Friday, January 11, 2013

Depression economics on Guam

The Guam Bureau of Statistics and Plans' Cost of Living Program has just recently released its 4th Quarter 2012 report on Guam's Consumer Price Index (CPI). The news is bad. Inflation has been gradually declining, which may sound like good news, but only by ignoring the bigger picture. Disinflation is fine when the economy has been "overheating", driving inflation to really high levels because spending outstrips supply, but is a very bad sign when an economy is depressed, as Guam's is now.

The last two unemployment reports show unemployment rates unmatched in the last 20+ years. Even before that, unemployment has not dropped below 7% in the last 15 years (to our knowledge, as the unemployment reports are very spotty since the late 1990s). It seems unlikely that such high unemployment rates represent full employment. With double-digit unemployment, times are very bad for Guam's working families.

And that's why the news that Guam has been in a disinflationary spiral for 18 months very dangerous. According to the New Keynesian Phillips Curve, there is a trade-off between the output gap (current and expected) and inflation. That means that when inflation is dropping, it's a sign that there is a significant output gap that isn't expected to close right away. Consider the following graph of Guam's recent quarterly inflation rate (on an annualized basis):

What we see is a fairly steady decline in inflation from 2nd Quarter 2011 to 4th Quarter 2012. There is a blip up, which might be accounted for by the tax refunds that people received in late 2011 (if that is it, then it seems to have been at least partially unanticipated), but there is no corresponding "blip" for the refunds that were given in June 2012, which is understandable since there was probably less question that they would be paid out.

Inflation, under Guam's current conditions, is partially driven by government spending (both federal and local). The federal government's spending has been declining and the growth of local government spending is certainly restrained (as it has been for a while). What is different now is that, with pretty much fixed interest rates, there is something that resembles fiscal dominance. Normally, the Federal Reserve could counteract Federal fiscal policy and have residual effects on the local economy (since we use the same currency), but this depression has restrained the standard toolbox of the Fed to set a course for the economy. This means that when the Federal or local government changes fiscal policy, it is more or less unconstrained by Fed policy. Obviously the Fed could raise its target interest rate, but to do so would damage the "recovery" and that is a very unlikely move.

As Paul Krugman has pointed out many times, the government, taken in aggregate, has gradually shifted toward austerity as the stimulus faded out. In Guam, the slide into deflation has been steady since the 4th Quarter of 2011. What this implies is that the economy is depressed and that actors in the economy expect it to remain so. Some of this may have to do with the world situation, although tourism has been trending upwards, recently, but my suspicion is that it has much more to do with fiscal policy. Federal spending is not likely to be a big growth factor, taxes may be set to rise and the local government is not about to make up the difference.

Since a more balanced fiscal path seems to be the political consensus, the only real option is to both conduct revenue enhancement and increase public sector spending sufficiently to more than offset the drag this would represent on the economy. Obviously cutting where operations would not be affected would be ideal, as well, but the point is that GovGuam needs to be mindful of its impacts on the private sector when it conducts excessive andpoorly-timed austerity.

1 comment:

  1. You are so right--definitely related to fiscal policy..... we need to end this race to the bottom that two Republican administrations have kept us in for so many years.....