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What Comes After the Evans Rule?, by Tim Duy: Since the last FOMC meeting, market participants have grown cautious about the near term path of monetary policy, sending two year rates higher even as the Fed lowers their expectation of the policy path. Is this entirely justified by the economic data, or is another explanation at work? I suggest that the Evans rule has turned hawkish and will increasingly be a challenge for Federal Reserve policy. In short, the nature of forward guidance is very much a question for 2014.
I believe it was David Andolfatto who first recognized the hawkish nature of the Evans Rule:
As Chairman Bernanke stressed in his press conference, the new policy does not imply that the Fed will necessarily raise its policy rate should the unemployment rate fall below the 6.5% threshold...But surely, if the unemployment rate crosses this threshold, the perceived probability of an imminent rate hike is likely to spike up. Absent the unemployment rate threshold, the market would likely expect the policy rate to instead remain low for a longer period of time. This is the hawkish nature of the Evans rule.
Take this in light of Accross the Curve's commentary today:
Several participants with whom I have spoken have expressed concern about the unemployment rate and how much it will drop when those jobless whose benefits expired drop out of the work force. That will be a participation rate event but since the FOMC did not tamper with threshold some are concerned about a big drop in the rate.
As I noted yesterday, there was some disappointment that the Fed did not change the thresholds. The Fed wants it both ways - they want the impact of changing the threshold without actually changing the threshold. Hence this sentence appears in the statement:
The Committee now anticipates, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal.
The Fed does want to be bound by rules; they want discretion. That is exactly what this sentence is meant to provide. Why don't they want rules? Because they don't know what the rule should be. Remember Federal Reserve Chairman Ben Bernanke's press conference - he thinks the decline in the labor force participation rate is largely structural and that current wage growth is sufficient to deliver a 2% inflation rate. He doesn't doesn't sound like he wants his hands tied by some rule, because he doesn't know where to draw the line. 6.5 percent is easy. Is 5.5 percent?
Indeed, those who want the Fed to have rules should pay attention to San Francisco President John Williams:
That said, I expect that the explicit link between future policy actions and specific numerical thresholds, as in the recent FOMC statements, will not be a regular aspect of forward guidance, at least when the federal funds rate is not constrained by the zero lower bound. This guidance has proven to be a powerful tool in current circumstances, when conventional policy stimulus has been limited by the zero lower bound. But such communication is difficult to get right and comes with the risk of oversimplifying and confusing rather than adding clarity. Therefore, in normal times, a more nuanced approach to policy communication will likely be warranted. I see forward guidance typically being of a more qualitative nature, highlighting the key economic factors that affect future policy actions.
This isn't the description of a rule. "Nuance" is equal to "discretion." Rules? We don't need no stinkin' rules! Rules are just an artifact of the zero bound. Once the economy is off the zero bound, Williams is looking to revert to business as normal - loose, discretionary forward guidance, nothing that locks down policy like the Evans rule.
The Fed is faced with a problem here. There is a high probability of smashing through the 6.5% threshold by midyear, rendering the Evans rule pointless. But what replaces the Evans rule? They do not want to lower the threshold unless they were absolutely positive they would not hike rates before that point. But they are not absolutely positive, so they hesitate. At the same time, they do not want the markets to front-run policy. But without a rule, and with a very clear desire to end their other non-conventional tool, asset purchases, can they control expectations? Once we hit 6.5%, we are in a zone in which the Fed is NOT committed to zero interest rates. We enter a zone where the null hypothesis must be that the Fed is biased towards raising rates simply because they are not willing to commit to a rule that suggests otherwise.
Another way to think about this is now that they set a rule, markets will evaluate policy against that rule. It is not easy to just pretend the rule never existed and slip back into discretionary policy.
In the absence of rules, we are looking at the possibility of a volatile year in bond markets as participants attempt to front-run the Fed, and in response the Fed tries to front-run the markets. This is exactly what happened with quantitative easing. Because it was not rule-based but instead discretionary (whatever definition of "stronger and sustainable" the Fed believes is appropriate at the moment), expectations for future policy, and with it interest rates, shifted throughout the year. Once we pass through 6.5 percent unemployment, we are right back there. Although we all know the Fed has said they expect to hold rates at zero for an extended period, they haven't promised to do so. Without that promise, challenges should be expected. The stronger the data, the bigger the challenge.
Bottom Line: The end of the Evans rule is fast approaching. The Fed does not have a backup plan other than talk. Are there new rules ahead? Or is it all discretion? And could you get a divided Fed to agree to new dovish rules in any event? They don't seem eager to change the thresholds. How much stress will force their hand? Might be tough times for Fed communications ahead.
Posted by Mark Thoma on Tuesday, December 31, 2013 at 12:24 AM in Economics, Fed Watch, Monetary Policy |
Posted by Mark Thoma on Tuesday, December 31, 2013 at 12:03 AM in Economics, Links |
The deficit scolds have been discredited:
Fiscal Fever Breaks, by Paul Krugman, Commentary, NY Times: In 2012 President Obama, ever hopeful that reason will prevail, predicted that his re-election would finally break the G.O.P.’s “fever.” It didn’t.
But the intransigence of the right wasn’t the only disease troubling America’s body politic in 2012. We were also suffering from fiscal fever... Instead of talking about mass unemployment and soaring inequality, Washington was almost exclusively focused on the alleged need to slash spending (which would worsen the jobs crisis) and hack away at the social safety net (which would worsen inequality).
So the good news is that this fever, unlike the fever of the Tea Party, has finally broken. ... What changed?...
First, the political premise behind “centrism” — that moderate Republicans would be willing to meet Democrats halfway in a Grand Bargain combining tax hikes and spending cuts — became untenable. There are no moderate Republicans. ...
Second, a combination of rising tax receipts and falling spending has caused federal borrowing to plunge. This is actually a bad thing, because premature deficit-cutting damages our still-weak economy... But a falling deficit has undermined the scare tactics so central to the “centrist” cause. Even longer-term projections of federal debt no longer look at all alarming.
Speaking of scare tactics, 2013 was the year journalists and the public finally grew weary of the boys who cried wolf... — for example, when Erskine Bowles and Alan Simpson ... warned that a severe fiscal crisis was likely within two years. But that was almost three years ago.
Finally, over the course of 2013 the intellectual case for debt panic collapsed. ... For ... several years fiscal scolds ... leaned heavily on a paper by ... Carmen Reinhart and Kenneth Rogoff, suggesting that government debt has severe negative effects on growth when it exceeds 90 percent of G.D.P. ...
Then Thomas Herndon, a graduate student at the University of Massachusetts, reworked the data, and found that the apparent cliff at 90 percent disappeared once you corrected a minor error and added a few more data points. ...
Still, does any of this matter? You could argue that it doesn’t — that fiscal scolds may have lost control of the conversation, but that we’re still doing terrible things like cutting off benefits to the long-term unemployed. But while policy remains terrible, we’re finally starting to talk about real issues like inequality, not a fake fiscal crisis. And that has to be a move in the right direction.
Posted by Mark Thoma on Monday, December 30, 2013 at 12:42 AM in Budget Deficit, Economics, Fiscal Policy, Politics |
Inflation, Wages, and Policy, by Tim Duy: As something of a addendum to my last piece, I wanted to follow up on the take-down of the inflation story by Ethan Harris of BAML as reported by Sam Ro at Business Insider. Harris' argument is that there is plenty of slack in the labor market, so there is no reason to worry that wage growth-fueled inflation is just around the corner. Fair enough; I have always said that the ultimate test of the theory that labor markets were tight would be higher wages. The part I wanted to follow up on was this quote:
Moreover, even if wages do inch higher, we are a long way from the normal 3 or 4% rate that could start to create serious pricing pressure.
I think this overlooks an important point - the Federal Reserve has historically tightened policy at or before wage growth turns upward and the policy peak occurs when wage growth is hovering in the 4-4.5 percent range:
In other words, we don't need to see wage growth high enough to create price pressures to trigger tighter monetary policy. Typically, the Fed is tightening policy ahead of higher wage growth. This, I think, is one reason to question the Fed's stated policy path and also explains why the Fed would be hesitant to embrace a lower unemployment threshold. The fact that wages are rising while unemployment remains high is probably something of a puzzle to them, and lends credence to the stories that the labor market is currently affected by severe structural issues even though they see the same measures of labor market slack that Harris identifies.
So it is not that the Fed is currently behind the curve, but that the upturn in wage growth will make them worry that they will need to act to prevent them from falling behind the curve. It is also another reason why they want to extract themselves from QE as soon as possible; they want to be prepared to act quickly should they find they took an overly dovish view of the labor market. I think there is a lot of uncertainty regarding unemployment/wage/inflation dynamics at the moment, and that uncertainty is not making the Fed happy given the size of the balance sheet.
Also consider also Federal Reserve Chairman Ben Bernanke's justification for expecting inflation to trend toward the Fed's 2 percent target. From his press conference (emphasis added):
First, there are some special factors, such as health-care costs and some other things, that have been unusually low and might be reversed. Secondly, if you look at the fundamentals for inflation, including inflation expectations, whether measured by financial markets or surveys; if you look at growth, which we now anticipate will be picking up both in the U.S. and internationally; if you look at wages, which have been growing at 2 percent and a little bit higher according to many indicators—all of these things suggest that inflation will gradually pick up.
In short, although as Harris states we would not expect significant price pressures until wage growth accelerates further, wage growth is already at a rate that biases the Federal Reserve toward tighter policy (or, at a minimum, less accommodative policy). Even the current meager wage growth rate is used as justification to ignore the inflation trend and initiate a plan to end asset purchases. What then might be the possibilities for policy from even slightly higher wage growth?
Posted by Mark Thoma on Monday, December 30, 2013 at 12:33 AM in Economics, Fed Watch, Monetary Policy |
On Challenging the Fed, by Tim Duy: At first blush, the Federal Reserve looked to have pulled off an almost seamless hand-off of accommodation from quantitative easing to forward guidance at the last FOMC meeting. The announcement of the long-awaited taper was met with a subdued bond market reaction while stocks soared. Since then, however, bond yields have climbed, breaching the three percent mark at the end of last week. Mortgage rates have been pulled along for the ride, and if they continue higher, the sustainability of the housing recovery will again be questioned. As discussed earlier by Matt Boesler at Business Insider, this very much looks like a challenge to the Federal Reserve's forward guidance. Or is it? It is not really a "challenge" if it simply reflects expectations of what a data-dependent policymaker would do in the face of a stronger than expected economy. I think a little of both is happening.
