The Recession is On, but Will It Include Inflation?

THE FOLLOWING COMMENTARY WAS DELIVERED OVER WAMC RADIO ON MARCH 7, 2008 by MICHAEL MEEROPOL


Last Thursday, Fed Chairman Ben Bernanke1 and President Bush both asserted they did not believe the US economy would fall into recession in 2008.

Then on Sunday the Business section of The New York Times ran three articles that seemed designed to completely contradict Bush and Bernanke. The first of two front page articles asserted that the recent recovery has seen job growth insufficient to reach the levels of employment in 2000.2

"Some 62.8 percent of all Americans age 16 and older were employed at the end of [2007] down from the peak of 64.6 … in early 2000." The second noted that "… a consumer-led recession has already begun, according to a new index that reflects how much money Americans can actually spend right now." 3

While the Federal Reserve has taken strong steps to stimulate the economy with a one and one quarter percentage cut in the Federal Funds Rate over the last two months - and promises more of the same - the federal government for now seems unwilling to provide more fiscal stimulus. President Bush opposed the efforts of some Congressional Democrats to come up with a second stimulus package focusing on infrastructure spending. He stated: "I know there's a lot of, you know [talk about] … - stimulus package II and all that. Why don't we let stimulus package I, … have a chance to kick in?" 4

Meanwhile, the efforts to combat the recession with fiscal and monetary stimulus may be complicated by the potential re-emergence of a problem our economy has not seen since 1980 - and that is stagflation.

What is "stagflation"? It's a combination of too much unemployment - too slow growth - perhaps even a recession and unacceptably high rates of inflation.5

Consider the difference between our situation today in 2008 and the early months of 2001 when the Federal Reserve and the Federal Government combined expansionary monetary policy with significant tax cuts in an attempt to head off a recession.

In 2000 and 2001, the rate of inflation measured 3.4 and 2.8 percent. After the recession began the rate fell to 1.6% in 2002.6 In that situation, the Fed, the President and Congress were able to stimulate the economy without accelerating inflation.

Now, we have a situation where the inflation rate was 3.2% in 2006 and 2.8% in 2007.7 If inflation continues to fall as it did in 2002, policy makers will be free to give the economy as much gas as it needs to reverse the downturn and get us on the road to recovery.

However, there are scary signs that this will not be easy. Gasoline prices have risen dramatically over the last few years and there are predictions of $4 a gallon gas this summer. The preliminary monthly figure on inflation for is .5% per cent which if continued for the next 11 months will bump the year's inflation rate up to 6%.8 (Compare that to 1.6% in 2002.) Bernanke's testimony on Thursday noted that "Consumer price inflation has increased since [July] in substantial part because of the steep run-up in the price of oil. Last year, food prices also increased significantly, and the dollar depreciated…. inflation excluding food and energy prices-- … [increased] toward the end of the year."

He concluded that, "The higher recent readings likely reflected some pass-through of energy costs to the prices of core consumer goods and services as well as the effect of the depreciation of the dollar on import prices." 9

If inflation does not fall significantly, it will make it very difficult for the Fed, the President and Congress to increase the vigor with which they combat the recession. That's because everything they do to combat the recession might increase inflation.10 2008 is not going to be an easy year for any of us - policy-makers included.

Footnotes:

1 See "Is a Lean Economy Turning Mean? Why It's Now Even Harder to Find Job" and "The Buck Has Stopped," The New York Times (March 2, 2008): Business Section, p. 1. See also "The Jump-Start That Hasn't Started," The New York Times (March 2, 2008): Business Section, p. 6. Then, the day after this commentary aired, March 8, 2008, The New York Times had two front page stories that made clear we are already in a recession: "Sharp Drop in Jobs Adds to Grim Economic Picture" and "End to the Good Times (Such as they Were)." The second article concluded with a really dismal picture of the past six years of economic recovery, "The median household earned $48,201 in 2006, down from $49,244 in 1999." [p. A9]. The 1999 figure is at the top of the recent business cycle before the stock market crash of 2000 and the recession of 2001 reduced income. The fact that median household income did not grow over a full business cycle is extraordinary. It means that the recent growth in consumption has mostly been fueled by debt expansion. This means that the decline in consumption will be quite significant because people have already borrowed a great deal and may have little room to borrow more.

2 "Is a Lean Economy Turning Mean?": p. 8.

3 "The Buck Has Stopped": p. 1.

4 See http://www.foxnews.com/story/0,2933,333553,00.html. The full statement from President Bush would have been impossible to really follow without the insertions I put into the text. Here it is verbatim from the transcript: 'It's - I know there's a lot of, you know - here in Washington, people are trying to, you know - stimulus package II and all that. Why don't we let stimulus package I, which seemed like a good idea at the time, have a chance to kick in?"

5 The decade of the 1970s was marred by stagflation. Here is the data:

Date Unemployment Rate (in percent) Inflation Rate (in percent)
1970 4.9 5.7
1971 5.9 4.4
1972 5.6 3.2
1973 4.9 6.2
1974 5.6 11.0
1975 8.5 9.1
1976 7.7 5.8
1977 7.1 6.5
1978 6.1 7.6
1979 5.8 11.3
1980 7.1 13.5
[Source: Economic Report of the President, 2004: 330, 357.]
Note the persistence of high levels of unemployment through much of the decade accompanied by surges in inflation 1973, 74 and 1978, 79 and 80.

6 See Economic Report of the President, 2006: 355. For some strange reason the number I spoke on the air was incorrect. I said 1.5% when I should have said 1.6%.

7 See the Bureau of Labor Statistics Table at ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt

8 The January figure is on the Bureau of Labor Statistics' front page: http://www.bls.gov/cpi/home.htm

9 See http://www.fxstreet.com/fundamental/interest-rates/ben-s-bernanke-testimony-before-the-committee-on-f/2008-02

On other issues he commented as follows:

Discussion on the housing market: "The housing market is expected to continue to weigh on economic activity in coming quarters. Homebuilders, still faced with abnormally high inventories of unsold homes, are likely to cut the pace of their building activity further, which will subtract from overall growth and reduce employment in residential construction and closely related industries."
Discussion on the economic outlook: "The risks to this outlook remain to the downside. The risks include the possibilities that the housing market or labor market may deteriorate more than is currently anticipated and that credit conditions may tighten substantially further."

10 The tools of monetary and fiscal policy mostly affect aggregate demand - either the consumption spending of individuals, the investment spending of businesses or the government's own spending. Expansionary monetary and/or fiscal policy (reduced interest rates by the FED, a stimulus package passed by Congress) will increase spending if it is effective. However, any increase in spending might make it easier for businesses to raise prices - and in the context of rising oil prices and other business costs, they will have a strong incentive to do that. Should the FED and Congress try to restrain inflation by raising interest rates or cutting government spending (this is what Congress and the FED did early in 1980), that could have the effect of making the recession deeper. During the 1970s, government policy shifted from anti-inflationary to expansionary and back again. There was even a period of direct wage and price controls in 1971 and 1972. For details see SURRENDER, chs. 3, 4, 5.

