Econofact

What Tools Does the U.S. Have to Combat the Next Recession? (VIDEO)

Monetary Policy

What Information Does the Yield Curve Yield? (UPDATED)

By Michael Klein·December 6, 2018
Fletcher School, Tufts University

The Issue:

An inverted yield curve — when interest rates on short-term Treasury bonds exceed those on longer-term Treasury bonds — has in the past proven to be an indicator of an oncoming recession. As of early December, the difference in yields between shorter- and longer-term Treasury bonds had inverted for the three-year five-year rate, and the two-year five-year rate, while the two-year and ten-year rate had continued to narrow, reaching 11 basis points. The movements in the yield curve, as well as in other financial market indicators, have raised concerns that the current long expansion of the United States economy may be coming to an end.

The Facts:

Before the start of every economic recession in the United States since the mid-1970s, the difference in yields between 10-year and 2-year U.S. Treasury bonds turned negative — meaning that the 10-year bond offered a lower interest rate than the 2-year bond (see chart). Rather than selecting two particular maturities, one can also consider more broadly the overall shape of the yield curve, which plots the interest rates on bonds of different maturities. The yield curve typically slopes upwards, with interest rates higher on longer-maturity bonds than on shorter-maturity bonds. An inverted yield curve, where interest rates on shorter-maturity bonds exceed those of longer-maturity bonds is often seen as a harbinger of a recession.
While a negative spread between the 10- and 2-year Treasuries is a strong predictor of a subsequent recession, there is no single well-accepted theory of why this relationship, or more generally an inverted yield curve, predicts a recession. When longer-maturity bonds offer lower yields relative to shorter-maturity bonds, it may be because investors expect lower future inflation, which might arise with a future slump in economic activity. Another potential reason why an inverted yield curve predicts a downturn is that efforts by the Federal Reserve to slow the economy and prevent overheating typically involve raising the Federal Funds rate, which has a bigger effect on short-maturity interest rates than on longer-maturity interest rates.
Concerns about the possibility of an upcoming recession based on the flattening of the yield curve and the reduction in the spread between the ten-year and two-year Treasuries are consistent with other indicators and forecasts, but not all point in this direction. For instance, John Williams, the President of the Federal Reserve Bank of New York, said on December 4, 2018 that he was "still of the view that with the economy on a very strong path with a lot of momentum, especially with some of the fiscal ... tailwinds and other factors, that further gradual increases over the next year or so still makes sense.”

What this Means:

The current expansion of the U.S. economy is among the longest on record. There have been 33 recessions since 1854, and, given the length of this expansion, one may think that we are now due for another downturn. The fiscal stimulus arising from the tax cut passed at the end of last year may keep the economy growing for some time, but this effect is expected to eventually wear off. While the Federal Reserve has shown a willingness to raise interest rates to prevent overheating, Federal Reserve Chairman Jerome Powell has recently indicated that interest rates are “just below” broad estimates of a neutral level — a setting designed to neither speed nor slow economic growth. Still, predicting recessions is a notoriously difficult endeavor, as pointed out by Nobel Laureate Robert Shiller. Nevertheless, there are some warning signs, among them the flattening of the yield curve and the decrease in the spread between 10-year and 2-year Treasuries – and these warnings would become stronger were these movements to continue in the same direction.

Editor's note: This is an updated version of a post originally published on April 26, 2018.

Social Policy

Should Governments Tax Sugary Drinks?

By Jan Gerson·December 5, 2018
University of Michigan

The Issue:

Sugary drinks are the primary source of added sugar consumed in America. Consumption of these drinks is associated with obesity. A number of cities, including Philadelphia and Berkeley, have taxed sugary drinks. But can a tax on something that people are better off not consuming be effective? Are these taxes fair?

The Facts:

Nearly 40 percent of U.S. adults were obese in 2016 according to the Centers for Disease Control and Prevention. This is a public health problem because obesity is linked to preventable and premature deaths.
As the share of Americans who are obese has increased, so too has the consumption of sugar-sweetened beverages. It rose markedly among children 2-18 and more than doubled for adults since the late 1970s.
The extent to which a tax on sugar-sweetened beverages will impact how much people drink will depend on how sensitive consumers are to changes in prices. Recent evidence from a study in Philadelphia suggests that a tax on sugary drinks does change people’s buying habits.
Opposition to taxes on sugary drinks focuses on freedom of choice, and on the fact that these taxes disproportionately hit the poor. However, another viewpoint is that sin taxes are the most favorable to the poor since they reap the most health benefits from smoking less, drinking less alcohol, and drinking fewer sugary beverages.