Policymakers will be alert to signs that recent gains in rates look to be driven by expectations that the Fed will hike rates sooner than suggested by the Fed's own forward guidance. Relying on the separation principle so well defined by Gavyn Davies, the Fed would be less concerned with rate increases driven by a higher term premium. Using the two year Treasury rate as a proxy for the forward path of short rates, however, it looks clear that market participants are fundamentally reassessing Fed policy:
Note too that recent movements are not in response to higher expected inflation, and thus represent rising real rates:
What is somewhat remarkable about higher short-term rates is that at their December meeting the Fed lowered the expected path of interest rates. The average of rate expectations for year end 2015 was 106bp, down from 125bp in September. In effect, the Fed and the market are moving in different directions.
What could account for the difference? Of most concern to the Fed is that market participants simply do not believe the Federal Reserve is committed to a sustained low rate path. But what has changed to make markets doubt the Fed? To answer this, consider that the low rate story was driven by a combination of faith in the optimal control framework championed by incoming Federal Reserve Chair Janet Yellen and the belief that the decline in the unemployment rate was overstating the improvement in the labor market. I tend to think that Federal Reserve Chairman Ben Bernanke threw cold water on both ideas in his final press conference.
In the press conference, Robin Harding jumps on the Fed's tapering decision in light of the optimal control framework:
ROBIN HARDING. Robin Harding from the Financial Times. Mr. Chairman, your inflation forecasts never get back to 2 percent in the time horizon that you cover here, out to 2016. Given that, why should we believe the Fed has a symmetric inflation target? And, in particular, why should we believe you’re following an optimal policy—optimal control policy, as you’ve said in the past—given that that would imply inflation going a bit above target at some point? Thank you.
CHAIRMAN BERNANKE. Well, again, these are individual estimates, there are big standard errors implicitly around them and so on. We do think that inflation will gradually move back to 2 percent, and we allow for the possibility, as you know, in our guidance that it could go as high as 2½ percent. Even though inflation has been quite low in 2013, let me give you the case for why inflation might rise...
After explaining why the Fed expects inflation to move higher, Bernanke adds:
CHAIRMAN BERNANKE. Well, even under optimal control, it would take a while for inflation—inflation is quite—can be quite inertial. It can take quite a time to move. And the responsiveness of inflation to increasing economic activity is quite low. So—and particularly given an environment where we have falling oil prices and other factors that are contributing downward forces on inflation, it’s difficult to get inflation to move quickly to target. But we are, again, committed to doing what’s necessary to get inflation back to target over the next couple of years.
In other words, don't believe all those nice little charts Yellen has been touting that show inflation smoothly rising above two percent. We are not trying to recreate those charts, so don't expect us to maintain accommodation even if inflation is below two percent. And, by the way, we aren't really trying to drive inflation above two percent, we are just making clear that we will not panic if inflation is up to 50bp above target. Moreover, a symmetric target also means that we will not panic if inflation is 50bp below target, and it is easy to see how we get to that minimum level.
I don't really believe they will not panic if inflation crosses two percent. I think that, given the size of the balance sheet, they will panic. In my mind, the decision to taper only reinforces my belief that the Fed is more comfortable with inflation below two percent than above it. The target is not symmetric.
Regarding unemployment, read carefully:
MURREY JACOBSON. Hi. Murrey Jacobson with the NewsHour. On the question of longer-term unemployment and the drop in labor force participation, how much do you see that as the result of structural changes going on in the economy at this point? And to what extent do you think government can help alleviate that in this environment?
CHAIRMAN BERNANKE. I think a lot of the declines in the participation rate are, in fact, demographic or structural, reflecting sociological trends. Many of the changes that we’re seeing now, we were also seeing to some degree even before the crisis, and we have a number of staffers here at the Fed who have studied participation rates and the like. So I think a lot of the unemployment decline that we’ve seen, contrary to sometimes what you hear, I think a lot of it really does come from jobs as opposed to declining participation.
That being said, there certainly is a portion of the decline in participation, which is related to people dropping out of the labor force because they are discouraged, because their skills have become obsolete, because they’ve lost attachment to the labor force, and so on. The Fed can address that, to some extent, if—you know, if we’re able to get the economy closer to full employment, then some people who are discouraged or who have been unemployed for a long time might find that they have opportunities to rejoin the labor market.
But I think, fundamentally, that training our workforce to fit the needs of 21st-century industry in the world that we have today is the job of both the private educational sector and the government educational sector...
With each passing month, the Fed is moving closer and closer to the belief that the decline in unemployment is not to be dismissed as simply a cyclical decline in labor force participation that will soon be reversed. Indeed, I suspect this is why the Fed is not likely to lower the unemployment threshold anytime soon. And if the Fed is now taking the unemployment rate decline at face value, consider the implications for policy given the path of unemployment:
It doesn't take much to believe that policymakers will find themselves hiking interest rates sooner than anticipated as they increasingly believe that a rise of labor force participation is not coming - and it doesn't sound like Bernanke expects to see much of a rise. Do others? Does Yellen?
In short, it is easy to see why financial market participants would be rethinking the path of short-term rates given that the Fed is dismissing the low inflation numbers and embracing the structural explanations for declining labor force participation. Furthermore, there was some expectation that the Fed would change the unemployment thresholds as an "action" to cement the forward guidance and to counter the "action" of reducing the pace of asset purchases. The Fed disappointed on that front. The old adage "actions speak louder than words" comes to mind. It comes back to the problem the Fed faced this summer - how essential is the tool of quantitative easing in controlling the path of short-term interest rates? Can the Fed effectively promise an interest rate path that is not consistent with past behavior without the "action" tool of asset purchases to put muscle into their words?
If the Fed believes that market participants are fundamentally misreading their intentions, they will want to push back against the current rise in short term rates. They will try to do so verbally at first; I believe they will be very resistant to reversing the taper or lower the unemployment threshold. Those are tools that I anticipate the Fed will use only if they believe they have completely lost control of the expectations for short rates.
Another possibility, however, is that the Fed validates the rise in rates by pointing to signs of stronger growth. After all, the Fed's forecast is data dependent - it is not truly a challenge to the Fed's forward guidance if economic conditions change such that a different path of short term rates is appropriate. Almost certainly you should expect the hawks to embrace this explanation. More interesting, and with the possibility of creating significantly more volatility in bond markets, is the situation in which doves also embrace the "stronger growth" explanation for higher short-term yields. This, I suspect, would lead market participants to further reject the current forward guidance.
As a final possibility, consider that the recent market movements may simply reflect trading in thin holiday markets, in which case the current "markets challenging the Fed" theme would be expected to disappear quickly in the new year.
Bottom Line: The Fed's stated expected rate path looks overly dovish relative to policymakers' growing belief that the declining unemployment rate should be taken at face value and their dismissal of low inflation when making the decision to taper. Consequently, short rates are moving higher, taking long rates with them. The interpretation of these moves is complicated by stronger economic data, suggesting not that the Fed is being challenged, but that a data dependent Fed will find its current expectations inconsistent with actual path of the economy. I tend to think some of both factors are at play - that any lingering doubts about the Fed's commitment are only aggravated by better data. How doves react to rising rates is critical. They will cement the shifting expectations if they embrace the rise as an expected response to stronger data.
Posted by Mark Thoma on Monday, December 30, 2013 at 12:24 AM in Economics, Fed Watch, Monetary Policy |
Posted by Mark Thoma on Monday, December 30, 2013 at 12:03 AM in Economics, Links |
Mixed thinking about markets: ... Chris Berg ... wants to argue that all the good things that have happened in the last two centuries are the product of the “market economy”, and that we should therefore scrap our existing social arrangements in favor of radical reforms in which market forces are given free rein.
In reality, modern society is characterized by a mixed economy, in which large components of economic activity take place outside the market, within households or through publicly funded and provided services. Even within the private business sector, the majority of activity takes place within corporations whose internal operations are characterized by central planning, not markets.
All of this reflects the fact that a pure market economy doesn’t work well. Rather than list all the problems which have led modern societies to constrain the role of markets (environmental pollution, inequality and so on), I’ll focus on the one discussed by Berg, that of technological innovation. Information is what economists call a public good... And while it’s possible to keep useful information secret for a while, it gets harder and harder over time. So, a pure market system often doesn’t provide much of a reward to people who come up with new ideas.
All sorts of solutions to the problem have been developed. They include patents (a temporary grant of government-enforced monopoly), prizes and awards, and publicly funded research institutions such as universities. ...
Berg’s argument is an example of a characteristic fallacy among advocates of market liberalism. Beginning with the fact that all modern societies are, in some sense, capitalist, they point to the successes of modern society to argue in favor of a particular version of capitalism (free markets, on the US model but taken even further) and against others that have been more successful in terms of human welfare (various forms of social democracy) or that might exist in the future. ...
Posted by Mark Thoma on Sunday, December 29, 2013 at 07:39 AM in Economics, Market Failure |
Posted by Mark Thoma on Sunday, December 29, 2013 at 12:03 AM
Living Standards in an Open Economy: The Danger of Front-Loading Income Inequality, by Lane Kenworthy: Over the past decade, the American left has directed a growing share of its attention at income inequality.
Indeed, for some, reducing income inequality seems to have become the central goal.
There are compelling reasons to object to America's high and rapidly rising level of income inequality.
One is fairness. Much of what determines a person's earnings and income - intelligence, creativity, physical and social skills, motivation, persistence, confidence, connections, inherited wealth, discrimination - is a product of genetics, parents' assets and traits, and the quality of one's childhood neighborhood and schools. These aren't chosen; they are a matter of luck. A non-trivial portion of income inequality is therefore undeserved.
Second, income inequality may increase inequality of other valuable things, such as education, health and happiness. Even if we think greater inequality in the distribution of income is acceptable, we may feel that greater inequality in the distribution of health, schooling and subjective well-being is not.
Third, a rise in income inequality contributes to slower absolute income growth for those in the middle and at the bottom.
These, however, are not the rationales commonly put forward for worrying about income inequality. Instead, the most common arguments are that inequality is bad for the economy, overall health, opportunity and democracy. "Of all the competing and only partially reconcilable ends that we might seek," writes Tony Judt in Ill Fares the Land, 'the reduction of inequality must come first. Under conditions of endemic inequality, all other desirable goals become hard to achieve?" Is that true? ...[continue]...
