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From the Brookings Institution"
Financial transaction taxes in theory and practice, by Leonard E. Burman, William G. Gale, Sarah Gault, Bryan Kim, Jim Nunns and Steve Rosenthal: The Great Recession, which was triggered by financial market failures, has prompted renewed calls for a financial transaction tax (FTT) to discourage excessive risk taking and recoup the costs of the crisis. ...
[...Review of arguments for and against an FTT...]
Our review and analysis of previous work suggests several conclusions. First, the extreme arguments on both sides are overstated. At the very least, the notion that a FTT is unworkable should be rejected. ... On the other hand, the idea that a FTT can raise vast amounts of revenue ... is inconsistent with actual experience with such taxes.
Second, a wide range of design issues are critical to the formulation of a FTT... Third, although empirical evidence demonstrates clearly that FTTs reduce trading volume, as expected, it does not show how much of the reduction occurs in speculative or unproductive trading versus transactions necessary to provide liquidity. The evidence on volatility is similarly ambiguous: empirical studies have found both reductions and increases in volatility as a result of the tax.
Fourth, the efficiency implications of a FTT are complex, depending on the optimal size of the financial sector, its impact on the rest of the economy, the structure and operation of financial markets, the design of the tax, and other factors.
We also present new revenue and distributional estimates for hypothetical U.S. FTTs... We ... find the tax would be quite progressive. ...
[Paper: Financial Transaction Taxes in Theory and Practice"]
Posted by Mark Thoma on Monday, February 29, 2016 at 06:47 PM in Economics, Financial System, Regulation, Taxes |
"Salvation is clearly within our grasp":
Planet on the Ballot, by Paul Krugman, Commentary, NY Times: We now have a pretty good idea who will be on the ballot in November: Hillary Clinton, almost surely..., and Donald Trump, with high likelihood.... But even if there’s a stunning upset in what’s left of the primaries, we already know very well what will be at stake — namely, the fate of the planet.
Obviously, the partisan divide on environmental policy has been growing ever wider..., denial of climate science and opposition to anything that might avert catastrophe have become essential pillars of Republican identity..., even a blowout Democratic victory this year probably wouldn’t create a political environment in which anything ... could pass Congress.
But here’s the thing: the next president won’t need to pass comprehensive legislation... Dramatic progress in energy technology has put us in a position where executive action ... can achieve great things. All we need is an executive willing to take that action, and a Supreme Court that won’t stand in its way.
And this year’s election will determine whether those conditions hold.
Many people ... still seem oddly oblivious to the ongoing revolution in renewable energy...: the cost of electricity generated by wind and sun has dropped dramatically, while costs of storage ... are plunging as we speak.
The result is that we’re only a few years from a world in which carbon-neutral sources of energy could replace much of our consumption of fossil fuels at quite modest cost. ... All it would take to push us across the line would be moderately pro-environment policies. ...
I don’t know about you, but this situation makes me very nervous. As long as the prospect of effective action on climate seemed remote, sheer despair kept me, and I’m sure many others, comfortably numb — you knew nothing was going to happen, so you just soldiered on. Now, however, salvation is clearly within our grasp, but it remains all too possible that we’ll manage to snatch defeat from the jaws of victory. And this is by far the most important issue there is; it, er, trumps even such things as health care, financial reform, and inequality.
So I’m going to be hanging on by my fingernails all through this election. No doubt there will be plenty of entertainment along the way, given the freak show taking place on one side of the aisle. But I won’t forget that the stakes this time around are deadly serious. And neither should you.
Posted by Mark Thoma on Monday, February 29, 2016 at 07:50 AM in Economics, Environment, Policy, Politics |
Fed Doves Still Have The Upper Hand For March, by Tim Duy: The Personal Income and Outlays report for January delivered a surprise for the Fed doves. It does not, however, derail their push for a March pause. I believe policymakers will still take a pass on the March meeting as they assess the impact of recent market unpleasantness. But if markets calm further ahead of the March meeting and data remains solid, beware that they may choose to re-instate the balance of risks into the FOMC statement. Furthermore, sufficiently supportive data may induce them to shift the risks to the upside to signal the hope of a June hike.
Real personal consumption expenditures rose 0.4% in January and stands a respectable 2.9% higher than last year. The death of the consumer has been greatly exaggerated (although the death of the department store has not). Fairly firm consumer spending should be expected given the broad-based support from the labor market. Equally if not more important is that the report rewarded the defenders of the Phillips curve as core-PCE inflation spiked higher during the month:
Core inflation was up 1.7 percent from a year ago, actually bringing the FOMC's target into view. Note that as of the December meeting, the Fed did not expect to see 1.6 percent until the end of the year. It is easy to see unemployment close to their year-end target of 4.7 percent by the next meeting. It is already at 4.9 percent. In other words, it is easy to see economic projections updated to reveal a faster than expected return to both mandates.
It seems then like the Fed should consider picking up the pace of rate hikes rather than pausing. Indeed, there is some commentary that the current level of interest rates is inconsistent with the expected path of growth and inflation. This is sometimes described as Treasury market participants "underestimating" the Fed. Fed Governor Lael Brainard, however, continues to reconcile this apparent disconnect between the bond market and the economy with her focus on the international side of the equation. In yet another compelling speech, Brainard argues that the decline in the neutral rate of interest is a common shock that prevents policy diversion:
To the extent that we are observing limited divergence in inflation outcomes and less divergence in realized policy paths than many anticipated, this could be attributable to common shocks or trends that cause economic conditions to be synchronized across economies. The sharp repeated declines in the price of oil have been a major common factor depressing headline inflation...Even so, most observers expect this source of convergence in inflationary outcomes to eventually fade and thereafter not affect monetary policy paths over the medium term...In contrast, a more persistent source of convergence may be found in an apparent decline in the neutral rate of interest.
The persistent of this shock has significant implications for policy:
The very low levels of the shorter run neutral rate reflect in part headwinds from the crisis that are likely to dissipate over time. However, if many of the common forces holding down neutral rates prove persistent, then neutral rates may remain low through the medium term, implying a shallower path for policy trajectories.
It seems reasonable to equate the "persistent" common shock weighing on the natural rate of interest with the concept of secular stagnation. She reiterates estimates of the degree of tightening already impacting the US economy:
...although the U.S. real economy has traditionally been seen as more insulated from foreign trade shocks than many smaller economies, the combination of the highly global role of the dollar and U.S. financial markets and the proximity to the zero lower bound may be amplifying spillovers from foreign financial conditions. By one rough estimate, accounting for the net effect of exchange rate appreciation and changes in equity valuations and long term yields, over the past year and a half, the United States has experienced a tightening of financial conditions that is the equivalent of an additional increase of over 75 basis points in the federal funds rate...
...Financial channels can powerfully propagate negative shocks in one market by catalyzing a broader reassessment of risks and increases in risk spreads across many financial markets...Recent events suggest the transmission of foreign shocks can take place extremely quickly such that financial markets anticipate and indeed may thereby front-run the expected monetary policy reactions to these developments.
In other word, market participants are correctly assessing the Fed's response to recent turmoil by anticipating a slower path of rate hikes. Or, as I have said, the Fed has to be easier because everything else is tighter. Brainard draws special attention to the exchange rate (emphasis added):
It also appears that the exchange rate channel may have played a particularly important role recently in transmitting economic and financial developments across national borders. Indeed, recent research suggests that financial transmission is likely to be amplified in economies with near-zero interest rates, such that anticipated monetary policy adjustments in one economy may contribute more to a shifting of demand across borders than a boost to overall demand. This finding could explain why the sensitivity of exchange rate movements to economic news and to changes in foreign monetary policy appear to have been relatively elevated recently.
Read that carefully. She is saying that at the zero bound, the domestic impact of monetary policy is limited, leaving external demand as the primary policy channel. Hence exchange rates shift rapidly to induce that shifting of demand.
Or, in other words, Brainard is saying that at the zero bound monetary policy degrades to currency wars. Chew on that admission for awhile.
The implication for US policy:
Financial tightening associated with cross-border spillovers may be limiting the extent to which U.S. policy diverges from major economies. As policy adjusts to the evolution of the data, the combination of heightened spillovers from weaker foreign economies, along with a lower neutral rate, could result in a lower policy path in the United States relative to what many had predicted.
Pulling away from the zero bound is easier said than done. The Fed cannot lift the rest of the world from the zero bound; the rest of the world drags the Fed to the zero bound.
How does this relate to the idea that market participants are underestimating the Fed? I see two paths. One is that Brainard's "common shock" lowering the neutral rate of output is very persistent. Hence small changes to short-term rates have substantial economic impacts and the Fed needs to be very cautious in their response to inflation. In this scenario, the yield curve continues to flatten just as in any other tightening cycle. There is little movement in the long-end because market participants anticipate that the Fed has little room to maneuver.
Alternatively, the common shock dissipates, the long-end of the yield curve rises, and the Fed chases it with a faster than expected pace of rate hikes. I do not view this as a best on the markets underestimating the Fed. I view this as a bet against secular stagnation (the common shock).
It is worth pointing out at this juncture that shorting the long end (once thought a no brainer) has been something of a widowmaker trade. Just like it has been for Japanese government bonds.
If you accept the secular stagnation hypothesis and that the Fed will need to tighten in response to higher inflation, then expect long rates to hold flat or more likely decline as short rates rise. In other words, the yield curve would flatten further. Note that the yield curve has flattened per usual after the Fed began tightening.
So how I do interpret the incoming information of recent weeks as it regards at least near term policy? As follows:
- The rise in wage growth and now inflation is consistent with an economy near full-employment. In this dimension, the world is not much different than it has always been. Push unemployment low enough and resource constraints start to bite.
- Fed hawks will argue vociferously that they will soon fall behind the curve, if they have not already. Even some moderates will push for higher rates sooner than later. Here I am thinking of Fed Vice Chair Stanley Fischer.
- Federal Reserve Chair Janet Yellen will be swayed by Brainard to a dovish position in the near term. Brainard correctly called the importance of the external transmission channels last year. Those channels are forcing the Fed to lower the path of rate hikes in response by skipping at least the March meeting. And incoming data is largely backward looking; the Fed needs time to assess the impact of recent tightening in financial markets.
- I don't expect Fed hawks to go quietly into the night on this. I think they will want something in return for pausing, and that solid incoming data with a whiff of inflation will prompt them to revive the balance of risks.
- Unless growth does slow down dramatically, delaying rate hikes now means, as the Fed sees it, falling behind the curve later this year (remember that the push for raising rates in 2015 was premised on the need to be able to raise slowly ahead of inflation). The Fed will then have a choice between accepting a greater risk of above target inflation or accelerating the pace of rate hikes. I don't know which way that debate will fall yet.
Bottom Line: Inflation concerns are not likely to prompt a the Fed to hike rates in March. Financial market issues will dominate; like it or not, the Fed cannot separate the financial system from the real economy. The former is signaling it requires a looser policy stance to compensate for the stronger dollar. It would be tempting fate to ignore that signal. Be wary, however, of a hawkish message sent through the statement.
Posted by Mark Thoma on Monday, February 29, 2016 at 04:00 AM in Economics, Fed Watch, Monetary Policy |
Posted by Mark Thoma on Monday, February 29, 2016 at 12:06 AM in Economics, Links |
An Open Letter to the Republican Establishment: You are the captains of American industry, the titans of Wall Street, and the billionaires who for decades have been the backbone of the Republican Party.