The Stimulus Package: The Good, the Bad and the Ugly

THE FOLLOWING COMMENTARY WAS DELIVERED OVER WAMC RADIO BY MICHAEL MEEROPOL ON FEBRUARY 1, 2008


On January 29, the House of Representatives passed, a bill called a "stimulus package." 1

According to the politicians, the bill is designed to provide an increase in spending soon so as to either head off a recession or (more likely) help counteract a recession that has already begun. 2Perhaps the most significant thing about this action is a question that too few people have asked - What took them so long?

Politicians, economists and pundits spent last year first denying that the housing bubble was exploding and then claiming that the problem was basically confined to the sub-prime lending market. 3

At the November meeting of the FOMC, the chief policy-making body of the FED, they were still talking about the danger of inflation. 4

But on January 22, they took the extraordinary step of cutting their major policy interest rate by three-quarters of a percent, thereby telegraphing their panic over the dangers of recession. 5

In the wake of stock market gyrations all around the world, the Fed's panic, and the continued free fall in the housing market which has had a very negative impact on consumer confidence, President Bush and Congress are under extreme pressure to "do something." The something they are doing is very little, very late, and focused in part on the wrong people.

First the numbers - The total decrease in Federal tax revenue associated with this package is $146 billion. 6 This is the good part because it will increase total income. Though not insignificant, (it is a bit over 1% of GDP) the change in the fiscal posture of the US government is much smaller than the fiscal stimulus created in 1975 when the economy was battling a deep, painful recession. 7

But unfortunately, the bad part of the package is that a lot of the tax relief will go to individuals and families with relatively high incomes. Families making between $100,000 and $150,000 will get a $1200 rebate. Individuals making that much will get $600. It is unlikely that much of that will be spent immediately. Short term windfalls will not change consumption patterns for well-off people. That is why the director of the Congressional Budget Office told members of Congress that the best way to get money into the hands of citizens most likely to spend all of it immediately would be to extend unemployment benefits and increase the availability of food stamps. 8

The failure to increase unemployment insurance is the worst thing about this bill - the truly ugly part. When people become unemployed, they strive to maintain their previous levels of consumption. Thus, virtually all of their unemployment checks get spent on current consumption items. Extending benefits from 26 weeks to 39 weeks or even longer will permit those laid off workers to keep their consumption spending up.

One of the great values of increasing food stamp availability is that unlike the tax cuts and rebates that will put cash in the hands of consumers - cash that might be spent on imported goods - food stamps can only be spent on food, most of which is produced domestically.

Because the politicians waited so long to act, we are now being told they must rush this compromise through in order to get the rebate checks into people's hands by May or June. Thus, there is tremendous pressure on the Senate not to attempt to amend this bill. I urge you to tell your Senators to resist this pressure. Extending unemployment benefits and expanding food stamp availability will not only be the right thing to do - it will make the bill a more effective stimulus.

Footnotes:

1 See "$146 Billion Stimulus Plan Passes House" Washington Post January 30, 2008; Page A03 http://www.washingtonpost.com/wp-dyn/content/article/2008/01/29/AR2008012901935.html?hpid=topnews

2On January 31, the New York Times reported that the GDP had grown at a disappointing .6% during the fourth quarter of 2007 suggesting that by the end of the year growth might have turned negative thus heralding the start of a recession. Recessions are "called" by the National Bureau of Economic Research many months after they have begun so we will not know for sure for some time. However, with growth slowing to a dead stop, declines in housing sales and prices, rises in unemployment, slowdowns in job creation, huge write-downs by financial institutions there is every indication that a recession is here or almost here. See my most recent commentary.

3 See, for example, the following article in the New York Times in October of 2007. Note that this was already into the last quarter - the quarter that now we find saw growth plummet to .6% after posting a 4.9% rate of growth in the third quarter (see http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm.). The New York Times piece described job growth in September as having "bounced back" which combined with a revision in the numbers for August were, "…easing fears of a recession and making it more likely the Federal Reserve will hold interest rates steady when it meets at the end of this month [September]. The news set off a surge on Wall Street, sending the Standard & Poor's 500-stock index to a record close. The economy added 110,000 jobs in September, and the Labor Department reported that employment increased by 89,000 jobs in August, revising an earlier report that showed an unexpected loss of 4,000 jobs. The original figure prompted a stock market sell-off and was followed by a half-point cut in the Fed's benchmark interest rates as investors worried that turmoil in the housing market had bled into the larger economy. Today's report - considered a leading indicator of the nation's economic health - suggests that pain from the subprime lending crisis subsided somewhat in September. Government and education jobs rose sharply, spurring the upward revision for August." http://www.nytimes.com/2007/10/05/business/04cnd-econ.html?emc=eta1 Read that ridiculously optimistic last sentence again!

4 It is sometimes instructive to read the minutes of the Federal Open Market Committee. At the meeting October 30-31 (the commentary called it the November meeting because the results were announced November 1) there were references to the "upside risks to the outlook for inflation" [p. 7] and the following statement as well: "Readings on core inflation had improved modestly during the year, but the Committee judged that some inflation risks remained, and the Committee planned to continue to monitor inflation developments carefully." [p. 4] For the full minutes see http://www.federalreserve.gov/monetarypolicy/files/fomcminutes20071031.pdf 5 Because the level of total (aggregate) demand helps determine both the inflation rate and the unemployment rate - but has the opposite effect of both - it is impossible to use the tool of aggregate demand management (fiscal and monetary policy tools) to fight both problems at the same time. Thus, policy-makers basically have to choose which problem - inflation or unemployment - is likely to pose the most immediate danger. It is clear that between the end of October and January 22, the Fed changed its main focus from fearing inflation to fearing recession.

6 This refers to the House bill passed on January 29. There will no doubt be many changes in the bill before it reaches the President's desk.

7 In March of 1975, Congress pass a significant tax cut at the urging of (Republican) President Gerald Ford. That tax cut was clearly focused on increasing consumption. Marginal rates were not cut, and instead all taxpayers and their dependents received a credit of $30 (over $100 in current dollars). In addition, the standard deduction was increased, and a refundable earned income tax credit was enacted. As a result, some beneficiaries of the 1975 tax cut carried no liability for federal individual income taxes. Here's where the fiscal stimulus difference becomes apparent. The federal budget was nearly balanced in 1974, with a deficit of less than 1% of GDP. That deficit, however, jumped to 3.4% of GDP in fiscal year 1975 and 4.3% in the following year. (See Economic Report of the President, 1998, p. 373.) It is clear that the 1975 tax cut, plus some increased spending in the form of extended unemployment compensation benefits, helped raise the federal deficit and increase aggregate demand. As a consequence, this deficit increase was temporary; both deficits and debt as a share of GDP fell at the close of the 1970s.