What this Means:

So-called sin taxes represent an effort to tilt consumption away from items that are harmful, such as tobacco, alcohol and sugary drinks. The revenues generated by these taxes could also benefit health outcomes if they were dedicated for that purpose. Evidence on taxing sugary drinks from the experience in Philadelphia and elsewhere suggests the policies do reduce people’s consumption of these drinks. Additional research would be needed to show concrete beneficial health outcomes from the reduction in the consumption of sugar due to the tax.

Required reading

How Can We Know if There is Discrimination in Hiring?

by David Neumark

Assessing the Impact of the Tax Cuts and Jobs Act (VIDEO)

by Kimberly Clausing

Health Insurance Without the Individual Mandate: Can a Three-legged Stool Stand on Two Legs?

by Daniel Sacks and Kosali Simon

Labor Force Participation

Understanding Trends in U.S. Labor Force Participation (VIDEO)

By Karen Dynan and Jay C. Shambaugh·December 3, 2018
Harvard University and George Washington University and The Hamilton Project, Brookings Institution

The Issue:

The share of the adult population that is either working or looking for work has been steadily declining in the U.S. Karen Dynan at Harvard University, Jay Shambaugh at George Washington University and The Hamilton Project at The Brookings Institution, and Eduardo Porter of the New York Times highlight a few reasons for the decline.

What this Means:

A substantial part of the decline in labor force participation can be explained by the the retirement of baby-boomers. But there are concerning trends in participation for those who are in prime working ages. The fact that the return to low-skilled work has been falling, together with poor options for elder care and child care, have contributed to more people leaving the work-force. In contrast to other advanced economies, since 2,000, labor force participation among prime-age women has been declining in the U.S. The good news is that considering this trend isn’t universal, the U.S. can look to other advanced countries and make policy shifts to help reverse the decline in women in the labor force.

Jobs and Employment

Who Benefits from a Higher Minimum Wage?

By Jonathan Meer·November 27, 2018
Texas A&M University

The Issue:

Raising the minimum wage is broadly viewed as a policy that combats poverty. Most of the focus of the debate over the minimum wage has been on whether raising it leads to job losses, but an overlooked key point is which workers see their wages rise with an increase in the minimum wage. The workers who benefit from a higher minimum wage are not necessarily those who one would target if the purpose of this policy is poverty alleviation.

The Facts:

At $7.25, the Federal minimum wage is low by historical standards — when adjusted for inflation — and has not been increased since 2009. Many states and municipalities have set local minimum wage policies above the Federal level.
Only a small number of workers are actually paid the prevailing minimum wage in their area — and they tend to be younger workers, most without children.
Most minimum wage workers do not live in low-income households (see chart). The median family income of those earning the minimum wage was $49,500 in 2017 – the poverty level of income for a family of four was $24,600.
An increase in the minimum wage can raise prices in a way that works against the poor. An increase in wage costs due to a rise in the minimum wage contributes to higher prices for those goods and services produced with minimum-wage labor.

What this Means:

The minimum wage is not an effective tool to reduce poverty or income inequality. Many of the beneficiaries do not live in low-income households. Moreover, there is some evidence that workers who earn the minimum wage tend to see relatively rapid gains in hourly wages as they acquire experience. Policies that supplement the incomes of low-wage workers, like the Earned Income Tax Credit, are better targeted to low-income families and encourage work.

Economic Growth

What Explains Slow Productivity Growth in the United States? (VIDEO)

By Karen Dynan and Jay C. Shambaugh·November 25, 2018
Harvard University and George Washington University and The Hamilton Project, Brookings Institution

The Issue:

Productivity growth, a measure of how efficiently goods and services are produced and a key determinant of economic growth, has been slow in the U.S. since the early 2000s. Karen Dynan at Harvard University, Jay Shambaugh at George Washington University and The Hamilton Project at The Brookings Institution, and Eduardo Porter of The New York Times look at some of the reasons for the slowdown.

What this Means:

Productivity growth is notoriously hard to measure and to predict. But there are a few factors that could be contributing to the slowdown in the U.S. Historically, a large part of productivity growth has come from new, fast growing firms hiring workers away from older, less productive firms. With declining dynamism and fewer start-ups in the economy, this mechanism is much less pronounced today. A slowing rate of capital accumulation – as well as the fact that the education differential between generations is not growing as quickly – could also be contributing factors.