Category Archive for: Economics [Return to Main]

Tuesday, July 22, 2014

'Will Automation Take Our Jobs?'

Running late today -- two very quick ones. First, from Scientific American:

Will Automation Take Our Jobs?: Last fall economist Carl Benedikt Frey and information engineer Michael A. Osborne, both at the University of Oxford, published a study estimating the probability that 702 occupations would soon be computerized out of existence. Their findings were startling. Advances in ... technologies could, they argued, put 47 percent of American jobs at high risk of being automated in the years ahead. Loan officers, tax preparers, cashiers, locomotive engineers, paralegals, roofers, taxi drivers and even animal breeders are all in danger of going the way of the switchboard operator.
Whether or not you buy Frey and Osborne's analysis, it is undeniable that something strange is happening in the U.S. labor market. Since the end of the Great Recession, job creation has not kept up with population growth. Corporate profits have doubled since 2000, yet median household income (adjusted for inflation) dropped from $55,986 to $51,017. ... Erik Brynjolfsson and Andrew McAfee ... call this divergence the “great decoupling.” In their view, presented in their recent book The Second Machine Age, it is a historic shift. ...

Tim Taylor:

The Next Wave of Technology?, by Tim Taylor: Many discussions of "technology" and how it will affect jobs and the economy have a tendency to discuss technology as if it is one-dimensional, which is of course an extreme oversimplification. Erik Brynjolfsson, Andrew McAfee, and Michael Spence offer some informed speculation on how they see the course of technology evolving in "New World Order: Labor, Capital, and Ideas in the Power Law Economy," which appears in the July/August 2014 issue of Foreign Affairs (available free, although you may need to register).

Up until now, they argue, the main force of information and communications technology has been to tie the global economy together, so that production could be moved to where it was most cost-effective. ...
But looking ahead, they argue that the next wave of technology will not be about relocating production around the globe, but changing the nature of production--and in particular, automating more and more of it. If the previous wave of technology made workers in high-income countries like the U.S. feel that their jobs were being outsourced to China, the next wave is going to make those low-skill workers in repetitive jobs--whether in China or anywhere else--feel that their jobs are being outsources to robots. ...
If this prediction holds true, what does this mean for the future of jobs and the economy?

1) Outsourcing would become much less common. ...

2) For low-income and middle-income countries like China..., their jobs and workforce would experience a dislocating wave of change.

3) Some kinds of physical capital are going to plummet in price, like robots, 3D printing, and artificial intelligence...

4)  So..., who does well in this future economy? For high-income countries like the United States, Brynjolfsson, McAfee, and Spence emphasize that the greatest rewards will go to "people who create new ideas and innovations," in what they refer to as a wave of "superstar-based technical change." ...

This final forecast seems overly grim to me. While I can easily believe that the new waves of technology will continue to create superstar earners, it seems plausible to me that the spread and prevalence of many different new kinds of technology offers opportunities to the typical worker, too. After all, new ideas and innovations, and the process of bringing them to the market, are often the result of a team process--and even being a mid-level but contributing player on such teams, or a key supplier to such teams, can be well-rewarded in the market. More broadly, the question for the workplace of the future is to think about jobs where labor can be a powerful complement to new technologies, and then for the education and training system, employers, and employees to get the skills they need for such jobs. If you would like a little more speculation, one of my early posts on this blog, back on July 25, 2011, was a discussion of "Where Will America's Future Jobs Come From?"

Links for 7-22-14

Monday, July 21, 2014

'The Wage Growth Gap for Recent College Grads'

Via the SF Fed:

The Wage Growth Gap for Recent College Grads, by Bart Hobijn and Leila Bengali, FRBSF Economic Letter: Starting wages of recent college graduates have essentially been flat since the onset of the Great Recession in 2007. Median weekly earnings for full-time workers who graduated from college in the year just before the recession, between May 2006 and April 2007, were $653. Over the 12 months ending in April 2014, the earnings of recent college graduates had risen to $692 a week, only 6% higher than seven years ago. 
The lackluster increases in starting wages for college graduates stand in stark contrast to growth in median weekly earnings for all full-time workers. These earnings have increased 15% from $678 in 2007 to $780 in 2014. This has created a substantial gap between wage growth for new college graduates and workers overall.
In this Economic Letter we put the wage growth gap in a historical context and consider what is at its heart. In particular, we find that the gap does not reflect a switch in the types of jobs that college graduates are able to find. Rather we find that wage growth has been weak across a wide range of occupations for this group of employees, a result of the lingering weak labor market recovery. ...

'Truth or Consequences: Ponzi Schemes and Other Frauds'

Cecchetti & Schoenholtz:

... A well-functioning financial system is based on trust. Widespread belief in honesty and integrity are essential for intermediation. That is, when we make a bank deposit, purchase a share of stock or a bond, we need to believe that terms of the agreement are being accurately represented. Yes, the value of the stock can go up and down, but when you think you buy an equity share, you really do own it. Fraud can undermine confidence, and the result will be less saving, less investment, less wealth and less income.
Unfortunately, in a complex financial system, the possibilities for fraud are numerous and the incidence frequent. Most cases are smaller and more mundane than Madoff or Ponzi. But they are remarkably common even today, despite enormous public efforts to prevent or expose them. One website devoted to tracking financial frauds in the United States lists 67 Ponzi schemes worth an estimated $3 billion in 2013 alone. ...

See also: Four years after passage, House keeps trying to kill Dodd-Frank.

Paul Krugman: The Fiscal Fizzle

"We don’t have a debt crisis, and never did":

The Fiscal Fizzle, by Paul Krugman, Commentary, NY Times: For much of the past five years readers of the political and economic news were left in little doubt that budget deficits and rising debt were the most important issue facing America. Serious people constantly issued dire warnings that the United States risked turning into another Greece ...
I’m not sure whether most readers realize just how thoroughly the great fiscal panic has fizzled...
In short, the debt apocalypse has been called off.
Wait — what about the risk of a crisis of confidence? There have been many warnings that such a crisis was imminent, some of them coupled with surprisingly frank admissions of disappointment that it hadn’t happened yet. For example, Alan Greenspan warned of the “Greece analogy,” and declared that it was “regrettable” that U.S. interest rates and inflation hadn’t yet soared.
But that was more than four years ago, and both inflation and interest rates remain low. Maybe the United States, which among other things borrows in its own currency and therefore can’t run out of cash, isn’t much like Greece after all.
In fact, even within Europe the severity of the debt crisis diminished rapidly once the European Central Bank began doing its job, making it clear that it would do “whatever it takes” to avoid cash crises in nations that have given up their own currencies and adopted the euro. Did you know that Italy, which remains deep in debt and suffers much more from the burden of an aging population than we do, can now borrow long term at an interest rate of only 2.78 percent? Did you know that France, which is the subject of constant negative reporting, pays only 1.57 percent?
So we don’t have a debt crisis, and never did. Why did everyone important seem to think otherwise?
To be fair, there has been some real good news about the long-run fiscal prospect, mainly from health care. But it’s hard to escape the sense that debt panic was promoted because it served a political purpose — that many people were pushing the notion of a debt crisis as a way to attack Social Security and Medicare. And they did immense damage along the way, diverting the nation’s attention from its real problems — crippling unemployment, deteriorating infrastructure and more — for years on end.

Links for 7-21-14

Sunday, July 20, 2014

Tyler Cowen on Global Inequality

Dan Little:

Tyler Cowen on global inequality: Tyler Cowen sounds a bit like Voltaire's Pangloss when he argues, as the New York Times headline puts it, that we are living "all in all, [in] a more egalitarian world" (link). Cowen acknowledges what most people concerned about inequalities believe: "the problem [of inequality] has become more acute within most individual nations"; but he shrugs this off by saying that "income inequality for the world as a whole has been falling for most of the last 20 years." The implication is that we should not be concerned about the first fact because of the encouraging trend in the second fact.

Cowen bases his case on what seems on its face paradoxical but is in fact correct: it is possible for a set of 100 countries to each experience increasing income inequality and yet the aggregate of those populations to experience falling inequality. And this is precisely what he thinks is happening. Incomes in (some of) the poorest countries are rising, and the gap between the top and the bottom has fallen. So the gap between the richest and the poorest citizens of planet Earth has declined. The economic growth in developing countries in the past twenty years, principally China, has led to rapid per capita growth in several of those countries. This helps the distribution of income globally -- even as it worsens China's income distribution.

But this isn't what most people are concerned about when they express criticisms of rising inequalities, either nationally or internationally. They are concerned about the fact that our economies have very systematically increased the percentage of income and wealth flowing to the top 1, 5, and 10 percent, while allowing the bottom 40% to stagnate. And this concentration of wealth and income is widespread across the globe. (Branko Milanovic does a nice job of analyzing the different meanings we might attach to "global inequality" in this World Bank working paper; link.)