8 For the testimony of Peter Orszag, Director of the Congressional Budget Office, see http://www.cbo.gov/ftpdocs/89xx/doc8932/1-22-TestimonyEconStimulus.htm Director Orszag noted that "… tax cuts or increases in transfer payments from the government to people (such as Food Stamps or unemployment insurance benefits) increase household demand by providing consumers with additional spending power. The bigger the chunk of that additional income that consumers are willing to spend instead of save, the more stimulus there will be from a particular tax reduction or increase in government transfer payments. But households do not predictably spend a fixed proportion of the extra income left in their hands when taxes are reduced or transfers

IS RECESSION NECESSARY?

THE FOLLOWING WAS DELIVERED AS A COMMENTARY OVER WAMC RADIO IN EARLY JANUARY OF 2008 BY MICHAEL MEEROPOL


Two days after my last commentary, the New York Times asked six economists about the upcoming recession. One of them, James Grant, asserted that recessions serve a useful purpose:

"They allow the sorting out of boom time error. They permit - indeed, force - the repricing of inflated assets. In a downturn, previously overpriced businesses, houses and buildings are made affordable again." 1

In other words, a recession "corrects" for mistakes made during the previous boom. Grant argued that policy-makers have gotten so good at responding vigorously to recessions, that the correction process gets aborted. Recessions are too short and too shallow.

The result, he laments, is that when, "… a new upcycle does begin, … it's slow off the mark. The world's top economy seems curiously sluggish. And the economists and politicians ask, 'What happened to America's dynamic economy?'"

In Grant's view, the failure to have a real rip-roaring recession such as our economy last experienced in 1981 and 1982, sets the stage for sluggish growth, reduced competitiveness and, in the long run, harm to the economy.

This is an inconvenient view. When students learn Principles of Economics, they are usually taught that the two problems our economy must confront are inflation and unemployment. There is a law on the books called the Employment Act which dates back to 1946 with a significant amendment in 1978. The amended law enjoins the government keep the unemployment rate at 4% or lower while making sure inflation never gets above 3%. 2

The Federal Reserve (our Central Bank) has mostly ignored that unemployment goal in its effort to achieve price stability while stating they also have a goal that the economy will grow "fast enough." In its publications, the FED concedes that pursuit of price stability may require short term slowdowns in growth which justifies them ignoring that 4% goal. 3

So here is the contradiction: while the official goal of US policymakers is to maximize employment and growth, the desire to contain inflation means that that goal has been honored in the breach. To put it bluntly, policy-makers implicitly agree with Grant that recessions are necessary every so often to contain inflation - while refusing to admit it.

This contradiction is not the result of stupidity or dishonesty - it is our economic system - American style free-market mixed capitalism -- with all its successes since the 19th century in terms of economic growth, technological change, economic opportunity, that is a system of contradictions..

To have the good (economic growth) some people must suffer the bad (periodic recessions - where they lose their jobs, businesses, homes, etc.). Since World War II, policies that reduced the length and severity of recessions have also reduced the chances for explosive growth. Between 1945 and the early 1970s, we in the United States thought we could have both explosive growth and short shallow recessions. Since then, even though we've had a couple of rather nasty recessions, the rate of growth has significantly slowed (with a short exception between 1996 and 2000). 4 Worse, the growth in income has been seriously skewed to a very small percentage of the population so that the vast majority of the people have benefited very little from it.

This is very significant. From 1973 to 2005 the 80 per cent of US workers in non-supervisory jobs saw a real hourly wage increase of 2% -- that's over 32 years. Meanwhile, productivity went up 75%. The benefits from that went to the richest Americans. 5

If you don't like this set of alternative choices, -- either periodic depressions as bad as 1981-82 or the sluggish growth since 1975 - and those ARE the two choices --- then you probably don't like US style capitalism - even if you think you do. 6

Footnotes:

1 For Grant's complete op-ed, see http://www.nytimes.com/2007/12/16/opinion/16grant.html?_r=1&oref=slogin. That entire OP-ED page set of articles is quite interesting. It is from the December 16, 2007 edition and available on line at http://www.nytimes.com/2007/12/16/opinion/16recession.html?ref=opinion. The other articles are: You Can Almost Hear It Pop, by Stephen S. Roach, The Facts Say No, by Marcelle Chauvet and Kevin Hassett, Bet the House on It, by Laura Tyson, Not if Exports Save Us, by Jason Furman, and Wait Till Next Year, by Martin Feldstein

2The Full Employment and Balanced Growth Act is Pub.L. 95-523. It was signed into law on October 27, 1978. The relevant passages specifying the goals to be achieved between 1978 and 1983 are as follows:

(b) Interim numerical goals for initial Economic Reports The medium-term goals in the first three Economic Reports and, subject to the provisions of subsection (d) of this section, in each Economic Report thereafter shall include (as part of the five-year goals in each Economic Report) interim numerical goals for- (1) reducing the rate of unemployment, as set forth pursuant to section 1022 (d) of this title, to not more than 3 per centum among individuals aged twenty and over and 4 per centum among individuals aged sixteen and over within a period not extending beyond the fifth calendar year after the first such Economic Report;

(2) reducing the rate of inflation, as set forth pursuant to section 1022 (e) of this title, to not more than 3 per centum within a period not extending beyond the fifth calendar year after the first such Economic Report: Provided, That policies and programs for reducing the rate of inflation shall be designed so as not to impede achievement of the goals and timetables specified in clause (1) of this subsection for the reduction of unemployment; See http://www4.law.cornell.edu/uscode/uscode15/usc_sec_15_00001022---a000-.html

To find these sections, you will need to go to the THIRD screen once you click on this link.

3 See, for example a staff report for the Federal Reserve Bank of New York which attempts to measure the so-called "sacrifice ratio" - the output lost due to constraining the economy with monetary policy aimed at reducing inflation. The authors note: "It is generally agreed that permanently low levels of inflation create long run benefits for society, increasing the level and possibly the trend growth rate of real output. There is also a strong belief that engineering inflation reductions involve short-term costs associated with a corresponding loss in output." "Structural Estimates of the US Sacrifice Ratio," Stephen Cecchetti and Robert Rich, Federal Reserve Bank of New York, March 15, 1999 (http://www.newyorkfed.org/research/staff_reports/sr71.pdf): 1

4 The National Bureau of Economic Research identifies the "turning points" of business cycles - the peaks tell us when an expansion ends and a recession begins - the troughs tell us when an expansion ends and a recession begins. See http://www.nber.org/cycles/cyclesmain.html. For rates of growth of GDP (in nominal and in real terms) see http://www.bea.gov/national/index.htm#gdp (on the first screen click on "percent change from preceding period." From 1945 to 1973, real GDP growth averaged 3.33% per year. From 1973 to 2006 that average fell to 2.8% per year. (The average for 1946 to 1973 is much higher because the year 1946 saw so much inflation that real GDP actually fell 11%. The 1946 to 73 average is 3.49% per year.) 5 These numbers all come from the Bureau of Labor Statistics. I found them on an article entitled Our Subprime Economy by Richard D. Wolff of the University of Massachusetts Economics Department. If anyone wants an electronic copy, just write me at mameerop@wnec.edu.