Posted by Mark Thoma on Saturday, December 28, 2013 at 05:05 PM in Economics, Income Distribution |
Posted by Mark Thoma on Saturday, December 28, 2013 at 12:03 AM in Economics, Links |
Unemployment and Profits: A dirty little secret, by Bill McBride: I'd like to repeat something I wrote 2 1/2 years ago:
[I]t really isn't much of a secret that Wall Street and corporate America like the unemployment rate to be a little high. But it is "dirty" in the sense that it is unspoken. Higher unemployment keeps wage growth down, and helps with margins and earnings - and higher unemployment also keeps the Fed on the sidelines. Yes, corporations like to see job growth, so people have enough confidence to spend (and they can have a few more customers). And they definitely don't want to see Depression era unemployment - but a slowly declining unemployment rate (even at 9%) with some job growth is considered OK.
Not much has changed (the unemployment rate is still high at 7%). And I still think unemployment should be the #1 political issue. ...
A high unemployment rate keeps wages down for most working Americans - and the recent income growth has flowed mostly to the owners of corporations and not to labor. This is not an ideal economic situation for most Americans (but ideal for a few). Enough rant - and I hope I don't repeat this again in another 2 years.
best to all
Posted by Mark Thoma on Friday, December 27, 2013 at 10:00 AM in Economics, Unemployment |
Why has Congress turned its back on the unemployed?:
The Fear Economy, by Paul Krugman, Commentary, NY Times: ... Some people would have you believe that employment relations are just like any other market transaction; workers have something to sell, employers want to buy what they offer, and they simply make a deal. But anyone who has ever held a job in the real world — or, for that matter, seen a Dilbert cartoon — knows that it’s not like that.
The fact is that employment generally involves a power relationship: you have a boss, who tells you what to do, ... and high unemployment has greatly weakened workers’ already weak position in that relationship.
We can actually quantify that weakness by looking at the quits rate... Quitting is ... a risk; unless a worker already has a new job lined up, he or she doesn’t know how long it will take to find a new job, and how that job will compare with the old one.
And the risk of quitting is much greater when unemployment is high, and there are many more people seeking jobs than there are job openings. As a result, you would expect to see the quits rate rise during booms, fall during slumps — and, indeed, it does. ...
Now think about what this means for workers’ bargaining power. When the economy is strong, workers are empowered. They can leave if they’re unhappy ... and know that they can quickly find a new job if they are let go. When the economy is weak, however, workers have a very weak hand, and employers are in a position to work them harder, pay them less, or both.
Is there any evidence that this is happening? And how..., at this point, after-tax profits are more than 60 percent higher than they were in 2007, before the recession began. We don’t know how much of this profit surge can be explained by ... the ability to squeeze workers who know that they have no place to go. But it must be at least part of the explanation. ...
What’s more, I don’t think it’s too much of a stretch to suggest that this reality helps explain why our political system has turned its backs on the unemployed..., the economy may be lousy for workers, but corporate America is doing just fine. ...
Too many Americans currently live in a climate of economic fear. There are many steps that we can take to end that state of affairs, but the most important is to put jobs back on the agenda.
Posted by Mark Thoma on Friday, December 27, 2013 at 01:17 AM in Economics, Unemployment |
Posted by Mark Thoma on Friday, December 27, 2013 at 12:03 AM in Economics, Links |
British Economic Triumphalism in Perspective, by Menzie Chinn: Prime Minister Chancellor of the Exchequer Osborne has lauded the recent UK growth numbers as validation for the policy of austerity  (recently relaxed, although he doesn't mention that). ...
I think it useful to compare the US and the UK. The former embarked upon a policy of fiscal stimulus, and then retrenchment, but nothing compared to the retrenchment implemented in the latter. And in the US, per capita GDP growth was much more rapid than in the UK.
The gap between the two series is 7.3% as of 2013Q3. So, the growth in the UK now is merely digging the economy out of a big hole dug for itself in the search of expansionary fiscal contraction. .
Figure 1: Log per capita US GDP, in Ch.09$ (blue) and per capita UK GDP, in Ch.2010£ (red). UK population is annual midyear data from IMF WEO, interpolated using quadratic match. Source: BEA, ONS, IMF WEO (October).
Posted by Mark Thoma on Thursday, December 26, 2013 at 12:33 AM in Economics, Fiscal Policy, Politics |
In the long-run, inflation is driven primarily by changes in money growth, but over shorter timeframes the connection is not as strong:
Prices from a Monetary Perspective, by Owen F. Humpage and Margaret Jacobson, FRB Cleveland: Economists like to remind people that inflation and deflation are monetary phenomena and that they ultimately stem from central banks’ monetary policies. Inflation results when a nation’s central bank creates more money than its public wants to hold, and deflation occurs when a central bank creates too little. The connection between central banks’ monetary policies and inflation, however, is imprecise and often drawn out over many years. This imprecision happens for two reasons: Not all price changes stem from inflation; some instead reflect an emerging scarcity or abundance of particular goods. And the public’s demand for money, the amount it wants to hold, often is not very stable. Economists can, however, employ a simple technique that helps us see more clearly the relationship between money and price movements.
To get at the monetary nature of inflation and deflation, economists can divide price changes into two components: excess-money growth and changes in the velocity of money. Excess-money growth is simply the difference between the growth of money and the growth in real output. The velocity of money, in theory, represents the average rate at which money changes hands in a given time period. In practice, economists calculate velocity as anything that affects aggregate prices besides excess-money growth. Velocity might, for example, respond to relative price changes, price controls, and factors that affect money demand besides real GDP, like interest rates or inflation expectations.
Applying this framework to the U.S. GDP deflator—a very broad price measure—provides an example. The GDP deflator rose 1.3 percent on average during the first three quarters of 2013. This average price change consisted of a 4.3 percent increase in excess-money growth and a 3 percent decline in velocity. As this method shows, the connection between aggregate price movements and U.S. money growth over the course of 2013 was so loose as to be unapparent.
This imprecision is not unusual. Over the short run—a year or two—excess-money growth explains very little of the changes in the GDP deflator. If excess-money growth explained all of the annual price changes, the dots in the scatter plot below would line up along the 45-degree line, and all price movements would be inflation—strictly a monetary phenomenon. Instead, the dots are spread about, showing almost no correspondence between the annual change in the GDP deflator and excess-money growth. The simple correlation coefficient is only 0.10. Moreover, the typical annual dispersion of price changes from excess-money growth is about 4 percentage points, but there are some enormous outliers. Many of the largest deviations occurred during the Great Depression and the Second World War, both highly disruptive and uncertain economic events. Likewise many dots associated with the recent Great Recession years also seem well off the mark. Clearly, central banks do not have much control over aggregate-price movements on a year-to-year basis.
As time passes, the effects of nonmonetary events (velocity) on the GDP deflator fade and the connection between excess-money growth and prices starts to predominate. Five-year averages of excess-money growth and price changes, for example, line up more closely along the 45 degree line. At this interval, the correlation between excess-money growth and price changes increases to 0.72, and the typical annual dispersion of price changes from excess-money growth falls by roughly half, to about 2 percentage points. Still, big outlying observations exist; particularly noticeable are again those associated with the Great Depression and the Second World War.
The velocity of money often falls during recessions or shortly thereafter, and its decline can persist for a long time after an economic recovery has taken hold. This is certainly true today. Since the onset of the Great Recession in 2007, the velocity of money in the United States has fallen sharply, at an annual average rate of 3.1 percent. This decline has offset average annual excess-money growth of 4.9 percent, resulting in an average annual increase in the GDP deflator of 1.8 percent.
While many factors affect prices that are beyond the Federal Reserve’s direct control, eventually monetary policy tends to re-emerge as the key driver of inflation. After abstracting from short-term movements caused by economic disruptions, recessions, and wars, inflation is ultimately a monetary phenomenon: since 1929, the average annual percentage increase in the GDP deflator has been 2.8 percent, and the average annual growth in excess money has been 2.9 percent.
Posted by Mark Thoma on Thursday, December 26, 2013 at 12:24 AM in Economics, Inflation, Monetary Policy |
Posted by Mark Thoma on Thursday, December 26, 2013 at 12:03 AM in Economics, Links |
If I had a Bitcoin for every time a journalist has called in the last couple of months wanting to ask me about Bitcoin, I’d be very rich today and rich with variance tomorrow. The reason they come a-calling is because of this paper I wrote with Hanna Halaburda that discusses digital currencies while avoiding all meaningful discussion of Bitcoin. Anyhow, as I continue to see much that is written that is actually incorrect, I thought I’d wade in here with some thoughts.
Thought 1: Is Bitcoin money?
Absolutely and so are chocolate Hannukah coins, casino chips, monopoly money and your frequent flyer miles. The traditional way of defining money is as a unit of account, medium of exchange and store of value. The problem with this definition is that it describes an equilibrium outcome not a given characteristic of something. What do I mean by that? Basically, if you want to count, exchange and hold on to something you can’t just will it to be so. Instead, you need others to believe it to be so. So with monopoly money, everyone playing the game has agreed that money has value. But everyone also knows that it has a floating exchange rate. There are times when it is better to have property than money and that changes depending upon the stage and circumstances of the game. So everyone must agree sufficiently that money has value in exchange but at the same time disagree enough about that value to actually have exchange take place. It is the kind of thing that simultaneously blows your mind and sends you fleeing to a fixed point theorem for comfort.
What the definition obscures that there are other things that go hand in hand with making money a means of transmitting value over time. An obvious thing is some sort of stability in value. If you get paid by someone in the hopes of paying someone else, you have to worry about what happens to the value of the money you hold in the interim. Put simply, ideally you want stability so that you don’t have to gamble at the same time as transacting. However, because prices are flexible in market economies, you never get that. But some money is more stable than others. That gives them an advantage in transacting and hence, reinforces their equilibrium value.
I believe that a better way to think about what is money and what isn’t is to think about these things as platforms. The Canadian dollar is the instrument of a platform. You can pick up a Canadian dollar and take it to Toronto and use it to buy things. It works because people in Canada make it work. To be sure, you can do that with other things too. For instance, with the assistance of a debit or credit card, you don’t need Canadian dollars at all. Instead, you can access the Canadian dollar platform through an intermediary. Sometimes, you can even use other currency directly. However, as the Canadian dollar has a better network base, it usually wins out and is a more efficient competitor in platform competition.