You’ve invested your millions in the GOP in order to get lower taxes, wider tax loopholes, bigger subsidies, more generous bailouts, less regulation, lengthier patents and copyrights and stronger market power allowing you to raise prices, weaker unions and bigger trade deals allowing you outsource abroad to reduce wages, easier bankruptcy for you but harder bankruptcy for homeowners and student debtors, and judges who will let you to engage in insider trading and who won’t prosecute you for white-collar crimes.
All of which have made you enormously wealthy. Congratulations.
But I have some disturbing news for you. You’re paying a big price – and about to pay far more. ...
Skipping to the end:
... Finally, by squeezing wages and rigging the economic game in your favor, you have invited an unprecedented political backlash – against trade, immigration, globalization, and even against the establishment itself.
The pent-up angers and frustrations of millions of Americans who are working harder than ever yet getting nowhere, and who feel more economically insecure than ever, have finally erupted. American politics has become a cesspool of vitriol.
Republican politicians in particular have descended into the muck of bigotry, hatefulness, and lies. They’re splitting America by race, ethnicity, and religion. The moral authority America once had in the world as a beacon of democracy and common sense is in jeopardy. And that’s not good for you, or your businesses.
Nor is the uncertainty all this is generating. A politics based on resentment can lurch in any direction at almost any time. Yet you and your companies rely on political stability and predictability. ...
You forgot the values of a former generation of Republican establishment that witnessed the devastations of the Great Depression and World War II, and who helped build the great post-war American middle class.
That generation did not act mainly out of generosity or social responsibility. They understood, correctly, that broad-based prosperity would be good for them and their businesses over the long term.
So what are you going to do now? ...
Posted by Mark Thoma on Sunday, February 28, 2016 at 05:02 PM in Economics, Politics |
Fiscal Policy Success Is All About Monetary Policy: Suppose that the US were to adopt a large fiscal stimulus program, with the aim of boosting aggregate GDP in 2020 by a considerable amount (15%?) relative to current forecasts. Under what circumstances would such a program be successful in achieving its goal? In this post, I’ll argue that the answer depends critically on the monetary policy response to the plan. I’ll describe two possible changes in the Fed’s operating framework that would lead its policy choices to be more supportive of the desired aggregate growth outcomes.
There are two possible monetary policy responses.
Response 1: The Fed’s chosen path of interest rates is higher than currently anticipated.
Assuming that inflationary expectations are little changed, the Fed’s tightening will drive down aggregate demand in unstimulated sectors of the economy. Suppose, for example, the government increased infrastructure spending greatly. If the Fed were to raise interest rates, it would constrain the growth of household consumption and business investment. By tightening sufficiently, the Fed could essentially eliminate the effects of any stimulus program on aggregate output. All that would happen is that the composition of aggregate activity would swing away from private expenditures toward public expenditures.
Response 2: There is little change in the evolution of interest rates.
Without tighter monetary policy, an increase in public expenditures will not crowd out private consumption and private investment. In fact, if inflation expectations were to rise in response to the increase in economic activity, then there would be a decline in the real interest rate. That decline would generate more private sector investment and private sector consumption.
To sum up: an aggressive demand stimulus plan can achieve its aggregate objectives if (but only if) the Fed does not tighten significantly in response to the program.
There are two changes in the Fed’s approach to monetary policy that would make the second (no-tightening) scenario more likely. ...
Thus, there are good reasons to believe that Fed need not tighten in response to fiscal stimulus. In that case, fiscal policy can generate materially super-normal aggregate growth over the next few years.
I’ll close with a thought about risk. There is a risk that fiscal stimulus would engender significantly tighter monetary policy, and so would fail to achieve the desired aggregate growth rates. In my view, it is appropriate to pursue materially super-normal economic growth despite this risk. But it is important for fiscal policymakers to be clear with the public about the existence of this risk. As well, and as discussed above, sufficiently tighter monetary policy would depress unstimulated economic activities. This risk underscores the need for fiscal policymakers to be deliberate in their choices about the composition of fiscal stimulus between private sector demand and public sector demand.
Posted by Mark Thoma on Sunday, February 28, 2016 at 12:11 PM in Economics |
Simon Wren-Lewis on whether higher growth is possible:
When to be optimistic on growth: ... Martin Sandbu, channeling Narayana Kocherlakota, is quite right that we should not discount the possibility that economic growth could be unusually strong over the next decade or two. There is a significant chance that some of the slowdown that has appeared to have occurred to trend growth since the Great Recession might be reversible, partly because many hysteresis effects are also reversible. Inflation may not respond positively to strong growth as it has done in the past.
That possibility is high enough that it should have a big influence on monetary policy, for reasons I and others have outlined many times. The cost of needlessly throwing away potential resources is much higher than the cost of small overshoots of an inflation target. For that and other reasons the Fed’s decision to raise rates - and the MPC's decision not to cut them - was a mistake, as is continuing austerity.
Does that mean we should hard wire this optimistic view into budget projections? Essentially no, because budget projections should be based on your central guess of what is going to happen rather than any best case scenario. Almost every politician thinks they have the magic ingredient that will lead to strong growth. There is nothing wrong in that, but they should hope for the best and plan for the ordinary. ...
Where the discussion can get confused is if we put these two things together, and note also that fiscal stimulus involving additional investment would be good for the world right now. But that should and is argued for without pretending that it can all be paid for with the taxes that will come rolling in as it happens. There is a rock solid case for paying for extra investment - investment in its widest sense including human capital - by borrowing, because future generations benefit from that investment. When real interest rates are as low as they currently are, you have to be ignorant, duplicitous or slightly mad to say otherwise.
See also How to Accelerate Growth Rates - Dietrich Vollrath.
Posted by Mark Thoma on Sunday, February 28, 2016 at 11:23 AM in Economics |
Posted by Mark Thoma on Sunday, February 28, 2016 at 12:06 AM in Economics, Links |
This sounds familiar:
The Cases for Public Investment, by Paul Krugman: One of the annoying aspects of the Sanders/Friedman flap was the assumption of many Sanders supporters that anyone who doesn’t accept extravagant economic projections is against a big program of public investment. Actually, it was destructive as well as annoying; aside from being an insult to progressive economists who believe in infrastructure but also believe in arithmetic, it created at least the possibility that other people would take the crash-and-burn of a particular piece of analysis as evidence that the whole case for spending more is wrong.
So let’s talk about the cases for a lot more public investment right now. Yes, cases, plural. There are at least three reasons to conclude that we should be spending much more than we are.
The first case is simply that America has an obvious infrastructure deficit, and that it has never been cheaper to address that deficit. ...
The second case is a bit, but only a bit, harder: we are still in or near a liquidity trap, a situation in which cutting interest rates as far as possible isn’t enough to restore full employment. ...
You might ask, but are we still in that condition, given that the Fed has started to raise rates? Well, it shouldn’t have — it shouldn’t be raising rates until it sees the whites of inflation’s eyes. And it would take only a modest shock to push us well into negative-natural-rate territory again. Put it this way: the asymmetric-risks story many of us have been using to argue against rate hikes is also a reason to consider increased public investment a valuable insurance policy, giving the economy headroom that might turn out to be crucial if anything goes wrong. ...
Finally, there’s hysteresis: the proposition that demand-side weakness now breeds supply-side weakness later, so that there are big payoffs to boosting the economy through public spending. There’s now a lot of evidence for that proposition, with my only worry being that potential output isn’t an actual number, just an estimate that may tell us more about the dreary minds of international agencies than about real supply-side effects. More on that soon too. But it’s a further reason to spend more now, and to worry even less about any debt that we run up at today’s low, low rates.
The point is that perfectly standard, mainstream economics makes a powerful case for (much) more infrastructure spending. And this needs to be said often.
Posted by Mark Thoma on Saturday, February 27, 2016 at 10:46 AM in Economics |
Posted by Mark Thoma on Saturday, February 27, 2016 at 12:06 AM in Economics, Links |
Here's my view on the controversy over Sander's economic plan:
I do not believe that we can sustain 5% growth over the next eight years. In the short-run -- over the next two to four years -- the situation is different. In that timeframe, our ability to achieve rapid growth depends upon the size of the output gap, the effectiveness of monetary and fiscal policy at boosting the economy (fiscal policy in particular), the difficulty in overcoming the factors that caused the recession in the first place, and the responsiveness of potential output to policy measures and the recovery itself (i.e. how much of the decline in potential output is permanent, and how much is cyclical).
The main point of emphasis is familiar: it would be a bigger mistake not to try and increase output if there actually is more room to expand than we think than it would be to push for expansion and find the gap is small. In the first case, we’d have people who could be employed remaining idle, a costly error, in the second inflation which the Fed can reverse fairly quickly. So it’s the same asymmetric cost tradeoff many of us have been pounding the Fed about.
I’m worried people will accept without question that the gap is small due to the pushback against Friedman's analysis of the Sander's plan, and that will justify policy passivity when we need just the opposite. So let's stop arguing, put the policies we need in place, and push as hard as we can to increase employment until inflation reveals that we have, in fact, hit capacity constraints. Maybe that happens quickly, but maybe not and we owe it to those who remain unemployed, have dropped out of the labor force but would return, or took a job with lousy wages to try. People who had nothing to do with causing the recession have paid the costs for it, and if we experience a short bout of above target inflation I can live with that. We've been wrong about this before in the 1990s, and we may very well be wrong about this again.
Posted by Mark Thoma on Friday, February 26, 2016 at 12:01 PM in Economics, Politics |
A New Deal for Europe, NYRB: The far right has surged in just a few years from 15 percent to 30 percent of the vote in France, and now has the support of up to 40 percent in a number of districts. Many factors conspired to produce this result: rising unemployment and xenophobia, a deep disappointment over the left’s record in running the government, the feeling that we’ve tried everything and it’s time to experiment with something new. These are the consequences of the disastrous handling of the financial meltdown that began in the United States in 2008, a meltdown that we in Europe transformed by our own actions into a lasting European crisis. The blame for that belongs to institutions and policies that proved wholly inadequate, particularly in the eurozone, consisting of nineteen countries. We have a single currency with nineteen different public debts, nineteen interest rates upon which the financial markets are completely free to speculate, nineteen corporate tax rates in unbridled competition with one another, without a common social safety net or shared educational standards—this cannot possibly work, and never will.
Only a genuine social and democratic refounding of the eurozone, designed to encourage growth and employment, arrayed around a small core of countries willing to lead by example and develop their own new political institutions, will be sufficient to counter the hateful nationalistic impulses that now threaten all Europe. ...[continue]...
Posted by Mark Thoma on Friday, February 26, 2016 at 11:19 AM in Economics, Politics |
Why is the Republican Party is such disarray?:
Twilight of the Apparatchik, by Paul Krugman, Commentary, NY Times: ... As many have noted, it’s remarkable how shocked — shocked! — that establishment has been at the success of Donald Trump’s racist, xenophobic campaign. Who knew that this kind of thing would appeal to the party’s base? ...
Seriously, Republican political strategy has been exploiting racial antagonism, getting working-class whites to despise government because it dares to help Those People, for almost half a century. So it’s amazing to see the party’s elite utterly astonished by the success of a candidate who is just saying outright what they have consistently tried to convey with dog whistles.
What I find even more amazing, however, are the Republican establishment’s delusions about what its own voters are for. ...
Here’s an example: Last summer,... when Mr. Trump ... promised not to cut Social Security,... insiders like William Kristol gleefully declared that he was “willing to lose the primary to win the general.” In reality, however, Republican voters don’t at all share the elite’s enthusiasm for entitlement cuts...
Oh, and the G.O.P. establishment was also sure that Mr. Trump would pay a heavy price for asserting that we were misled into Iraq — evidently unaware just how widespread that (correct) belief is among Americans of all political persuasions.