6 I am not trying to be flip here. One of the major aspects of growth in a market economy (a capitalist economy) is that it happens over a boom and bust cycle. The late David M. Gordon penned an article in the New York Times Magazine entitled, "Recession is Capitalism as Usual" on April 27, 1975 which spells out the argument completely. The argument being made in my commentary, following the Grant piece in the New York Times is that the suppression of the role of recessions has a potentially negative feedback onto the rate of growth of the economy as a whole. This point is developed quite forcefully in Michael Perelman's book The Pathology of the US Economy Revisited which was published in paperback in 2002.

WHAT IS A RECESSION AND IS ONE COMING?

THE FOLLOWING WAS DELIVERED AS A COMMENTARY OVER WAMC RADIO IN DECEMBER OF 2007 BY MICHAEL MEEROPOL

You hear a lot these days about fears of a recession -- But what is a recession and why would we want to avoid one? A recession is defined as a period of at least six months when the total output of society declines. 1

During a recession incomes fall for a large percentage of the population. More significantly: some people lose their jobs, some people are forced to work part time when they want to work full time, some businesses fail. 2

However, the loss to the economy affects everyone, not just the unemployed. A recession is a waste of human resources. A person who is unemployed for a year has continued to live and grow older. That year of potential contributions to society (as a factory worker, retail clerk, fire-fighter, social worker, you name it) is lost forever. Economists call this the Gross Domestic Product gap - the output that is lost whenever the economy underperforms. 3

During the 20th century, there were 20 recessions in the US. The economy lost on average the equivalent of three months of GDP in each of them. 4 In 2006, the GDP was 13 trillion dollars. 25% of that is $5.2 trillion. It is this reduction in output that affects everyone. Maybe a person won't lose his or her job but will have reduced overtime. Workers in state or city government won't get raises because revenues are down. Business profits may fall - or, the business may lose money. Remember, the reduced output in a recession is output that can never be recouped.

The fears expressed by policy-makers and experts have focused on three things happening at once, two of which are closely related. The two closely related problems are first the deflation of the housing bubble which is causing a significant reduction in home sales, home prices and construction activity; and, second, a credit crunch which is causing lenders to shy away from granting credit to all but the most trustworthy potential borrowers.5

I have spoken about the housing bubble before and given the nature of the headlines, it is probably unnecessary for me to say anything more than that the current fall is unprecedented. The bad news is the fall in housing sales and prices has just begun.

The credit crunch is caused in part by the nature of the housing bubble. Because mortgages have been securitized the bank that issued the mortgage rarely holds on to it. Because many mortgages (and parts of mortgages) have been rolled into securities and sold as packages, the holders of these securities are beginning to wonder how many of the mortgages represented by those securities are bad. No one wants to buy any more of these securities, and institutions sitting on these assets are already worried about having to write them down - that is reduce the value the owners expect to realize. Fearing that they're already overextended, these financial institutions are worried about making new loans. These two problems are sure to depress both consumption and investment in the coming months.6

The third problem that is making people fear a recession is the volatility in the price of oil. Here in the Northeast we are looking at a 20% or more increase in the price of home heating oil for this coming winter.

Unleaded regular gasoline is consistently at or above $3.00 per gallon and could go higher. Any significant rise in the price of gasoline and home heating oil will cut into consumption spending even further while raising the cost of doing business, thereby dampening profits as well. 7

With consumption likely to decline and investment likely to follow, I am afraid a recession is inevitable. The question is, will the Federal Reserve and the federal government take remedial steps quickly enough to make sure it is short and shallow rather than deep and devastating. 8

Footnotes:

1 See SURRENDER, 284-5 for a discussion of the term recession and the dating of recessions from 1948 through 1991. See pp. 21-22 for a general discussion of the business cycle. Before the 1930s, economists used to divide the business cycle into four phases: The upswing when the economy was doing really well, the recession when it was starting to go down after reaching its peak, the depression when it was stuck at the bottom, and the recovery when it was starting to grow after hitting bottom. The Great Depression of the 1930s was so traumatic for the US economy (and the citizenry as a whole) that after World War II it became fashionable never to use the term "depression" in describing economic activity. Thus, we have used the word "recession" to describe the interruptions in economic growth that have occurred since the war and have (for the moment) shelved the word "depression."

2For a rather typical textbook discussion of recessions, etc. see PRINCIPLES OF MACROECONOMICS by Karl Case and Ray Fair (Upper Saddle River, NJ: Pearson, Prentice-Hall, 2007): 134-143. There is even a reference to the potential benefit of a recession - namely the ability to reduce inflation. This is actually quite a controversial point. There are those that argue that if recession reduces inflation, that might increase economic growth in the future over and above what it would have been if the inflation had not been reduced.

3 Notice that this assertion runs counter to the point mentioned briefly in footnote 2. I am well aware of that argument, I just do not find it convincing.

4 In an article entitled "When the Economy Goes South" by Jane Katz in the Regional Review published by the Federal Reserve Bank of Boston (http://www.bos.frb.org/economic/nerr/rr1999/q3/katz99_3.htm) there is a table identifying 20th century recessions in the US with a column for production lost in months. These recessions averaged 11 months and lost on average 3.1 months of output. The recession in the 21st century began, according to the National Bureau of Economic Research in March of 2001 and ended in November of 2001. See http://www.nber.org/cycles/cyclesmain.html.

5 There are so many references to these issues that the best advice I can give is to use Google to search for articles about "the Housing bubble" and "the credit crunch." Here are a couple of examples: "3 Big Banks See No Relief as Write-Offs Mount" The New York Times Dec 13, 2007: C7. "Central Bankers to Lend Billions in Credit Crisis" The New York Times Dec 13, 2007: A1 "Big Banks Scale Back Plan to Aid in Debt Crisis," The New York Times Dec 10, 2007: C1. For a recent summary see Paul Krugman, "After the Money's Gone" The New York Times Dec 14, 2007: A35. 6 Consumption has been very strong since the 2001 recession in large part because the increased value of homes made it possible for individuals to take out loans using that increased value as collateral. Thus, consumption as a percentage of GDP held steady at 70% as GDP grew after the recession. If consumption growth slackens, which is virtually inevitable, GDP will also. Meanwhile, investment as a percentage of GDP rose from 15% in 2002 to 16.7% in 2006. (This 1.7% change is quite significant - it represented over $132 billion!). See http://www.bea.gov/national/nipaweb/TableView.asp#Mid. For discussion of how this will negatively affect the economy, see Mark Weisbrot: "Housing Crash Still Weights Heavily on the Economy" Center for Economic Policy Research, December 12, 2007.