Bitcoin is money. You can store some wealth in it. But how does it stand up as a platform competitor in payments? On the stability front, it is pretty awful. The Bitcoin exchange rate with other currencies and also with other prices is terrible. I have not found a place where prices are denominated in Bitcoins. For instance, Cloud Sky Leatherworks (to pick a random example) accepts Bitcoins. The prices are denominated in US dollars. If you buy something with Bitcoins you can but the price is given at the checkout time according to the current Bitcoin/USD exchange rate. So while technically you can buy something with Bitcoins, no merchant is willing to fix a price in Bitcoins. In that regard, it is less of a payments platform than most state-sponsored currencies. Of course, that is also why gold these days fares poorly as a payments platform.
However, it does have some other features. First, it may actually be a better platform in some countries than others. This is why the demand for Bitcoins is heavily related to the stability of other currencies. Where US dollars are hard to come by, Bitcoin can offer a safer haven for wealth.
Second, you can potentially deal in Bitcoins and exchange them with others without going through a financial institution or holding cash. That makes them potentially useful for operating outside of the watch of governments. This can be a benefit or a curse. If you want to operate without being watched, it is hard to reverse some contracts for non-performance. Enforcement can be useful even if it removes anonymity. However, when you understand the operation of the Bitcoin ‘network’ it is apparent that anonymity could be an illusion. In this, Michael Nielsen has written a very illuminating exposition of how the Bitcoin protocol actually works. Anyone interested in this topic should absorb it immediately. But here is what he says about anonymity:
Many people claim that Bitcoin can be used anonymously. This claim has led to the formation of marketplaces such as Silk Road(and various successors), which specialize in illegal goods. However, the claim that Bitcoin is anonymous is a myth. The block chain is public, meaning that it’s possible for anyone to see every Bitcoin transaction ever. Although Bitcoin addresses aren’t immediately associated to real-world identities, computer scientists have done a great deal of work figuring out how to de-anonymize “anonymous” social networks. The block chain is a marvellous target for these techniques. I will be extremely surprised if the great majority of Bitcoin users are not identified with relatively high confidence and ease in the near future. The confidence won’t be high enough to achieve convictions, but will be high enough to identify likely targets. Furthermore, identification will be retrospective, meaning that someone who bought drugs on Silk Road in 2011 will still be identifiable on the basis of the block chain in, say, 2020. These de-anonymization techniques are well known to computer scientists, and, one presumes, therefore to the NSA. I would not be at all surprised if the NSA and other agencies have already de-anonymized many users. It is, in fact, ironic that Bitcoin is often touted as anonymous. It’s not. Bitcoin is, instead, perhaps the most open and transparent financial instrument the world has ever seen.
Suffice it to say, you can bet the NSA and anyone else spending their time chasing the money is aware of this. The entire history of transactions you have engaged in may be transparent. In this respect, Bitcoin may change from an ‘under the radar’ instrument to perhaps one of the more contractually friendly payments platforms — but more on this below.
Thought 2: Will Bitcoin collapse?
The reason Bitcoin has managed to establish an equilibrium, despite volatility, in the payments platform market is because it was designed to be limited in supply. At its essence, the easiest way to lose as a payments platform is to not control supply. Monopoly money works so long as there isn’t another monopoly set in the house whose cash can be accessed. The US dollar works because the Fed controls the money supply and is concerned about platform competitiveness. And Bitcoin works because its aggregate supply is limited by the amount of mining that goes on. As Nielsen points out, that mining is progressively costly but also performs a useful function of validating transactions within the Bitcoin network — something you should read but I am in no position to describe here.
The point is that — given sufficient demand (an assumption that requires discussion below) — the exchange rate of Bitcoin will be bounded by the cost of mining (mainly computing power plus energy). When the (expected) value of a Bitcoin is below the cost of mining it, none will be produced and the value of Bitcoin will rise. The reverse happens if the (expected) value of a Bitcoin exceeds mining cost. So if you want to predict the long-run value of Bitcoin, calculate the cost of mining.
The same logic applies to gold. As Paul Krugman pointed out yesterday, mining Bitcoins or gold is driven by the same essential calculus. But he actually misses one important bit: gold can add to a miner’s wealth without mining while Bitcoins can’t. These days, mining engineers know how much gold is in a mine before they start digging. So why dig at all? Why not sell off the rights to the gold in the mine and save those costs? The answer surely lies in a weakness of property rights rather than a need to mine per se. With the gold still in the ground, property rights may be less secure and so it is hard to write instruments based on your holdings. Better to dig it all up and move it somewhere ‘safe’ even if that is just another holding in the ground. In other words, gold mining is all about ownership claims.
By contrast, you actually have to do some work to get Bitcoins. They are created out of thin air as payment for that work. There is no other way to produce new Bitcoins. You can’t easily write a contract on that work because the work as to be done for Bitcoins to enter the system. If you were a payments platform designer from outer space, one suspects the Bitcoin network would look far more sensible than the gold platform.
But to understand whether Bitcoin will collapse or not, we can’t ignore demand. In the platform business, this is Bitcoin’s weak point. Unlike the US dollar, it does not have a guaranteed demand. The US government says that it will only accept US dollars as taxes. That means there will always be a minimum demand for US dollars. Bitcoins have no similar commitment and in a platform market that represents risk.
That said, the traditional government-sponsored currencies have not been as innovative in the payments business. To be sure, we can now settle things digitally without actually handling cash but we all know that even that is surprisingly costly. At least a percentage point and perhaps as much as three percent goes to facilitating each transaction. The costs are nowhere near that so that is a problem for demand on those platforms.
Bitcoin is transactionally costly too but that comes because it has issues with stability. Otherwise, it holds the promise of virtually zero percent transaction fees. This is a huge opportunity not just for Bitcoin but for other platform entrants as well. For instance, Ripple is trying to replicate these features of the Bitcoin network to open up low transaction fee payments.
Thought 3: How significant an innovation is Bitcoin?
Having read Michael Nielsen’s essay, it is incredible just how clever and well-executed Bitcoin is. The elements that it gets in place requires an appreciation of monetary economics far exceeding any academic knowledge I am aware of. The achievement is phenomenal. Whatever else Bitcoin is, demonstrating how to get the ‘ducks in a row’ to launch a platform based on no owned infrastructure — the first payments platform I am aware of that has ever achieved this — is one of the most significant monetary innovations we have seen. I am awestruck by it.
What worries me is that we have not identified the innovator? As an economist, I would be so disappointed if the person who came up with this did not, at the same time, work out how to make a ton of money from it. That would likely be done by holding Bitcoins in reserve and eventually cashing out. But it may be some other way. Hopefully, we will eventually find out. For the moment, you can see how a return might arise through the example of Ripple. They’ll launch a zero transaction fee platform but hold money back for the purposes of improving monetary stability (changing demand as shocks arise) and also for some cashing out. As that model now makes sense, those who currently profit from transaction fees on other platforms should be worried.
But as Nielsen points out “Bitcoin is programmable money.” You can use it to write algorithms not possible in an open and transparent way with traditional currencies. Who knows where that innovation may lead.
Posted by Mark Thoma on Wednesday, December 25, 2013 at 09:10 AM in Economics |
Posted by Mark Thoma on Wednesday, December 25, 2013 at 12:03 AM in Economics, Links |
As a number of writers have noted previously, sales of Christmas cards Granger-cause Christmas, but they certainly don't cause Christmas!
Posted by Mark Thoma on Tuesday, December 24, 2013 at 02:03 PM in Economics |
Robots and Economic Luddites: They Aren't Taking Our Jobs Quickly Enough: Lydia DePillis warns us in the Post of 8 ways that robots will take our jobs. It is amazing how the media have managed to hype the fear of robots taking our jobs at the same time that they have built up fears over huge budget deficits bankrupting the country. You don't see the connection? Maybe you should be an economics reporter for a leading national news outlet.
Okay, let's get to basics. The robots taking our jobs story is a story of labor surplus, too many workers, too few jobs. Everything that needs to be done is being done by the robots. There is nothing for the rest of us to do but watch.
There can of course be issues of distribution. If the one percent are able to write laws that allow them to claim everything the robots produce then they can make most of us very poor. But this is still a story of society of plenty. We can have all the food, shelter, health care, clean energy, etc. that we need; the robots can do it for us.
Okay, now let's flip over to the budget crisis that has the folks at the Washington Post losing sleep. This is a story of scarcity. We are spending so much money on our parents' and grandparents' Social Security and Medicare that there is no money left to educate our kids.
Some confused souls may say that the problem may not be an economic one, but rather a fiscal problem. The government can't raise the tax revenue to pay for both the Social Security and Medicare for the elderly and the education of our kids. This is confused because if we are living in the world where the robots are doing all the work then the government really doesn't need to raise tax revenue, it can just print the money it needs to back its payments.
Okay, now everyone is completely appalled. The government is just going to print trillions of dollars? That will send inflation through the roof, right? Not in the world where robots are doing all the work it won't. If we print money it will create more demands for goods and services, which the robots will be happy to supply. As every intro econ graduate knows, inflation is a story of too much money chasing too few goods and services. But in the robots do everything story, the goods and services are quickly generated to meet the demand. Where's the inflation, robots demanding higher wages?
In short, you can craft a story where we have huge advances in robot technology so that the need for human labor is drastically reduced. You can also craft a story where an aging population leads to too few workers being left to support too many retirees. However, you can't believe both at the same time unless you write on economic issues for the Washington Post.
Just in case anyone cares about what the data says on these issues, the robots don't seem to be winning out too quickly. Productivity growth has slowed sharply over the last three years and it is well below the pace of 1947-73 golden age. (Robots are just another form of good old-fashioned productivity growth.)
On the other hand, the scarcity mongers don't have much of a case either. Even if productivity growth stays at just a 1.5 percent annual rate its impact on raising wages and living standards will swamp any conceivable tax increases associated with caring for a larger population of retirees.
Posted by Mark Thoma on Tuesday, December 24, 2013 at 09:20 AM in Economics, Inflation, Productivity, Technology, Unemployment |
Posted by Mark Thoma on Tuesday, December 24, 2013 at 12:03 AM in Economics, Links |
Turning back the clock:
Bits and Barbarism, by Paul Krugman, Commentary, NY Times: This is a tale of three money pits. It’s also a tale of monetary regress — of the strange determination of many people to turn the clock back on centuries of progress.
The first money pit is ... the Porgera open-pit gold mine in Papua New Guinea, one of the world’s top producers. The mine has a terrible reputation for both human rights abuses ... and environmental damage... But gold prices, while down from their recent peak, are still three times what they were a decade ago, so dig they must.
