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Economic Reporting Review

August 30, 1999

By Dean Baker

Inflation | Foreign Investment | Japan | France | Russia | Ecuador | Outstanding Stories

INFLATION

"Inflation? It Just Doesn't Add Up"
Sylvia Nasar
New York Times, August 22, 1999, Section 3 page 1

This article examines the factors that have helped to keep inflation low during this expansion. While much of the analysis is insightful, it includes several statements that are inaccurate or misleading.

For example, at one point it contrasts the current period of stable low inflation with the "bad old days, when upwardly spiraling prices seemed as inevitable as the sunrise." This description of the bad old days really refers to just two periods: the gradual acceleration of inflation in the late '60s, which was associated with the escalation of the Vietnam War, and the oil shock driven inflation of the '70s. The '80s were characterized by declining and then stable inflation and the '50s by generally low inflation. Examined against the backdrop of the entire post-war period, the experience of the '90s does not stand out as being unusual.

The article also asserts that increased competition due to the deregulation of industries such as airlines, railroads and telecommunications has been a major factor in keeping prices down. This claim seems dubious, since corporations have managed to increase their profit margins considerably in the last two decades. In 1978, at the profit peak of the late '70s business cycle, the capital share (profits plus interest) of corporate income was 19.1 percent. By comparison in 1997, the profit peak in the current cycle, the profit share of corporate income had risen by more than two and a half percentage points to 21.6 percent. The fact that firms have been able to significantly increase their profit margins seems inconsistent with the claim that they are feeling greater competitive pressures.

The article also comments on the high human costs associated with prior recessions which were induced to control inflation. It asserts that the memory of these recessions help keep inflation at bay. Although the Federal Reserve Board did use unemployment to control inflation in the '70s and '80s, it does not follow that this was the only possible way to control inflation. Nor is it obviously the case, that in the absence of the extraordinary events of the '60s and '70s—a major war and an effective oil cartel—that the United States economy faces the prospect of anything other than a minor acceleration in the rate of inflation.

There are two small errors in the article that are worth noting. The article notes a comment from Northwestern University Professor Robert Gordon, that declining computer prices have reduced the annual rate of inflation by half a percentage point. While this comment is accurate, it refers to the inflation rate measured by the GDP deflator. The inflation rate measured by the consumer price index (CPI) is the main focus of the article. The impact of falling computer prices has been to lower the rate of inflation measured by the CPI by approximately 0.05 percentage points since 1998. Prior to 1998 the impact of falling computer prices on the CPI inflation rate was considerably smaller.

The other error is a graph accompanying the article which is labeled as the "four-quarter moving average of the medical care component of Consumer Price Index." The graph actually shows the difference between the inflation rate shown by medical care component and the overall Consumer Price Index.

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FOREIGN INVESTMENT

"Foreign Investors Abandoning Treasuries"
Tim Smart
Washington Post, August 25, 1999, page E1

This article examines recent investment patterns among foreign holders of U.S. financial assets. It notes a large switch to increased holdings of stocks instead of government bonds. It attributes this switch to the large increase in stock prices in recent years.

If this is really the cause of the switch, it would imply that the people who manage these funds do not understand financial markets. The fact that a market has been rising does not guarantee that it will continue to rise. In fact, since it lowers the dividend return (other things equal, the higher the stock price the lower the annual dividend return), the recent surge in the stock market should make it less attractive to foreign investors.

The article makes a similar error when it asserts that if the dollar falls "then interest rates would have to rise to compete for foreign capital." Interest rates are affected by the direction in which a currency is perceived to be moving, not its absolute level. Therefore, a falling dollar would lead to a rise in interest rates. A dollar that had already taken a large fall, but was not expected to decline further, would not be associated with high interest rates.

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JAPAN

"Japanese Banks' Link Seen as First of Many Mergers"
Calvin Sims
New York Times, August 21, 1999, page A1

This article discusses the future of Japan's financial system in the wake of the announced merger of three major banks. At one point, it refers to the yen as "the most visible symbol of the nation's economic might," and implies that there is a direct relationship between the strength of the value of the currency and the strength of the economy.

There is no economic theory that would support this view. Currency values are often driven by factors that have no direct relationship to the strength of an economy. For example, between 1980 and 1985, the dollar rose by more than 60 percent measured against the German mark. The rise in the dollar was driven by high U.S. interest rates, which were in turn attributable largely to record U.S. budget deficits. The dollar subsequently fell by 55 percent against the mark between 1985 and 1990.

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FRANCE

"Solidarity and the Price of Apricots"
Craig R. Whitney
New York Times, August 21, 1999, page A4

This article discusses a new government regulation which requires retail sellers of produce to display the price that was received by farmers for the produce. French farmers hope that this will lead to pressure on retailers to raise the prices paid to farmers. The article begins by commenting that French people "really do seem to think differently." It then gives as an example the willingness of the French public to support rail or subway strikes, even when they lead to traffic tie-ups.

It actually isn't uncommon for people anywhere in the world to show solidarity with striking workers. Even in the United States, where a relatively small percentage of the work force is unionized, there are many people who refuse to cross picket lines, in spite of the resulting inconvenience. It is not clear whom the article presumes to think differently from the French on this issue.