7 Any decline in profits will reduce investment incentives. In addition, any decline in profits will cause businesses to reduce their predictions of future profits. It is these dampened expectations of future profits that have even more of an impact on investment decisions.

8 For the behavior of the FED see "Credit Crisis Prompts FED to Roll Back Rates Again," The New York Times, December 12, 2007, p. C1. Unfortunately, many investors felt that the Fed's action was too little too late as evidenced from the stock market decline that very day. That was why the world Central Bankers stepped in - see "Central Bankers to Lend Billions in Credit Crisis" The New York Times Dec 13, 2007 from footnote 5 above. In this context, the recent Republican debate where all candidates spoke of the need to cut government spending was very disappointing. Equally disappointing were some Democrats who insist on maintaining the "PAYGO" rules regarding government expenditure. As anyone who has taken one course in economics ought to know, during a recession the important role of government is to INCREASE its spending and/or DECREASE it's taxation to counter the declines in consumption and investment that are causing the recession.

A Proposed Solution to the Credit Crunch in Housing That You Won't Read in the Mainstream Media

THE FOLLOWING COMMENTARY WAS DELIVERED OVER WAMC RADIO BY MICHAEL MEEROPOL on SEPTEMBER 7, 2008


On Friday, August 31, three important news items dealt with the current housing crisis. In one, Ben Bernanke, the Chairman of the Federal Reserve Board, stated that the central bank "stands ready to take additional actions as needed" to prevent, "the chaos in mortgage markets from derailing the broader economy." 1

Bernanke was promising lenders and borrowers that the FED would turn on the money spigot to counter the market jitters. Meanwhile, President Bush offered a series of steps to "help … Americans with credit problems avoid losing their homes ..." 2

Implicit in both Bernanke's promise and Bush's proposals was the goal of avoiding foreclosure by helping borrowers continue to make payments. Unstated was the corollary that this would make it more likely that the lenders who made these poor investments would get their full rate of return.

The third item was an OP ED piece in the Providence Journal.3 In it, Dean Baker and Andrew Samwick begin with the following premise:

"It is important that policy be focused on assisting financially strapped homeowners, not lenders that issued deceptive mortgages or investors who foolishly speculated in mortgage-backed debt." They want to "allow troubled homeowners to stay in their homes without also bailing out the mortgage issuers and speculators."

Their key recommendation is for Congress to pass a law capping the monthly payments at a home's fair market rent. Deceptive advertising has led homeowners to purchase houses at prices they cannot truly afford. New markets in liquid mortgages have made lenders less careful about buying securities containing those mortgages.

A typical economist's response is that both parties must accept the consequences of their "poor choices" - the homeowner must be forced out of his/her home and the mortgage holder must take a loss.

Baker and Samwick argue that the important group to rescue is the homeowners not the lenders.

Their solution does not reward lenders -- it punishes them by forcing them to accept a loss on the mortgage securities they've bought while protecting homeowners from foreclosure.

Why is this a better solution than the ones we are reading about coming out of Washington? The answer is in an understanding of why the situation has become so dire.4 The current problem to a large extent stems from the emergence of the housing bubble. Bubbles work on the principal of the "bigger fool" theory - I know I'm buying something that's costing much more than it's really worth but I also know that when the time comes I can sell it to a "bigger fool" than I am.

Sooner or later speculators discover that they are the "biggest fools" -- they cannot find a buyer -- they have to sell at a loss. This is true for money managers who have bought securitized mortgages as well as for homeowners who bought a house they truly couldn't afford at a mortgage whose terms they didn't really understand.5

Bailing out lenders sends a message that they can behave irresponsibly in the future and get away with it.

The Baker-Samwick solution has the great virtue of penalizing them for their bad investments by significantly cutting their rate of return.

I fear that Congress and the President will respond with something much more to the liking of the speculators and the Federal Reserve will do the only thing it knows how to do, cut interest rates.

Too bad. The Baker-Samwick proposal is a good one. Maybe you can suggest that your member of Congress support it?

Footnotes:

1 The New York Times: September 1, 2007: "Bernanke Says Fed is Prepared for More Action" (p. 1) Since then, there appears to be a consensus among financial and economic prosnosticators that the Federal Open Market Committee will lower the federal funds rate, it's benchmark short term interest rate, by either ¼ or ½ of a percent.

2The New York Times: ibid. "On Mortgages, Bush Plans a Limited Intervention." [B1]. In this article, President Bush quite rightly notes that "A federal bailout of lenders would only encourage a recurrence of the problem. It's not the government's job to bail out speculators, or those who made the decision to buy a home they knew they could never afford." It is in his last sentence where President Bush erroneously creates an equivalence between the victims of shady lending processes and the perpetrators. Obviously no one buys a home knowing "they could never afford"(emphasis added) it. They were tricked into believing they could afford that home by deceptive lending practices. According to the article (p. B6) a half a million homeowners are in danger of foreclosure because of already missed payments. The Bush proposal will make it easier for some low income mortgage holders to get federal mortgage insurance - that would help about 80,000 but it would really help the very speculators Bush said he didn't want to help. If these folks get federal mortgage insurance, then the speculators who bought those mortgages won't lose money on them. Much worse, by the way, are some proposals by Congressional Democrats that would use Fannie Mae and/or Freddie Mac to come to the rescue of hard-pressed homeowners and thus, on a much larger scale, validate the bad investment choices of speculators.

3 This article ran in the Providence Journal on September 3. I consider it so valuable that I recommend that it be read in its entirety. Read the article

4 And it has become so dire not just for the homeowners who are in danger of losing their homes but for the economy as a whole. As home prices across the country fall, construction activity falls. The construction industry is an important component of investment. As it declines, job growth slows. (The August job figures were quite disappointing - a predicted increase turned into a decline.). Another important fact is the the rising values of homes had been a major source of consumer spending. In effect, consumers who owned homes were using the rising equity in their homes as an ATM machine to increase consumption spending. That has stopped --- and as home values fall, homeowners will have to cut back on spending just to stay in their homes. As we move through September, economists are recognizing the possibility of a recession sometime before the year is over.