This rising income inequality is a profound problem for many reasons. First, it means that the quality of life for the poorest 40% of each economy's population is significantly lower than it could and should be, given the level of wealth of the societies in which they live. That is a bad thing in and of itself. Second, the relative poverty of this sizable portion of society places a burden on future economic growth. If the poorest 40% are poorly educated, poorly housed, and poorly served by healthcare, then they will be less productive than they have the capacity to be, and future society will be the poorer for it. Third, this rising inequality is further a problem because it undermines the perceived legitimacy of our economic system. Widening inequalities have given rise to a widespread perception that these growing inequalities are unfair and unjustified. This is a political problem of the first magnitude. Our democracy depends on a shared conviction of the basic fairness of our institutions. (Kate Pickett and Richard Wilkinson also argue that inequality has negative effects on the social wellbeing of whole societies; link.)

The seeming paradox raised here can be easily clarified by separating two distinct issues. One is the issue of income distribution within an integrated national economy -- the United States, Denmark, Brazil, China. And the second is the issue of extreme inequalities of per capita GDP across national economies -- the poverty of nations like Nigeria, Honduras, and Bangladesh compared to rich countries like Sweden, Germany, or Canada. Both are important issues; but they are different issues that should not be conflated. It is misleading to judge that global inequality is falling by looking only at the rank-ordered distribution of income across the world's 7 billion citizens. This decline follows from the moderate success achieved in the past fifteen years in ameliorating global poverty -- a Millenium Development Goal (link). But it is at least as relevant to base our answer to the question about the trend of global inequalities by looking at the average trend across the world's domestic economies; and this trend is unambiguously upward.

Here is a pair of graphs from The Economist that address both topics (reproduced at the XrayDelta blog here). The left panel demonstrates the trend that Cowen is highlighting. The global Gini coefficient has indeed leveled off in the past 40 years. The right panel indicates rising inequalities in US, Britain, Germany, France, and Sweden. As the second panel documents, the distribution of income within a sample set of national economies has dramatically worsened since 1980. So global inequalities are both improving and worsening -- depending on how we disaggregate the question.

The global Gini approach is intended to capture income inequalities across the world's citizens, not across the world's countries. Essentially this means estimating a rank-order of the incomes of all the world's citizens, and estimating the Lorenz distribution this creates.

We get a very different picture if we consider what has happened with inequalities within each of the world's national economies. Here is a graph compiled by Branko Milanovic that represents the average Gini coefficient for countries over time (link):

This graph makes the crucial point: inequalities within nations have increased dramatically across the globe since 1980, from an average Gini coefficient of about .45 to an average of .54 in 2000 (and apparently still rising). And this is the most important point: each of these countries is suffering the social disadvantages that go along with the fact of rising inequalities. So we could use the Milanovic graph to reach exactly the opposite conclusion from the one that Cowen reaches: in fact, global inequalities have worsened dramatically since 1980.

Thomas Piketty's name does not occur once in Cowen's short piece; and yet his economic arguments about capitalism and inequality in Capital in the Twenty-First Century are surely part of the the Cowen's impetus in writing this piece. Ironically, Piketty's findings corroborate one part of Cowen's point -- the global convergence of inequalities. Two French economists, François Bourguignon and Christian Morrisson, made a substantial effort to measure historical Gini coefficients for the world's population as a whole (link). Their work is incorporated into Piketty's own conclusions and is included on Piketty's website. Here is Piketty's summary graph of global inequalities since 1700 -- which makes the point of convergence between developed countries and developing countries more clearly than Cowen himself:

So what about China? What role does the world's largest economy (by population) play in the topic of global economic inequalities? China's per capita income has increased by roughly 10% annually during that period; as a population it is no longer a low-income economy. But most development economists who study China would agree that China's rapid growth since 1980 has sharply increased inequalities in that country (linklink). Urban and coastal populations have gained much more rapidly than the 45% or so of the population (500 million people) still living in backward rural areas. A recent estimate found that the Gini coefficient for China has increased from .30 to .45 since 1980 (link). So China's rapid economic growth has been a major component of the trend Cowan highlights: the rising level of incomes in previously poor countries. At the same time, this process of growth has been accompanied by rising levels of inequalities within China that are a source of serious concern for Chinese policy makers.

Here are charts documenting the rise of income inequalities in China from the 2005 China Human Development Report (link):

 
 
 

So rising global income inequality is not a minor issue to be brushed aside with a change of topic. Rather, it is a key issue for the economic and political futures of countries throughout the world, including Canada, Great Britain, the United States, Germany, Egypt, China, India, and Brazil. And if you don't think that economic inequalities have the potential for creating political unrest, you haven't paid attention to recent events in Egypt, Brazil, the UK, France, Sweden, and Tunisia.

'California's Job Growth Defies Predictions after Tax Increases'

This article, by David Cay Johnston, is getting a surprising number of retweets:

State’s job growth defies predictions after tax increases, by David Cay Johnston, The Bee: Dire predictions about jobs being destroyed spread across California in 2012 as voters debated whether to enact the sales and, for those near the top of the income ladder, stiff income tax increases in Proposition 30. Million-dollar-plus earners face a 3 percentage-point increase on each additional dollar.
“It hurts small business and kills jobs,” warned the Sacramento Taxpayers Association, the National Federation of Independent Business/California, and Joel Fox, president of the Small Business Action Committee.
So what happened after voters approved the tax increases, which took effect at the start of 2013?
Last year California added 410,418 jobs, an increase of 2.8 percent over 2012, significantly better than the 1.8 percent national increase in jobs. ...

Links for 7-20-14

Saturday, July 19, 2014

'Is Choosing to Believe in Economic Models a Rational Expected-Utility Decision Theory Thing?'

Brad DeLong:

Is Choosing to Believe in Economic Models a Rational Expected-Utility Decision Theory Thing?: I have always understood expected-utility decision theory to be normative, not positive: it is how people ought to behave if they want to achieve their goals in risky environments, not how people do behave. One of the chief purposes of teaching expected-utility decision theory is in fact to make people aware that they really should be risk neutral over small gambles where they do know the probabilities--that they will be happier and achieve more of their goals in the long run if they in fact do so. ...[continue]...

Here's the bottom line:

(6) Given that people aren't rational Bayesian expected utility-theory decision makers, what do economists think that they are doing modeling markets as if they are populated by agents who are? Here there are, I think, three answers:

  • Most economists are clueless, and have not thought about these issues at all.

  • Some economists think that we have developed cognitive institutions and routines in organizations that make organizations expected-utility-theory decision makers even though the individuals in utility theory are not. (Yeah, right: I find this very amusing too.)

  • Some economists admit that the failure of individuals to follow expected-utility decision theory and our inability to build institutions that properly compensate for our cognitive biases (cough, actively-managed mutual funds, anyone?) are one of the major sources of market failure in the world today--for one thing, they blow the efficient market hypothesis in finance sky-high.

The fact that so few economists are in the third camp--and that any economists are in the second camp--makes me agree 100% with Andrew Gelman's strictures on economics as akin to Ptolemaic astronomy, in which the fundamentals of the model are "not [first-order] approximations to something real, they’re just fictions..."

Links for 7-19-14

Friday, July 18, 2014

Stiglitz Interview

Joseph Stiglitz Hails New BRICS Bank Challenging U.S.-Dominated World Bank & IMF

Transcript - Part 1

Joseph Stiglitz on TPP, Cracking Down on Corporate Tax Dodgers

Transcript - Part 2

'Did the Banks Have to Commit Fraud?'

Dean Baker:

Did the Banks Have to Commit Fraud?: Floyd Norris has an interesting piece discussing Citigroup's $7 billion settlement for misrepresenting the quality of the mortgages in the mortgage backed securities it marketed in the housing bubble. Norris notes that the bank had consultants who warned that many of the mortgages did not meet its standards and therefore should not have been included the securities.
Towards the end of the piece Norris comments:
"And it may well be true that actions like Citigroup’s were necessary for any bank that wanted to stay in what then appeared to be a highly profitable business. Imagine for a minute what would have happened in 2006 if Citigroup had listened to its consultants and canceled the offerings. To the mortgage companies making the loans, that might have simply marked Citigroup as uncooperative. The business would have gone to less scrupulous competitors."
This raises the question of what purpose is served by this sort of settlement. Undoubtedly Norris' statement is true. However, the market dynamic might be different if this settlement were different.
Based on the information Norris presents here, Citigroup's top management essentially knew that the bank was engaging in large-scale fraud by passing along billions of dollars worth of bad mortgages. If these people were now facing years of prison as a result of criminal prosecution then it may well affect how bank executives think about these situations in the future. While it will always be true that they do not want to turn away business, they would probably rather sacrifice some of their yearly bonus than risk spending a decade of their life behind bars. The fear of prision may even deter less scrupulous competitors. In that case, securitizing fraudulent mortgages might have been a marginal activity of little consequence for the economy.
Citigroup's settlement will not change the tradeoffs from what Citigroup's top management saw in 2006. As a result, in the future bankers are likely to make the same decisions that they did in 2006.

