Category Archive for: Fiscal Policy [Return to Main]

Sunday, July 17, 2016

Helicopter Money

Jim Hamilton:

Helicopter money: Despite aggressive actions by central banks, many of the world’s economies are still stagnating and facing new shocks, leading to renewed calls for helicopter money as a serious policy prescription for countries like Japan and the U.K.. And, if things go badly, maybe the United States? ...

After discussing helicopter money, he concludes with:

... If helicopter money is no more than a combination of fiscal expansion and LSAP, and if we think LSAP hasn’t been able to do that much, it’s clear that the fiscal expansion part is where the real action is coming from. On the other hand, if we think both components make a difference, there’s no inherent reason that the size of the fiscal operation has to be exactly the same as the size of the monetary operation.

Nevertheless, as has been true with LSAP, there might be some psychological impact, if nothing else, from announcing this as if it were a new policy. For example, I could imagine the Fed announcing that for the next n months, it will buy all the new debt that the Treasury issues. For maximal effect this would be coupled with a Treasury announcement of a new spending operation. Doubtless the announcement would bring out calls from certain quarters that the U.S. was going the route of Zimbabwe. And just as in the previous times we heard those warnings, those pundits would be proven wrong, as indeed the effects would not be that different from what we’re already getting from central bank expansions around the globe.

Helicopter money is no bazooka for stimulating the economy. Ben Bernanke offered this reasonable summary:

Money-financed fiscal programs (MFFPs), known colloquially as helicopter drops, are very unlikely to be needed in the United States in the foreseeable future. They also present a number of practical challenges of implementation, including integrating them into operational monetary frameworks and assuring appropriate governance and coordination between the legislature and the central bank. However, under certain extreme circumstances– sharply deficient aggregate demand, exhausted monetary policy, and unwillingness of the legislature to use debt-financed fiscal policies– such programs may be the best available alternative. It would be premature to rule them out.

Wednesday, July 06, 2016

A Remarkable Financial Moment

Larry Summers:

A Remarkable Financial Moment: The US 10 and 30 year interest rates today reached all time low levels of 1.32 percent and 2.10 percent. Record low 10 year interest rate were also registered in Germany, France, Switzerland and Australia. Notably Swiss 50 year interest rates are now for the first time negative. Rates out 15 years are negative in Germany and 9 years in France. ...

Remarkably the market does not now expect a full Fed tightening until early 2019. This is despite all the Fed speeches expressing optimism about the economy and a desire to normalize interest rates.
I believe that these developments all reflect a growing awareness of the importance of the secular stagnation risks that I have highlighted over the last several years. ...
Unfortunately markets have been much more aggressive in responding to events than policymakers. ... Having the right world view is essential if there is to be a chance of making the right decisions. Here are the necessary adjustments.
First..., neutral real interest rates are likely close to zero going forward. ...
Second, as counterintuitive as it is to central bankers who came of age when the inflation of the 1970s defined the central banking challenge, our problem today is insufficient inflation. ...
Third, in a world where interest rates over horizons of more than a generation are far lower than even pessimistic projections of growth, traditional thinking about debt sustainability needs to be discarded. ...Brad Delong and I set out in 2012 for expansionary fiscal policy to pay for itself are much more easily satisfied today than they were at that time.
Fourth, the traditional suite of structural policies to promote flexibility are not especially likely to be successful in the current environment... Indeed in the presence of chronic excess supply structural reform has the risk of spurring disinflation rather than the contributing to a necessary increase in inflation. There is in fact a case for strengthening entitlement benefits so as to promote current demand. ...

Thursday, June 23, 2016

Making Automatic Stabilizers More Effective for the Next U.S. Recession

Nick Bunker:

Making automatic stabilizers more effective for the next U.S. recession: When the next recession hits, policymakers can take steps right then and there to fight the economic downturn. The Federal Reserve can lower interest rates and the legislative and executive branches can deploy fiscal stimulus by cutting taxes or boosting spending. But another way to counteract a recession relies on steps taken before economic growth begins to turn downward, relying on so called automatic stabilizers, which trigger on when the economy worsens. Think of unemployment insurance, which laid off workers collect, or the Supplemental Nutrition Assistance Program, which is eligible for workers under a certain income threshold.
These automatic programs were designed as forms of social insurance to help people weather the shock of losing a job. But they also boast the benefit of increasing consumer spending and therefore dampening the severity of a recession...
The next U.S. recession is probably not just around the corner. But it’s never too early to start preparing. If policymakers want to give themselves (or their future colleagues) a running start, they should take a look at strengthening automatic stabilizers such unemployment insurance and consider how other types of automatic-stabilizer programs might help the broader U.S. economy when it eventually takes another tumble.