Dean Baker goes much further. He put it this way in an on-line commentary ("Alan Greenspan and His Bubbles" By Dean Baker CENTER FOR ECONOMIC POLICY RESEARCH September 18, 2007:)

"[T]he biggest effect will be the impact that the loss of housing wealth will have on consumption. As the bubble expanded, people borrowed against housing equity almost as rapidly as it was created. The Fed estimated that a dollar of housing wealth translates into 5 cents of additional consumption. This story works in reverse also. A loss of $4 trillion in housing wealth will lead to a reduction of approximately $200 billion in annual consumption. This drop in consumption, coupled with the downturn in the housing sector, virtually guarantees a recession, and quite likely a very severe recession."



5 One example of fine print coming to bite homeowners was highlighted in the New York Times of September 13. "A Home Loan Trap." (C1). The article notes that individuals who bought mortgages at initial low rates with the hope of paying them off when the rates rose are finding themselves hit with so-called "exit fees." These are penalties for paying off the mortgage earlier or refinancing. In other words, many people who were induced to buy homes with low "teaser" interest rates were under the impression that they could just pay off the loan when the rates started to adjust upwards. On the contrary, they are begin hit with large penalties - so large that selling the house and paying the penalty will actually consume all the equity they have. The problem for the money managers is spelled out in an excellent article by Roger Lowenstein in the New York Times Magazine on September 2. ("Subprime Time: How did Homeownership become so rickety?" pp. 11-12). Lowenstein describes the process of turning illiquid assets, mortgages on homes, into liquid assets, securities backed by mortgages on homes. "Even though each unit of real esates continued to be a slow-moving, illiquid asset, … the underlying mortgages could be traded as rapidly as stocks and bonds. Instead of keeping his mortgages in a drawer, the banker on Main Street could unload his risk by selling them to Salomon [Brothers]. The banker was thus converted from a long-term lender to a mere originator of loans. Salamon and other institutions would take the mortgages sold by banks and stitch together bonds backed by the payments of many mortgagees, which they dsold to investors. … a group of inert mortgages [were now] a tradable security. … Once the mortgage originator became, in effect, a supplier to Wall Street, new, often unregulated nonbanking companies jumped into the game of brokering and also issuing mortgages. Over time, this weakened lending standards…" Lowenstein concluded, "What happened over the last generation is that housing was turned from a market that responded to consumers to one largely driven by investors." The bubble that fueled the dot.com boom of the late 1990s was replaced by a similar bubble in homebuilding and investing since 2002. The second bubble was why the recession of 2001-2002 while experiencing a significant decline in investment spending, saw no drop in consumer spending. Unfortunately, that situation is ending now. One other impact of the housing bust is that lenders are now doubly shy of getting caught investing in securities of dubious value. This may lead to a credit crunch similar to the one that caused a very sluggish housing and construction market after the Savings and Loan meltdown of 1989 and beyond. A credit crunch will mean even legitimate investors will find it difficult to borrow funds for new investments, compounding the negative impact of the fall in consumption spending.

What's All the Fuss about the Death Tax?

THE FOLLOWING COMMENTARY WAS DELIVERED BY MICHAEL MEEROPOL OVER WAMC RADIO IN SEPTEMBER OF 2008


A public relations coup occurred recently. The estate tax has been reincarnated as the death tax. Though this tax is levied on only 2% of the population, millionaires and billionaires, it is one of our most unpopular taxes.

How is it a death tax? Consider the income or payroll tax. One reduces your income. The other reduces your wages. And what does the death tax reduce? What you keep after dying? Are there IRS agents taking a cut as you enter the pearly gates?

The so-called death tax is actually a tax on the value of assets – the estate – left by someone who dies. Those paying the tax are very much alive – they are the heirs.
And – they only have to pay the tax if the estate’s total value is greater than $2,000,000.

What are the pros and cons of such a tax? [1]

First of all the government needs to raise revenue. The estate tax is an almost perfect example of a tax based on ability to pay. What that means is that the people paying the tax can most afford to pay it.[2]

Suppose I were the grand-child of a very rich person. I might be earning $30,000 a year, I might be earning $300,000. I might be earning no income at all. Whatever my income, it is a fact that exists before I get my share of my grandparent’s estate.

Suppose the estate is $3 million. The tax is levied only on the $1 million over and above the $2 million exemption. The tax rate is 45%. The estate loses $450,000 to the IRS reducing it to $2,550,000. If I share with nine other people, I will get $255,000.

My annual income has not been reduced. No harm has been done to me by the tax. It was never my money – it belonged to my grandfather and just landed on me because he died.

According to one estimate, the estate tax would raise $39 billion in 2011 if the law reverted to 2001 rules and $29 billion if the exemption stayed at $2 million.

This is not a lot of revenue when you consider the federal budget will exceed $3 trillion by 2001. However, for every dollar of reduced taxes, someone else has to pay higher taxes or some government service has to be reduced or more revenue has to be borrowed. In other words, there is some impact.

Some have argued that the existence of the estate tax discourages individuals from making investments and building up an estate because they know their heirs won’t get all of it. This argument seems nonsensical to me. Even at a tax rate of 45%, the heirs get to keep 65 cents for every dollar left by grandpa. (after paying nothing on the first $2 million).


Actually, the existence of that tax often convinces wealthy people to donate some of their wealth to non-profit organizations. Wealthy families often create tax-exempt foundations and make donations to colleges and universities. Such contributions reduce the estate tax burden while creating institutions that outlive the founders – think of the Rockefeller and Ford Foundations or Carnegie Mellon University.


A little understood effect of abolishing the estate tax is that it would be terribly destructive of the incentives and self-reliance of those heirs who receive a millions of dollars in inheritance. Pundits and politicians worry about the bad incentives created by our public welfare system – the willingness to work hard is virtually destroyed by the thousand dollars given to poor women with children to just “sit around” and allegedly “don’t work…”

Imagine the disincentive to work or achieve anything if you know from the time you’re born that you’re going to inherit over a million dollars from grandpa. The estate tax reduces that serious disincentive as grandpa gives a lot away and the government takes 45% over $2 million.


The estate tax – we should keep it.


1. For a good summary of the issues relating to the estate tax see the following: “Options to Reform the Estate Tax” by Leonard Burman, William Gale and Jeffrey Rohaly Tax Policy Issues and Options (Urban-Brookings Tax Policy Center) No. 18 March, 2005. It is available on the web at: http://taxpolicycenter.org/publications/template.cfm?PubID=9218

In 2001, President Bush’s first tax cut was passed by Congress. One of its most significant provisions was the phase out of the estate tax. In 2001, the top rate of taxation was 55% and the exemption was less than $1 million. For 2007, 8 and 9, the exemption is set at $2 million with a rate of taxation not to exceed 45%. In 2010 unless the law is changed before then, the estate tax will disappear. However, in order not to appear to be losing the Treasury too much money over the ten years after the 2001 tax cut was passed, Congress provided for the estate tax to return with the exemption at $1 million and the top rate back up to 55% in 2011 (prompting many jokes about people killing off their rich elderly relatives in 2010). It is clear that some compromise will occur so as to create some estate tax with an exemption higher than $1 million before 2010 – though perhaps that one year window without an estate tax will occur with the compromise coming in 2011 to avoid a big increase in the burden. For a brief discussion of different perspectives on the estate tax – and how the idea of calling it a “death tax” caught on – see, C. Eugene Steuerle Contemporary US Tax Policy (Washington, DC: The Urban Institute Press, 2004).

