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One year of Joe Biden as US President: U.S. economy at least one step ahead of euro area

One year has now passed since Joe Biden was inaugurated as US President. He has been able to achieve some of his economic policy goals during this time – such as passing the major aid and stimulus package in March 2021 or getting Congress to approve infrastructure renewal in November. But recently, Joe Biden has also had to take a lot of economic criticism – some blame his expansionary fiscal policy for higher inflation, for example.

Yet there are also positive sides to the strong fiscal stimulus. For example, in contrast to the euro area, the U.S. economy has already returned to the pre-crisis level of economic output seen at the end of 2019 by early summer 2021. One important reason for this is probably the extremely expansionary fiscal policy during the pandemic. In total, three fiscal packages amounting to about 15 percent of U.S. gross domestic product were passed in 2020 and 2021 under Presidents Trump and Biden. These fiscal packages have stimulated private consumption, which already returned to pre-crisis levels by early 2021. But investment has also developed much better in the USA than in the euro area. The subdued investment trend in the euro area is likely to put the brakes on further recovery, especially as companies were already investing more cautiously than in the United States before the pandemic. At least there is reason to hope that the “Next Generation EU” fund will boost investment in the euro area in the coming years.

On the US labor market, these developments have been reflected in significant and rapid improvements. Admittedly, there are still far fewer jobs than before the pandemic because, for example, many people have to look after their children or relatives in need of care at home and have not yet returned to the labor market. But overall, the situation has nevertheless improved much faster than many had expected even as recently as spring 2021. Wages also grew more strongly than in the 2010s.

However, higher inflation has recently eaten up the nominal wage increases again. Although inflation – at an annual rate of 7.0 percent in December – is now expected to ease gradually, also in view of the expiry of the fiscal stimulus, it is likely to remain high this year. For example, the price-driving problems in international supply chains will not disappear any time soon in view of the omicron wave.

In principle, there is no need to fear somewhat higher inflation than in the years before the pandemic. It can be a positive sign of a dynamic economy in which low- and middle-income people also participate via higher wage increases. Nevertheless, there is a risk that inflation will remain long and well above the Fed’s average two percent target and can only be controlled with strong monetary tightening.

The comparatively favorable development of the U.S. economy despite continuing problems is not an isolated case. It has already proved resilient in the past and, for example, grew more strongly than in the euro area after the financial crisis until the start of the pandemic. In the United States, the economy grew by more than a quarter in real terms from 2009 to 2019, compared with only around 15 percent in the euro area. Even Donald Trump’s unpredictable and confrontational leadership has not led to the economic crash that has occasionally been predicted.

To be sure, it is quite possible that the euro area economy will grow more strongly than the U.S. economy in 2022. But this is mainly due to the fact that the US economy is at least one step ahead of the euro area in recovering from the pandemic. For the coming years, the United States has a good chance of leaving many economies in the euro area behind, despite the ongoing domestic political polarization.

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U.S. economy: Lower but still solid growth and higher inflation

The U.S. economy probably grew by a significant annualized 5 to 7 percent in the fourth quarter of 2021 compared with the previous quarter (we will have the exact figures at the end of January). The economic recovery after the pandemic-related slump in the first half of 2020 thus continued. By the summer of 2021, U.S. economic output had already returned to the level of the final quarter of 2019 before the pandemic. In the fourth quarter of 2021, private consumption in particular is likely to have increased at a solid rate, but corporate investment activity is also likely to have picked up. In the wake of strong domestic demand, imports have probably increased at a faster rate than exports, as was the case throughout last year; the trade deficit has therefore probably widened. Many infection control measures in the states had already been relaxed in the summer of 2021. This probably benefited personal services in particular.

At the beginning of the current year, the U.S. economy is now likely to grow less dynamically. The Omicron mutation has led to an enormous number of corona cases. Although hospital admissions and deaths have risen much less sharply than in previous corona waves, the U.S. healthcare system is nevertheless being strained. Pandemic containment measures have been stepped up again regionally. As in previous waves, personal services are suffering the most economically as a result. Although strict containment measures are unlikely as they were last winter, economic recovery will nevertheless be dampened by the spread of the omicron variant.