The problem is "Making Congress More Effective for the Next U.S. Recession."

Wednesday, June 22, 2016

The Myth of Austerity and Growth

Noah Smith:

The Myth of Austerity and Growth: ...Five years ago, it was common to hear claims that too much government borrowing would hurt growth -- an idea known as expansionary austerity. Much of the research cited by the proponents of this theory was done by scholars at the International Monetary Fund. But during the past few years, there have been quite a few questions about the IMF’s past cheerleading for belt-tightening. ...
Some pieces of research seemed to support austerity policies. Work by economists Carmen Reinhart and Kenneth Rogoff ... purported to show that countries that borrowed more grew more slowly. ... Subsequent analysis ... showed that there isn’t any evidence that high debt causes low growth.
Another paper on the austerity side ... was a 2002 study by Olivier Blanchard and Roberto Perotti. ... That pro-austerity result contradicts a lot of other papers -- see here and here, for example -- but it was very influential in part because of the prestige of Blanchard...
But in recent years, Blanchard has shifted his stance. In a 2013 paper with Daniel Leigh, he showed that the IMF had been consistently wrong in its forecasts of the effects of austerity. ...
This paper isn’t a one-shot mea culpa. ...
There are still a few pro-austerity papers out there ... but they’re increasingly swimming against the tide of evidence. ...

Monday, June 06, 2016

A Pause That Distresses

If the economy goes into recession, Republicans will stand in the way of the needed response from monetary and fiscal policy:

A Pause That Distresses, by Paul Krugman, NY Times: Friday’s employment report was a major disappointment: only 38,000 jobs added, a big step down from the more than 200,000 a month average since January 2013. Special factors, notably the Verizon strike, explain part of the bad news, and in any case job growth is a noisy series... Still, all the evidence points to slowing growth. It’s not a recession, at least not yet, but it is definitely a pause in the economy’s progress. ...
So what is causing the economy to slow? My guess is that the biggest factor is the recent sharp rise in the dollar, which has made U.S. goods less competitive on world markets. The dollar’s rise, in turn, largely reflected misguided talk by the Federal Reserve about the need to raise interest rates. ...
Whatever the cause of a downturn, the economy can recover quickly if policy makers can and do take useful action. ...
But that won’t — in fact, can’t — happen this time. Short-term interest rates, which the Fed more or less controls, are still very low... We now know that it’s possible for rates to go slightly below zero, but there still isn’t much room for a rate cut.
That said, there are other policies that could easily reverse an economic downturn. ... For the simplest, most effective answer to a downturn would be fiscal stimulus...
But unless the coming election delivers Democratic control of the House, which is unlikely, Republicans would almost surely block anything along those lines. Partly, this would reflect ideology... It would also reflect an unwillingness to do anything that might help a Democrat in the White House. ...
If not fiscal stimulus, then what? For much of the past six years the Fed, unable to cut interest rates further, has tried to boost the economy through large-scale purchases of things like long-term government debt and mortgage-backed securities. But it’s unclear how much difference that made — and meanwhile, this policy faced constant attacks and vilification from the right, with claims that it was debasing the dollar and/or illegitimately bailing out a fiscally irresponsible president. We can guess that the Fed will be very reluctant to resume the program...
So the evidence of a U.S. slowdown should worry you. I don’t see anything like the 2008 crisis on the horizon (he says with fingers crossed behind his back), but even a smaller negative shock could turn into very bad news, given our political gridlock.

Friday, May 20, 2016

Helicopter Money and Fiscal Policy

Simon Wren-Lewis:

Helicopter money and fiscal policy: ... We can have endless debates about whether HM is more monetary or fiscal. While attempts to distinguish between the two can sometime clarify important points (as here from Eric Lonergan) it is ultimately pointless. HM is what it is. Arguments that attempt to use definitions to then conclude that central banks should not do HM because its fiscal are equally pointless. Any HM distribution mechanism needs to be set up in agreement with governments, and existing monetary policy has fiscal consequences which governments have no control over. ...
At this moment in time, even if a global recession is not about to happen, public investment should increase in the US, UK and Eurozone. There is absolutely no reason why that cannot be financed by issuing government debt. ... Indeed there would be a good case for bringing forward public investment even if monetary policy was capable of dealing with the recession on its own, because you would be investing when labour is cheap and interest rates are low. ...
HM is fiscal stimulus without any immediate increase in government borrowing. It therefore avoids the constraint that Osborne and Merkel said prevented further fiscal stimulus. ... HM is not financed by increasing government debt.
Many argue that these concerns about debt are manufactured, and that in reality politicians on the right pushing austerity are using these concerns as a means of achieving a smaller state: what I call here deficit deceit. HM, particularly in its democratic form, calls their bluff. If we can avoid making the recession worse by maintaining public spending, financed in part by creating money while the recession persists, how can they object to that? Politicians who wanted to use deficit deceit will not like it, but that is their problem, not ours.
There is a related point in favour of HM... Independent central banks are a means of delegating macroeconomic stabilisation. Yet that delegation is crucially incomplete, because of the lower bound for nominal interest rates. While economists have generally understood that governments can in this situation come to the rescue, politicians either didn’t get the memo, or have proved that they are indeed not to be trusted with the task. HM is a much better instrument than Quantitative Easing, so why deny central banks the instrument they require to do the job they have been asked to do.