So what’s the source of this obliviousness? ... Most Republican officeholders hold safe seats, which they can count on keeping if they are sufficiently orthodox. Moreover, if they should stumble, they can fall back on “wingnut welfare,” the array of positions at right-wing media organizations, think tanks and so on that are always there for loyal spear carriers. ... They know that people outside their party disagree, but that doesn’t matter much for their careers.
Now, however, they face the reality that most voters inside their party don’t agree with the orthodoxy, either. And all signs are that they still can’t wrap their minds around that fact. ... Even now, when it’s almost too late to stop the Trump Express, they still imagine that “But he’s not a true conservative!” is an effective attack.
Things would be very different, obviously, if Mr. Trump were in fact to lock in the Republican nomination (which could happen in a few weeks). Would his raw appeal to white Americans’ baser instincts continue to work? I don’t think so. But given the ineffectuality of his party’s elite, my guess is that we will get a chance to find out.
Posted by Mark Thoma on Friday, February 26, 2016 at 08:30 AM in Economics, Politics |
Posted by Mark Thoma on Friday, February 26, 2016 at 12:06 AM in Economics, Links |
This is the conclusion to Christina and David Romer's detailed evaluation and critique of Gerald Friedman's analysis of Senator Sander's economic plan:
Senator Sander's Proposed Policies and Economic Growth: ...IV. CONCLUSION The bottom line of our evaluation of Professor Friedman’s analysis is that it is highly deficient. The estimated demand - induced effects of Senator Sanders’s policies are not just implausibly large but literally incredible. Moreover, even if they were not deeply flawed, Freidman’s enormous estimates of demand - fueled growth could not and would not come to pass. Even very generous estimates of the amount of slack still present in the American economy would not be enough to accommodate demand - driven growth of anything near what Friedman is estimating. As a result, inflation would soar and monetary policy would swing strongly to counteract them. Finally, a realistic evaluation of the impact of Senator Sanders’s policies on productive capacity (something that is neglected in Friedman’s analysis) suggests that those impacts are likely small and possibly negative.
Though we have been frankly critical of Professor Friedman’s analysis, he has provided a service to public debate by posting his analysis so that other economists can evaluate its validity. We are posting our evaluation in the same spirit.
Posted by Mark Thoma on Thursday, February 25, 2016 at 03:27 PM in Economics, Politics |
From Simon Wren-Lewis:
A letter to Tony Blair: Dear Mr. Blair
We have not met, but I have talked to your former colleague Gordon a few times and I did some academic work on his 5 tests for Euro entry. I saw a report that you were mystified by the popularity of Jeremy Corbyn and Bernie Sanders. I have an article today in The Independent that might help you understand your puzzle.
I know you find it strange that people that appear to you like those your predecessor Neil Kinnock did battle with over the future of the Labour Party in the 1980s are now running the party. It must also seem strange that in the US where socialism once seemed to be regarded as a perversion, large numbers should be supporting a socialist candidate. You suggest some explanations, but you do not mention the power of finance, inequality and the senselessness of austerity. You say that these new leaders will not be electable. But if the alternative is to try and elect leaders from the centre who will do nothing to confront these great issues, and will instead cut spending, accept stagnation and wait for the next financial crisis, is it any wonder that many people would rather take their chance with someone different? ...
There are many Labour MPs and left leaning journalists who seem to share your puzzlement, and have decided that they have to fight again the battles of the 1980s by doing everything to undermine their new Labour leadership. ... Rather than celebrating the enthusiasm and interest of the many young people that have recently joined (even if they regard some of their aspirations as naive), and who will be vital in future election campaigns, this overtly anti-Corbyn group seem to regard them as a threat. ...
Please tell them to stop. I fear they need someone they respect like you to point out the foolishness of their actions.
Posted by Mark Thoma on Thursday, February 25, 2016 at 01:17 PM in Economics, Politics |
Srdan Tatomir of the Bank of England:
How do firms adjust to falls in demand?: How do firms response to falls in demand for their products in the real world? Do they cut wages? Or are they able only to freeze them? What other methods can they use to adjust their labour costs? And does any of this matter? The answer to the final question is emphatically yes. How firms adjust the quantity and cost of their labour input, particularly in response to a downturn, is relevant for monetary policy. If firms are unable to cut wages – what economists call ‘downward nominal wage rigidity’ (DNWR) – then they have to reduce the number of employees, increasing unemployment, further depressing output and weighing on inflation.
To explore just how firms adjust to changes in demand conditions, the Bank carried out a wage-setting survey in 2014. This survey is a part of a cross-country European project carried out by the Wage Dynamics Network (WDN). (Previous reports are available on the ECB’s website). Part of the survey asked a series of questions to gauge how firms adjusted their labour decisions during 2010-2013, following the Great Recession of 2008-2009. This post focuses on our analysis of the answers to these questions. A richer exposition can be found in our recently published Working Paper. ...
The UK WDN survey evidence provides support for some of the theoretical arguments for wage rigidity. ...
Many firms did not freeze pay but increased wages. Yet nominal wage growth must be assessed against the rate of inflation. The survey also allows the measurement of downward real wage rigidity (DRWR). In particular, firms were asked whether or not they directly and explicitly linked changes in base wages to inflation over the period 2010-13. My probit estimates suggest that a strong increase in demand is positively associated with inflation-linked pay. This is perhaps because firms that saw a strong recovery in demand were able to link wage growth explicitly to inflation. Also, the share of workers with more than five years of tenure is positively associated with DRWR. This is in line with the predictions of Lindbeck and Snower (1989), where insiders have more bargaining power than outsiders and are more likely to resist any falls in real wages.
Why the downward rigidity?
While there is evidence of downward wage rigidity among UK firms during 2010-13, our statistical analysis does not uncover the reasons why that might be the case. That is why the survey also asked those firms that did not cut wages why they did not do so. Some of the most common answers were that the most productive workers would leave and that outside wage options acted as a constraint on pay (Chart 5). Firms also emphasised the importance of morale and employee effort. This supports the ‘shirking’ model of Shapiro and Stiglitz (1984) which posits that pay differences have a negative impact on employees’ work effort, and the ‘fair wage-effort’ hypothesis of Akerlof and Yellen (1990), according to which pay differences are perceived as unfair by existing employees, who bid pay up. In contrast, comparatively less importance was placed on implicit wage contracts i.e. firms ‘smoothing’ through wage changes because workers are risk averse and like wage stability. And, perhaps unsurprisingly, given the low union density in the United Kingdom, regulations and collective agreements were less important reasons for not cutting wages.
When firms face a fall in demand and they can’t reduce wages, they might end up hiring fewer workers. Survey data suggests that was an important channel of adjustment during 2010-2013 but other measures were used, too (Chart 6). Firms also reduced working hours, decreased their use of agency workers and allocated more work to junior staff. This suggests that there is a variety of ways firms can adjust their labour costs, even in the presence of wage rigidity.
In the United Kingdom many firms tend not to adjust wages downwards. Instead they reduce labour costs in other ways – they appear to be flexible in their use of other measures affecting the quantity of labour input. But in the presence of downward wage rigidity, firms’ response to changes in demand may well amplify changes in employment, output and inflation. To some extent, this will be cushioned by the UK’s inflation targeting regime. A positive inflation target will help to ‘grease the wheels’ of the labour market, allowing firms to adjust real wages and dampen employment and output volatility.
Posted by Mark Thoma on Thursday, February 25, 2016 at 09:51 AM in Economics, Unemployment |
Lacker, Kaplan, Fischer, by Tim Duy: Today Richmond Federal Reserve President Jeffrey Lacker argued that the case for rate hikes remains intact, arguing that monetary policy remains quite accommodative:
So at this point, estimates of the natural real rate of interest do not suggest that the zero lower bound is impeding the Fed’s ability to attain its 2 percent inflation objective. In fact, this perspective would bolster the case for raising the federal funds rate target.
And in he is quoted by Reuters adding:
Ongoing strength in the U.S. job market could give the Federal Reserve justification for multiple interest rate increases this year, Richmond Fed President Jeffrey Lacker said on Wednesday...
.."I still think prospects for rate increases this year is the logical" view, Lacker said in a presentation to a business school in Baltimore, adding that economic data did not indicate that a recession was imminent in the United States.
If Lacker were still voting this year, he would likely be a serial dissenter. On the opposite side of the table sits Dallas Federal Reserve President Robert Kaplan. In an interview with the Financial Times, Kaplan leans very dovish:
Now was a time for patience as the Federal Reserve seeks to understand the impact of financial market turbulence and slowing growth in other economies, said Mr Kaplan, who does not vote on Fed rates this year but takes part in the debate.
“In order to reach our inflation objective we may need to be more patient than we previously might have thought,” he said. “If that means we take an extended period of time where we stop and don’t move, that may also be necessary. I am not prejudging that.”
Pure wait-and-see, risk management mode, and the most likely direction the Fed will take in March and April. Federal Reserve Vice Chair Stanley Fischer remains less-moved by recent developments. Instead, low unemployment rates capture his attention (emphasis added):
..most estimates of the full employment rate of unemployment are close to 5 percent. The actual rate of unemployment is now slightly below 5 percent, and the median view of the members of the FOMC is that it will decline further, perhaps even to the vicinity of 4.7 percent. The question is, should we be concerned about that possibility? In my view, a modest overshoot of this sort would be appropriate in current circumstances for two reasons. The first reason is that other measures of labor market conditions--such as the fraction of workers with part-time employment who would prefer to work full time and the number of people not actively looking for work who would like to work--indicate that more slack may remain in the labor market than the unemployment rate alone would suggest. And the second reason is that with inflation currently well below 2 percent, a modest overshoot could actually be helpful in moving inflation back to 2 percent more rapidly. Nonetheless, a persistent large overshoot of our employment mandate would risk an undesirable rise in inflation that might require a relatively abrupt policy tightening, which could inadvertently push the economy into recession. Monetary policy should aim to avoid such risks and keep the expansion on a sustainable track.
Unemployment is currently at 4.9 percent. It doesn't take much imagination to see it falling to 4.7 percent in short order. Fischer sounds very uncomfortable with the prospect of the unemployment rate falling much below 4.7%. He is getting an itchy trigger finger.
I remain unmoved by this logic:
If the recent financial market developments lead to a sustained tightening of financial conditions, they could signal a slowing in the global economy that could affect growth and inflation in the United States. But we have seen similar periods of volatility in recent years--including in the second half of 2011--that have left little visible imprint on the economy, and it is still early to judge the ramifications of the increased market volatility of the first seven weeks of 2016. As Chair Yellen said in her testimony to the Congress two weeks ago, while "global financial developments could produce a slowing in the economy, I think we want to be careful not to jump to a premature conclusion about what is in store for the U.S. economy."
This echoes the comments of San Francisco Federal Reserve President John Williams, and again misses the Fed's response to financial turmoil. In 2011, it was Operation Twist. One would think they would keep a chart like this on hand:
I really do not understand how Fed officials can continue to dismiss market turmoil using comparisons to past episodes when those episodes triggered a monetary policy response. They don't quite seem to understand the endogeneity in the system.
My sense is that there remains a nontrivial contingent within the Fed that really, truly believes they need to hike sooner than later for fear that overshooting the employment mandate will result in overshooting the inflation target. This contingent is attempting to look at the financial system as separate from the "real" economy. That will not work. No matter how good the underlying fundamentals, if you let the financial system implode, it will take the economy down with it. I don't know that the Fed needs to cut rates, or that they needed to cut rates as deeply as they did during the Asian Financial crisis, but I do know this: The monetary authority should not tighten into financial turmoil. Wait until you are out of the woods. That's Central Banking 101. And I suspect that is ultimately the direction the Fed will take.