In addition, the stimulating effect of the fiscal packages adopted in December 2020 and March 2021, which boosted private consumption in particular via cash payments to households and a temporary increase in unemployment benefits, is now gradually coming to an end. Given the high level of savings accumulated during the pandemic, consumer demand is nevertheless likely to be the main growth driver of the U.S. economy in the coming quarters. In the course of 2022 and 2023, however, growth in private consumer spending will gradually weaken. Against this background, business investment will also increase noticeably over the forecast period. Although corporate financing conditions will become somewhat less favorable than recently, they will continue to support the propensity of companies to invest.

The dynamic recovery of the U.S. economy has also steadily improved the situation on the labor market. The unemployment rate was only 3.9 percent in December, down from 6.0 percent in March 2021 and as high as 14.7 percent in April 2020. However, many people have withdrawn from the labor market, at least temporarily. The labor force participation rate in December was still 1.5 percentage points lower than before the pandemic in February 2020, so the official unemployment rate probably underestimates the true extent of unemployment by 1 to 1 ½ percentage points. The labor market situation will continue to improve over the forecast period. In 2022 and 2023, however, the decline in the unemployment rate is likely to be much smaller than recently. In view of increasing labor market shortages, wages are likely to increase noticeably more than before the pandemic.

Inflation has picked up significantly in 2021, reaching a temporary high of an annual 7.0 percent in December 2021. Monetary policy will gradually become less expansionary in the face of this higher inflation and continued economic recovery. Inflation is also expected to be well above three percent this year. The personal consumption expenditures index published by the Bureau of Economic Analysis, which the U.S. Federal Reserve primarily uses for its monetary policy decisions, will also increase by more than three percent in 2022 before price increases might approach the central bank’s average inflation target of two percent in 2023. While much of the higher inflation at the beginning of 2021 was still attributable to temporary factors such as higher oil prices as well as supply bottlenecks and associated price increases for various goods – such as semiconductors and raw materials – a somewhat higher price increase is now visible for a broader number of goods. Against this backdrop, the U.S. Federal Reserve began gradually reducing its securities purchases as early as November 2021 and phasing them out by March 2022. The first increase in key interest rates is expected in March 2022. Two to three further interest rate steps are likely to be added in the current year. In addition, the central bank will probably announce its plans to gradually reduce its balance sheet – i.e. sell U.S. government bonds and mortgage securities – in the coming months. I expect it to start shrinking its balance sheet before the summer. All in all, the U.S. economy will probably grow by 3.8 percent this year. In 2023, the growth rate should be 2.6 percent.

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The Future of Work and Cities: Will More People Live in Cities than Today? – A Fictitious Look Back

In 2035, the statistical office of an advanced economy publishes the latest statistics on the number of inhabitants in cities and rural areas.  For the first time in a long time, the trend often referred to as “urban flight,” which began in the 2020s, is turning around. The proportion of the population living in agglomerations is increasing again, but remains below the level of the 2020s. Many commentators predict that by 2050, significantly more people will be living in cities. In an interview, however, one expert says with a slight smile that a well-known think tank had already been clearly wrong with similar forecasts almost fifteen years ago and that one should therefore be careful with such predictions.

2020 and 2021 marked a turning point worldwide: the corona pandemic had left a lasting mark on people at the time, severely restricting the possibilities for physical exchange for a time and thus leading to a digitalization push in many areas. And even if the measures to curb the pandemic remained temporary – many new behaviors were permanent: Work from home, for example, remained widespread even after the pandemic had subsided.  Proximity to nature had also become more important.  During the lockdown, everyday life had been more pleasant for those who had more living space and lived close to green spaces. Thanks to more work from home, life in the countryside not only became more compatible with working life, but also appeared more relaxed and family-friendly. In addition, already high rent and real estate prices had skyrocketed during the pandemic, which was particularly noticeable in urban centers. As a result, more and more people not only moved to medium-sized towns, but also discovered small villages in remote regions as places to live and work.

Especially among young and urban people and families, it became more and more fashionable to live entirely in the countryside.  Until then, they had mostly opted to live in cities because of the more attractive leisure activities on offer or the better availability of childcare. Rural areas, however, became more and more attractive in this respect due to social innovations. A life in the countryside was soon no longer considered old fashioned but contemporary and, thanks to digital work options from home, also ecological.

