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Economic Reporting Review

May 24, 1999

By Dean Baker

"On the Road Again to Higher Consumer Prices"
Stephanie Stoughton
Washington Post, May 15, 1999, page E1

This article argues that the strength of the economy led to the 0.7 percent jump in prices reported by the consumer price index (CPI) in April. (The subhead is "Healthy Economy Gave Rise to Costlier Prices.") In fact, virtually all of April's rise in inflation can be attributed to factors that had little or nothing to do with increased demand.

For example, higher oil prices added 0.3 percentage points to April's inflation rate. This is attributable to the fact that the OPEC nations have successfully curtailed their oil output in order to raise the world price of oil.

Another 0.1 percentage point was added by a 1.5 percent jump in apparel prices that virtually all economists attribute to problems in seasonally adjusting prices for spring clothing lines, not a surge in apparel prices. Similarly, tobacco and used cars both had large prices increases in April, after showing large price declines the prior two months. A careful analysis of the April CPI shows almost no evidence of the accelerating inflation which is the theme of this article.

"Federal Reserve Leaning to Rise in Interest Rates"
Richard W. Stevenson
New York Times, May 19, 1999, page A1

This article reports on the decision by the Federal Reserve Board to adopt a monetary stance that it is leaning towards raising interest rates. At one point the article asserts that the recent run-up in stock prices "has left people from all walks of life feeling affluent and willing to spend." In fact, only about half of the population holds any stock at all, including people who hold it indirectly through mutual funds in 401(k) plans. For this group, the median holding was just $13,000 in 1995, the year of the last survey done by the Federal Reserve Board. Even if this amount has doubled in the last four years, the typical stockholder still has only $26,000 invested in the market, and half of all stockholders own less than this amount.

Later, the article notes the view of Alan Greenspan that the stock market is significantly over-valued and asserts that "the Fed also has to be careful not to unsettle the stock market too much." If the market is significantly over-valued, then it's possible that a quick correction may be the best strategy for the economy as a whole. Allowing the economy to continue to move along with an inflated market simply delays the inevitable correction. It also raises the possibility that the ultimate adjustment may be even larger if the market continues to move higher.

Furthermore, an inflated market badly distorts investment decisions. For example, if Internet companies are wildly over-valued, as believed by many economists, then the sale of shares of new Internet companies are draining away savings that could be more productively used elsewhere. The economy will pay a large price from such misdirected investment if this situation persists for a long period of time.

"House Approves $15 Billion to Fund War, Relief"
Eric Pianin
Washington Post, May 19, 1999, page A4

"G.O.P. in Congress to Cut Domestic Spending by $26 Billion"
Tim Weiner
New York Times, May 19, 1999, page A18

These article discuss spending proposals. The first article reports on an emergency bill to support the Kosovo operation, and the second article reports on House Republican plans for the 2000 budget. Both articles refer to spending plans that will tap into the Social Security surplus. This is an extremely misleading way to present the budget.

There is no direct relationship between the level of government spending this year and the solvency of the financial situation of Social Security. The Social Security system will be credited with the full value of the surplus it accrues regardless of whether Congress spends from this money or not. The only way that Congresses spending decisions on other programs could affect the solvency of Social Security is if they raise the total national debt to levels where default is a possibility. No politician or economist has suggested that a default is even plausible any time in the foreseeable future. Therefore, it is misleading to imply that current spending is any way coming at the expense of the Social Security program.

The government does keep a separate budget (the "on-budget" budget) that excludes the Social Security surplus and the operations of the other smaller trust funds which are incorporated into the unified budget. The most accurate way to characterize the claims about the Social Security surplus being spent is simply that the on-budget budget is not balanced. The point is that the government is borrowing, which may be viewed as good or bad; it is not misappropriating money that was designated for Social Security.

"Congress and White House Try to Break Social Security Deadlock"
Richard W. Stevenson
New York Times, May 20, 1999, page A23

This article reports on efforts by members of Congress to work with President Clinton to devise a compromise plan for restructuring Social Security. The article characterizes their work as an effort to address "Social Security's looming problems." Since the program can pay all scheduled benefits for the next 35 years with no changes whatsoever, it is questionable whether the projected shortfall in the very distant future can be regarded as "looming."

"Trade Deficit Rises Faster Than Forecast"
Richard W. Stevenson
New York Times, May 21, 1999, page C1

This article discusses a report showing a large jump in trade deficit in March. At one point the article comments "the best news in today's report was the increase in exports. For years, the administration was able to point to growing exports as evidence that its policy of opening markets to American goods was paying off in the form of domestic jobs and profits."

While the administration could make the claim that growing exports were evidence that its trade policy was creating domestic jobs, they could not do so honestly. The impact of trade on jobs is determined by the trade balance, exports minus imports, not exports alone. Since the annual trade balance has deteriorated by almost $200 billion under the Clinton Administration, trade has been on net a large source of job loss.

The fact that jobs are linked to the trade balance, and not exports alone, is a basic point in economic logic that would generally be taught in an introductory economics course. Even strong proponents of the Administration's trade policy, such as Federal Reserve Board Chairman Alan Greenspan (see "Greenspan Denounces Growing Protectionism," by Richard W. Stevenson, New York Times, 4/17/99, page C1), acknowledge this simple truth.