The second money pit is a lot stranger: the Bitcoin mine in Reykjanesbaer, Iceland. Bitcoin is ... by design, a kind of virtual gold. And like gold, it can be mined: you can create new bitcoins, but only by solving very complex mathematical problems...
The third money pit is hypothetical. Back in 1936 ... Keynes argued that increased government spending was needed to restore full employment. But then, as now, there was strong political resistance... So Keynes whimsically suggested ... the government bury bottles full of cash in disused coal mines, and let the private sector spend its own money to dig the cash back up. ...
Keynes ... went on to point out that ... gold mining was a lot like his thought experiment. Gold miners were, after all, going to great lengths to dig cash out of the ground, even though unlimited amounts of cash could be created at essentially no cost with the printing press. ...
Keynes would, I think, have been sardonically amused to learn how little has changed...
So why are we tearing up the highlands of Papua New Guinea to add to our dead stock of gold and, even more bizarrely, running powerful computers 24/7 to add to a dead stock of digits?
Talk to gold bugs and they’ll tell you that ... governments ... can’t be trusted not to debase their currencies. The odd thing, however, is that ... such debasement is getting very hard to find. ...
Bitcoin seems to derive its appeal from more or less the same sources, plus the added sense that ... it must be the wave of the future.
But don’t let the fancy trappings fool you: What’s really happening is a determined march to the days when money meant stuff you could jingle in your purse. In tropics and tundra alike, we are for some reason digging our way back to the 17th century.
Posted by Mark Thoma on Monday, December 23, 2013 at 12:33 AM in Economics |
Posted by Mark Thoma on Monday, December 23, 2013 at 12:03 AM in Economics, Links |
In No One We Trust, by Joe Stiglitz, Commentary, NY Times: In America today, we are sometimes made to feel that it is naïve to be preoccupied with trust. Our songs advise against it, our TV shows tell stories showing its futility, and incessant reports of financial scandal remind us we’d be fools to give it to our bankers.
That last point may be true, but that doesn’t mean we should stop striving for a bit more trust in our society and our economy. Trust is what makes contracts, plans and everyday transactions possible; it facilitates the democratic process, from voting to law creation, and is necessary for social stability. It is essential for our lives. It is trust, more than money, that makes the world go round.
We do not measure trust in our national income accounts, but investments in trust are no less important than those in human capital or machines.
Unfortunately, however, trust is becoming yet another casualty of our country’s staggering inequality: As the gap between Americans widens, the bonds that hold society together weaken. So, too, as more and more people lose faith in a system that seems inexorably stacked against them, and the 1 percent ascend to ever more distant heights, this vital element of our institutions and our way of life is eroding.
The undervaluing of trust has its roots in our most popular economic traditions. ...
Posted by Mark Thoma on Sunday, December 22, 2013 at 10:08 AM in Economics |
Are changes in labor force participation cyclical? Timothy Dunne and Ellie Terry at macroblog:
Labor Force Participation Rates Revisited: In an earlier macroblog post, our colleague Julie Hotchkiss examined the decline in labor force participation from the onset of the Great Recession into early 2012, concluding that cyclical factors likely accounted for most of the drop. In this post, we examine how labor force participation has changed since the start of 2012 (and admittedly, we’re much less ambitious in our analysis than Julie). Motivating our analysis, in part, is the observation that much of the recent decline in the labor force participation rate (LFPR) is related to rising retirements (see the November 19 Research Rap by Shigeru Fujita). This is not surprising, as the percentage of individuals aged 65 and older in the population has been increasing sharply over the last half decade. That said, our approach indicates that the LFPR of prime-age workers (ages 25–54) continues to fall, and this is an important source of the overall decline in LFPR in the recent data. Such declines in LFPR in these age categories should be less related to retirement decisions, keeping on the table the possibility that a weak overall labor market remains a key drag on labor force participation.
A straightforward decomposition illustrates that the decline in LFPR among prime-age workers is a major contributor to the overall decline in LFPR. To see this, we separate the change in LFPR into three components: one that measures the change due to shifts in the LFPR within age groups—the within effect; one that measures changes due to population shifts across age groups—the between effect; and one that allows for correlation across the two effects—a covariance term. It works out the covariance term is always very close to zero, so we will omit discussion of that term here. The analysis breaks the data down into five age groups: 16–24, 25–34, 35–44, 45–54, and 55+.
The chart presents the decomposition from Q1 2012 to Q3 2013. Over this period, the overall LFPR declined by half a percentage point, from 63.8 percent to 63.3 percent. The blue areas represent the change due to within-age-group effects, and the green areas represent the change due to between-age-group effects. The sum of the bars is equal to the overall change in labor force participation.
Three key results emerge. First, increases in labor force participation for the youngest age group boosted overall labor force participation by 0.075 percentage points. Second, the growing population share of the 55+ age group reduced LFPRs over the period by 0.21 percentage points, accounting for roughly 40 percent of the overall decline. Third, labor force participation for prime-age workers continued to fall. The combined within effect for the prime-age individuals (25–34, 35–44, and 45–54) reduced the participation rate by 0.28 percentage points—or a little over half of the overall decline in labor force participation. Additional declines in labor force participation were associated with the reduction in population shares of prime age workers.
From an accounting standpoint, the analysis shows that the fall in the LFPR for prime-age workers is a main contributing factor to the recent decline in labor force participation. Indeed, the LFPR of prime-age workers fell from 81.6 to 81.0 from Q1 2012 to Q3 2013, with similar declines for both men and women. Given that prime-age workers make up more than half of the population, it is not surprising that the drop in the LFPR for these age groups accounts for a substantial fraction of the overall decline.
To put this in perspective, we present the same decomposition from Q1 2010 to Q4 2011, where the decline in the LFPR is 0.8 percentage point. While the magnitude of the overall change is different, the decomposition results are quite similar. The decline in participation rates for prime-age workers accounts for a little over 60 percent of the overall decline, with a substantial drag from the rise in the share of older workers (accounting for a third of the drop). In short, the changes in participation due to within and between effects over the first two years look quite similar to that of the second two years of the labor market recovery.
A corollary to this analysis is that these sources of decline in labor force participation have allowed the unemployment rate to decline more sharply than expected, given the moderate employment growth observed. We will not take a stand on whether these are “wrong” or “right” reasons for unemployment rate declines. Rather, we note that the patterns observed early in the recovery are still in place (more or less) in the recent data.
Posted by Mark Thoma on Sunday, December 22, 2013 at 10:00 AM in Economics, Unemployment |
Posted by Mark Thoma on Sunday, December 22, 2013 at 01:17 AM in Economics, Links |
Don’t Mistake This for Gridlock, by Tyler Cowen, Commentary, NY Times: Economic policy in the United States is ruled by gridlock. That’s the common belief, and it’s easy to see the evidence for it in the daily headlines. Immigration reform didn’t even come up for a vote in Congress this year, and the budget deal approved by the Senate last week managed to amend the sequestration but was far from a “grand fiscal bargain.” It was the best that could be accomplished, given gridlock.
Yes, there’s some truth to this view of our state of affairs. Still, the American political system allows for more change than its current reputation suggests.
The Affordable Care Act offers an example...
This is not a new debate. For example, Tyler Cowen and Larry Summers are in agreement, but here's another view:
Gridlock is no way to govern, by Norman J. Ornstein and Thomas E. Mann, Commentary, Washington Post: Larry Summers is a brilliant, award-winning economist. Monday, in his monthly op-ed column for The Post, he opined about politics and history [“Sometimes, gridlock is good for America,” April 15]. Our advice, as political scientists, is that Summers should stick to economics.
Summers painted a rosy scenario, saying that the frustration people feel at the slowness and gridlock of recent years is misplaced — that things were just as bad, if not worse, in the early 1960s; that the failures to enact health-care and welfare reform in the Nixon years were a good thing; and that more gridlock, not less, would have been helpful during the George W. Bush years. Summers also lauded the economic policies that have enabled the United States to avoid the double- or triple-dip recessions that have hit Europe, as well as passage of the Affordable Care Act and financial regulation, and advances in energy and the widespread acceptance of same-sex marriage.
We were left wondering what political system Summers has been living in the past several years. This level of partisan polarization, veering from ideological differences into tribalism, has not been seen in more than a century. The U.S. system has always moved slowly, but in times past major advances were achieved with some level of cooperation or restraint, if not consensus, between the parties. No more. ...
Larry Summers responds.
Posted by Mark Thoma on Saturday, December 21, 2013 at 12:34 PM in Economics, Politics |
Posted by Mark Thoma on Saturday, December 21, 2013 at 12:03 AM in Economics, Links |
Robert Solow reviews Alan Greenspan's book:
Alan Greenspan Is Still Trying to Justify His Bad Decisions: What the maestro doesn't understand, by Robert M. Solow: You remember Alan Greenspan: you know, the one who was chairman of President Gerald Ford’s Council of Economic Advisers from 1974 to 1977, and was then appointed chairman of the Federal Reserve Board by President Ronald Reagan in 1987, a position that he served in for nineteen years, retiring just in time for the financial crisis. His reputation as grand maestro of monetary policy and general oracle about the economy has gone downhill since then, but I think it is only fair to say that he was a very good chairman of the Fed.
Greenspan was masterly in the first two challenges that popped up during his tenure. When the stock market collapsed by almost a third one day in October 1987, the Fed did the classically right thing. It made clear that it stood ready to provide every bit of the liquidity that might be needed to keep the financial system functioning, so that anyone who acted in panic would probably live to regret it. There was no financial breakdown, and the real economy was essentially unaffected by the episode. Score one for Greenspan.
During the long Clinton-era upswing from 1992 to 2000, Greenspan and the Fed faced a much more complex problem, and again did the right thing. Nearly all of the punditry and probably most professional economists (including those in the Fed itself) believed that the key inflation-safe unemployment rate (below which inflation arrives and accelerates) was something like 6.5–7.0 percent. As the upswing continued and the unemployment rate drifted down below that level (and, you may remember, budget surpluses appeared), the Fed was beset with urgent reminders that the time had come, and maybe passed, to tighten credit and choke off the boom before the inevitable inflationary disaster arrived.
Greenspan looked at the data and the economy around him, and saw few, if any, signs of gross imbalance or impending inflation, and persuaded his colleagues to let the expansion go on. In the end the unemployment rate dipped briefly below 4.0 percent without trauma. Greenspan thought that productivity was improving faster than anyone or the conventional measurements realized, and that was what provided the room for further expansion. He was right, though there were several other factors that helped, as became clearer after the fact. Never mind: it was an exhibition of pragmatism and cool that saved the economy from wasting trillions of dollars of output in unnecessary unemployment and idle capacity.