'Further Thoughts on Phillips Curves'

Simon Wren-Lewis:

Further thoughts on Phillips curves: In a post from a few days ago I looked at some recent evidence on Phillips curves, treating the Great Recession as a test case. I cast the discussion as a debate between rational and adaptive expectations. Neither is likely to be 100% right of course, but I suggested the evidence implied rational expectations were more right than adaptive. In this post I want to relate this to some other people’s work and discussion. (See also this post from Mark Thoma.) ...
The first issue is why look at just half a dozen years, in only a few countries. As I noted in the original post, when looking at CPI inflation there are many short term factors that may mislead. Another reason for excluding European countries which I did not mention is the impact of austerity driven higher VAT rates (and other similar taxes or administered prices), nicely documented by Klitgaard and Peck. Surely all this ‘noise’ is an excellent reason to look over a much longer time horizon?
One answer is given in this recent JEL paper by Mavroeidis, Plagborg-Møller and Stock. As Plagborg-Moller notes in an email to Mark Thoma: “Our meta-analysis finds that essentially any desired parameter estimates can be generated by some reasonable-sounding specification. That is, estimation of the NKPC is subject to enormous specification uncertainty. This is consistent with the range of estimates reported in the literature….traditional aggregate time series analysis is just not very informative about the nature of inflation dynamics.” This had been my reading based on work I’d seen.
This is often going to be the case with time series econometrics, particularly when key variables appear in the form of expectations. Faced with this, what economists often look for is some decisive and hopefully large event, where all the issues involving specification uncertainty can be sidelined or become second order. The Great Recession, for countries that did not suffer a second recession, might be just such an event. In earlier, milder recessions it was also much less clear what the monetary authority’s inflation target was (if it had one at all), and how credible it was. ...

I certainly agree with the claim that a "decisive and hopefully large event" is needed to empirically test econometric models since I've made the same point many times in the past. For example, "...the ability to choose one model over the other is not quite as hopeless as I’ve implied. New data and recent events like the Great Recession push these models into unchartered territory and provide a way to assess which model provides better predictions. However, because of our reliance on historical data this is a slow process – we have to wait for data to accumulate – and there’s no guarantee that once we are finally able to pit one model against the other we will be able to crown a winner. Both models could fail..."

Anyway...he goes on to discuss "How does what I did relate to recent discussions by Paul Krugman?," and concludes with:

My interpretation suggests that the New Keynesian Phillips curve is a more sensible place to start from than the adaptive expectations Friedman/Phelps version. As this is the view implicitly taken by most mainstream academic macroeconomics, but using a methodology that does not ensure congruence with the data, I think it is useful to point out when the mainstream does have empirical support. ...

Paul Krugman: Addicted to Inflation

What does "inflation addiction" tell us?:

Addicted to Inflation, by Paul Krugman, Commentary, NY Times: The first step toward recovery is admitting that you have a problem. That goes for political movements as well as individuals. So I have some advice for so-called reform conservatives trying to rebuild the intellectual vitality of the right: You need to start by facing up to the fact that your movement is in the grip of some uncontrollable urges. In particular, it’s addicted to inflation — not the thing itself, but the claim that runaway inflation is either happening or about to happen. ...
Yet despite being consistently wrong for more than five years,... at best, the inflation-is-coming crowd admits that it hasn’t happened yet, but attributes the delay to unforeseeable circumstances. ... At worst, inflationistas resort to conspiracy theories: Inflation is already high, but the government is covering it up. The ... inflation conspiracy theorists have faced well-deserved ridicule even from fellow conservatives. Yet the conspiracy theory keeps resurfacing. It has, predictably, been rolled out to defend Mr. Santelli.
All of this is very frustrating to those reform conservatives. If you ask what new ideas they have to offer, they often mention “market monetarism,” which translates under current circumstances to the notion that the Fed should be doing more, not less. ... But this idea has achieved no traction at all with the rest of American conservatism, which is still obsessed with the phantom menace of runaway inflation.
And the roots of inflation addiction run deep. Reformers like to minimize the influence of libertarian fantasies — fantasies that invariably involve the notion that inflationary disaster looms unless we return to gold — on today’s conservative leaders. But to do that, you have to dismiss what these leaders have actually said. ...
More generally, modern American conservatism is deeply opposed to any form of government activism, and while monetary policy is sometimes treated as a technocratic affair, the truth is that printing dollars to fight a slump, or even to stabilize some broader definition of the money supply, is indeed an activist policy.
The point, then, is that inflation addiction is telling us something about the intellectual state of one side of our great national divide. The right’s obsessive focus on a problem we don’t have, its refusal to reconsider its premises despite overwhelming practical failure, tells you that we aren’t actually having any kind of rational debate. And that, in turn, bodes ill not just for would-be reformers, but for the nation.

Links for 7-18-14

Thursday, July 17, 2014

'Do Patents Stifle Cumulative Innovation?'

Joshua Gans

Do patents stifle cumulative innovation?: There has been a movement that began with the notion of the anti-commons that suggested that, whatever the other benefits and faults might be with the patent system, a fault that really matters for the operation of the system and for growth prospects (a la endogenous growth theory) is how patents might stifle cumulative or follow-on innovation. ...
The standard, informal theory of harm here is that follow-on innovators, feeling that they can’t easily deal with the patent holder on the pioneer innovation, decide that the risks are too high to invest and so opt not to do so. To be sure, this ‘hold-up’ concern is not good for anyone, including possibly the patent rights holder who loses the opportunity to earn licensing fees from applications of their knowledge. Suffice it to say, this has been a big feature of the movement against the current strength and, indeed, existence of the patent system.
One issue, however, was that the evidence on the impact of patents on cumulative innovation was weak. Mostly that was due to the problem of finding an environment where impact could be measured. ...
For this reason, all previous attempts concerned intermediate steps — most notably, the impact of patents on citations whether in publications or in patents. This includes work by Fiona Murray and Scott Stern, Heidi Williams and Alberto Galasso and Mark Schankerman. While there is some variation, this work showed, using various clever approaches, that patent protection (or other IP changes) might deter cumulative innovation upwards of 30%. That’s a big effect and a big concern even if the results were somewhat intermediate.
At the NBER Summer Institute a new paper by Bhaven Sampat and Heidi Williams (the same Williams from the previous paper) actually found a way to examine the impact of patents on follow-on innovations themselves. ... The ... paper presents pretty convincing evidence that you cannot reject zero as the likely prediction. That is, the effect patents on follow-on research appears to be non-existent. ...
Suffice it to say, while it is only a particular area, this is evidence enough that should cause many to identify and change their bias regarding the impact of patents on cumulative innovation. ...

The original post has a much longer discussion of the theory and evidence.

'Debt, Great Recession and the Awful Recovery'

Cecchetti & Schoenholtz:

Debt, Great Recession and the Awful Recovery: ... In their new book, House of Debt, Atif Mian and Amir Sufi portray the income and wealth differences between borrowers and lenders as the key to the Great Recession and the Awful Recovery (our term). If, as they argue, the “debt overhang” story trumps the now-conventional narrative of a financial crisis-driven economic collapse, policymakers will also need to revise the tools they use to combat such deep slumps. ...
House of Debt is at its best in showing that: (1) a dramatic easing of credit conditions for low-quality borrowers fed the U.S. mortgage boom in the years before the Great Recession; (2) that boom was a major driver of the U.S. housing price bubble; and (3) leveraged housing losses diminished U.S. consumption and destroyed jobs.
The evidence for these propositions is carefully documented... The strong conclusion is that – as in many other asset bubbles across history and time – an extraordinary credit expansion stoked the boom and exacerbated the bust. Of that we can now be sure.
What is less clear is that these facts diminish the importance of the U.S. intermediation crisis as a trigger for both the Great Recession and the Awful Recovery..., while the U.S. recession started in the final quarter of 2007, it turned vicious only after the September 2008 failure of Lehman. ...
What about the remedy? Would greater debt forgiveness have limited the squeeze on households and reduced the pullback? Almost certainly. ...
The discussion about remedies to debt and leverage cycles is still in its infancy. House of Debt shows why that discussion is so important. Its contribution to understanding the Great Recession (and other big economic cycles) will influence analysts and policymakers for years, even those (like us) who give much greater weight to the role of banks and the financial crisis than the authors.