Even though more and more people opted for a life in the countryside, it still never became a trend that the majority of people followed. Living in urban agglomerations remained the dominant way of life and most social, cultural and economic activity still took place in urban areas.

The rich and well-educated enjoyed the best of the two worlds. Often, these people had two or even three residences in the countryside and in the city, each of which they spent about equal amounts of time in for both work and leisure purposes. These people were often able to work in hybrid jobs and combined living in spacious apartments or houses in city centers with houses on a lake, by the sea or in mountainous areas. Middle-income people also exhibited similar behavior, living in both smaller apartments in cities and larger homes in the countryside. Low-income people were forced to live in agglomerations close to work more often than others because of their jobs, which were often less amenable to work from home. Overall, the change in people’s behavior led to a much greater demand for housing. A brisk construction activity emerged, which was slowed only briefly even by interim interest rate rises and price corrections.

By the early 2030s, however, there were signs that the trends shown were leveling off. In the meantime, many people living in rural areas had often taken on several jobs that they did exclusively from home.  However, working purely from home meant that these people were now increasingly competing in the labor market with people from other countries. Stress was therefore high and wages developed sluggishly. Privileged in this respect were those people who worked hybrid both from home and in a business office. They were more difficult to replace and had more social contacts. There was greater resentment of these people because they took up a lot of housing in good locations, both in the countryside and in the city, driving up prices. In some cases, their apartments in inner cities were unoccupied for long periods, so that certain cities feared becoming dormitory towns.

More and more people felt uncomfortable in the countryside amid expensive mansions and stressed home workers who seemed to have little time for social contacts or nature. The allure of the new, which had still dominated in the mid-2020s, slowly waned and the cities developed more appeal again. More and more pioneers tried to breathe new life into the increasingly sleepy-looking city districts and agglomerations. They benefited from the fact that housing costs in these places had become relatively low. The dense coexistence in the city, as well as various innovative housing projects, encouraged exchange and the development of new ideas.

So in 2035, cities are facing a renewed boom with their historic old towns and the coming together of different people. However, we are still a long way from the very high proportion of people living in cities that the think tank predicted in 2021.

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What caught my eye: Global supply chain pressures, monetary policy operations, U.S. exports, and much more…

The World Bank Economic Outlook: “Slowing Growth, Rising Risks”:

https://www.worldbank.org/en/publication/global-economic-prospects

Macro Musings with David Beckworth: Lorie Logan on “Monetary Policy Operations, the Fed’s New Standing Repo Facility, and the Future of the Fed’s Balance Sheet”:

https://macromusings.libsyn.com/

“A New Barometer of Global Supply Chain Pressures” (by the Federal Reserve Bank of New York) by Gianluca Benigno, Julian di Giovanni, Jan J. J. Groen, and Adam I. Noble:

“Historical Parallels to Today’s Inflationary Episode” by Chair Cecilia Rouse, Jeffery Zhang, and Ernie Tedeschi:

https://www.whitehouse.gov/cea/written-materials/2021/07/06/historical-parallels-to-todays-inflationary-episode/

“U.S.-China technology competition” A Brookings Global China Interview by Ryan Hass, Patricia M. Kim, Emilie Kimball, Jessica Brandt, David Dollar, Cameron F. Kerry, Aaron Klein, Joshua P. Meltzer, Chris Meserole, Amy J. Nelson, Pavneet Singh, Melanie W. Sisson, and Thomas Wright:

“When Will U.S. Exports Take Off?” by Ruth Cesar Heymann and Julian di Giovanni:

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Quote of the week – Elinor Ostrom

“Scientific knowledge is as much an understanding of the diversity of situations for which a theory or its models are relevant as an understanding of its limits.”

Elinor Ostrom

The last quotes were from David Hume, Hannah Arendt, Janet Yellen, Niccolò Machiavelli, Joseph Schumpeter, Piero Sraffa, Winston Churchill, Christina Romer, Esther Duflo, Peter Drucker, Frank Knight, Joan Robinson, Robert Mundell, Alfred Marschall, Janet Yellen, Ludwig von Mises, Thorstein Veblen, Deirdre N. McCloskey, Paul Samuelson, Elinor Ostrom, Robert Solow, Joan Robinson, and Friedrich A. Hayek.

