

But there is one thing that I’m watching that could be a game changer, and that is schools. If schools in cities are closed this fall, and open everywhere else, then that could have a lasting impact, because a strong middle- and upper-middle-class presence in cities has been an important trend in urbanization. I think that’s a bigger deal than tech workers, for example. If parents face the choice of subjecting their children to a full year of online education, in addition to high housing costs and taxes, then I think that could lead to persistent changes in terms of where people live and how they work.

Until next time, Pension Geeks!

Allison


[*] The one with inflation expectations, not the original one.