They also talk about the desirability of "new financial contracts that place the burden of bearing the risk of house price declines primarily on wealthy investors (rather than on borrowers) who can better afford it."

Links for 7-17-14

Wednesday, July 16, 2014

'The Rise of the Non-Working Rich'

Robert Reich:

The Rise of the Non-Working Rich: In a new Pew poll, more than three quarters of self-described conservatives believe “poor people have it easy because they can get government benefits without doing anything.” In reality, most of America’s poor work hard, often in two or more jobs.
The real non-workers are the wealthy who inherit their fortunes. And their ranks are growing. In fact, we’re on the cusp of the largest inter-generational wealth transfer in history. ...
The “self-made” man or woman, the symbol of American meritocracy, is disappearing. Six of today’s ten wealthiest Americans are heirs to prominent fortunes. ...
This is the dynastic form of wealth French economist Thomas Piketty warns about. ... What to do? First, restore the estate tax in full.
Second, eliminate the “stepped-up-basis on death” rule. This obscure tax provision allows heirs to avoid paying capital gains taxes... Such untaxed gains account for more than half of the value of estates worth more than $100 million, according to the Center on Budget and Policy Priorities.
Third, institute a wealth tax. ...
We don’t have to sit by and watch our meritocracy be replaced by a permanent aristocracy, and our democracy be undermined by dynastic wealth. We can and must take action — before it’s too late.

'Double Irish Dutch Sandwich'

Tim Taylor:

Double Irish Dutch Sandwich: Want a glimpse of how companies can shift their profits among countries in a way that reduces their tax liabilities? Here's the dreaded "Double Irish Dutch Sandwich" as described by the International Monetary Find in its October 2013 Fiscal Monitor. This schematic to show the flows of goods and services, payments, and intellectual property. An explanation from the IMF follows, with a few of my own thoughts. ...

'Risk Aversion and the Natural Interest Rate'

From the NY Fed's Liberty Street Economics blog:

Risk Aversion and the Natural Interest Rate, by Bianca De Paoli and Pawel Zabczyk: One way to assess the stance of monetary policy is to assert that there is a natural interest rate (NIR), defined as the rate consistent with output being at its potential. Broadly speaking, monetary policy can be seen as expansionary if the policy rate is below the NIR with the gap between the rates measuring the extent of the policy stimulus. Of course, there are many challenges in defining and measuring the NIR, with various factors driving its value over time. A key factor that needs to be considered is the effect of uncertainty and risk aversion on households’ savings decisions. Households’ tolerance for risk tends to be lower during downturns, putting upward pressure on precautionary savings, and thereby downward pressure on the natural interest rate. In addition, uncertainty dictates how much precautionary savings responds to changes in risk aversion. So policymakers need to be aware that rate moves to offset adverse economic conditions that are appropriate in tranquil times may not be sufficient in times of high uncertainty.
As nicely explained in an FRBSF Economic Letter, the NIR is unobservable, but can be tracked with a model that identifies the interest rate that would prevail when output is at its potential—or, absent cost shocks, at a level consistent with stable inflation. In a recent article, we describe the determinants of the natural rate of interest in a fairly standard economic model of the so-called New Keynesian (NK) variety. Our simple setup clearly doesn’t account for all factors driving the natural rate. For example, the closed-economy nature of the model excludes the possibility that global factors such as reserve purchases by foreign central banks or a significant increase in the global supply of savings could be pushing down the equilibrium interest rate. But our model does account for uncertainty and precautionary savings motives. The importance of both of these factors has been apparent during the recent recession, and both are typically ignored in the textbook NK model. Considering the ability of changes in risk aversion and uncertainty to affect the transmission mechanism of shocks and monetary policy allows our setup to clarify how these considerations affect the natural interest rate. ...
A recent IMF paper finds that two-fifths of the sharp increase in household saving rates between 2007 and 2009 can be attributed to the precautionary savings motive. An increase in precautionary savings is consistent with a lower natural interest rate. ...
What then is the policy implication of this insight? We argue that accounting for a cyclical change in precautionary savings points to a more accommodative stance during downturns by lowering the NIR. As negative shocks to demand are magnified by an increase in precautionary behavior, a larger policy rate response is required to curb deflationary pressures. Even negative supply shocks—which are generally inflationary—may be less so if they motivate people to save more for precautionary reasons. Accordingly, the policy rate that is consistent with stable prices ends up being lower when one takes into account that risk aversion falls during downturns.
By the same reasoning, this risk aversion propagation mechanism implies that the policy rate should be higher in boom periods when risk aversion is lower. To the extent that positive demand and supply shocks are relatively more inflationary if accompanied by a decrease in risk aversion, monetary policy needs to respond to these shocks more aggressively.
Policymakers should also be aware that changes in the NIR driven by precautionary savings are more dramatic in volatile times. And the arguments made here for the NIR hold for other approaches to measuring monetary policy. Namely, volatility needs to be accounted for when designing monetary policy rules as policy responses that are appropriate in relatively tranquil times may not be sufficient in times of high uncertainty.

Links for 7-16-14

Tuesday, July 15, 2014

Fed Watch: Yellen Testimony

Tim Duy:

Yellen Testimony, by Tim Duy: Fed Reserve Chair Janet Yellen testified before the Senate today, presenting remarks generally perceived as consistent with current expectations for a long period of fairly low interest rates. Binyamin Applebaum of the New York Times notes:
Ms. Yellen’s testimony is likely to reinforce a sense of complacency among investors who regard the Fed as convinced of its forecast and committed to its policy course. She reiterated the Fed’s view that the economy will continue to grow at a moderate pace, and that the Fed is in no hurry to start increasing short-term interest rates.
A key reason that Yellen is in no hurry to tighten is her clear belief that an accommodative monetary policy is warranted given the persistent damage done by the recession:
Although the economy continues to improve, the recovery is not yet complete. Even with the recent declines, the unemployment rate remains above Federal Open Market Committee (FOMC) participants' estimates of its longer-run normal level. Labor force participation appears weaker than one would expect based on the aging of the population and the level of unemployment. These and other indications that significant slack remains in labor markets are corroborated by the continued slow pace of growth in most measures of hourly compensation.
Another reminder to watch compensation numbers. Without an acceleration in wage growth, sustained higher inflation is unlikely and hence the Fed sees little need to remove accommodation prior to reaching its policy objectives.
The only vaguely more hawkish tone was that identified by Applebaum:
But Ms. Yellen added that the Fed was ready to respond if it concluded that it had overestimated the slack in the labor market, a more substantial acknowledgment of the views of her critics than she has made in other recent remarks.
The exact quote:
Of course, the outlook for the economy and financial markets is never certain, and now is no exception. Therefore, the Committee's decisions about the path of the federal funds rate remain dependent on our assessment of incoming information and the implications for the economic outlook. If the labor market continues to improve more quickly than anticipated by the Committee, resulting in faster convergence toward our dual objectives, then increases in the federal funds rate target likely would occur sooner and be more rapid than currently envisioned. Conversely, if economic performance is disappointing, then the future path of interest rates likely would be more accommodative than currently anticipated.
Her choice of words is important here. Note that she does not say "If the labor market improves more quickly". Yellen says "continues to improve more quickly" which means that the economy is already converging towards the Fed's objective more quickly than anticipated by current forecasts. This is a point repeatedly made by St. Louis Federal Reserve President James Bullard in recent weeks. For example, via Bloomberg:
Federal Reserve Bank of St. Louis President James Bullard said a rapid drop in joblessness will fuel inflation, bolstering his case for an interest-rate increase early next year.
“I think we are going to overshoot here on inflation,” Bullard said yesterday in a telephone interview from St. Louis. He predicted inflation of 2.4 percent at the end of 2015, “well above” the Fed’s 2 percent target.
“That is a break from where most of the committee seems to be, which is a very slow convergence of inflation to target,” he said in a reference to the policy-making Federal Open Market Committee.
His picture:

BULLARD071514

With Yellen at least acknowledging this point, it brings into question whether or not the Fed should maintain its "considerable period" language:
The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends...
Fed hawks, such as Philadelphia Federal Reserve President Charles Plosser, increasingly see the need to remove this language from the statement, and for some good reason. The Fed foresees ending asset purchases in October and can reasonably foresee raising interest rates in the first quarter given the trajectory of unemployment. Hence it is no longer clear that a "considerable period" between the end of asset purchases and the first rate hike remains a certainty.
To be sure, there will be resistance to changing the language now - the Fed will want to ensure that any change is interpreted as the result of a change in the outlook rather than a change in the reaction function. But the hawks will argue that the communications challenge is best handled by dropping the language sooner than later - later might appear like an abrupt change and be more difficult to distinguish from a shift in the reaction function. This I suspect is the next battlefield for policymakers.
Bottom Line: A generally dovish performance by Yellen today consistent with current expectations. But notice her acknowledgement of her critics, and watch for the "considerable period" debate to heat up as October approaches.