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The Italian Economy: Solid economic growth but bumpy road ahead

Italy has been in a difficult economic situation for many years. The pandemic made the economic and social Italy has been in a difficult economic situation for many years. Initially, the pandemic made the economic and social problems even worse. After a solid economic recovery in 2021, I am cautiously optimistic for Italy and the Italian economy. Despite various remaining problems, there is hope for new dynamism after the pandemic. After an economic contraction of 9 percent in 2020, economic expansion may have amounted to 6.5 percent in 2021 followed by a growth rate of 4.7 percent in 2022 and an expansion of around 2.4 percent in 2023. Inflation will likely exceed two percent in 2022 before averaging approximately two percent in 2023.

In 2020, the coronavirus pandemic caused a health crisis and a severe recession in Italy leading to a decrease in economic output of nine percent. Economic recovery has been solid so far. My cautious optimism regarding the Italian economy has been confirmed so far. In 2021, the economy probably expanded by well above six percent. The availability of vaccines greatly helped improve the situation. However, it has remained always obvious that virus mutations could make the situation worse again. The so-called omicron mutation currently shows us that some or all the available vaccines might not be fully effective against new mutations. Increased uncertainty and new restrictions to curb the rapid spread of omicron will weigh on economic activity in the first quarter of 2022. Private consumption expenditures – particularly related to personal services – will probably stagnate. Some modest growth rates can be expected, however, for private investment and public spending.

Expansionary fiscal and monetary policies will support the gradual recovery of the economy and the labor market. But the situation will continue to be difficult for a considerable number of people. Monetary policy of the European Central Bank will continue to be expansionary, although the scale of the quantitative easing programs will be gradually reduced in 2022. Inflation will be well above two percent inflation target in 2022. Interest rate increases are generally not expected for 2022. However, I think that a first interest rate increase might be adopted in this year, because my expectations for inflation are somewhat higher than the consensus forecast (I still expect that inflation pressures will be lower in 2023 than in 2022, but price increasing will remain somewhat higher than in the pre-pandemic period).

Importantly, Italy will receive financial support from the recovery fund of the European Union (probably more than 200 billion euros). Many effects of these public expenditures will be relevant for the medium term, but there might also be some smaller short-run impacts. These funds are planned to be used, among others, for infrastructure projects such as high-speed trains, “green” energy, and projects surrounding the “digital economy”. One may expect that the recovery fund will lift the gross domestic product of Italy by around 4 percent in the coming years. In the years to come, the further accumulation of public debt might be a burden and the government should aim at gradually achieving a balanced budget to bring the debt-to-GDP ratio gradually down again in the medium term. The new prime minister, Mario Draghi (the former ECB president), is trying to implement sensible measures to reform the Italian economy. One should not expect miracles, but I am cautiously optimistic for the Italian economy. It has a lot of potential such as a lot of productive small and medium-sized firms and skilled people.

I expect a solid growth rate in 2022. For the whole year 2022, my current forecast is 4.7 percent. The recovery will then slow down to more “usual” rates in 2023. Currently, I expect a growth rate of 2.4 percent. Inflation will be above two percent (the target of the ECB) in 2022 and average around two percent in 2023. The situation on the labor market will also gradually improve, but remain difficult for a considerable number of people. As mentioned above, my expectations for inflation are somewhat higher than the consensus forecast but I still expect that inflation pressures will be lower in 2023 than in 2022. However, price increasing will remain somewhat higher than in the pre-pandemic period. This does not have to be a bad thing. In my view, it will reflect somewhat higher economic dynamism in the euro area and Italy.

For the medium-term, I am cautiously optimistic that the Italian economy will be able to deliver higher productivity and growth rates than in the past decades where economic output and household incomes almost stagnated on average.