There ends the plus side of the Greenspan ledger. On the minus side, Greenspan’s reputation has suffered from two big mistakes. The first was his failure to see the importance of the housing bubble and the dangerous vulnerability of the financial mechanism that supported it. Had he done so and punctured the bubble promptly, the economy would have been spared the prolonged weakness that it is still suffering. The second was his deep-seated conviction that the unregulated financial system was self-stabilizing, that the self-interest of all those clever and experienced participants with a lot of their wealth at stake would keep the accumulation of risk within tolerable bounds. So he promoted deregulation and financial consolidation (as did others, of course) and, when this simple faith proved wrong, allowed disaster to strike. I think that the first mistake may be partially excusable, but the second mistake was a catastrophe, and it was not an accident. ...[continue]...
Posted by Mark Thoma on Friday, December 20, 2013 at 10:34 AM in Economics, Monetary Policy |
Guest Post: Data Mash-up — Manufacturing and Economic Mobility, by Carter Price, Senior Mathematician: We took two of this year’s most interesting data-centric economic analyses related to equitable growth and started looking for insights that come from putting them together. Specifically, we used the data Raj Chetty, Nathaniel Hendren, Patrick Kline, and Emmanuel Saez compiled on economic mobility and the industry/trade data used by David Autor, David Dorn and Gordon Hanson in their work on the effects of the decline in manufacturing. A quick analysis of the data found some interesting relationships and we encourage graduate students to take a look at these data sets (or other data sets too) and send us any interesting stories about equitable growth that come out in at most three graphs and a few hundred words. We’ll ask the authors of the most interesting submissions to write them up to get posted on the Equitablog. Send submissions as a word document to nbunker at equitablegrowth dot org by the end of February 2014. We hope to make this a periodic feature. ...
Posted by Mark Thoma on Friday, December 20, 2013 at 10:24 AM in Economics, Income Distribution |
Austerity in an already depressed economy is a bad idea:
Osborne and the Stooges, by Paul Krugman, Commentary, NY Times: There was, I’m pretty sure, an episode of “The Three Stooges” in which Curly kept banging his head against a wall. When Moe asked him why, he replied, “Because it feels so good when I stop.” ... But I never imagined that Curly’s logic would one day become the main rationale that senior finance officials use to defend their disastrous policies.
Some background: In 2010, most of the nation’s wealthy nations, although still deeply depressed in the wake of the financial crisis, turned to fiscal austerity ... to reduce budget deficits that had surged as their economies collapsed. Basic economics said that austerity in an already depressed economy would deepen the depression. But the “austerians,” as many of us began calling them, insisted that spending cuts would lead to economic expansion, because they would improve business confidence.
The result came as close to a controlled experiment as one ever gets in macroeconomics. Three years went by, and the confidence fairy never made an appearance. ... The depressing effect of austerity in a slump is, in short, as clear a story as anything in the annals of economic history. But the austerians were never going to admit their error. ... And now they’ve seized on the latest data to claim vindication, after all. You see, some austerity countries have started growing again. ...
Perhaps the most brazen example is George Osborne, Britain’s chancellor of the Exchequer, and the prime mover behind his country’s austerity agenda. No sooner had positive growth numbers appeared than Mr. Osborne declared that “Those in favor of a Plan B” — that is, an alternative to austerity — “have lost the argument.”
O.K., let’s think about this... Economies do tend to grow unless they keep being hit by adverse shocks. It’s not surprising, then, that the British economy eventually picked up...
But is this a vindication of his austerity policies? Only if you accept Three Stooges logic, in which it makes sense to keep banging your head against a wall because it feels good when you stop.
Now, I’m well aware that the austerians may win political points all the same. Political scientists tell us that voters are myopic, that they judge leaders based on economic growth in the year or so before an election...
But that’s politics. When it comes to economics, there’s only one possible answer to the absurd triumphalism of the austerians: Nyuk. Nyuk. Nyuk.
Posted by Mark Thoma on Friday, December 20, 2013 at 01:17 AM
Posted by Mark Thoma on Friday, December 20, 2013 at 12:42 AM in Economics, Links |
Is finance guided by good science or convincing magic?: Noah Smith posted a piece on "Freshwater vs. Saltwater" divides macro, but not finance. As a mathematician the substance of the piece wasn't that interesting (a nice explanation is here) but there was a comment from Stephen Williamson that really caught my attention
Another thought. You've persisted with the view that when the science is crappy - whether because of bad data or some kind of bad equilibrium I guess - there is disagreement. ... What's at stake in finance? The flow of resources to finance people comes from Wall Street. All the Wall Street people care about is making money, so good science gets rewarded. I'm not saying that macroeconomic science is bad, only that there are plenty of opportunities for policymakers to be sold schlock macro pseudo-science.
What I aim to do in this post is offer an explanation for the 'divide' in economics from the perspective of moral philosophy and on this basis argue that finance is not guided by science but by magic. ...
Posted by Mark Thoma on Thursday, December 19, 2013 at 11:43 AM in Economics, Methodology |
More on the illusion of superiority: For economists, and those interested in methodology Tony Yates responds to my comment on his post on microfoundations, but really just restates the microfoundations purist position. (Others have joined in - see links below.) As Noah Smith confirms, this is the position that many macroeconomists believe in, and many are taught, so it’s really important to see why it is mistaken. There are three elements I want to focus on here: the Lucas critique, what we mean by theory and time.
My argument can be put as follows: an ad hoc but data inspired modification to a microfounded model (what I call an eclectic model) can produce a better model than a fully microfounded model. Tony responds “If the objective is to describe the data better, perhaps also to forecast the data better, then what is wrong with this is that you can do better still, and estimate a VAR.” This idea of “describing the data better”, or forecasting, is a distraction, so let’s say I want a model that provides a better guide for policy actions. So I do not want to estimate a VAR. My argument still stands.
But what about the Lucas critique? ...[continue]...
[In Maui, will post as I can...]
Posted by Mark Thoma on Thursday, December 19, 2013 at 11:37 AM in Economics, Macroeconomics, Methodology |
Posted by Mark Thoma on Thursday, December 19, 2013 at 12:03 AM in Economics, Links |
The Beginning of the End for Quantitative Easing, by Tim Duy: In his final press conference, Federal Reserve Chairman Ben Bernanke announced and explained the plan to end the quantitative easing, beginning with a $10 billion reduction in the pace of asset purchases. This policy action is something of a fitting end to Bernanke's tenure, as it marks the exit from the unconventional efforts that characterized monetary policy during the crisis. And at first blush, Bernanke and his colleagues managed the process deftly in comparison to Bernanke's ill-fated press conference in June as stock markets surged to new highs while Treasury yields edged down. Attention will now shift to the timing of the first rate hike, still not expected to arrive until 2015.
It has been long known that the Federal Reserve desperately wanted to end the asset purchase program; the issue for months has been timing the first step in that direction in coordination with market acceptance that tapering is not tightening. To that end, the Fed has leaned heavily on forward guidance to entrench expectations of the path of short term interest rates to cap the rise in long-term rates. We knew that the time for such a move was soon at hand, with analysts largely split on the exact date between the next three meetings, with no forecast coming with much conviction (I thought they would wait until after the New Year).
To justify tapering, the Fed cited progress toward goals. From the statement:
In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions, the Committee decided to modestly reduce the pace of its asset purchases.
The last labor report and its reported decline in the unemployment rate, were the final straw. Moreover, they have greater confidence in the sustainability in the pace of job gains. First, fiscal policy is on a less contractionary path:
Fiscal policy is restraining economic growth, although the extent of restraint may be diminishing.
Second, FOMC members see the risks as largely balanced rather than tilted to the downside
The Committee expects that, with appropriate policy accommodation, economic growth will pick up from its recent pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. The Committee sees the risks to the outlook for the economy and the labor market as having become more nearly balanced.
The Federal Reserve essentially disregarded the trajectory of inflation in this decision, falling back on stable inflation expectations and their forecasts to support the policy shift.
The Fed did not, as some expected, cut the thresholds, instead choosing to enhance the forward guidance to emphasize the expectation that rates would remain low:
The Committee now anticipates, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal.
Policy makers do not seem to be inclined to change the threshold. If they can accomplish the same expectations for rates without changing the threshold, they retain flexibility and the ability to change the threshold at some point in the future if needed.
There was no hint of lowering interest on reserves. Bernanke might not believe this would have much impact. During the press conference, he said that credit was not tight. Instead, willingness and ability to borrow were the cause of weak lending. Basically, he might see this as a demand side problem, and lower interest on reserves is a supply side tool.
We learned that, assuming growth is more or less in line with the Fed's forecasts, we can pencil in a $10 billion reduction at subsequent meetings until the program is wound down at the end of 2014. To be sure, Bernanke emphasized the data dependent nature of the program, but it was clear that this is the expectation of the FOMC members.
We also learned that the Fed does not view quantitative easing as a natural extension of policy when rates hit zero, but instead it is a separate, supplemental policy. Quantitative easing works via lowering the term premium, but in normal times this impact can be mimicked with forward guidance. Moreover, quantitative easing comes along with some additional costs, including uncertainty of managing policy via the term premium and managing a greatly expanded balance sheet. The Fed would like to wind down the asset purchase program before the costs outweigh the benefits, and note the benefits have fallen now that they have held rates down via forward guidance.
Bottom Line: Another historic moment for a Federal Reserve that has had its share of historic moments in the past several years. Most likely, we can now move past the issue of tapering and asset purchases. Barring a dramatic change in the data, I doubt the Fed will reverse course. The issue now is to what extent incoming data impact our expectations of the first rate hike.
Posted by Mark Thoma on Wednesday, December 18, 2013 at 10:27 PM in Economics, Fed Watch, Monetary Policy |
Posted by Mark Thoma on Wednesday, December 18, 2013 at 12:03 AM in Economics, Links |
My latest column:
Of Course the Safety Net Redistributes Income…That’s Why It Works: Many conservatives have attacked social insurance programs such as Social Security and Obamacare because they redistribute income from the rich to the poor, the young to the old, or from makers to takers. But there is nothing unusual about the fact that insurance programs redistribute income among participants. If they didn’t, it wouldn’t be insurance.
Consider, for example, a case you may not think of as insurance at first, risk pooling in financial markets. ...
[Traveling today, will post as I can.]