2. There are two basic principles of taxation: One is the so-called benefit principle which attempts to levy a tax so that those that benefit from the government services provided end up paying for the tax. A good example of this tax is the gasoline tax though it is rather imperfect. The tax on the gallons of gasoline you burn in your car is held in a fund to build and maintain highways. The reason it’s an imperfect tax on the benefit one derives from driving is cars have different gasoline mileage. Also, different sized cars have different impacts on the roads. Finally, the benefits of driving cannot be measured by the number of miles one drives. Driving to work has a much higher intensity of benefit associated with it than driving for pleasure. If you stopped driving for pleasure you might be less happy. If you stopped driving to work you’d have a significant reduction in income. The second principle of taxation is called the ability-to-pay principle. Since most government programs do not provide specific services which individuals can “consume” and attempt to measure their personal satisfaction from (as one might do in driving down a highway) it is often impossible to calculate the “benefit” that accrues to this person as opposed to another. (How could I quantify the benefit I get from the existence of the Federal Aviation Administration or the National Parks Service or the Postal Service or the Coast Guard?) Thus, the alternative method of calculating the appropriate tax is based solely on the ability of the taxpayer to pay. Using this principle, the tax should be levied either on a person’s income, wealth or (according to some) consumption. In addition, there is a strong preference for taxes that provide an exemption for certain levels of income, wealth and/or consumption from taxation. The idea here is that if you have a low income or low consumption, all of it is being spent on necessities and it would actually create real hardship to take some of that away. Once one has agreed that some level of income, consumption or wealth should be taxed at a zero rate, then the positive rate on the amount over the exemption means that you have favored a progressive tax system where the higher your income, the higher the RATE at which you are taxed. If there is agreement on this point, there is a significant debate as to whether rates should escalate as incomes get even higher or should stay at the same fixed level once the income exempt from taxation (taxed at a zero percentage rate) has been exceeded. For a discussion of a number of these issues see Steuerle: ch. 2. On the income vs. consumption taxation, see Economic Report of the President, 2004, ch. 6.

Thomas Sowell Defends the so-called "free market"

THE FOLLOWING COMMENTARY WAS DELIVERED OVER WAMC RADIO in JUNE of 2008.

Thomas Sowell Defends the “Free Market” from “Elites.”

When I appeared on VOX POP last September, one caller said he was a fan of the economist, Thomas Sowell. I responded that every time I read a Sowell column I find something that I disagree with. Take for example his May 21 column in the Springfield Republican. Sowell arrived at a false conclusion from an obvious fact.[1]


The fact was that, “The most knowledgeable person on earth does not have even one percent of the total knowledge on earth.” Sowell’s conclusion was that because of this, “social engineering, economic central planning, judicial activism and innumerable other ambitious notions favored by the political left…are formulas for disaster.” [2]

Note the buzzwords. “Central economic planning” might make you think of Stalin. “Social engineering”-- of Mao and the Chinese communes. In case you missed his point, Sowell reminds us that many people died in Stalin’s collectivization of agriculture and in the famine following Mao’s Great Leap Forward. [3]

Then he brings his point home, and I quote: “… the political left … share … the notion that knowledgeable … people like themselves have … a right and a duty to use the power of government to impose their superior knowledge and virtue on others.” [4]

The danger is in our midst warns Sowell. His solution: “… free markets, judicial restraint and reliance on decisions and traditions growing out of the experience of the many—rather than the groupthink of the elite few – are [very] important.”

Sowell opposes minimum wage laws -- an example of social engineering. He also opposes laws forbidding child labor. [5]

Why do we have a central bank, or Federal Deposit Insurance, which, following his logic, Sowell would oppose. Why have regulatory agencies and laws forbidding child labor and establishing a minimum wage?

It is not because some mini-elite has “thought up” these things. These institutions (excepting the Federal Reserve) are in existence because political movements formed to force the so-called free market to take action – action that market participants would not do if left alone.[6]

Left alone, businesses produce not just products but pollution. Though individual consumers by their decisions to buy cars can “signal” their desires to producers through their purchases (take the example of SUVs vs. smaller cars) there is no way for those individuals to “signal” that they would like commuter rail lines in major cities or a European style railroad system. [7]

Left alone, food producers produce attractive food but may not be concerned about the long term health effects of the additives they use.

A free market for unskilled or semi-skilled labor leads to very low wages unless either a labor union or government limits the ability of employers to pay low wages.

Sowell plays a trick on his readers by asserting that the government policies just described are enacted by a small group of very bright people who think they know better than the collective decision-making of millions of independently thinking and acting economic agents. But this is actually the opposite of the truth. The millions of independently thinking and acting economic agents discovered long ago that without political cooperation to enforce their collective will on the market (through laws like the minimum wage or the prohibition against child labor) a few elites with lots of money and power are able to take advantage of the powerlessness of the individuals they confront as either workers or consumers. [8]

Sowell acts as if the only power that damages the will of the people as expressed through the so-called free market is the government.. Not once in his column does he mention the word corporation -- yet a corporation is a significant center of power. Without government intervention, no matter how imperfect, to counter corporate power, we would be immeasurably worse off.


1. The column in the Republican is entitled “Knowing it all is not enough.” It is available on a web site called TownHall.com dated May 16. There is has the title, “Presumptions of the Left.” http://www.townhall.com/columnists/ThomasSowell/2007/05/16/presumptions_of_the_left

2. Because of the need to compress the text into the time available for a radio commentary, the full text of this section of Sowell’s argument was compressed. Here it is without the ellipses: “If you start from a belief that the most knowledgeable person on earth does not have even one percent of the total knowledge on earth, that shoots down social engineering, economic central planning, judicial activism and innumerable other ambitious notions favored by the political left. If no one has even one percent of the knowledge currently available, not counting the vast amounts of knowledge yet to be discovered, the imposition from the top of the notions favored by elites convinced of their own superior knowledge and virtue is a formula for disaster.”

3. Here is Sowell’s reference to Stalin and Mao: “ …economic disasters, important as they are, have not been the worst consequences of people with less than one percent of the world's knowledge superimposing the ideas prevailing in elite circles on those subject to their power -- that is, on the people who together have the other 99 percent of knowledge. Millions of human beings died of starvation, and of diseases related to severe malnutrition, when the economic ideas of Stalin in the Soviet Union and Mao in China were inflicted on the population living -- and dying -- under their iron rule. In both cases, the deaths exceeded the deaths caused by Hitler's genocide, which was also a consequence of ignorant presumptions by those with totalitarian power.” Note that Sowell cannot quite bring himself to acknowledge that Hitler’s genocide was also the product of a mini-elite running an entire nation. In fact, there is nothing in his column to indicate that he believes there is any such thing as a right-wing or “conservative” elite.