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What caught my eye: Labor markets and inflation, central bank digital currencies, international trade, and much more…

“Bottlenecks, labour markets and inflation in the wake of the pandemic” Speech by Hyun Song Shin, Economic Adviser and Head of Research of the BIS, G20 International Seminar “Recover together, recover stronger”, 9 December 2021.

https://www.bis.org/speeches/sp211209.htm

“Revisiting the EU framework: Economic necessities and legal options” by Miguel Maduro, Philippe Martin, Jean-Claude Piris, Jean Pisani-Ferry, Lucrezia Reichlin, Armin Steinbach and Beatrice Weder di Mauro:

“Project Jura – Cross-border settlement using wholesale CBDC”:

https://www.bis.org/publ/othp44.htm

Mundell-Fleming Lecture: 2021 IMF Annual Research Conference by Pierre-Olivier Gourinchas (University of California, Berkeley) on International Macroeconomics: From the Great Financial Crisis to the Great Lockdown, and Beyond:

https://www.imf.org/en/Videos/view?vid=6282142610001

“Finance and technology conference 2021 on crypto-assets and asset tokenization” November 5th, 2021, Swiss Tech Convention Center, EPFL:

“Trade, development and political economy: The life and work of Ronald Findlay, 1935-2021” by Douglas Irwin:

https://voxeu.org/article/ronald-findlay-1935-2021

“Focus on bank supervision, not just bank regulation” by Peter Conti-Brown and Sean Vanatta:

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Quote of the week – David Hume

“In our reasonings concerning matter of fact, there are all imaginable degrees of assurance, from the highest certainty to the lowest species of moral evidence. A wise man, therefore, proportions his belief to the evidence.”

David Hume

The last quotes were from Hannah Arendt, Janet Yellen, Niccolò Machiavelli, Joseph Schumpeter, Piero Sraffa, Winston Churchill, Christina Romer, Esther Duflo, Peter Drucker, Frank Knight, Joan Robinson, Robert Mundell, Alfred Marschall, Janet Yellen, Ludwig von Mises, Thorstein Veblen, Deirdre N. McCloskey, Paul Samuelson, Elinor Ostrom, Robert Solow, Joan Robinson, and Friedrich A. Hayek.

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U.S. economy: solid economic growth rates despite various headwinds

In October and November, the U.S. economy seems to have regained some momentum. In late summer, however, the U.S. economy hit the brakes. Against the backdrop of problems with international supply chains and higher Corona infection numbers, economic output increased only slightly by 0.5 percent in the third quarter. Even though GDP is expected to grow faster again at the end of the year, the coming months will remain difficult. There are increased uncertainties surrounding the new Omicron mutation. Recently, however, the situation on the labor market has improved more rapidly than in the summer (although there are various measurement issues concerning the labor market). This year, I expect the U.S. economy to grow by 5.7 percent. For 2022 and 2023, I then expect growth rates of 3.8 and 2.6 percent. Inflation will probably average more than 5 percent in 2021 and might be well over three percent next year. Is this the new normal? Moderate growth with somewhat higher inflation?

In the United States, gross domestic product in the third quarter of the current year increased by only an annualized 2.1 percent compared with the previous quarter. Although economic output had already returned to pre-pandemic levels by the summer, momentum has slowed considerably compared with the first half of the year. Against the backdrop of problems with international supply chains and higher Corona infection rates, private consumption in particular increased only slightly. Business investment also increased only moderately.

The economy is expected to pick up again in the fourth quarter, although the pandemic is still there and there are increased uncertainties surrounding the new Omicron mutation. Corona case numbers have recently fallen again, although there are likely to be repeated increases in the coming months. The fiscal packages passed in December and March, as well as savings from the lockdown periods, continue to support private consumption.

The purchasing manager indices from the Institute for Supply Management and IHS Markit were recently still well above the expansion threshold of 50 index points, but have not reached the highs of early summer. The picture is similar for consumer sentiment. Consumers are less optimistic than in the summer. In particular, higher inflation is worrying many people.

The fiscal packages adopted in December and March are still having a stimulating effect. With a volume of around 13 percent of GDP, they have injected a great deal of liquid funds into households – in particular via one-off payments and the temporary increase in unemployment benefits until September. Even if the stimulating effect of the fiscal packages is now gradually fading, consumer demand is likely to remain the main driver of growth in the US economy in the coming quarters. In the course of 2022 and 2023, growth in private consumer spending will then gradually weaken. The recovery of the US economy will also continue to improve the situation on the labor market. The unemployment rate in November was only 4.2 percent, down from 6.9 in October 2020 and 14.7 percent in April 2020. The steady, but somewhat bumpy recovery can also be seen in solid growth rates of jobs. Since the start of the pandemic, however, measurement problems are particularly strong when assessing the labor market. It is expected that further fiscal packages will be adopted by the end of the year, but these will be mainly medium-term oriented and include spending on infrastructure, renewable energy sources and education and social purposes.