Bottom Line: Despite some hawkish talk, the Fed will find themselves in risk management mode at the March meeting. Some will not like it. There will remain a contingent that fears standing still risks excessive overshooting of the inflation target.
Posted by Mark Thoma on Thursday, February 25, 2016 at 12:15 AM in Economics, Fed Watch, Monetary Policy |
Posted by Mark Thoma on Thursday, February 25, 2016 at 12:06 AM in Economics, Links |
Branko Milanovic at VoxEU:
Introducing Kuznets waves: How income inequality waxes and wanes over the very long run: In 1955 when Simon Kuznets wrote about the movement of inequality in rich countries (and a couple of poor ones), the US and the UK were in the midst of the most significant decrease of income inequality ever registered in history, coupled with fast growth. It thus seemed eminently reasonable to look at the factors behind the decrease of inequality, and Kuznets famously found them in expanded education, lower inter-sectoral productivity differences (thus the rent component of wages would be equalized), lower return to capital, and political pressure for greater social transfers. He then looked at (or rather imagined) the evolution of inequality during the previous century and thought that, driven by the transfer of labor from agriculture to manufacturing, inequality rose and reached its peak in the rich world sometime around the turn of the 20th century. Thus, he created the famous Kuznets curve.
The Kuznets curve was the main tool used by inequality economists when thinking about the relationship between development or growth and inequality over the past half century. But the Kuznets curve gradually fell out of favor because its prediction of low inequality in very rich societies could not be squared with the sustained increase in income inequality that started in the late 1970s in practically all developed nations (see the long-run graphs for the US and the UK). Many people thus rejected it.
The upswing in current inequality as a second Kuznets curve
In a new book (Milanovic 2016), I argue however that we should see the current upswing in inequality as the second Kuznets curve in the modern times, being driven, like the first, mostly by a technological revolution and the transfer of labor from more homogeneous manufacturing into skill-heterogeneous services (and thus producing a decline in the ability of workers to organize), but also (again like the first) by globalization, which has both led to the famous hollowing out of the middle classes in the west and to a pressure to reduce high tax rates on mobile capital and high-skilled labor. The elements listed here are not new. But putting them together (especially viewing technological progress and globalization as practically indissoluble, even if conceptually different) and viewing this as part of regular Kuznets waves is new. It has obvious implications for the future, not the least that this bout of inequality growth will peak like the previous one and eventually go down. ...
Inequality may not be overturned soon
Which leads us to the present. How long will the current upswing of the Kuznets wave continue in the rich world, and when and how will it stop? I am skeptical that it will be overturned soon, at least not in the US where I see four powerful forces that keep on pushing inequality up. I will just list them here (they are, of course, discussed in the book):
- Rising share of capital income which is in all rich countries extremely concentrated among the rich (with a Gini in excess of 90);
- Growing association of high incomes from both capital and labor in the hands of the same people (Atkinson and Lakner 2014);
- Homogamy (the educated and the rich marrying each other); and
- Growing importance of money in politics which allows the rich to write rules favorable to them and thus to maintain the inequality momentum (Gilens 2012).
The peak of inequality in the second Kuznets wave should be lower than in the first (when in the UK, it was equal to the inequality level of today’s South Africa) because the rich societies have in the meantime acquired a number of ‘inequality stabilizers’, from unemployment benefits to state pensions.
The pro-inequality trends will be very hard to overturn during the next generation, but eventually they may be – through a combination of political change, pro-unskilled labor technological innovations (which will become more profitable as skilled labor’s price increases), dissipation of rents acquired during the current bout of technological efflorescence, and possibly greater attempts to equalize ownership of assets (through forms of ‘people’s capitalism’ and workers’ shareholding).
Now, these are of course the benign factors that, I think, will ultimately set inequality in rich countries on its downward path. But history teaches us too that there are malign factors, notably wars, in turn caused by domestic maldistribution of income and power of the elites (as was the case in the World War I), that can also do the job of income leveling. But they do it at the cost of millions of human lives. One can hope that we have learned something from history and would avoid this destructive path to equality in poverty and death.
Posted by Mark Thoma on Wednesday, February 24, 2016 at 12:35 AM in Economics, Income Distribution |
Not All Fed Presidents On Board With March Pause: The Fed will almost certainly pause in March. But not all Fed presidents are leaning that way. And at least one seems to be shifting closer to March than further away. At the end of January, San Francisco Federal Reserve President John Williams had this to say, via Reuters:
San Francisco Federal Reserve Bank President John Williams told reporters he now sees slightly slower growth, slightly higher unemployment, and about a tenth of a percent lower inflation this year than he had expected in December, when the Fed raised rates for the first time in nearly a decade...
..."Standard monetary policy strategy says a little less inflation, maybe a little less growth ... argue for just a smidgen slower process of normalizing rates," Williams said.
"We got a little stronger dollar, some mixed data on the economy, some weakness in (fourth-quarter U.S. GDP growth), all of those coming together kind of tell me that we probably need a little bit more monetary accommodation this year than I was thinking in the middle of December."
But yesterday, the LA Times reported:
And unlike some of his colleagues at the Fed, who have suggested that the central bank hold off on raising interest rates next month, Williams says no such thing. The Fed lifted its benchmark rate in December after keeping it at near zero for seven years, but officials made no change at their last meeting in late January, amid tumbling stock and oil prices, and rising fears about China’s slowdown.
Williams, in an interview with the Los Angeles Times, said the recent global developments certainly need to be closely monitored. But he said the “big picture for me hasn’t changed,” and his view on U.S. employment and inflation — the two key areas determining the Fed’s monetary policy — remains sanguine.
Sounds like Williams is backing down from his "smidgen" slower pace of rate hikes. Of course, really the only way to have just a "smidgen" slower pace is to skip the March meeting and acquiesce to at most three rate hike this year. So if Williams is backing down, he is saying that March remains an open question.
What would have changed his position? Data would be my guess. Since Williams spoke with reporters in January, the data has been fairly supportive. As he notes in his most recent speech, unemployment has fallen below 5%, his estimate of the natural rate of unemployment, and wage growth is starting to accelerate. Moreover, he still expects inflation will accelerate. I would add that initial unemployment claims turned back down:
Quits rates rose in December, indicating more, not less, confidence among workers:
Industrial production ticked up and weakness remains fairly concentrated:
Retail sales were stronger than expected, knocking a hole in the "consumer is dying" story:
In addition, housing remains solid - and housing generally does not strengthen into a recession. Indeed, Toll Brothers is not exactly worried about the economy in 2016. And, to top it off, last week we saw more evidence of rising inflation in the CPI report:
Hence I am not surprised to hear more optimism among Fed presidents than at the end of January. To be sure, some never wavered in their confidence. Kansas City Federal Reserve President Esther George today, via Bloomberg:
Federal Reserve policy makers should be prepared to consider raising interest rates in March despite recent financial market volatility, said Kansas City Fed President Esther George, whose outlook for solid growth this year remains intact.
“It absolutely should be on the table” at the next meeting, George told Pimm Fox and Kathleen Hays in a Bloomberg Radio interview Tuesday from the bank. “At this point I would not say that the data have suggested there has been a fundamental shift in the outlook.”
She even suggests that the Fed could surprise markets:
“It is clear the markets have taken that off the table,” said George, a voting member of the FOMC in 2016. “Policy makers have to look at what are the fundamentals of the economy.” Investors currently view the probability of a single rate rise in 2016 at around 45 percent, according to trading in federal funds futures contracts. The FOMC next meets on March 15-16.
That's not going to happen; the Fed will pause in March because ultimately they have to. The events since December have only bolstered the position of Federal Reserve Governor Lael Brainard, the strongest voice on the Board arguing for a cautious approach. That said, not all will see it this way. Back to Williams:
Of course, I am aware of, and closely monitoring, potential risks. But I want to be clear what that means. It’s often said that the economy isn’t the stock market and the stock market isn’t the economy. That’s very true. Short-term fluctuations or even daily dives aren’t accurate reflections of the state of the vast, intricate, multilayered U.S. economy. And they shouldn’t be viewed as the four horsemen of the apocalypse. Remember, the expansion of the 1980s wasn’t derailed by the crash of ’87, and we sailed through the Asian financial crisis a decade later. I say “remember”—some of you here will actually remember and others will remember it from your high school history class.
This paragraph was almost painful to read. Revisionist history. It is as if Williams completely forgets the role of monetary policy in both instances. What did the Fed do in November of 1987? Did they continue hiking rates? What did the Fed do in 1998? Did they continue hiking rates? No, in both instances they actually cut rates. And it was that monetary response that helped the economy "sail through" these episodes.
The Fed will reach the same conclusion this time as well: Even if the economic data is solid and the recovery remains intact, there is reason to believe that tightening financial conditions alone give sufficient reason for the Fed to pause. The Fed knows this. From the January minutes:
Almost all participants cited a number of recent events as indicative of tighter financial conditions in the United States; these events included declines in equity prices, a widening in credit spreads, a further rise in the exchange value of the dollar, and an increase in financial market volatility. Some participants also pointed to significantly tighter financing conditions for speculative-grade firms and small businesses, and to reports of tighter standards at banks for C&I and CRE loans. The effects of these financial developments, if they were to persist, may be roughly equivalent to those from further firming in monetary policy.
These issues are not going away by March. Hence, risk management mode remains the order of the day.
Moreover, consider the situation from the perspective of Federal Reserve Chair Janet Yellen. You have no doubt that your actions at this point define your legacy. On one side is the risk that your policy traps the US economy at the zero bound. You are just another in a long line of failed central bankers who tried to normalize too soon. This risk has been brought into sharp relief in the past two months (Brainard warned you, you think). On the other side is the risk that inflation drifts above your 2% target but you raise the odds of pulling off the zero bound. And you know that if push comes to shove, you can always argue that a period of above-2% inflation only makes up for a extended period of sub-2% inflation. And that you need somewhat higher inflation to firm up faltering inflation expectations. Which risk do you want to embrace? I am guessing the second. That's what Yellen will choose.
Bottom Line: The Fed is on hold. No clear end to the pause. But be wary that some Presidents might want something in return for that pause. What I am watching for are signs that Fed officials will lean toward re-instating the balance of risks assessment to the post-FOMC statement. And which way would that assessment lean? That, I think, is the question I would like to see financial journalists asking of Fed officials.
Posted by Mark Thoma on Wednesday, February 24, 2016 at 12:15 AM in Economics, Fed Watch, Monetary Policy |
Posted by Mark Thoma on Wednesday, February 24, 2016 at 12:06 AM in Economics, Links |
Narayana Kocherlakota has, as he says on Twitter, a new post related to my column:
Thoughts on a Pro-Growth Policy Mix: There are three key macroeconomic questions facing the country as it prepares for the Presidential and Congressional elections in November.
First, is it possible to adopt policies that would lead the economy to achieve materially super-normal rates of growth in the coming four years? I answered this question in the affirmative in this post.
Second, would it be socially beneficial to adopt policies that would lead the economy to achieve materially super-normal rates of growth in the coming four years? I answered this question in the affirmative in this post and in this one. My conclusion was that, given the low level of real interest rates and real wages compared to historical norms. it would be beneficial to adopt policies that would lead the economy to grow at 5-6% per year over the next four years.
In this post, I turn to the final question: what policy mix should be pursued in order to deliver the desirable super-normal growth rates? ...[continue reading]...