Posted by Mark Thoma on Tuesday, December 17, 2013 at 07:08 AM in Economics, Income Distribution, Social Insurance |
My latest "Explainer" At CBS MoneyWatch:
What is the best way to measure inflation?
Should CPI vor PCE be used, and should it be core or overall inflation? It depends...
Posted by Mark Thoma on Tuesday, December 17, 2013 at 07:07 AM in Economics, Inflation, MoneyWatch |
Four missing ingredients in macroeconomic models: It is refreshing to see top academics questioning some of the assumptions that economists have been using in their models. Krugman, Brad DeLong and many others are opening a methodological debate about what constitute an acceptable economic model and how to validate its predictions. The role of micro foundations, the existence of a natural state towards the economy gravitates,... are all very interesting debates that tend to be ignored (or assumed away) in academic research.
I would like to go further and add a few items to their list... In random order:
1. The business cycle is not symmetric. ... Interestingly, it was Milton Friedman who put forward the "plucking" model of business cycles as an alternative to the notion that fluctuations are symmetric. In Friedman's model output can only be below potential or maximum. If we were to rely on asymmetric models of the business cycle, our views on potential output and the natural rate of unemployment would be radically different. We would not be rewriting history to claim that in 2007 GDP was above potential in most OECD economies and we would not be arguing that the natural unemployment rate in Southern Europe is very close to its actual.
2. ...most academic research is produced around models where small and frequent shocks drive economic fluctuations, as opposed to large and infrequent events. The disconnect comes probably from the fact that it is so much easier to write models with small and frequent shocks than having to define a (stochastic?) process for large events. It gets even worse if one thinks that recessions are caused by the dynamics generated during expansions. Most economic models rely on unexpected events to generate crisis, and not on the internal dynamics that precede the crisis.
[A little bit of self-promotion: my paper with Ilian Mihov on the shape and length of recoveries presents some evidence in favor of these two hypothesis.]
3. There has to be more than price rigidity. ...
4. The notion that co-ordination across economic agents matters to explain the dynamics of business cycles receives very limited attention in academic research. ...
I am aware that they are plenty of papers that deal with these four issues, some of them published in the best academic journals. But most of these papers are not mainstream. Most economists are sympathetic to these assumption but avoid writing papers using them because they are afraid they will be told that their assumptions are ad-hoc and that the model does not have enough micro foundations (for the best criticism of this argument, read the latest post of Simon Wren-Lewis). Time for a change?
On the plucking model, see here and here.
Posted by Mark Thoma on Tuesday, December 17, 2013 at 12:33 AM in Economics, Macroeconomics, Methodology |
Could it really be that no fraud was committed prior to the Great Recession? It's unlikely:
The Financial Crisis: Why Have No High-Level Executives Been Prosecuted?, by Jed S. Rakoff, NYRB: Five years have passed since the onset of what is sometimes called the Great Recession. While the economy has slowly improved, there are still millions of Americans leading lives of quiet desperation: without jobs, without resources, without hope.
Who was to blame? Was it simply a result of negligence, of the kind of inordinate risk-taking commonly called a “bubble,” of an imprudent but innocent failure to maintain adequate reserves for a rainy day? Or was it the result, at least in part, of fraudulent practices, of dubious mortgages portrayed as sound risks and packaged into ever more esoteric financial instruments, the fundamental weaknesses of which were intentionally obscured?
If it was the former—if the recession was due, at worst, to a lack of caution—then the criminal law has no role to play in the aftermath. ... If the Great Recession was in no part the handiwork of intentionally fraudulent practices by high-level executives, then to prosecute such executives criminally would be “scapegoating” of the most shallow and despicable kind.
But if, by contrast, the Great Recession was in material part the product of intentional fraud, the failure to prosecute those responsible must be judged one of the more egregious failures of the criminal justice system in many years. Indeed, it would stand in striking contrast to the increased success that federal prosecutors have had over the past fifty years..., Michael Milken..., the so-called savings-and-loan crisis, which again had some eerie parallels to more recent events, resulted in the successful criminal prosecution of more than eight hundred individuals, right up to Charles Keating. And again, the widespread accounting frauds of the 1990s, most vividly represented by Enron and WorldCom, led directly to the successful prosecution of such previously respected CEOs as Jeffrey Skilling and Bernie Ebbers.
In striking contrast with these past prosecutions, not a single high-level executive has been successfully prosecuted in connection with the recent financial crisis, and given the fact that most of the relevant criminal provisions are governed by a five-year statute of limitations, it appears likely that none will be. It may not be too soon, therefore, to ask why.
One possibility, already mentioned, is that no fraud was committed. This possibility should not be discounted. ... For example, the Financial Crisis Inquiry Commission, in its final report, uses variants of the word “fraud” no fewer than 157 times in describing what led to the crisis, concluding that there was a “systemic breakdown,” not just in accountability, but also in ethical behavior. ...[continue]...
Posted by Mark Thoma on Tuesday, December 17, 2013 at 12:24 AM in Economics, Financial System |
Posted by Mark Thoma on Tuesday, December 17, 2013 at 12:03 AM in Economics, Links |
Kathleen Geier at the Washington Monthly:
What social science says about the impact of unemployment on well-being: it’s even worse than you thought, by Kathleen Geier: While reading this odd and meandering New York Times op-ed this morning, I stumbled upon a link to a fascinating study from last year on the impact of unemployment on non-monetary well-being. It was conducted by Stanford sociologist Cristobal Young, who discovered that unemployment has an even more catastrophic effect on personal happiness that we thought.
The study produced three major findings. The first is the devastating impact job loss has on personal well-being. Job loss, says Young, “produces a large drop in subjective well-being”
The second finding is that while unemployment insurance (UI) is successful as a macroeconomic stabilizer, it doesn’t make unemployed people any happier. ...
Third, job loss has a strong, lasting negative impact on well-being that may persist for years ...
Other research suggests that what Young refers to as “the scarring effect” of job loss can last from three to five years, or even longer. He also notes that “the more generalized fear of becoming jobless” may persist. ...
The sheer human misery created by the economic downturn has been stunning. The economic damage is, in some ways, the least of it. Another study shows that the long-term unemployed experience shame, loss of self-respect, and strained relationships with friends and family. They even suffer significantly higher rates of suicide. ...
It's hard to understand why policymakers haven't done more to try to alleviate the unemployment crisis.
Posted by Mark Thoma on Monday, December 16, 2013 at 01:31 PM in Economics, Unemployment |
Inequality is "the defining challenge of our time":
Why Inequality Matters, by Paul Krugman, Commentary, NY Times: Rising inequality isn’t a new concern. ... But politicians, intimidated by cries of “class warfare,” have shied away from making a major issue out of the ever-growing gap between the rich and the rest.
That may, however, be changing..., the discussion has shifted enough to produce a backlash from pundits arguing that inequality isn’t that big a deal.
They’re wrong. ...
Start with the numbers..., inequality is rising so fast that over the past six years it has been as big a drag on ordinary American incomes as poor economic performance, even though those years include the worst economic slump since the 1930s.
And if you take a longer perspective, rising inequality becomes by far the most important single factor behind lagging middle-class incomes.
Beyond that,... it’s now widely accepted that rising household debt helped set the stage for our economic crisis; this debt surge coincided with rising inequality, and the two are probably related... After the crisis struck, the continuing shift of income away from the middle class toward a small elite was a drag on consumer demand, so that inequality is linked to both the economic crisis and the weakness of the recovery that followed.
In my view, however, the really crucial role of inequality in economic calamity has been political.
In the years before the crisis, there was a remarkable bipartisan consensus in Washington in favor of financial deregulation... Deregulation helped make the crisis possible, and the premature turn to fiscal austerity has done more than anything else to hobble recovery. Both ... corresponded to the interests and prejudices of an economic elite whose political influence had surged along with its wealth. ...
Surveys of the very wealthy have ... shown that they — unlike the general public — consider budget deficits a crucial issue and favor big cuts in safety-net programs. And sure enough, those elite priorities took over our policy discourse.
Which brings me to my final point. Underlying some of the backlash against inequality talk, I believe, is the desire of some pundits to depoliticize our economic discourse, to make it technocratic and nonpartisan. But that’s a pipe dream. Even on what may look like purely technocratic issues, class and inequality end up shaping — and distorting — the debate.
So the president was right. Inequality is, indeed, the defining challenge of our time. Will we do anything to meet that challenge?
Posted by Mark Thoma on Monday, December 16, 2013 at 12:33 AM in Economics, Income Distribution |
FOMC Meeting Something of a Nailbiter, by Tim Duy: Tapering will be on the table at this week's FOMC meeting, but will the Fed take the first step to ending the asset purchase program or let it ride into the new year? Wall Street analysts, economists, and pundits are all over the map on the tapering question, via Supeed Reddy at the Wall Street Journal. My own position is that while the Fed wants to taper, they will pass on this opportunity - although I admit I don't hold that position with any great conviction. The data flow in my opinion, is rather ambiguous in regards to tapering. Given that ambiguity, other factors will comes into play. One factor is the potential for disrupting bond markets during a traditionally illiquid month. We know from this summer's experience that the Federal Reserve is very sensitive to market functioning. Another factor is the institutional shake-up underway at the Fed. There is a potential continuity risk in changing policy now given the number of new faces among the voting members next year. In the absence of a dire rush to taper, it is reasonable to think the Fed will defer judgement until the crop of officials who will actually be carrying out the asset purchase wind down are all seated at the table.
Regarding the ambiguity of the data, I am hard-pressed to say that the economy has changed radically since September. To be sure, the employment data is arguably firmer, but this really speaks more to the tendency of Fed officials to be overly sensitive to the last data point than any real change in the underlying pace of activity. Compare the 12-month and 3-month trends in nonfarm payroll growth:
Job growth has been cycling around the 180-200k mark for 2 years. And even that cycle is suspect, partly an artifact of the impact of the recession on the seasonal adjustment procedures. Those impacts may be lessening (as they should over time) as indicated by the smaller fluctuations around the 12-month average. In short, the Fed has tended to define "stronger and sustainable" on the basis of the last two or three months of data, which thus opens the door again to tapering. It seem, however, that looking at the underlying trend the job market is neither more nor less "stronger and sustainable" now than any other time in the last two years.