4. The full text is: “Many on the left may protest that they do not believe in the ideas or the political systems that prevailed under Hitler, Stalin or Mao. No doubt that is true. Yet what the political left, even in democratic countries, share is the notion that knowledgeable and virtuous people like themselves have both a right and a duty to use the power of government to impose their superior knowledge and virtue on others.” This is definitely a correct description of the Leninist conception of communist organizations and the way governments controlled by parties calling themselves Leninist have behaved. However, movements of the left, in general, have often been highly democratic in organizational form and in practice. The most obvious examples have been anarchist groups. [Though there have been very few examples where true principles of anarchism have had a chance to be put into practice, one such example was during the Spanish Civil War. The details can be followed in Noam Chomsky’s first major political work: American Power and the New Mandarins in his chapter: “On objectivity in liberal scholarship” where he shows how the story of the Spanish anarchists has been totally distorted by the scholarly community.] In the US, the Industrial Workers of the World (the IWW, known as the “Wobblies”) was a highly democratic bottom up labor movement. Students for a Democratic Society and the Student Non Violent Coordinating Committee which were important organizations in the 1960s were highly democratic in structure as well as in their goals. (SDS has recently revived. You can check out their website at http://www.studentsforademocraticsociety.org/.) Since Sowell and the right-wing echo chamber that he invites [Anyone interested can go to the townhall.com web site and follow any of the discussion threads that respond to Sowell’s postings. With one or two ‘liberal’ interlopers as exceptions, the attitudes of the posters are a pretty predictable example of right-wing groupthink.] include liberals and social democrats in their blanket condemnation of “the left” it is important to note that virtually every “liberal imposition” on the so-called free market that Sowell decries has come from bottom up pressure and not from the top down.

5. Sowell has published a detailed popularized version of his philosophy of economics and economic policy in Basic Economics. (3rd edition, NY: Basic Books, 2007) His attack on the minimum wage is presented on pages 210-221. His attack on Child Labor laws is presented on pages 232-4. (Reading the endnotes to these pages is quite revealing. [see p. 586] Sowell writes [p. 214] “Even though most studies show that unemployment tends to increase as minimum wages are imposed or increased, those few studies that seem to indicate otherwise are hailed as having ‘refuted’ this ‘myth’.” In the endnotes Sowell points the reader to articles that support his view and counter “those few studies…” but not to the articles that present the arguments and evidence in support of the view that the minimum wage does not increase unemployment. For a balanced view, and a reference to David Card and Alan Krueger’s summary work Myth and Measurement, the New Economics of the Minimum Wage see an interesting set of exchanges from the blog of N. Gregory Mankiw, a former head of President Bush’s Council of Economic Advisers: http://gregmankiw.blogspot.com/2006/06/sperling-on-minimum-wage.html

6. Minimum wage laws and laws banning child labor have been a demand of the labor movement from the earliest years of capitalism. Today, the labor movement is often characterized as part of the elite because labor leaders are well-paid executives of large organizations. However, the original labor movements (and this applies to the vast majority of union members and organizers and officials today as well) were groups of workers who recognized that they were powerless alone to force their bosses to pay them decent wages but that in unity there was strength. Many years, many struggles, (many deaths) later, they achieved things we take for granted – like the weekend, the eight-hour day, seniority, the ability to bargain over working conditions, and for some – health insurance and a pension. It is true that it took an act of Congress and the signature of a President to transform the minimum wage and a ban on child labor from demands into laws but Congress would never have acted without years of struggle and pressure. Many of the regulatory bodies that exist in the US today (the Food and Drug Administration, the Federal Trade Commission, the Occupational Safety and Health Administration, the National Highway Traffic Safety Administration) were created in response to wide public outrage against abuses documented often by muckraking journalists.

The Federal Reserve System (our nation’s Central Bank) is an exception to this rule. Though there had been a long serious of popular movements in the 19th century who agreed that the control of the nation’s finances by large private banks had a negative effect on the ability, particularly of farmers, to get credit when they needed it and to escape from the rising burden of debt as the currency deflated (yes, the US economy suffered a long run deflation between 1873 and 1897), the solution created with the Federal Reserve Act of 1914 was clearly a product of elite, top-down, decision making. The story is told in William Greider’s masterful work, Secrets of the Temple (NY: Simon and Shuster, 1987): 243-289.

7. In other words, though I can go buy a small fuel efficient car and if lots of other people do that, then businesses will produce less SUVs and more of the fuel-efficient kind, there is no market out there where I as an individual can make a purchase that will cast my “dollar vote” for a light-rail line in the urban area where I live or a national rail system like France’s or Japan’s. Obviously, such a “vote” would have to be a political vote to get a majority of my fellow-citizens to support raising taxes to create such a transportation set-up.

8. For just one example of how real elites operate, check out the documentary “Who Killed the Electric Car” (2006). It argues that GM created and then failed to market the first battery-operated car called EV1. Meanwhile, the California Air Resources Board which had previously mandated the sale of zero-emissions vehicles, caved under pressure from industry lobbyists and removed that requirement. (The federal government had joined private industry in a suit against California to prevent them from enforcing the Zero Emission Vehicle mandate.) It’s a complicated story and obviously subject to debate but the main point of the movie is that we as citizens have no way in the “free market” to “vote” for an electric car so long as oil companies are making lots of money selling gasoline. It requires government activity to make an electric car a viable alternative.

Note that the recent growth of hybrid cars as a share of the market in the context of very high gasoline prices shows that markets can at times accurately signal what people want. However, the price of gasoline at the pump does not reflect the full cost borne by society as a result of the burning of that gasoline. This is an example of what economists call externalities. Sowell’s celebration of the so-called free market [I use the modifier “so-called” because it isn’t really free…] ignores the many situations where the prices charged in the market are actually sending the wrong signals. If the gasoline tax were more in tune to the true cost imposed on society of running a car on gasoline, the demand for SUVs would plummet. But that would cut auto industry profits and the demand for gasoline, so you can imagine how strong the political campaign would be against anyone who advocated a big hike in gasoline taxes. In addition, there would definitely be legitimate differences of opinion about what the “true cost” imposed on society by driving gasoline powered cars actually is.

For a general discussion of the role of private elites in the US, I still believe G. William Domhoff’s work Who Rules America? and The Higher Circles is the best summary. For a summary see Professor Domhoff’s web site: http://sociology.ucsc.edu/whorulesamerica/power/national.html