Posted by Mark Thoma on Tuesday, February 23, 2016 at 02:03 PM
Donald Trump, Crony Capitalist: Four years ago, in the first draft of my book “A Capitalism for the People,” I had a section dedicated to how worrisome a Donald J. Trump presidential bid would be for America. I was not prescient. It’s just that having grown up in Italy, I knew how a real estate tycoon — in this case, Silvio Berlusconi — whose career exemplified crony capitalism could become the leader of supposed pro-market forces, and I knew what it meant for the country.
I cut this section after being told that my point was irrelevant: In America, there was no chance that a character like Mr. Trump would ever be seriously considered as a candidate.
Then 2016 happened. ...
Mr. Trump ... is, in short, the essence of that commingling of big business and government that goes under the name of crony capitalism. ...
Posted by Mark Thoma on Tuesday, February 23, 2016 at 08:40 AM in Economics, Politics |
I have a new column:
Here’s Why Bernie Sanders’ 5% Growth Plan Isn’t Crazy After All: Controversy erupted last week when University of Massachusetts Professor Gerald Friedman produced estimates showing that under the Sander’s economic plan, “The growth rate of the real gross domestic product will rise from 2.1 percent per annum to 5.3 percent so that real GDP per capita will be over $20,000 higher in 2026 than is projected under the current policy.” The reaction from critics is exemplified by a letter from four former heads of the Council of Economic Advisors under Democratic presidents, Alan Krueger, Austan Goolsbee, Christina Romer, and Laura D’Andrea Tyson:
“As much as we wish it were so, no credible economic research supports economic impacts of these magnitudes. Making such promises runs against our party’s best traditions of evidence-based policy making and undermines our reputation as the party of responsible arithmetic.”
Defenders such as Jamie Galbraith, an economist at the University of Texas, argued that there is nothing “magical” or outlandish about the estimates, Professor Friedman used a defensible model to obtain his results:
“What the Friedman paper shows, is that under conventional assumptions, the projected impact of Senator Sanders' proposals stems from their scale and ambition.
When you dare to do big things, big results should be expected. The Sanders program is big, and when you run it through a standard model, you get a big result.”
Is it possible for the economy to reach such a high rate of economic growth? ...
Not a big fan of the title they gave this -- I didn't address the specifics of Sander's economic program.
Posted by Mark Thoma on Tuesday, February 23, 2016 at 08:09 AM in Economics, Politics |
Posted by Mark Thoma on Tuesday, February 23, 2016 at 12:06 AM in Economics, Links |
The economic outlook from Kevin Lansing of the SF Fed:
FRBSF FedViews: Kevin J. Lansing, research advisor at the Federal Reserve Bank of San Francisco, stated his views on the current economy and the outlook as of February 11, 2016.
- Real GDP growth slowed in the fourth quarter of 2015 to less than 1% at an annual rate. Declines in business investment, inventories, and net exports were offset by solid increases in personal consumption expenditures and residential investment. For 2015 as a whole, real GDP growth was 1.8%, slightly below the average annual growth rate of 2.1% observed since the Great Recession ended.
- We expect real GDP growth to pick up in 2016 and then ease to trend by the end of 2017. Downside risks to the U.S. growth outlook include possible spillovers from economic slowdowns in foreign markets and a continued strengthening of the U.S. dollar which would pose a headwind for net exports.
- Payroll employment increased by 151,000 jobs in January, signaling continued improvements in the labor market. The six-month moving average remains above 200,000 new jobs per month. The unemployment rate dipped to 4.9% in January, which is slightly below the level that we judge to be the natural rate of unemployment.
- Inflation as measured by the four-quarter change in the personal consumption expenditures (PCE) price index has remained below the Federal Open Market Committee’s (FOMC) 2% target since mid-2012. Absent further declines in energy prices or a further strengthening of the U.S. dollar, we would expect PCE inflation to rise gradually towards 2% as economic slack continues to dissipate.
- Treasury yields have declined recently reflecting a “flight-to-safety” in response to investor concerns about economic slowdowns in foreign economies and the prospect that such events could have negative spillovers for U.S. growth. Since May 2015, the yield spread between Baa-rated corporate bonds and 10-year Treasury bonds has widened by nearly 100 basis points, indicating that corporate bondholders are demanding more compensation for exposure to credit risk.
- Recent declines in the Standard & Poor’s (S&P) 500 have caused the index to dip below levels that prevailed one year ago. Over the same time frame, oil prices have dropped precipitously to levels last observed in 2002. Historically, U.S. recessions have often been associated with oil price spikes, but not sharp declines. The recent contemporaneous drop in stock prices suggests that equity market investors are interpreting lower oil prices as a signal of slowing global growth—a development that would have negative consequences for future corporate profits.
- The Federal Reserve Board’s index of industrial production has recorded three consecutive monthly declines, mainly reflecting production slowdowns in the energy sector. Still, the December 2015 reading is only about 1% below the prior peak recorded in September 2015.
- The Chicago Fed National Activity Index (CFNAI) has proved useful as an early indicator of recessions. It is distilled from 85 monthly series drawn from four broad data categories: consumption and housing; employment, unemployment, and hours worked; sales, orders, and inventories; and production and income. The index is constructed to have an average value of zero, with a positive reading indicating growth above trend and a negative reading indicating growth below trend. The three-month moving average CFNAI is currently at –0.24, well above the threshold of –0.7 that has typically signaled the onset of a recession. But as a caveat, it should be noted that the index has often dropped quickly in the months leading up to past downturns. For example, the index stood at –0.2 in July 2007, only five months before the start of the Great Recession.
- Few, if any, past recessions have been successfully predicted by professional forecasters. Forecasting recessions is difficult because each one tends to differ in important ways from previous episodes. Past recessions have been triggered by upward spiking oil prices, increases in policy interest rates designed to bring down high inflation, and bursting asset price bubbles. None of these scenarios would seem to fit the present circumstances.
The views expressed are those of the author, with input from the forecasting staff of the Federal Reserve Bank of San Francisco. They are not intended to represent the views of others within the Bank or within the Federal Reserve System.
Posted by Mark Thoma on Monday, February 22, 2016 at 03:34 PM in Economics, Monetary Policy |
Social programs "need to be refitted for a polarized labor market hard-wired to generate inequalities":
Why Canada should foster a ‘second-chance’ society, by Miles Corak: Canadians should be thumping their chests, after all many others are patting us on the back. When it comes to social mobility we are among the world leaders. Even U.S. President Obama acknowledged that a poor child is more likely to move up in life in Canada than in the United States.
This kind of mobility, the capacity for children to become all that they can be without regard to their starting point in life, is the bedrock of fairness. ...
But ... the ... foundations of fairness are shifting; luck will matter more, meritocracy will be perverted by growing inequality, and our public policies haven’t really changed to prepare for the new reality that is already pressing on young people. ...
Canadians need to build a “second chance” society so that the consequences of bad luck or bad choices don’t matter as much.
There is a whole host of ways our social programs built up in an era of stable and steady job growth need to be refitted for a polarized labor market hard-wired to generate inequalities. ...
He goes on to explain some of the ways this might be accomplished.
Posted by Mark Thoma on Monday, February 22, 2016 at 09:24 AM in Economics, Income Distribution, Social Insurance |
Cranks on Top, by Paul Krugman, Commentary, NY Times: ... Marco Rubio has yet to win anything, but by losing less badly than other non-Trump candidates he has become the overwhelming choice of the Republican establishment. Does this give him a real chance of overtaking the man who probably just won all of South Carolina’s delegates? I have no idea.
But what I do know is that one shouldn’t treat establishment support as an indication that Mr. Rubio is moderate and sensible. On the contrary, not long ago someone holding his policy views would have been considered a fringe crank.
Let me leave aside Mr. Rubio’s terrifying statements on foreign policy and his evident willingness to make a bonfire of civil liberties, and focus on what I know best, economics.
You probably know that Mr. Rubio is proposing big tax cuts..., for example,... Mitt Romney would end up owing precisely zero in federal taxes. What you may not know is that Mr. Rubio’s tax cuts would be almost twice as big as George W. Bush’s...
But not to worry: Mr. Rubio insists that his tax cuts would pay for themselves... Never mind the complete absence of any evidence for this claim...
Then there’s Mr. Rubio’s call for a balanced-budget amendment, which, aside from making no sense at the same time he is calling for budget-busting tax cuts, would have been catastrophic during the Great Recession.
Finally, there’s monetary policy. Republicans have spent years inveighing against the Fed’s efforts to stave off economic disaster, warning again and again that runaway inflation is just around the corner — and being wrong all the way. But Mr. Rubio hasn’t changed his monetary tune at all, declaring a few days ago that it’s “not the Fed’s job to stimulate the economy” (although the law says that it is).
In short, Mr. Rubio is peddling crank economics. What’s interesting, however, is ... he’s not pandering to ignorant voters; he’s pandering to an ignorant elite. Donald Trump’s rise has confirmed ... that most Republican voters don’t actually subscribe to much of the party’s official orthodoxy. ...
In the G.O.P., crank doctrines in economics and elsewhere aren’t bubbling up from below, they’re being imposed from the top down. ...
So don’t let anyone tell you that the Republican primary is a fight between a crazy guy and someone reasonable. It’s idiosyncratic, self-invented crankery versus establishment-approved crankery, and it’s not at all clear which is worse.
Posted by Mark Thoma on Monday, February 22, 2016 at 08:44 AM in Economics, Politics |
Posted by Mark Thoma on Monday, February 22, 2016 at 12:06 AM in Economics, Links |
I thought this was interesting:
Absolute Changes in Living Standards, by Dietrich Vollrath: This may or may not be interesting, I'm not entirely sure myself. But I got a question from an undergrad in my economic growth course, and it was one of those questions that kind of catches you off guard because you hadn't really thought about it. The question was - paraphrasing - "Why do we look at growth rates rather than how much GDP per capita actually changed?". ...
Why do we focus on growth rates - percentage changes - as opposed to absolute changes in GDP per capita? ... For example, a growth rate of 2% implies an absolute change of 1000 in an economy with a GDP per capita of 50,000, and only a change of 200 in an economy with GDP per capita of 10,000.
First, what does the distribution of absolute changes in GDP per capita even look like? I had no idea. So I calculated the absolute growth in real GDP per capita per year for each country in the PWT. ...
As you can see, for India ... absolute growth tended to be very small. On average, from 1950 to 2011, GDP per capita rose by 51 dollars per year in India. The median was 42 dollars. Despite these small absolute changes, the percentage growth rate in could actually be quite high because GDP per capita is very low to begin with.
Compare that to the United States... For the US, average absolute growth in GDP per capita was 482 dollars, with a median of 617 dollars. Of course, those large changes in GDP per capita reflect very small percentage growth rates in the US, because GDP per capita is already so large.
From the perspective of growth rates, the US isn't growing very quickly compared to India, at least over the last 25 years. But in absolute terms, the increase in living standards in the US is about 10 times higher than in India in a given year.
Should we care about these absolute changes? ... It is really common to assume "log utility"... Log utility has the very particular property that the same growth rate of GDP per capita yields the same absolute change in welfare. If India and the US both have growth rates of 3%, then welfare in both countries rises by 3%, even though the absolute change in GDP per capita in the US is much larger. ...
Now what if utility is "more curved" than log? That is, what if marginal utility falls very quickly as GDP per capita goes up? Then ... the richer country would have a smaller change in welfare than the poorer country. ... But we could go the other direction, and look at utility that is "less curved" than log, or where marginal utility diminishes very slowly. Now,... the richer country has a higher gain in welfare. ...
An argument for thinking of utility as "more curved" than log is subsistence constraints. ... On the other hand, habit formation would be a force pushing towards "less curved" utility. ...