Improving Social Insurance Can Narrow the 'Opportunity Gap'

I have a new column:

Improving Social Insurance Can Narrow the “Opportunity Gap”: The justification for social insurance programs that protect workers is usually based upon the fact that employment in capitalist economies is subject to substantial variation due to cyclical fluctuations and structural change. Economic systems such as socialism have much less variation in employment since everyone, pretty much, is guaranteed a job. But the growth rate of output in those systems is not as high as it is in capitalist economies, and that leads to a lower average standard of living. 
Why not enjoy the benefits of a capitalist system while minimizing its costs through the use of social insurance programs that insulate workers from harm when they lose their jobs for one of these reasons? ...
We don’t do enough to insulate workers from the fluctuations in employment inherent in capitalist economies. ...
Doing more to help workers affected by economic downturns and structural change is not the only way in which social insurance could be improved. There other risks, in particular the risk of unequal opportunity, that are baked into capitalist systems. ...

Does Extending Unemployment Benefits Raise Joblessness?

Me, at MoneyWatch:

Can unemployment benefits raise joblessness?: Did the extension of unemployment compensation during the Great Recession cause joblessness to go up? ...

The latest research on this topic from Katharine Bradbury of the Federal Reserve Bank of Boston ... finds that unemployment does go up when unemployment benefits are extended, but the question is why. Does it discourage workers from taking jobs, or discourage them from leaving the labor force?

Bradbury pointed out that the earlier research shows it's mostly the latter, that extending unemployment benefits causes workers to stay in the labor force longer before dropping out. No notable impact was found on their willingness to take available jobs. ...

Links for 7-15-14

Monday, July 14, 2014

'Empirical Evidence on Inflation Expectations in the New Keynesian Phillips Curve'

Via email, a comment on my comments about the difficulty of settling questions about the Phillips curve empirically:

Dear Professor Thoma,
I saw your recent post on the difficulty of empirically testing the Phillips Curve, and I just wanted to alert you to a survey paper on this topic that I wrote with Sophocles Mavroeidis and Jim Stock: "Empirical Evidence on Inflation Expectations in the New Keynesian Phillips Curve". It was published in the Journal of Economic Literature earlier this year (ungated working paper).
In the paper we estimate a vast number of specifications of the New Keynesian Phillips Curve (NKPC) on a common U.S. data set. The specification choices include the data series, inflation lag length, sample period, estimator, and so on. A subset of the specifications amount to traditional backward-looking (adaptive expectation) Phillips Curves. We are particularly interested in two key parameters: the extent to which price expectations are forward-looking, and the slope of the curve (how responsive inflation is to real economic activity).
Our meta-analysis finds that essentially any desired parameter estimates can be generated by some reasonable-sounding specification. That is, estimation of the NKPC is subject to enormous specification uncertainty. This is consistent with the range of estimates reported in the literature. Even if one were to somehow decide on a given specification, the uncertainty surrounding the parameter estimates is typically large. We give theoretical explanations for these empirical findings in the paper. To be clear: Our results do not reject the validity of the NKPC (or more generally, the presence of a short-run inflation/output trade-off), but traditional aggregate time series analysis is just not very informative about the nature of inflation dynamics.
Kind regards,
Mikkel Plagborg-Moller
PhD candidate in economics, Harvard University

Congress and Monetary Policy

Zero percent agree that Congress should impose a monetary policy rule on the Fed:

IGM Forum: Should the Fed be required to follow a rule?

I am surprised that 11% are uncertain, but see their accompanying comments (the question also asks about how certain respondents are of their answers -- some people are fairly certain they are uncertain).

Is There a Phillips Curve? If So, Which One?

One place that Paul Krugman and Chris House disagree is on the Phillips curve. Krugman (responding to a post by House) says:

New Keynesians do stuff like one-period-ahead price setting or Calvo pricing, in which prices are revised randomly. Practicing Keynesians have tended to rely on “accelerationist” Phillips curves in which unemployment determined the rate of change rather than the level of inflation.
So what has happened since 2008 is that both of these approaches have been found wanting: inflation has dropped, but stayed positive despite high unemployment. What the data actually look like is an old-fashioned non-expectations Phillips curve. And there are a couple of popular stories about why: downward wage rigidity even in the long run, anchored expectations.

House responds:

What the data actually look like is an old-fashioned non-expectations Phillips curve. 
OK, here is where we disagree. Certainly this is not true for the data overall. It seems like Paul is thinking that the system governing the relationship between inflation and output changes between something with essentially a vertical slope (a “Classical Phillips curve”) and a nearly flat slope (a “Keynesian Phillips Curve”). I doubt that this will fit the data particularly well and it would still seem to open the door to a large role for “supply shocks” – shocks that neither Paul nor I think play a big role in business cycles.

Simon Wren-Lewis also has something to say about this in his post from earlier today, Has the Great Recession killed the traditional Phillips Curve?:

Before the New Classical revolution there was the Friedman/Phelps Phillips Curve (FPPC), which said that current inflation depended on some measure of the output/unemployment gap and the expected value of current inflation (with a unit coefficient). Expectations of inflation were modelled as some function of past inflation (e.g. adaptive expectations) - at its simplest just one lag in inflation. Therefore in practice inflation depended on lagged inflation and the output gap.
After the New Classical revolution came the New Keynesian Phillips Curve (NKPC), which had current inflation depending on some measure of the output/unemployment gap and the expected value of inflation in the next period. If this was combined with adaptive expectations, it would amount to much the same thing as the FPPC, but instead it was normally combined with rational expectations, where agents made their best guess at what inflation would be next period using all relevant information. This would include past inflation, but it would include other things as well, like prospects for output and any official inflation target.
Which better describes the data? ...
[W]e can see why some ... studies (like this for the US) can claim that recent inflation experience is consistent with the NKPC. It seems much more difficult to square this experience with the traditional adaptive expectations Phillips curve. As I suggested at the beginning, this is really a test of whether rational expectations is a better description of reality than adaptive expectations. But I know the conclusion I draw from the data will upset some people, so I look forward to a more sophisticated empirical analysis showing why I’m wrong.

I don't have much to add, except to say that this is an empirical question that will be difficult to resolve empirically (because there are so many different ways to estimate a Phillips curve, and different specifications give different answers, e.g. which measure of prices to use, which measure of aggregate activity to use, what time period to use and how to handle structural and policy breaks during the period that is chosen, how should natural rates be extracted from the data, how to handle non-stationarities, if we measure aggregate activity with the unemployment rate, do we exclude the long-term unemployed as recent research suggests, how many lags should be included, etc., etc.?).

Event Time vs. Clock Time

I taught my first class at UT Austin today. I am staying a little over a mile and a half from the campus, so I decided to walk. I discovered that it's a lot hotter in Texas than in Oregon! I will have to get used to this so I'm not dripping wet during my classes...

Anyway, back to the usual. This is from Chris Dillow (I am definitely an even time type, one of the big reasons I avoided the 8-5 world):

Time, by Chris Dillow: Google boss Larry Page recently called for the end of the conventional 40-hour working week. Some new research suggests this could have more profound cultural effects than generally thought.
Anne-Laure Sellier and Tamar Avnet primed people to choose between organizing some jobs in "clock-time" (scheduling a specific job at a specific time) or in "event-time" (doing a job until you reach a natural break). They found that the choice led to two big pyschological differences.
First, clock-timers were more likely to have an external locus of control; they were more likely to see their lives as determined by fate or powerful others. Event-timers, on the other hand, tended to have an internal locus, regarding themselves as in control of their own fate. ...
Secondly, clock-timers were less able to savour positive emotions than event-timers - perhaps because if you have an eye on the clock you are less likely to lose yourself in a job and so enjoy flow. ...
Here, though, we need some history. One key feature of the emergence of industrial capitalism was that bosses replaced event-time with clock-time. ... But as Sellier and Avnet suggest, this replacement had some cultural and psychological effects...
And herein lies the thing. If Mr Page is right and/or if some combination of robots and a citizens basic income create a post-scarcity economy in which we are ... less subject to the tyranny of the clock, this could lead to big cultural changes which we have barely begun to think about.