Beyond employment data, broad industrial activity is rising at a relatively tepid pace:
Seems to be bouncing around 3% year-over-year. Nothing to suggest a dramatic change in pace since 2011. If anything, perhaps a bit weaker. As far as household spending is concerned, consider growth of retail sales excluding volatile auto and gasoline components:
Growth seems to have settled into the 4% year-over-year range. Broad household spending after inflation has also settled into a pattern of tepid growth:
Likewise, if you think of underlying growth as close to the average of GDP and GDI growth, that too is reasonably stable:
If you take anything but the most near-term look at the data, there is little to suggest much has changed one way or another. It's no real surprise that the Beige Book continues to describe activity as "modest to moderate." Move alone, nothing to see here, folks. But if monetary policymakers focus on the most recent few months of data, then they can argue that what they are seeing is "stronger and sustainable."
Where they might see more promise is that the forecast for fiscal policy in 2014 is brighter. The budget deal is consistent with reduced fiscal drag next year while eliminating the possibility of another budget crisis. Indeed, I think a good story can be told that 2014 is an inflection point for economic activity. Still, we have told that story before, and with that lessen in mind it seems too early to declare "sustainable" without some actual 2014 data to work with. Where the Fed might find more traction is with beginning tapering on the basis of progress toward goals with a focus on unemployment:
That said, if one of the goals is price stability, that pesky dual mandate thing is rearing its ugly head with the falling inflation numbers:
I would say the Fed needs to abandon low-inflation concerns if they taper with these numbers, instead falling back on stable inflation expectations and a forecast of rising inflation. That forecast, however, really hasn't worked out yet.
Overall, "stronger and sustainable" and "progress toward goals" are in the eye's of the beholder. Same too with "progress toward goals." It depends the goal. No wonder then that Fed officials appear so ridiculously noncommittal with regards to tapering. And no wonder then that market participants are also noncommittal over the outcome of this next meeting.
Given that ambiguity, the Fed may have a difficult time communicating any policy changes. Does the tiny taper suggest a more hawkish Fed considering the path of inflation? Or a more dovish Fed considering the path of unemployment? With no strong market expectations, the Fed may worry that any action they take would be misinterpreted in the thin holiday trading. Perhaps they believe that Federal Reserve Chairman Ben Bernanke could smooth out any issues during the press conference, but there is no certainty in that prediction. It's not like he cleared much up with the June press conference. The importance of communication is even more important given that the nature of tapering itself is on the table - no longer are we guaranteed a data-dependent policy as the calendar-dependent suggestion is on the table. Hence there is a good case to be made for leaving policy broadly unchanged with the exception of modification to the forward guidance while setting the stage for a policy shift next year.
Finally, another reason to hold policy steady is the institutional changes raining down on the Federal Reserve. Next year we see a new chair, and new vice chair, a new governor, a new president, and a change in the FOMC that brings two hawkish voices into voting positions. Presumably, policymakers should be concerned that the policies they enact today will be consistent with the desires of the policymakers of two months from now. This is especially the case when policy is at an inflection point as it is now. In the absence of pressing need, it is thus easy to make the case that policy changes should be deferred to the next group of policymakers. Now, clearly the Fed would not let such an issue dissuade it from acting during a financial crisis, or in the face of incipient inflation risks. But neither of those are on the table right now, so there is no pressing need to act. Of course, some might argue that given the impending changes, this is this Fed's last opportunity to leave its mark on policy - completely the opposite conclusion. More ambiguity.
Bottom Line: Unless you are living in a cave, you shouldn't be surprised if the Fed decides to taper this week. At the same time, you shouldn't be surprised if they do not taper. Even if they don't at this meeting, they soon will.
Posted by Mark Thoma on Monday, December 16, 2013 at 12:24 AM in Economics, Fed Watch, Monetary Policy |
Posted by Mark Thoma on Monday, December 16, 2013 at 12:03 AM in Economics, Links |
As a follow-up to the previous post, here's Larry Mishel of the EPI:
On that Income Inequality and Income Growth Thing Out There: Ezra Klein has kicked off an expansive and useful conversation about whether reducing inequality or increasing growth ... should be the top priority of policymakers. ...
I’d like to add a few thoughts to this discussion.
1. There’s a danger to dwelling on the question of ‘does inequality hurt growth?’ if it establishes a litmus test that means addressing inequality requires a firm yes. Some lesser lights from the Manhattan Institute are already using this logic. If inequality has no effect on growth it is certainly still worth working towards more equitable growth because it would mean the vast majority—the 99 percent, you might say—would do far better. My colleague Josh Bivens (in the State of Working America) used the CBO’s comprehensive income data to calculate the middle fifth’s income was lower in 2007 by roughly $19,000 compared to a scenario where there had been equitable growth from 1979 to 2007. Josh refers to this as the inequality tax. I think this is the type of calculation that Krugman was looking for in his most recent post, when he illustrates that inequality matters.
This is really a question of where the burden of proof lies in the inequality debate. Too many—even progressives who are deeply concerned about inequality—think they need to make the case that rising inequality affirmatively and mechanically hinders overall growth. They don’t. All they need to show to argue that curbing inequality will benefit the income growth of the vast majority (which is my goal) is to show that rising inequality does not affirmatively and mechanically increase overall growth. And there is no reliable evidence that more inequality leads to more growth. ...
2. There’s certainly no need to choose between the goals of reducing persistent high unemployment and generating more equal growth. As Bernstein points out, these are compatible. I’d go further and say that the very first step in any policy agenda aimed at more equitable growth would be to radically lower unemployment. Of course, as many folks are pointing out, the same political forces and economic interests stand in the way of both goals.
3. Policy should be focused on generating higher standards of living for the vast majority (consistent with preserving our planet for the following generations). If you accept this, then addressing inequality and growth become a pretty similar enterprise. ... In a Journal of Economic Perspectives paper that I co-authored with Josh Bivens, we argue that rising pay for executives and high earnings in finance have driven the growth of top one percent incomes, and that these groups are collecting rents above their economic value. This means we could eliminate their income surge and leave aggregate growth unaffected! See, we could do both at once—fight inequality and generate more income for the vast majority.
4. My nominee for the ‘defining economic challenge of our time’ would be generating broad-based wage growth. After all, that’s what facilitating upward mobility and expanding the middle class is all about, since middle class families depend almost entirely on wage income. Sometimes the discussion of income inequality seems to overlook this. Of course, the immediate task for generating wage growth is to lower unemployment.
Posted by Mark Thoma on Sunday, December 15, 2013 at 11:13 AM in Economics, Income Distribution |
Ezra Klein Misses the Mark: Inequality and Unemployment Are the Same Problem [Creative Commons]: In his Washington Post column this morning, Ezra Klein dismisses the problem of inequality and argues that progressives should instead focus on unemployment. While he will get no argument from me on the need to focus on unemployment, the idea that this is a separate issue from inequality is seriously misplaced.
Ezra gets to this spot by first dismissing the idea that inequality harms growth. He is certainly right that the evidence is less conclusive than we might like, but I would attribute that largely to the reluctance of the economic profession to even consider this possibility.
For example, Ezra notes my friend and co-author Jared Bernstein's conclusion that it is difficult to find a link between rising inequality and weaker consumption in the data. This is true, but the obvious reason is that the decades of rising inequality have also been the decades of the stock market and housing market bubbles.
Standard economic theory predicts that these bubbles would increase consumption, a story that fits the data well. Consumption as a share of income hit highs (i.e. savings rates reached lows) at the peaks of both the stock and housing bubbles. Consumption fell sharply following the collapse of both bubbles.
If we just do some simple arithmetic we can get an idea of the size of the effect of the upward redistribution of 10 percentage points of disposable income from the bottom 80 percent to the top 1 percent. If we assume that the bottom 80 percent would have spent 95 percent of this income and the top 1 percent would only spend 75 percent, then the difference would be 20 percentage points or 2 percent of disposable income.
This would translate into a loss of demand of 1.6 percentage points of GDP. That is what would have to be made up by larger budget deficits, trade surpluses, or a flood of investment. We certainly had much larger budget deficits on average over the last three decades than we did in prior decades so that can make up the shortfall in demand, although we also had much larger trade deficits making the problem worse.
In any case, the fact that we didn't have solid evidence on this issue should not be as surprising as Ezra suggests. While some of us have long warned of this scenario, leading economists like Paul Krugman and Larry Summers have just recently begun to take seriously the possibility of secular stagnation. For decades the profession has treated it as an article of faith that there could not be sustained shortfalls in demand so inadequate consumption due to the upward redistribution of income could not possibly be a problem.
However the other side of the unemployment inequality issue is possibly more important. One of the main points of Jared and my new book is that unemployment is a main cause of inequality. This is because when more people get hired it disproportionately benefits those in the bottom half and especially the bottom fifth of the income distribution.
These are the people who are most likely to get jobs. And those with jobs will also have the opportunity to work longer hours. And, a tight labor market will create conditions in which workers at the bottom will have more bargaining power. Walmart and McDonalds will be paying workers $15 an hour if that is the only way that they can get people to work for them.
For this reason, the high unemployment policy that Congress is pursuing with its current budget policy is a key factor in the upward redistribution of income that we have seen in the last three decades. This means that people concerned about inequality should be very angry over budgets that don't spend enough to bring the economy to full employment (also an over-valued dollar). So Ezra is absolutely right that progressives should be yelling about unemployment, but inequality is a very big part of that picture.
Posted by Mark Thoma on Sunday, December 15, 2013 at 09:01 AM in Economics, Income Distribution, Unemployment |
Posted by Mark Thoma on Sunday, December 15, 2013 at 12:03 AM in Economics, Links |
It's even worse for women:
US ranks near bottom among industrialized nations in efficiency of health care spending. EurekAlert: A new study by researchers at the UCLA Fielding School of Public Health and McGill University in Montreal reveals that the United States health care system ranks 22nd out of 27 high-income nations when analyzed for its efficiency of turning dollars spent into extending lives.
The ... U.S.'s inferior ranking reflects a high price paid and a low return on investment. For example, every additional hundred dollars spent on health care by the United States translated into a gain of less than half a month of life expectancy. In Germany, every additional hundred dollars spent translated into more than four months of increased life expectancy.
The researchers also discovered significant gender disparities within countries.
"Out of the 27 high-income nations we studied, the United States ranks 25th when it comes to reducing women's deaths," said Dr. Jody Heymann, senior author of the study and dean of the UCLA Fielding School of Public Health. "The country's efficiency of investments in reducing men's deaths is only slightly better, ranking 18th." ...
"While there are large differences in the efficiency of health spending across countries, men have experienced greater life expectancy gains than women per health dollar spent within nearly every country," said Douglas Barthold, the study's first author...
Posted by Mark Thoma on Saturday, December 14, 2013 at 08:58 PM in Economics, Health Care |