Monetary policy remains expansionary – also because the central bank is temporarily accepting higher inflation due to its revised monetary policy strategy.  In the current year, inflation is likely to average more than 5 percent. Even after the gradual fading of some temporary influences, inflation is likely to remain well above the medium-term inflation target of two percent in 2022, given continued dynamic domestic demand and international supply chain disruptions.

Against this backdrop, the U.S. Federal Reserve started to gradually make its monetary policy less expansionary in November and December. This initially involves a gradual reduction in monthly securities purchases. This process is expected to be completed by March 2022. The first key interest rate increases are expected in summer 2022. All in all, the U.S. economy is likely to expand by 5.7 percent in the current year, which is somewhat less than I had recently expected. In 2022 and 2023, economic growth rates are likely to be 3.8 and 2.6 percent. Inflation is likely to average more than 5 percent in 2021 and is also likely to be above three percent in the coming year.

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Japan: Economic recovery in sight, but remains subdued

In Japan, gross domestic product contracted by 0.8 percent quarter-on-quarter in the third quarter of 2021, after the economy had recovered slightly by 0.4 percent in the second quarter in view of temporary easing of pandemic containment measures. Both private consumption and business investment have recently declined, with only public sector consumption and investment spending increasing slightly. The marked decline in domestic demand contributed to lower imports, which contracted more sharply than exports.

The Japanese economy is expected to pick up again slightly in the fourth quarter. Corona case rates have fallen recently and the vaccination rate has increased significantly after a slow start to the vaccination program. Against this backdrop, containment measures have been eased. There are increased uncertainties surrounding the new Omicron mutation. Business sentiment and consumer confidence improved somewhat in the fall, but are likely to remain subdued, particularly in light of the new Omicron mutation.

Expansionary fiscal and monetary policy will support the moderate recovery process of the Japanese economy in winter 2021/22. The new Japanese head of government Fumio Kishida is planning further fiscal stimulus measures. Monetary policy also remains expansionary in view of low inflation rates. The Japanese central bank’s two percent inflation target will probably not be reached in the forecast period despite the continued expansionary monetary policy.

Foreign demand, which has been weak recently, is expected to recover somewhat, but high export growth rates are not anticipated; the economy has recently cooled in many regions of the world. In addition, problems with international supply chains are likely to persist until summer 2022.

The stable situation on the labor market should also support household consumption. Despite the economic slump, the official unemployment rate has increased only slightly since the outbreak of the pandemic; in September 2021, the unemployment rate was only 2.8 percent, having risen from 2.2 at the end of 2019 to just over three percent in October 2020; the government’s short-time work program and Japanese companies’ reluctance to lay off workers in particular have probably prevented unemployment from rising more sharply. However, wage development is sluggish – which is another reason why there is no inflationary pressure in Japan. Recently, the Japanese head of government called on companies to allow a “three percent” increase in wages in the upcoming wage negotiations.

All in all, gross domestic product is likely to increase by 1.6 percent in the current year. In 2022 and 2023, growth rates will probably be 2.4 and 1.4 percent respectively.

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What caught my eye: Stablecoins, taxation of business income in the global economy, and the invention of economic growth

“Report on Stablecoins”: President’s Working Group on Financial Markets Released Report and Recommendations on Stablecoins:

https://home.treasury.gov/news/press-releases/jy0454

“Next STEP Global Conference 2021”, Peterson Institute for International Economics (PIIE) and Lee Kuan Yew School of Public Policy (LKYSPP):

https://www.piie.com/events/next-step-global-conference-2021

“The 2021 Martin Feldstein Lecture: The Taxation of Business Income in the Global Economy”:

https://www.nber.org/lecture/2021-martin-feldstein-lecture-taxation-business-income-global-economy

“The Invention of Economic Growth: The Forgotten Origins of Gross Domestic Product in American Institutionalist Economics” by Onur Özgöde:

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