Paul Krugman: Obamacare Fails to Fail

Why don't we hear more about the success of Obamacare?:

Obamacare Fails to Fail, by Paul Krugman, Commentary, NY Times: How many Americans know how health reform is going? For that matter, how many people in the news media are following the positive developments?
I suspect that the answer to the first question is “Not many,” while the answer to the second is “Possibly even fewer”... And if I’m right, it’s a remarkable thing — an immense policy success is improving the lives of millions of Americans, but it’s largely slipping under the radar.
How is that possible? Think relentless negativity without accountability. The Affordable Care Act has faced nonstop attacks from partisans and right-wing media, with mainstream news also tending to harp on the act’s troubles. Many of the attacks have involved predictions of disaster, none of which have come true. But absence of disaster doesn’t make a compelling headline, and the people who falsely predicted doom just keep coming back with dire new warnings. ...
Yes, there are losers from Obamacare. If you’re young, healthy, and affluent enough that you don’t qualify for a subsidy (and don’t get insurance from your employer), your premium probably did rise. And if you’re rich enough to pay the extra taxes that finance those subsidies, you have taken a financial hit. But it’s telling that even reform’s opponents aren’t trying to highlight these stories. Instead, they keep looking for older, sicker, middle-class victims, and keep failing to find them.
Oh,... the overwhelming majority of the newly insured, including 74 percent of Republicans, are satisfied with their coverage.
You might ask why, if health reform is going so well, it continues to poll badly. It’s crucial ... to realize that Obamacare, by design, by and large doesn’t affect Americans who already have good insurance. As a result, many peoples’ views are shaped by the mainly negative coverage in the news... Still, the latest tracking survey from the Kaiser Family Foundation shows that a rising number of Americans are hearing about reform from family and friends, which means that they’re starting to hear from the program’s beneficiaries.
And as I suggested earlier, people in the media — especially elite pundits — may be the last to hear the good news, simply because they’re in a socioeconomic bracket in which people generally have good coverage.
For the less fortunate, however, the Affordable Care Act has already made a big positive difference. The usual suspects will keep crying failure, but the truth is that health reform is — gasp! — working.

Links for 7-14-14

Sunday, July 13, 2014

New Classical Economics as Modeling Strategy

Judy Klein emails a response to a recent post of mine based upon Simon Wren Lewis's post “Rereading Lucas and Sargent 1979”:

Lucas and Sargent’s, “After Keynesian Macroeconomics,” was presented at the 1978 Boston Federal Reserve Conference on “After the Phillips Curve: Persistence of High Inflation and High Unemployment.” Although the title of the conference dealt with stagflation, the rational expectations theorists saw themselves countering one technical revolution with another.

The Keynesian Revolution was, in the form in which it succeeded in the United States, a revolution in method. This was not Keynes’s intent, nor is it the view of all of his most eminent followers. Yet if one does not view the revolution in this way, it is impossible to account for some of its most important features: the evolution of macroeconomics into a quantitative, scientific discipline, the development of explicit statistical descriptions of economic behavior, the increasing reliance of government officials on technical economic expertise, and the introduction of the use of mathematical control theory to manage an economy. [Lucas and Sargent, 1979, pg. 50]

The Lucas papers at the Economists' Papers Project at the University of Duke reveal the preliminary planning for the 1978 presentation. Lucas and Sargent decided that it would be a “rhetorical piece… to convince others that the old-fashioned macro game is up…in a way which makes it clear that the difficulties are fatal”; it’s theme would be the “death of macroeconomics” and the desirability of replacing it with an “Aggregative Economics” whose foundation was “equilibrium theory.” (Lucas letter to Sargent February 9, 1978). Their 1978 presentation was replete, as their discussant Bob Solow pointed out, with the planned rhetorical barbs against Keynesian economics of “wildly incorrect," "fundamentally flawed," "wreckage," "failure," "fatal," "of no value," "dire implications," "failure on a grand scale," "spectacular recent failure," "no hope." The empirical backdrop to Lucas and Sargent’s death decree on Keynesian economics was evident in the subtitle of the conference: “Persistence of High Inflation and High Unemployment.”

Although they seized the opportunity to comment on policy failure and the high misery-index economy, Lucas and Sargent shifted the macroeconomic court of judgment from the economy to microeconomics. They fought a technical battle over the types of restrictions used by modelers to identify their structural models. Identification-rendering restrictions were essential to making both the Keynesian and rational expectations models “work” in policy applications, but Lucas and Sargent defined the ultimate terms of success not with regard to a model’s capacity for empirical explanation or achievement of a desirable policy outcome, but rather with regard to the model’s capacity to incorporate optimization and equilibrium – to aggregate consistently rational individuals and cleared markets.

In the macroeconomic history written by the victors, the Keynesian revolution and the rational expectations revolution were both technical revolutions, and one could delineate the sides of the battle line in the second revolution by the nature of the restricting assumptions that enabled the model identification that licensed policy prescription. The rational expectations revolution, however, was also a revolution in the prime referential framework for judging macroeconomic model fitness for going forth and multiplying; the consistency of the assumptions – the equation restrictions - with optimizing microeconomics and mathematical statistical theory, rather than end uses of explaining the economy and empirical statistics, constituted the new paramount selection criteria.

Some of the new classical macroeconomists have been explicit about the narrowness of their revolution. For example, Sargent noted in 2008, “While rational expectations is often thought of as a school of economic thought, it is better regarded as a ubiquitous modeling technique used widely throughout economics.” In an interview with Arjo Klamer in 1983, Robert Townsend asserted that “New classical economics means a modeling strategy.”

It is no coincidence, however, that in this modeling narrative of economic equilibrium crafted in the Cold War era, Adam Smith’s invisible hand morphs into a welfare-maximizing “hypothetical ‘benevolent social planner’” (Lucas, Prescott, Stokey 1989) enforcing a “communism of models” (Sargent 2007) and decreeing to individual agents the mutually consistent rules of action that become the equilibrating driving force. Indeed, a long-term Office of Naval Research grant for “Planning & Control of Industrial Operations” awarded to the Carnegie Institutes of Technology’s Graduate School of Industrial Administration had funded Herbert Simon’s articulation of his certainty equivalence theorem and John Muth’s study of rational expectations. It is ironic that a decade-long government planning contract employing Carnegie professors and graduate students underwrote the two key modeling strategies for the Nobel-prize winning demonstration that the rationality of consumers renders government intervention to increase employment unnecessary and harmful.

'Why Macroeconomists, Not Bankers, Should Set Interest Rates'

Simon Wren-Lewis:

Why macroeconomists, not bankers, should set interest rates: More thoughts on the idea that interest rates ought to rise because of the possibility that the financial sector is taking excessive risks: what I called in this earlier post the BIS case, after the Bank of International Settlements, the international club for central bankers. I know Paul Krugman, Brad DeLong, Mark Thoma, Tony Yates and many others have already weighed in here, but - being macroeconomists - they were perhaps too modest to draw this lesson. ...

Links for 7-13-14

Saturday, July 12, 2014

Are Interest Rates Artificially Low? Nope.

Discouraging:

The Meme is Out There, by Paul Krugman: I just answered some questions for Princeton magazine, and among them was this:

Please comment on how artificially low interest rates have impacted the current value of baby boomers’ retirement portfolios and should this be a consideration of the Federal Reserve?

I don’t blame the editor, who after all isn’t supposed to be an economist. But what this must reflect is what people are hearing on the financial news; I’m pretty sure that a lot of people think that all the experts regard interest rates as “artificially low”, and have no idea that to the extent that such a notion makes any sense at all — which is to say in terms of the Wicksellian natural rate — interest rates are too high, not too low.

'The Collapse of the French Assignat and Its Link to Virtual Currencies Today'

In case you missed this in links, I thought it was interesting:

Crisis Chronicles: The Collapse of the French Assignat and Its Link to Virtual Currencies Today, by James Narron and David Skeie, Liberty Street Economics: In the late 1700s, France ran a persistent deficit and by the late 1780s struggled with how to balance the budget and pay down the debt. After heated debate, the National Assembly elected to issue a paper currency bearing an attractive 3 percent interest rate, secured by the finest French real estate to be confiscated from the clergy. Assignats were first issued in December 1789 and initially were a boon to the economy. Yet while the first issues brought prosperity, subsequent issues led to stagnation and misery. In this edition of Crisis Chronicles, we review how fiat money inflation in France caused the collapse of the French assignat and describe some interesting parallels between the politics of French government finance in the late 1700s and more recent fiscal crises.

Remembering John Law and the Mississippi Bubble
It was not without grave reservation that the National Assembly elected to pursue a new issue of paper currency. Some who spoke out against issuing the assignat recalled the wretchedness and ruin to which their families were subjected during John Law’s tenure as head of French finance and the Mississippi Bubble of 1720. But there was also great political willpower against raising taxes of any sort and deficits were already high. So the only option was to turn to the printing press once again.
But this time, the National Assembly was convinced it would be different. The currency would be secured by confiscated church property...[continue reading]...