Ultimately, then, I think the answer to the students question is that we think there is diminishing marginal utility, and so growth rate rates make sense because they tell us something about absolute changes in welfare. But...who said utility of GDP per capita has to be as curved as log? ...
Posted by Mark Thoma on Sunday, February 21, 2016 at 04:03 PM in Economics |
Posted by Mark Thoma on Sunday, February 21, 2016 at 12:06 AM in Economics, Links |
How did globalization affect the job biographies of German manufacturing workers?, by Wolfgang Dauth, Sebastian Findeisen, and Jens Südekum: What are the labor market effects of globalization? This question dates back, at least, to the seminal work by Stolper and Samuelson (1941), but even today relatively little is known about the micro-level impacts of trade shocks on the job biographies of single workers. How are different individuals affected? Does it depend on their initial sectoral affiliation, location, and personal characteristics? Do they systematically adjust to globalization by moving across industries, regions, or plants to mitigate import shocks or to benefit from export opportunities? Does this endogenous mobility occur smoothly, or does it involve disruptive unemployment spells? And what are the cumulated long-run effects of trade shocks? These are central concerns for policymakers who worry about the distributive consequences of trade liberalizations. ...
Moving forward to the conclusion:
Summing up, our key insight is that German manufacturing workers benefited at large from this particular globalization episode. Yet, there have been winners and losers. Moreover, we find that individuals systematically adjust to globalization, and we discover a notable asymmetry in the individual labor market response to positive and negative shocks.
Trade shocks do not seem to trigger much ‘voluntary’ sorting from import-competing to export-oriented manufacturing industries. The patterns we observe in the data are more consistent with a type of mobility that is ‘forced’ by job displacement and unemployment. The push effects out of import-competing manufacturing industries are not mirrored by comparable pull effects into export-oriented branches. Often, the direction of the move is to the service sector.
We also find strong heterogeneity across different types of workers. Younger and less-skilled individuals, for example, are hit harder by import shocks but also benefit more from export opportunities. Women and men are affected similarly from import penetration, but men seem to materialize the benefits of rising export exposure better than women, thereby fueling the gender-wage gap. The basic upshot is that trade causes strong distributional effects in the German labor market, and our micro-level empirical findings might be informative for policymakers to design targeted policies that aim at those who benefit the least from globalization.
Posted by Mark Thoma on Saturday, February 20, 2016 at 07:36 PM in Economics, Income Distribution, International Trade |
Posted by Mark Thoma on Saturday, February 20, 2016 at 12:06 AM in Economics, Links |
Narayana Kocherlakota has a follow up to something of his I posted yesterday:
How Cheap Labor and Capital Suggest that Faster Growth is a Great Deal: In my last post, I stated that the current low level of real wages and real interest rates suggested that there may be large net social benefits associated with markedly faster growth. In this post, I provide a more detailed justification for this claim. I consider the possibility that the government expands its level of activity sufficiently that capital, labor, and output all grow 2.5% faster per year (something like 4-5% per year) than is currently projected over the next four years. Under this alternative profile, all three variables would be (a little more than) 10% higher than is currently projected at the end of 2020.
Because of constraints on the supply of labor and capital, the alternative profile that I propose would push upward on real wages and real interest rates. The key to my analysis is that both real wages and real interest rates are unusually low by historical standards. I use conventional elasticity estimates to argue that the supply pressures induced by the alternative growth profile would only be sufficient to push these prices back into more normal ranges.
Let me begin with employment. This picture is key in understanding the opportunities that may be available. It depicts the evolution of labor share - the ratio of real wages to average labor productivity - in the nonfarm business sector.
This ratio remains low by historical standards. The low level suggests that, for whatever reason, labor is unusually cheap. (Note the Congressional Budget Office projects that real wages and productivity will grow at roughly the same rate over the next five years.)
I am proposing an alternative profile that scales up both labor and capital by 10% in four years’ time. If production is constant-returns-to-scale, this profile will leave average labor productivity unaffected. However, in order to induce workers and non-workers to increase aggregate labor input by 10%, the real wage will have to rise. The recent meta-analysis of labor supply estimates elasticities in Chetty, et. al. suggest that it would require an increase of about 12% in the real wage to increase aggregate hours to that extent. That would push labor share back up to be a little higher than its 2000 peak (admittedly near the top of its historical range).
The above analysis ignores income effects on labor supply (that are usually estimated to be small). Incorporating those effects would push up on my estimate of the needed increase in the real wage. But the analysis also assumes that we are currently at full employment (which I don’t believe). The current underemployment of labor means that, for many workers, the shadow real wage is even lower than the observed real wage. Hence, allowing for involuntary underemployment at the current time would push down on my estimate of the needed increase in the real wage.
Let me turn from labor to capital. As argued here, the average productivity of capital is near its usual historical level. My proposed alternative growth path would not change this average productivity. But, as measured by Treasury Inflation Protected Securities (TIPS), the five-year real interest rate is very low (about zero). Again, capital looks cheap by historical standards.
My proposed faster growth profile would put upward pressure on the real interest rate. If households anticipated that their consumptions were to grow 2.5% faster per year, their demand for TIPS and other forms of saving would decline. Assuming an intertemporal elasticity of substitution of 1, the fall in demand would push the real interest rate back to 2.5 percent, which is consistent with more usual historical ranges. (Caution: There is a large range of available estimates of the relevant elasticity.)
Again, this discussion of capital assumes full employment. I have argued for some time that the current real interest rate is actually above r* (the real interest rate that would be consistent with full resource utilization). Given that consideration, my proposed alternative growth profile would lead to a lower real interest rate than 2.5 percent.
To sum up: I consider a growth profile in which capital, labor, and output all grow 2.5% faster per year than is currently anticipated for the next four years. Such a growth profile would put upward pressure on the real wage and the real interest rate. However, the real wage and the real interest rate both seem unusually low relative to historical norms. The above analysis suggests that the price pressures from my proposed alternative growth path would only be sufficient to push those prices back into alignment with their historical ranges.
Let me close with three brief comments.
- The above is obviously simplistic on many dimensions. I'd love to see more sophisticated analyses that use market prices as a source of information.
- The above is an analysis of the benefits of increasing the growth rate of potential output. The alternative growth profile should not put any extra pressure on the Fed to dampen inflationary pressures.
- I ignore an effect that I believe could be important. The prospect of higher demand could lead to more innovation and faster total factor productivity growth over this period. I argue here that we saw exactly that kind of effect from anticipated higher demand in the Great Depression. Such an effect would make faster growth an even better deal.
Posted by Mark Thoma on Friday, February 19, 2016 at 01:51 PM in Economics |
Quantitative Easing: Walking the Walk without Talking the Talk?: The extremely-sharp Joe Gagnon is approaching the edge of shrillness: he seeks to praise the Bank of Japan for what it has done, and yet stress and stress again that what it has done is far too little than it should and needs to do ...
Those of us who are, like me, broadly in Joe Gagnon's camp are now having to grapple with an unexpected intellectual shock. When 2010 came around and when the "Recovery Summers" and "V-Shaped Recoveries" that had been confidently predicted by others refused to arrive, we once again reached back to the 1930s. We remembered the reflationary policies of Neville Chamberlain, Franklin Delano Roosevelt, Takahashi Korekiyo, and Hjalmar Horace Greeley Schacht gave us considerable confidence that quantitative easing supported by promises that reflation was the goal of policy would be effective. They had been effective in the major catastrophe of the Great Depression. They should, we thought, also be effective in the less-major catastrophe that we started by calling the "Great Recession", but should now have shifted to calling the "Lesser Depression", and in all likelihood will soon be calling the "Longer Depression".
Narayana Kocherlakota's view, if I grasp it correctly, is that in the United States the Federal Reserve has walked the quantitative-easing walk but not talked the quantitative-easing talk. Increases in interest rates to start the normalization process have always been promised a couple of years in the future. Federal Reserve policymakers have avoided even casual flirtation with the ideas of seeking a reversal of any of the fall of nominal GDP or the price level vis-a-vis its pre-2008 trend. Federal Reserve policymakers have consistently adopted a rhetorical posture that tells observers that an overshoot of inflation above 2%/year on the PCE would be cause for action, while an undershoot is... well, as often as not, cause for wait-and-see because the situation will probably normalize to 2%/year on its own.
By contrast, Neville Chamberlain was very clear that it was the policy of H.M. Government to raise the price level in order to raise the nominal tax take in order to support the burden of amortizing Britain's WWI debt. Franklin Delano Roosevelt was not at all clear about what he was doing in total, but he was very clear that raising commodity prices so that American producers could earn more money was a key piece of it. Takahashi Korekiyo. And all had supportive rather than austere and oppositional fiscal authorities behind them.
But, we thought, monetary policy has really powerful tools expectations-management and asset-supply management tools at its disposal. They should be able to make not just a difference but a big difference. And yet…
There are three possible positions for us to take now:
- In a liquidity trap, monetary policy is not or will rarely be sufficient to have any substantial effect—active fiscal expansionary support on a large scale is essential for good macroeconomic policy.
- In a liquidity trap, monetary policy can have substantial effects, but only if the central bank and government are willing to talk the talk by aggressive and consistent promises of inflation—backed up, if necessary, by régime change.
- We are barking up the wrong tree: there is something we have missed, and the models that we think are good first-order approximations to reality are not, in fact, so.
I still favor a mixture of (2) and (1), with (2) still having the heavier weight in it. Larry Summers is, I think, all the way at (1) now. But the failure of the Abenomics situation to have developed fully to Japan’s advantage as I had expected makes me wonder: under what circumstances should I being opening my mind to and placing positive probability on (3)?
Posted by Mark Thoma on Friday, February 19, 2016 at 11:09 AM in Economics, Inflation, Monetary Policy |
False Beliefs about Food Stamps: In this post on the University of Illinois Policy Matters blog, Craig Gundersen tries to lay to rest a few false beliefs (or misconceptions) that may people (and policy makers) have about the Supplemental Nutrition Assistance Program (SNAP, also known as "food stamps").
Does SNAP participation lead to obesity obesity? [no]...
Does SNAP participation cut down hunger? [yes] ...
Finally, Gundersen takes on the idea that various health restrictions on SNAP spending will have much impact. ...
To that I'll add that most SNAP participants can easily get around the restrictions on what they buy by rearranging what they buy with SNAP and what they buy with non-SNAP dollars (see my explanation of that phenomenon here). ...
Posted by Mark Thoma on Friday, February 19, 2016 at 09:15 AM in Economics, Social Insurance |
"Sorry, but there’s just no way to justify this stuff":
Varieties of Voodoo, by Paul Krugman, Commentary, NY Times: America’s two big political parties are very different from each other... Republicans routinely engage in deep voodoo, making outlandish claims about the positive effects of tax cuts for the rich. Democrats tend to be cautious and careful about promising too much...
But is all that about to change?
On Wednesday four former Democratic chairmen and chairwomen of the president’s Council of Economic Advisers ... released a stinging open letter to Bernie Sanders and Gerald Friedman, a University of Massachusetts professor... The economists called out the campaign for citing “extreme claims” by Mr. Friedman that “exceed even the most grandiose predictions by Republicans” and could “undermine the credibility of the progressive economic agenda.” ...
Sorry, but there’s just no way to justify this stuff. For wonks like me, it is, frankly, horrifying. ...
Mr. Sanders is calling for a large expansion of the U.S. social safety net... But ... such a move ... would probably create many losers as well as winners — a substantial number of Americans, mainly in the upper middle class, who would end up paying more in additional taxes than they would gain in enhanced benefits.