"Effort to Impeach Yeltsin Falters"
David Hoffman
Washington Post, May 15, 1999, page A17

"Signs That Russia's Economy May Be Gradually Reviving"
Neela Banerjee
New York Times, May 15, 1999, page B2

These articles discuss aspects of the current situation in Russia. The Times article discusses a report from an economic research group that showed that industrial output had risen by 1.5 percent from February to March. According to the report, it now stands at its highest level since December 1997. This rapid growth in the industrial sector contradicts the widely reported assertion that Russia's economy had stagnated under Yevgeny Primakov's government. (See, e.g., "Yeltsin Dismisses His Prime Minister" by David Hoffman, Washington Post, 5/13/99, page A1; "Yeltsin Dismisses His Prime Minister in Latest Shakeup" by Celestine Bohlen,
New York Times, 5/13/99, page A1.)

The Times article goes on to say that "the growth in production is the unlikely side-benefit of the decision last August to devalue the ruble." Actually, the growth in production was an entirely predictable outcome of the ruble's devaluation. At the time of the devaluation, many economists believed that ruble was significantly over-valued. This over-valuation made Russian goods very expensive relative to foreign goods. Therefore, it was very difficult for Russia's manufacturers to compete in the world market.

In spite of this over-valuation, the IMF insisted that Russia should maintain the value of the ruble at all costs. This meant raising interest rates to ever higher levels. Eventually the IMF strategy collapsed when even 40 percent interest rates turned out to be insufficient to sustain the value of the ruble. With the ruble falling back to more reasonable levels, it should not be surprising that Russian manufacturers are now doing considerably better.

The Post article asserts that Russia "badly needs" a $4.5 billion aid package from the IMF, which is currently being negotiated. It's not clear that Russia has any significant need for the proposed package at this point. Under the terms the IMF has put forward, no new money will actually go to Russia. The aid will simply be credited against past debts that Russia has accumulated with the IMF, so that the IMF does not have to declare Russia in default. The IMF has always worked hard to avoid declaring nations in default, reserving this status for rogue states such as Iraq and Libya. If it were declared in default, Russia would be the first nation with a democratically elected government ever to attain this status. This would likely be at least as much an embarrassment for the IMF as for Russia.

"Mexico Measures Identity in Dollars"
Julia Preston
New York Times, May 16, 1999, Section 1, page 16

This article discusses the debate in Mexico over adopting the U.S. dollar as its national currency. The article implies that there would be enormous advantages to Mexico associated with switching to the dollar, and that only nationalistic sentiments prevent this move.

For example, the article asserts that "because of the peso's persistent ups and downs, interest rates remain around a crippling 20 percent." According to economic theory, the only interest rate that is relevant to the economy is the real interest rate, the difference between the nominal interest rate and the inflation rate. Mexico's inflation rate over the last year has been 18.5 percent. If the nominal interest rate is around 20 percent, as asserted in the article, then the real interest rate in Mexico is around 1.5 percent, considerably below the 5.0 percent-6.0 percent real interest rates that borrowers in the United States presently pay.

There are also many economists who would argue against adopting the dollar for reasons that have nothing to do with nationalistic sentiments. United States monetary policy is determined by the needs of the U.S. economy, a point made explicitly by Alan Greenspan in discussions of the merits of other nations adopting the dollar as their currency. This means, for example, that if the Federal Reserve Board chooses to raise interest rates because it is concerned about inflation in the United States economy, Mexico's economy will also be subjected to the contractionary effect of higher interest rates, even if inflation is posing no problem there.

Outstanding Stories of the Week

"Drug Trials Hide Conflicts for Doctors"
Kurt Eichenwald and Gina Kolata
New York Times, May 16, 1999, Section 1, page 1

"A Doctor's Drug Studies Turn Into Fraud"
Kurt Eichenwald and Gina Kolata
New York Times, May 17, 1999, page A1

This two-part series presents the results of a 10-month investigation into current state of clinical research in pharmaceuticals. These articles document how drug companies pay doctors large sums, often several thousand dollars per patient, to get them to test their drugs. This provides doctors with a large incentive to prescribe drugs that may not be appropriate for their patients. These payments can also provide incentives for doctors to misrepresent their research, which is the main topic of the second article.

The sort of corruption documented in these articles is exactly the outcome that economic theory would predict as a result of the government granting monopolies, through patent protection, to the pharmaceutical industry. Economic theory predicts that firms will spend large amounts of money, which could otherwise have gone into research, to protect and extend their monopolies.

It is also worth noting that the doctor who is the focus of the second article only received a 15-month jail sentence after he was caught. This is in spite of the fact that he effectively stole millions of dollars by producing fraudulent research, and jeopardized the health and lives of people whose treatment might be based on his faked research findings. By comparison, inner-city youths often serve much longer sentences for stealing parked cars or the possession of illegal drugs.

"Fearing For Jobs, I.R.S. Workers Relax Effort to Get Unpaid Taxes"
David Cay Johnston
New York Times, May 18, 1999, page A1

This article examines the extent to which the Internal Revenue Service has abandoned efforts to collect unpaid taxes as a result of recent criticism by Republican members of Congress. The article points out that seizures of property are down by 98 percent, and other collection mechanisms, such as liens on property, are down by two-thirds or more. This decline in enforcement has made it relatively easy for people to choose not to pay the taxes they owe.

Dean Baker is a senior research fellow at the Preamble Center and at the Century Foundation.

Recent articles can be found on the websites of the New York Times and Washington Post.

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