Links for 7-12-14

Friday, July 11, 2014

'Rereading Lucas and Sargent 1979'

Simon Wren-Lewis with a nice follow-up to an earlier discussion:

Rereading Lucas and Sargent 1979: Mainly for macroeconomists and those interested in macroeconomic thought
Following this little interchange (me, Mark Thoma, Paul Krugman, Noah Smith, Robert Waldman, Arnold Kling), I reread what could be regarded as the New Classical manifesto: Lucas and Sargent’s ‘After Keynesian Economics’ (hereafter LS). It deserves to be cited as a classic, both for the quality of ideas and the persuasiveness of the writing. It does not seem like something written 35 ago, which is perhaps an indication of how influential its ideas still are.
What I want to explore is whether this manifesto for the New Classical counter revolution was mainly about stagflation, or whether it was mainly about methodology. LS kick off their article with references to stagflation and the failure of Keynesian theory. A fundamental rethink is required. What follows next is I think crucial. If the counter revolution is all about stagflation, we might expect an account of why conventional theory failed to predict stagflation - the equivalent, perhaps, to the discussion of classical theory in the General Theory. Instead we get something much more general - a discussion of why identification restrictions typically imposed in the structural econometric models (SEMs) of the time are incredible from a theoretical point of view, and an outline of the Lucas critique.
In other words, the essential criticism in LS is methodological: the way empirical macroeconomics has been done since Keynes is flawed. SEMs cannot be trusted as a guide for policy. In only one paragraph do LS try to link this general critique to stagflation...[continue]...

Paul Krugman: Who Wants a Depression?

Why has there been so much "hysteria over Fed policy"?:

Who Wants a Depression?, by Paul Krugman, Commentary, NY Times: One unhappy lesson we’ve learned in recent years is that economics is a far more political subject than we liked to imagine. ...
It’s not that many years since the administration of George W. Bush declared that one lesson from the 2001 recession and the recovery that followed was that “aggressive monetary policy can make a recession shorter and milder.” Surely, then, we’d have a bipartisan consensus in favor of even more aggressive monetary policy to fight the far worse slump of 2007 to 2009. Right?
Well, no. I’ve written a number of times about the phenomenon of “sadomonetarism,” the constant demand that the Federal Reserve and other central banks stop trying to boost employment and raise interest rates instead, regardless of circumstances. I’ve suggested that the persistence of this phenomenon has a lot to do with ideology, which, in turn, has a lot to do with class interests. And I still think that’s true.
But I now think that class interests also operate through a cruder, more direct channel. Quite simply, easy-money policies, while they may help the economy as a whole, are directly detrimental to people who get a lot of their income from bonds and other interest-paying assets — and this mainly means the very wealthy, in particular the top 0.01 percent. ...
Complaints about low interest rates are usually framed in terms of the harm being done to retired Americans living on the interest from their CDs. But the interest receipts of older Americans go mainly to a small and relatively affluent minority..., and it surely explains a lot of the hysteria over Fed policy. The rich ... ensure that there are always plenty of supposed experts eager to find justifications for this attitude. Hence sadomonetarism.
Which brings me back to the politicization of economics.
Before the financial crisis, many central bankers and economists were, it’s now clear, living in a fantasy world, imagining themselves to be technocrats insulated from the political fray. ...
It turns out, however, that using monetary policy to fight depression, while in the interest of the vast majority of Americans, isn’t in the interest of a small, wealthy minority. And, as a result, monetary policy is as bound up in class and ideological conflict as tax policy.
The truth is that in a society as unequal and polarized as ours has become, almost everything is political. Get used to it.

Links for 7-11-14

Thursday, July 10, 2014

'In Search of Search Theory'

John Quiggin:

In search of search theory: This is going to be a long and wonkish post, so I’ll just give the dot-point summary here, and let those interested read on below the fold, for the explanations and qualifications.
* The dominant model of unemployment, in academic macroeconomics at least, is based on the idea that unemployment can best be modelled in terms of workers searching for jobs, and remaining unemployed until they find a good match with an employer
* The efficiency of job search and matching has been massively increased by the Internet, so, if unemployment is mainly explained by search, it should have fallen steadily over the past 20 years.
* Obviously, this hasn’t happened, but economists seem to have ignored this fact or at least not worried too much about it
* The fact that search models are more popular than ever is yet more evidence that academic macroeconomics is in a bad way ...

Fed Explores Overhaul of Its Target Interest Rate

Robin Harding reports:

Fed explores overhaul of key rate: The US Federal Reserve is exploring an overhaul of the Federal funds rate – a benchmark that underlies almost every financial transaction in the world – as it prepares for an eventual rise in interest rates. ...
According to people familiar with the discussions, the Fed is could redefine its main target rate so that it takes into account a wider range of loans between banks, making it more stable and reliable.  ...
In particular, the Fed is looking at redefining the Fed funds rate to include eurodollar transactions – dollar loans between banks outside the US markets – as well as traditional onshore loans between US banks. Other closely related rates that it could include are those on transactions for bank commercial paper and wholesale certificates of deposit between banks.

Fed Watch: QEInfinity Not

Tim Duy:

QEInfinity Not, by Tim Duy: The Federal Reserve released the minutes of the June FOMC meeting today, but the contents had little in the way of groundbreaking news. Most interesting was that Fed officials tired of being pestered about the "October or December" question regarding the end of the QE and decided to more or less commit to the earlier date:
Some committee members had been asked by members of the public whether, if tapering in the pace of purchases continues as expected, the final reduction would come in a single $15 billion per month reduction or in a $10 billion reduction followed by a $5 billion reduction. Most participants viewed this as a technical issue with no substantive macroeconomic consequences and no consequences for the eventual decision about the timing of the first increase in the federal funds rate--a decision that will depend on the Committee's evolving assessments of actual and expected progress toward its objectives.
In other words, who cares about that last $5 billion? The Fed's answer was to take away the mystery:
In light of these considerations, participants generally agreed that if incoming information continued to support its expectation of improvement in labor market conditions and a return of inflation toward its longer-run objective, it would be appropriate to complete asset purchases with a $15 billion reduction in the pace of purchases in order to avoid having the small, remaining level of purchases receive undue focus among investors.
with, of course, the usual "data dependent" caveat. Thus the predictions of QE Infinity come to an end. In other news, the Fed fretted over market complacency:
However, participants also discussed whether some recent trends in financial markets might suggest that investors were not appropriately taking account of risks in their investment decisions. In particular, low implied volatility in equity, currency, and fixed-income markets as well as signs of increased risk-taking were viewed by some participants as an indication that market participants were not factoring in sufficient uncertainty about the path of the economy and monetary policy.
I find this somewhat irritating. What is "sufficient" uncertainty? I find it especially irritating given that, as Josh Zumbrun at the Wall Street Journal reports, Fed officials themselves appear to have less uncertainty regarding the outlook:

BN-DP809_dwindl_G_20140709142508

If the Fed has a well-communicated reaction function, and there is little uncertainty about the outlook, why should there be uncertainty about the path of monetary policy? The Fed's unease about complacency seems misplaced. The goal of the communications strategy should be to limit uncertainty regarding the path of monetary policy by clearing defining the objective function. The only residual uncertainty will be economic uncertainty. And even that arguably is reduced by establishing a well-communicated reaction function.
In any event, the Fed concluded that even if complacency is a problem, there is not much they can do about it:
They agreed that the Committee should continue to carefully monitor financial conditions and to emphasize in its communications the dependence of its policy decisions on the evolution of the economic outlook; it was also pointed out that, where appropriate, supervisory measures should be applied to address excessive risk-taking and associated financial imbalances. At the same time, it was noted that monetary policy needed to continue to promote the favorable financial conditions required to support the economic expansion.
Very similar to Federal Reserve Chair Janet Yellen's recent comments:
Taking all of these factors into consideration, I do not presently see a need for monetary policy to deviate from a primary focus on attaining price stability and maximum employment, in order to address financial stability concerns. That said, I do see pockets of increased risk-taking across the financial system, and an acceleration or broadening of these concerns could necessitate a more robust macroprudential approach.
If the Fed wants to increase uncertainty and, presumably, reduce potential financial instability, they could do so by changing the reaction function in a hawkish direction. The Fed, however, is not yet sufficiently concerned about complacency to attempt to gain more financial stability at the cost of economic growth.
Inflation remains well below target:

INF070914

But the Fed believes we have seen the lows:
Readings on a range of price measures--including the PCE price index, the CPI, and a number of the analytical measures developed at the Reserve Banks--appeared to provide evidence that inflation had moved up recently from low levels earlier in the year, consistent with the Committee's forecast of a gradual increase in inflation over the medium term. Reports from business contacts were mixed, spanning an absence of price pressures in some Districts and rising input costs in others. Some participants expressed concern about the persistence of below-trend inflation, and a couple of them suggested that the Committee may need to allow the unemployment rate to move below its longer-run normal level for a time in order keep inflation expectations anchored and return inflation to its 2 percent target, though one participant emphasized the risks of doing so. In contrast, some others expected a faster pickup in inflation or saw upside risks to inflation and inflation expectations because they anticipated a more rapid decline in economic slack.
Seems like broad agreement that inflation rates bottomed out, but less agreement on where they head from here. Toward target, to be sure, but at what speed? That question, like all the forecasts, feeds into future policy decisions:
Some participants suggested that the Committee's communications about its forward guidance should emphasize more strongly that its policy decisions would depend on its ongoing assessment across a range of indicators of economic activity, labor market conditions, inflation and inflation expectations, and financial market developments. In that regard, circumstances that might entail either a slower or a more rapid removal of policy accommodation were cited. For example, a number of participants noted their concern that a more gradual approach might be appropriate if forecasts of above-trend economic growth later this year were not realized. And a couple suggested that the Committee might need to strengthen its commitment to maintain sufficient policy accommodation to return inflation to its target over the medium term in order to prevent an undesirable decline in inflation expectations. Alternatively, some other participants expressed concern that economic growth over the medium run might be faster than currently expected or that the rate of growth of potential output might be lower than currently expected, calling for a more rapid move to begin raising the federal funds rate in order to avoid significantly overshooting the Committee's unemployment and inflation objectives.
Is there any new information here? I think not. The current expected path of rates is data dependent, and as that data changes, so too will the expected rate path. The pattern of rate forecasts in the Summary of Economic Projections largely reflects differing forecasts rather than differing reaction functions. As the data evolves, the pattern of rate forecasts will converge as one of the paths becomes more obvious.
My own view is:
  1. The existing mix of data and forecasts suggest the first rate hike in the second quarter of 2015 with a gradual increase in rates thereafter. This is my baseline.
  2. If unemployment continues to drop at the same rate as recent months, bring forward the rate hike to the first quarter but continue to assume a gradual increase.
  3. If core-PCE inflation exceeds 2.25% and wage growth is accelerating , expect first quarter liftoff and a steeper path of rate hikes.

Obviously, the data could suggest a delay in the first rate hike, but I do not believe the risks are weighted in that direction. I think the risks are weighted toward tighter than expected policy.

Bottom Line: Fairly straightforward minutes. Policy is data dependent. The Fed, like all of us, are simply waiting to see how that data evolves.

Links for 7-10-14

Wednesday, July 09, 2014

Note

I am on the road and have a long travel day ahead of me, the second in a row, so probably not much more blogging until much later, if at all (I'm headed to UT Austin to teach a four week class beginning next Monday).

Adam Smith as Malthusian: 'The Surplus Population'

Brad DeLong quotes Adam Smith:

Adam Smith as Malthusian: “The Surplus Population”, by Brad DeLong: ...Adam Smith: Smith: Wealth of Nations, Book I, Chapter 8: “Is this improvement in the circumstances of the lower ranks of the people…

…to be regarded as an advantage or as an inconveniency to the society? The answer seems ... abundantly plain. Servants, abourers and workmen of different kinds, make up the far greater part of every great political society. But what improves the circumstances of the greater part can never be regarded as an inconveniency to the whole. No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable. It is but equity, besides, that they who feed, cloath and lodge the whole body of the people, should have such a share of the produce of their own labour as to be themselves tolerably well fed, cloathed and lodged.

Poverty… seems even to be avourable to generation. A half-starved Highland woman frequently bears more than twenty children…. Luxury in the fair sex, while it enflames perhaps the passion for enjoyment, seems always to weaken and frequently to destroy altogether, the powers of generation. But poverty… is extremely unfavourable to the rearing of children…. It is not uncommon… in the Highlands… for a mother who has borne twenty children not to have two alive…. In civilized society it is only among the inferior ranks of people that the scantiness of subsistence can set limits to the further multiplication of the human species… by destroying a great part of the children which their fruitful marriages produce. The liberal reward of labour, by enabling them to provide better for their children, and consequently to bring up a greater number, naturally tends to widen and extend those limits…. The liberal reward of labour, therefore, as it is the effect of increasing wealth, so it is the cause of increasing population. To complain of it, is to lament over the necessary effect and cause of the greatest public prosperity.

ItIt deserves to be remarked, perhaps, that it is in the progressive state, while the society is advancing to the further acquisition, rather than when it has acquired its full complement of riches, that the condition of the labouring poor, of the great body of the people, seems to be the happiest and the most comfortable. It is hard in the stationary, and miserable in the declining state. The progressive state is in reality the cheerful and the hearty state to all the different orders of the society. The stationary is dull; the declining melancholy…

And then Brad remarks:

Two things are worth noting here:

The first is that even as early as 1776 economics had already acquired the utilitarian bias toward an equal distribution of income: feeding, clothing, and lodging the working class “tolerably well” contributed much more to the flourishing and happiness of society then would devoting the same resources to further increasing the luxury of the rich. We are in the world of Jeremy Bentham, where any claim that we cannot make interpersonal comparisons of utility between rich and poor is dismissed with a laugh.

The second is that Adam Smith is, in the longest run and in the last analysis, a Malthusian: economies are headed for a stationary–or, worse, a declining–state, and that stationary state is not a good one: “the condition of the… great body of the people… is hard in the stationary, and miserable in the declining state…” But there is no sense that we should not grab for the boom as long as we can, and as long as we are in the boom period, Adam Smith says, we should not complain about population growth

The liberal reward of labour… is the effect of increasing wealth… [and] the cause of increasing population. To complain… is to lament over the necessary effect and cause of the greatest public prosperity…

'Lifting the Veil on the U.S. Bilateral Repo Market'

Via the Liberty Street Economics blog at the NY Fed, should we worry as much about the bilateral repo market as we do about the tri-party market (which played a key role in the financial crisis and remains vulnerable to another "run on the shadow banking system")?:

Lifting the Veil on the U.S. Bilateral Repo Market, by Adam Copeland, Isaac Davis, Eric LeSueur, and Antoine Martin, Liberty Street Economics: The repurchase agreement (repo), a contract that closely resembles a collateralized loan, is widely used by financial institutions to lend to each other. The repo market is divided into trades that settle on the books of the two large clearing banks (that is, tri-party repo) and trades that do not (that is, bilateral repo). While there are public data about the tri-party repo segment, there is little to no information on the bilateral repo segment. In this post, we update a methodology we developed earlier to estimate the size and composition of collateral posted for bilateral repos, and find that U.S. Treasury securities are the dominant form of collateral for bilateral repos. This new finding implies that the collateral posted for bilateral repos is of higher quality than the collateral posted for tri-party repos. ...

Fed Watch: When The Fed Starts Raising Rates

Tim Duy:

When The Fed Starts Raising Rates, by Tim Duy: Via Twitter, modest proposal summarizes my last post:
Shorter @TimDuy, short the front end not the 10 year because the Fed will tighten before inflation is a problem http://t.co/1a0xRNueEO
— modest proposal (@modestproposal1) July 7, 2014
This made me think about the last tightening cycle. For those that hope to use tighter monetary policy to bolster the case against equities, recall that patience may be required:

FedTight1

For those making the bear case against long bonds, recall that initially long rates fell, and over the entire cycle rose just (roughly) 50bp:

FedTight2

The short end of the curve suffered, and the yield curve inverted:

FedTight3

How does this compare to now? If we consider last December's taper the beginning of this tightening cycle (the Fed does not; they prefer to think of it at reducing financial accommodation), stocks continue to power higher:

FedTight4

The 10 year bond initially fell on the taper talk and the yield curve steepened through the 10 year. But that steepening ended when the taper began:

FedTight5

More interesting is the flattening of the very long end after the taper began:

FedTight6

It looks like rates are signalling that the Fed will act to contain activity such that the economy does not overheat. Which, assuming the Fed maintains its current reaction function, tends to support modest porposal's interpretation - favor the long end of the curve over the short end.
I think the flattening of the yield curve should be a concern to the Fed. It suggests that while we frequently hear Janet Yellen described as a dove, the expectation is that her actual policy approach will be cautious bordering on hawkish. Not good if you think like Andy Harless:
I will consider Yellen's tenure a failure if the economy does not overheat.
— Andy Harless (@AndyHarless) July 5, 2014
I am sympathetic to this view. I would be a little more optimistic that the Fed would have more room to maneuver in the next recession if the long-end of the yield curve was signalling that the Fed was a little behind instead of a little ahead. And for more on why that is important, see Brad DeLong and his 17 tweet bear case for inflation.