By endorsing outlandish economic claims, the Sanders campaign is basically signaling that it doesn’t believe its program can be sold on the merits, that it has to invoke a growth miracle to minimize the downsides of its vision. It is, in effect, confirming its critics’ worst suspicions.
What happens now? In the past, the Sanders campaign has responded to critiques by impugning the motives of the critics. But ... Alan Krueger is one of the founders of modern research on minimum wages, which shows that moderate increases in the minimum don’t cause major job loss. Christina Romer was a strong advocate for stimulus during her time in the White House, and a major figure in the pushback against austerity in the years that followed.
The point is that if you dismiss the likes of Mr. Krueger or Ms. Romer as Hillary shills or compromised members of the “establishment,” you’re excommunicating most of the policy experts who should be your allies.
So Mr. Sanders really needs to crack down on his campaign’s instinct to lash out. More than that, he needs to disassociate himself from voodoo of the left — not just because of the political risks, but because getting real is or ought to be a core progressive value.
Posted by Mark Thoma on Friday, February 19, 2016 at 01:49 AM in Economics, Politics |
Posted by Mark Thoma on Friday, February 19, 2016 at 12:06 AM in Economics, Links |
Wonkery Has A Well-Known Liberal Bias: ... So, about wonks and progressive values: the reason the joke about facts having a liberal bias rings so true is that this really has become a defining difference between the two sides of our political chasm. On the right, allegiance to voodoo has become obligatory — leading Republican economists fell right in line when Jeb! announced his 4-percent solution. On the left, real policy research and political positions have marched hand in hand. The push for higher minimum wages, to take a not at all arbitrary example, has been mightily helped by the research literature showing that higher minimums don’t cost jobs, a line of research pioneered by Alan Krueger, one of the signatories of that open letter.
And in general, progressivism in America has valued intellectual integrity and openness to evidence, while conservatism increasingly rejects all of that — which is why scientists overwhelmingly lean Democratic.
But what if the political left starts behaving like the political right, making support for implausible claims a litmus test of loyalty, declaring that anyone raising hard questions is ipso facto corrupt? That would become very uncomfortable, to say the least. ...
So I hope that the Sanders campaign doesn’t just brush off this criticism as the “establishment” doing its corrupt thing, and realizes that it really is in danger of losing not just an election but an important part of what it should be standing for.
Narayana Kocherlakota (note that this is about "above-normal growth"):
Faster Growth IS Possible - And It May Well Be Desirable: Professor Gerald Friedman has argued here that, by adopting Senator Bernie Sanders’ economic proposals, the US economy would grow in excess of 5% per year over the next decade. Previously, former Governor Jeb Bush put forward (different) proposals that he has argued would lead to 4% economic growth over an extended period. These kinds of growth outcomes are often dismissed as prima face unachievable given the historical behavior of the US economy. (That’s one way that some readers have interpreted this letter.)
In this post, I make three points related to this discussion:
- There is no technological reason why real gross domestic product (GDP) cannot grow at 4% or even over 5% per year over the coming decade.
- Given (1), the relevant issue is: are the benefits of achieving such a growth path higher than the costs of doing so? I suggest that there are good reasons to believe that the answer to this question is more likely to be positive than at any time since the end of World War II.
- If the answer to (2) is affirmative, the question becomes: what set of economic proposals will best allow the country to achieve those positive net benefits? I don’t attempt a detailed examination of the consequences of Senator Sanders’ proposals or those of Mr. Bush. I only make the broad point that, given current economic circumstances, demand-based stimulus is likely to be more effective than supply-based stimulus.
My first point is familiar to all economists. Technologically speaking, the US can grow much faster over the next ten years than is currently forecast if two changes take place. The first is that Americans allocate a much larger share of expenditures than is forecast to physical investment (like hospitals or housing) as opposed to current consumption. The second change is that Americans work a lot more hours in ten years' time than is forecast. (Of course, the super-normal growth will be followed by sub-normal growth unless these changes are sustained over time.) Neither change is in any way technologically impossible. The question is whether they are desirable or not.
With that in mind, my second point is about the benefits versus the costs of a higher growth path. Economists often attempt to answer this question by referring only to the historical time series behavior of quantities (like GDP or employment). But it’s a cost-benefit question - we surely have to use market prices. The behavior of the relevant prices is without precedent in the post-World War II period.
For example, the real interest rate is very low (and yet still seems to be too high to be consistent with full resource utilization). This price signal suggests that Americans are willing to give up a lot of current resources for the promise of certain future resources - that is, they seem unusually willing to forego consumption for growth. In terms of employment, wages remain unprecedentedly low relative to (average) worker productivity. This price signal suggests that there may be large net social benefits available associated with drawing many more Americans into the labor market.
My third point is about the right policy steps to take in order to achieve a higher growth path. Here, again, the macroeconomic circumstances matter. If the Fed and other central banks were well away from the zero lower bound, then I would be more favorably inclined to incentive-based supply-side interventions as the best way forward. But that’s not the situation. Around the world, aggregate demand remains low. In Larry Summers’ words, aggregate demand interventions like physical infrastructure investment may not be a free lunch - but it certainly seems like a cheap lunch.
To sum up: above-normal growth is always possible. The current data on market prices like interest rates and wages suggest that above-normal growth might well be desirable. The ongoing constraints on monetary policy suggest that we can best achieve that faster growth through demand-oriented policies.
Posted by Mark Thoma on Thursday, February 18, 2016 at 10:46 AM
FOMC Minutes and More, by Tim Duy: So much Fed, so little time. But the short story is this: The Fed is in risk management mode, which means they will leave rates on hold until they see clear evidence that markets are stabilizing, growth remains on track, and they are even leaning towards needing to see the white in the eyes of the inflation beast. This has the makings of a significant strategic shift. To date, the Fed has argued for early and modest action toward "normalizing" policy with the ultimately goal of staying ahead of the inflation curve. We are moving to a new strategy where Fed policy lags the cycle. The cost of a Fed pause now is the risk of more aggressive policy later.
The minutes of the January FOMC meeting revealed that policymakers struggled to reconcile market volatility with their economic outlook:
In discussing the appropriate path for the target range for the federal funds rate over the medium term, members agreed that it would be important to closely monitor global economic and financial developments and to continue to assess their implications for the labor market and inflation, and for the balance of risks to the outlook. Members expressed a range of views regarding the implications of recent economic and financial developments for the degree of uncertainty about the medium-term outlook, with many members judging that uncertainty had increased. Members generally agreed that the implications of the available information were not sufficiently clear to allow members to assess the balance of risks to the economic outlook in the Committee's postmeeting statement.
That said, they could agree on the following:
However, members observed that if the recent tightening of global financial conditions was sustained, it could be a factor amplifying downside risks.
And they had plenty of reasons to fear the downside risks:
Almost all participants cited a number of recent events as indicative of tighter financial conditions in the United States; these events included declines in equity prices, a widening in credit spreads, a further rise in the exchange value of the dollar, and an increase in financial market volatility. Some participants also pointed to significantly tighter financing conditions for speculative-grade firms and small businesses, and to reports of tighter standards at banks for C&I and CRE loans. The effects of these financial developments, if they were to persist, may be roughly equivalent to those from further firming in monetary policy.
It is very unlikely that these fears will be ameliorated by the March meeting, or even the April meeting, and Fed speakers are signaling as much. See, for example, remarks by Philadelphia Federal Reserve President Patrick Harker and Boston Federal Reserve President Eric Rosengren.
These concerns are growing:
Several participants noted that monetary policy was less well positioned to respond effectively to shocks that reduce inflation or real activity than to upside shocks, and that waiting for additional information regarding the underlying strength of economic activity and prospects for inflation before taking the next step to reduce policy accommodation would be prudent.
And echo a repeated warning from the Fed staff:
The staff viewed the uncertainty around its January projections for real GDP growth, the unemployment rate, and inflation as similar to the average of the past 20 years. The risks to the forecast for real GDP were seen as tilted to the downside, reflecting the staff's assessment that neither monetary nor fiscal policy was well positioned to help the economy withstand substantial adverse shocks; the downside risks to the forecast of economic activity were seen as more pronounced than in December, mainly reflecting the greater uncertainty about global economic prospects and the financial market turbulence in the United States and abroad. Consistent with the downside risk to aggregate demand, the staff viewed the risks to its outlook for the unemployment rate as skewed to the upside. The risks to the projection for inflation were seen as weighted to the downside, reflecting the possibility that longer-term inflation expectations may have edged down and that the foreign exchange value of the dollar could rise substantially further, which would put downward pressure on inflation.
The recent unpleasantness in financial markets has likely prompted the FOMC to take the downside risks more seriously than they did in December. The fact of the matter is that they have very little left in their toolkit should the economy take a turn for the worse. Yes, they could turn toward more quantitative easing, but I think on average they are loathe to go down that route. And yes, they could consider negative interest rates, but that now looks a lot riskier than it did just a few weeks ago. Indeed, from the minutes:
The effects of a relatively flat yield curve and low interest rates in reducing banks' net interest margins were also noted.
A financial system based on banking starts to run into challenges when banks can't make a profit. Significantly negative rates likely require some substantial re-plumbing of the financial pipes to be effective.
The Fed may be turning toward my long-favored policy position - the best chance they have of lifting off from the zero bound is letting the economy run hot enough that inflation becomes a genuine concern. That means following the cycle, not trying to lead it. And I would argue that if the recession scare is just that, a scare, they are almost certainly going to fall behind the curve. The unemployment rate is below 5 percent and wage pressures are rising. The economy is already closing in on full-employment. If we don't have a recession, then how much further along will the economy be by the time the Fed deems they are sufficiently confident in the economy that they can resume raising rates? And note the importance of clearly progress on inflation:
Several participants reiterated the importance of monitoring inflation developments closely to confirm that inflation was evolving along the path anticipated by the Committee.
A couple of members emphasized that direct evidence that inflation was rising toward 2 percent would be an important element of their assessments of the appropriate timing of further policy firming.
By the time we actually see inflation we will be in my "scenario five":
Financial markets remain choppy in the first half of the year, pushing the Fed into “risk management” mode despite solid labor market activity. The Fed skips the March and April meetings. Officials’ delayed response calms markets and prevents a slowdown in activity, but they feel behind the curve and try to catch up with a steeper pace of hikes late in the year.
Separately, some members questioned the effectiveness of the Fed communication strategy:
A couple of participants questioned whether some financial market participants fully appreciated that monetary policy is data dependent, and a number of participants emphasized the importance of continuing to communicate this aspect of monetary policy.
St. Louis Federal Reserve President James Bullard was likely one such participant. From the press release of his speech tonight:
Bullard noted that the FOMC has repeatedly stated in official communication and public commentary that future monetary policy adjustments are data dependent. He then addressed the possibility that the financial markets may not believe this since the SEP may be unintentionally communicating a version of the 2004-2006 normalization cycle, which appeared to be mechanical.
“The policy rate component of the SEP was perhaps more useful when the policy rate was near zero, and the Committee wished to commit to the idea that the policy rate was likely to remain near zero for some period into the future,” Bullard explained. “But now, post liftoff, communicating a path for the policy rate via the median of the SEP could be viewed as an inadvertent calendar-based commitment to increase rates.”
You might forgive market participants for believing that the SEP infers some calendar-based guidance when Federal Reserve Vice Chair Stanley Fischer says things like:
Well, we watch what the market thinks, but we can't be led by what the market thinks. We've got to make our own analysis. We make our own analysis and our analysis says that the market is underestimating where we are going to be. You know, you can't rule out that there is some probability they are right because there's uncertainty. But we think that they are too low.