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RUSSIA

"Hardened to Hardships, Russians Simply Stretch the Rubles Further"
Michael R. Gordon
New York Times, August 23, 1999, page A1

This article examines the state of the Russian economy one year after the collapse of the ruble. The article notes that Russia's economy and its people appear to have survived this financial crisis in spite of predictions of disaster from the IMF and the Clinton administration. The article suggests that this result is surprising, attributing it to a "strange mixture of self-reliance, humor and weary resignation."

Standard economic theory would have predicted much of the economic resilience described in the article. Therefore, Russia's relative economic health should not be viewed as surprising.

Prior to August of 1998, at the insistence of the IMF and the U.S. Treasury Department, Russia was maintaining a grossly over-valued ruble. This made its exports uncompetitive on world markets, and allowed imports to undercut the sale of domestically produced goods.

This policy also forced the Russian government to spend tens of billions of dollars to maintain the value of the ruble in international currency markets, as it had to buy rubles using its reserves of dollars and other currencies. This sort of intervention in currency markets essentially amounts to transferring government funds to currency speculators. Since the Russian economy is approximately one-fifteenth the size of the U.S. economy, the actions of the Russian government would be comparable to the U.S. government spending $300 to $600 billion dollars in international financial markets.

Once the Russian government finally decided to ignore the IMF and allow the value of its currency to be determined by the market, it no longer had to continue this massive outflow of money to currency speculators. In addition, its exports suddenly became far cheaper around the world and imports became much more expensive relative to the price of domestically produced goods. Under these circumstances, it would be expected that Russia's industrial production would begin to surge, as it has, once the nation had weathered the immediate financial fallout from the collapse of the ruble.

While this outcome is exactly what economic theory would predict, the article suggests that the result is surprising and somehow unnatural. At two points it describes the weakened ruble as "protecting" Russian industry, completely reversing the standard economic use of the term.

While this article presents a relatively positive picture, it is worth noting that virtually all of the news reporting on the financial crisis last summer predicted that the devaluation of the ruble would be disastrous for the Russian economy. (See, e.g., " U.S. Expects Yeltsin Will Survive Economic Woes," by Thomas W. Lippman, Washington Post, 8/15/98, page A12; "Yeltsin and Crew Are Sinking Like the Ruble," by Michael Wines, New York Times, 8/22/98, page A1; and "Yeltsin Must Resort to Reform by Decree," by Sharon LaFraniere, Washington Post, 7/18/98, page A14.)

This article also exaggerates the hardships that have resulted from the collapse of the ruble relative to the impact of the prior seven years of IMF-supervised transition to a market economy. (See "Wither Reform: Ten Years of the Transition," by Joseph E. Stiglitz, www.worldbank.org/research/abcde/stiglitz.html.) According to the article, Russian government statistics show that the number of people living below the national poverty line jumped by more than 60 percent from 1998 to 1999. The reliability of this assertion is questionable. The United States government does not yet have data on family income for 1998. It would be quite impressive if a country in as much disarray as Russia already has data on family income for 1999.

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ECUADOR

"Sharing Ecuador's Debt Burden, but at What Cost?"
Jonathan Fuerbringer
New York Times, August 27, 1999, page B1

This article discusses Ecuador's efforts to reach an arrangement with its creditors to reschedule its debt. At one point the article asserts that "without a viable economic plan that is backed by the IMF and appears credible to investors, there is not much chance the country can work its way out of its current predicament." It is not obvious that Ecuador will necessarily fare any better if it follows a path advocated by the IMF than if it doesn't. In the last year and a half, both Malaysia and Russia have managed to weather economic crises without reaching an agreement with the IMF. (See, e.g., "Russia, One Year After the Fall," by Daniel Hoffman, Washington Post, August 17, 1999, page A1.) In Russia's case, the IMF insisted that Russia maintain an over-valued ruble. This was destroying the ability of its manufacturing sector to compete internationally and costing the country tens of billions of dollars in foreign exchange.

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OUTSTANDING STORIES OF THE WEEK

"Poorest Families Are Losing Ground"
Kathy Sawyer
Washington Post, August 22, 1999, page A7

This article reports on a new study by the Center on Budget and Policy Priorities which found that the poorest 20 percent of female headed households experienced a drop in income from 1995 to 1997, in spite of the strong economy. The study attributed this decline in income to welfare reform.

"When Work Is Not Enough"
Michael M. Weinstein
New York Times, August 26, 1999, page B1

This article examines the work prospects of people who have left the welfare rolls as a result of the 1996 reform bill. It points out the relative success of a welfare mother who has had the benefit of an intensive 14-week training program in woodworking. By contrast, it notes that the vast majority of the people pushed off welfare do not have access to this sort of training. The evidence suggests that these people are not likely to do well in the work force.

"Corporations Battling to Bar Use of E-Mail For Unions"
Noam S. Cohen
New York Times, August 23, 1999, page C1

This article reports on the legal battle between unions and corporations over the use of company email systems for union organizing drives. Unions have argued that the access to common areas such as company cafeterias, which they are guaranteed under the National Labor Relations Act, also applies to e-mail systems. Corporations have argued that these systems are private property and therefore off-limits to union organizers.

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


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