Saying the markets are wrong implies that the policy direction is fairly rigid. In any event, I am not confident there is yet much support for Bullard's position (you would think to switching to a press conference at every FOMC meeting would be easier, but he hasn't apparently made much progress there either). Instead, the Fed is debating enhancing the SEP with fan charts around the projections to illustrate the associated uncertainty. My preference is to reveal each participant's forecast and their associated dot, as well as the Greenbook forecast. This can be done anonymously. Then we could throw out the crazy forecasts and focus on the reaction functions of the remaining forecasts. I don't think, however, the Fed wants us identifying any forecasts as crazy because they would like us to believe all are equally valid. And they don't want to use the Greenbook forecast because that would imply a central FOMC forecast, which they maintain does not exist. So we are stuck with the dot plot for the foreseeable future.
Bullard has also gone full-dove. He remembered that he thought inflation expectations were supposed to be important, and the decline in 5-year, 5-year forward expectations has him spooked. And he thinks that the excess air has been released from financial markets, so his fears of asset bubbles has eased. Hence, the Fed can easily pause now. But note that Bullard is fickle - just one higher inflation number and he will quickly change his tune.
Bottom Line: The Fed is on hold, stuck in risk management mode until the skies clear. If you are in the "recession" camp, the path forward is obvious. The Fed cuts back to zero, drags its heals on more QE, and fumbles around as they try to figure out if negative rates are a good or bad thing. Not pretty. But if you are in the "no recession" camp, it's worth thinking about the implications of a Fed pause now on the pace of hikes later. Being on hold now raises the risk that by the time the Fed moves again, they will be behind the cycle.
Posted by Mark Thoma on Thursday, February 18, 2016 at 12:15 AM in Economics, Fed Watch, Monetary Policy |
Posted by Mark Thoma on Thursday, February 18, 2016 at 12:06 AM in Economics, Links |
In case you want to talk about this:
What Has the Wonks Worried, by Paul Krugman: The open letter to Sanders and Friedman by former CEA chairs didn’t get into specifics, and I’m already hearing from Bernie supporters accusing them of arrogance, or high-handedness, or something. But here’s what Friedman has said, in what the campaign’s policy director calls “outstanding work”:
– Real growth at 5.3 percent a year, versus a baseline of around 2 – Labor force participation rate back to 1999 level – 3.8 percent unemployment
OK, progressives have, rightly, mocked Jeb Bush for claiming that he could double growth to 4 percent. Now people close to Sanders say 5.3??? ...
Sanders needs to disassociate himself from this kind of fantasy economics right now. If his campaign responds instead by lashing out — well, a campaign that treats Alan Krueger, Christy Romer, and Laura Tyson as right-wing enemies is well on its way to making Donald Trump president.
Posted by Mark Thoma on Wednesday, February 17, 2016 at 10:02 AM
The "In Praise of Alexander Hamilton" Section from Our "Concrete Economics". In Fortune Online: ... Over at Fortune Online:
Stephen S. Cohen and J. Bradford DeLong: Why Hamilton—Not Jefferson—Is the Father of America's Economy: ... How we can better energize America’s economy, create more jobs, and provide more fulfilling lives for our citizens? Politics says that the answer is either ‘Left!’ or ‘Right!’ But neither of those is the solution. To find the answer, we need to look at our American past.
We Americans have been repeating the same political-economic arguments in different keys and with different harmonies—the arguments over the costs and benefits of freer trade, of government support for industry, over the righteousness of libertarian government, over activist New Dealism—for more than two centuries now. Yet today we have largely forgotten the earlier rounds of this debate: the ones that started with Thomas Jefferson and Alexander Hamilton. ...
Before Hamilton, it was the Jeffersonian economic mold, the mold that Britain had imposed through its mercantilist colonial policy, into which the American economy was being poured. Jefferson wanted to cut America loose politically from what he saw as the corruption of Imperial Britain. But he had no major quarrel with the un-industrialized agrarian economy that the British Empire was designing America to be.
Hamilton, a New Yorker, thought differently: that liberty could spring from the city as well as the countryside, and that prosperous market economies needed big pushes to get themselves going. And so Hamilton pushed the United States into a pro-industrialization, high-tariff, pro-finance, big-infrastructure political economy, and that push set in motion a self-sustaining process. ...
After Hamilton, the U.S. economy was different. It was a bet on manufacturing, technologies, infrastructure, commerce, corporations, finance, and government support of innovation. That turned out to be good for more than just farmers and the bosses and workers: it turned out to be good for the country as a whole. ...
The economy was to be reshaped to promote industry. And the principal instrument for this was a high tariff on manufactured imports from Britain...
It was also to be the major source of federal government revenues, and would thus support an extensive program of infrastructure development. This was vital for territorial expansion and economic development, and for adding the critical political support of the western farmers to the northern coastal commercial and labor interests.
But that was not all. The tariff was also the instrument that permitted the federal government to credibly assume states’ debts incurred to fund the Revolutionary War, thus strengthening the central government (central to Hamilton’s plans).
The creation of a federal government debt also constituted the basis of a new and vigorous financial market. No wonder then that in Hamilton’s strong and settled opinion: ‘a national debt, if it is not excessive, will be to us a national blessing.’
Finally there was Bank of the United States, which Hamilton designed to sit at the center of the financial system and tame the wildcat banks and their wildcat currencies. ...
So what is the lesson? ... The lesson is that ideologies—no matter what they are—are bad masters. Hamilton’s genius was in focusing on not what was decreed according to ideological first principles laid down by some academic scribbler, but rather focusing on what was in a pragmatic sense likely to generate prosperity at that moment in that situation. ...
It is only in the past generation that we have forgotten our pragmatic past and applied ideological litmus tests to what our public policies will be. And we have suffered for it.
Posted by Mark Thoma on Wednesday, February 17, 2016 at 09:46 AM in Economics |
Larry Summers is becoming more and more worried that secular stagnation is real:
Convinced of the Secular Stagnation Hypothesis: Foreign Affairs has just published my latest on the secular stagnation hypothesis. I am increasingly convinced that it captures what is going on in the industrialized world and that the risks of long term weakness on the current policy path are growing.
Unfortunately since I put forward the argument in late 2013, the data have been all too supportive. Despite monetary policy being much more expansionary than was expected and medium term interest rates falling rapidly, growth and inflation throughout the industrial world have been much lower than anticipated. This is exactly what one would expect if structural factors were increasing saving propensities relative to investment propensities. ...
If I am right in these judgments, monetary policy should now be focused on avoiding an economic slowdown and preparations should be starting with respect to the rapid application of fiscal policy. The focus of global coordination should shift from clichés about structural reform and budget consolidation to assuring an adequate level of global demand. And policymakers should be considering the radical steps that may be necessary if the US or global economy goes into recession.
Of course, real time economic theorizing is problematic and I cannot be certain that I am reading the current situation accurately. If the Fed succeeds in significantly raising rates over the next two years without a growth slowdown and if inflation accelerates to 2 percent, I will conclude that the secular stagnation hypothesis was overly alarmist in confusing cyclical elements with long term problems. If on the other hand, the economy turns down even at current interest rates, secular stagnation will have to be taken more seriously by policymakers than is currently the case.
Posted by Mark Thoma on Wednesday, February 17, 2016 at 08:08 AM in Economics |
Posted by Mark Thoma on Wednesday, February 17, 2016 at 12:06 AM in Economics, Links |
Ben Bernanke and Don Kohn:
The Fed’s interest payments to banks: At Janet Yellen’s recent hearing before the House Financial Services Committee, a few representatives expressed concern that the Federal Reserve is making interest payments to banks. Specifically, the Fed uses authority granted by Congress in 2008 to pay interest on the reserves that banks hold with it. Total payments to banks last year were about $7 billion. Why is the Fed paying such sums to banks? Are they “giveaways” to the financial sector, as some have implied? We’ll argue in this post that the interest payments the Fed is making are well-justified. In particular, they are essential to prudent monetary policy in current circumstances and do not unduly subsidize banks. ...
Posted by Mark Thoma on Tuesday, February 16, 2016 at 08:18 AM in Economics, Monetary Policy |
My Unicorn Problem: It has been an interesting few months on the progressive side of the political debate, and I mean that in the worst way. A significant number of progressives are very, very excited by the unexpected support for Bernie Sanders, and are shocked and horrified to find many — I think most — liberal policy wonks rather skeptical. For me this is somewhat familiar territory: I was skeptical about Barack Obama’s promises of transcendence back in 2008, too. And then as now a fair number of enthusiasts took no time at all to declare that I was a corrupt villain, a tool of the oligarchs, desperate for a job with Hillary etc.. OK, this too shall pass. But I thought it might be worth saying a bit more about where people like me find ourselves. ...
Posted by Mark Thoma on Tuesday, February 16, 2016 at 08:13 AM in Economics, Politics |
It’s Time To Go After Big Money: The Mossavar-Rahmani Center for Business and Government at Harvard that I am privileged to direct has just issued an important paper by Senior Fellow Peter Sands and a group of student collaborators. Sands’ paper makes a compelling case for stopping the issuance of high denomination notes like the 500 euro note and 100 dollar bill or even withdrawing them from circulation. ...
The fact that – as Sands points out — in certain circles the €500 is known as the “Bin Laden” confirms the arguments against it. Sands’ extensive analysis is totally convincing on the linkage between high denomination notes and crime. ...
Even better than unilateral measures in Europe would be a global agreement to stop issuing notes worth more than say $50 or $100. Such an agreement would be as significant as anything else the G7 or G20 has done in years. China, which is hosting the next G-20 in September, has made attacking corruption a central part of its economic and political strategy. More generally, at a time when such a demonstration is very much needed, a global agreement to stop issuing high denomination notes would also show that the global financial groupings can stand up against “big money” and for the interests of ordinary citizens.
Posted by Mark Thoma on Tuesday, February 16, 2016 at 08:10 AM in Economics |
Donald Trump and Other Republicans Are Unemployment “Truthers”, The Big Picture: Among Donald Trump’s stump sound bites is that the national unemployment rate is far, far higher than the official rate of 4.9 percent. He is not alone in making such claims. Both former Texas Governor Rick Perry, who dropped out of the presidential race last year, and retired surgeon Ben Carson have repeated this claim during this election cycle. Its origin dates back to the 2012 election when many Republicans believed that Barack Obama had ordered the Bureau of Labor Statistics to report a much lower unemployment rate in October, just before the election, than seemed plausible. It also feeds into a growing distrust for government statistical data that parallels a denial of scientific facts such as climate change.
The first to make an explicit conspiracy charge was former GE CEO Jack Welch...
The reason people like Trump can get away with making up numbers and making baseless charges is because many Americans are receptive to his message. An August 2014 survey found that on average people thought the unemployment rate was 32 percent rather than the official rate of 6 percent.
But even numbers people who should know better have made absurd claims about the unemployment rate and other government data. The CEO of Gallup, Jim Clifton, called the official rate “misleading” and implied that the White House has engaged in manipulation. Former Reagan Office of Management and Budget Director Dave Stockman, who now peddles conspiracy theories for almost everything, also claimed that the true unemployment rate was 43 percent in June 2015. Billionaire investor Paul Singer, a big Republican Party contributor, has said that virtually all government data, including the inflation rate, are faked and unreliable.
Why Republicans seem so willing to believe statistical nonsense as well as conspiracies about Obama’s birthplace and global warming is unclear. But there is no doubt that it is extensive and seemingly immune from refutation.
[There is quite a bit more in the original post.]
Posted by Mark Thoma on Tuesday, February 16, 2016 at 12:24 AM in Economics, Politics, Unemployment |