Tuesday, May 17, 2016

A General Theory of Austerity

Simon Wren-Lewis:

A General Theory of Austerity: ...I have just completed a working paper... It has the title of this post: in part an allusion to Keynes who had been here before, but also because its scope is ambitious. The first part of the paper tries to explain why austerity is nearly always unnecessary, and the second part tries to understand why the austerity mistake happened.
I start by making a distinction which helps a great deal. It is between fiscal consolidation, which is a policy decision, and austerity, which is an outcome where that fiscal consolidation leads to an increase in aggregate unemployment. If you understand why monetary policy can normally stop fiscal consolidation leading to austerity, but cannot when interest rates are stuck near zero, then you are a long way to understanding why austerity was a mistake. Fiscal consolidation in 2010 was around 3 years too early. A section of the paper is devoted to showing that the idea that markets prevented such a delay in consolidation is a complete myth. ...
None of this theory is at all new: hence the allusion to Keynes in the title. That makes the question of why policy makers made the mistake all the more pertinent. One set of arguments point to an unfortunate conjunction of events: austerity as an accident if you like. Basically Greece happened at a time when German orthodoxy was dominant. I argue that this explanation cannot play more than a minor role: mainly because it does not explain what happened in the US and UK, but also because it requires us to believe that macroeconomics in Germany is very special and that it had the power to completely dominate policy makers not only in Germany but the rest of the Eurozone.
The set of arguments that I think have more force, and which make up the general theory of the title, reflect political opportunism on the political right which is dominated by a ‘small state’ ideology. It is opportunism because it chose to ignore the (long understood) macroeconomics, and instead appeal to arguments based on equating governments to households, at a time when many households were in the process of reducing debt or saving more. But this explanation raises another question in turn: how was the economics known since Keynes lost to simplistic household analogies. ....
If my analysis is right, it means that we cannot be complacent that when the next liquidity trap recession hits the austerity mistake will not be made again. Indeed it may be even more likely to happen, as austerity has in many cases been successful in reducing the size of the state. My paper does not explore how to avoid future austerity, but it hopefully lays the groundwork for that discussion.

Wednesday, May 04, 2016

Ben Bernanke and Democratic Helicopter Money

Simon Wren-Lewis:

Ben Bernanke and Democratic Helicopter Money: “The fact that no responsible government would ever literally drop money from the sky should not prevent us from exploring the logic of Friedman’s thought experiment, which was designed to show—in admittedly extreme terms—why governments should never have to give in to deflation.”
The quote above is from a post by Ben Bernanke... I put it up front because it expresses a macroeconomic truth that no one should ever forget: persistent recessions and deflation are never inevitable, and always represent the failure of policy makers to do the right thing.
There are many useful points in his post, but I just want to talk about one: Bernanke is in fact not talking about helicopter money in its traditional sense, but what I have called elsewhere ‘democratic helicopter money’.
When most people talk about HM, they imagine some scheme whereby the central bank sends ‘everyone’ a cheque in the post, or transmits some money to each individual some other way. It is what economists would call a reverse lump sum tax, or reverse poll tax: the amount you get is independent of your income. That makes it different from a normal tax cut.
In practice the central bank could only really do this with the cooperation of governments. It would not want to take the decision about what 'everyone' means on its own. (Do we include children or not. How do we find everyone?) But once those details had been sorted out, a system would be in place that the central bank could operate whenever it needed to.
Bernanke suggests an alternative. The central bank sets aside a sum of newly created money, and the fiscal authorities then spend it as they wish. They could decide to use all the money to build bridges or schools rather than give it to individuals. There might be two reasons for doing HM this way. First, for some reason the fiscal authorities are reluctant to spend if they have to fund it by creating more debt, so it may allow them to get around this (normally self-imposed) ‘constraint’. Second, a money financed fiscal expansion could be more expansionary than a bond financed fiscal expansion. Lets leave the second advantage to one side, as the first is sufficient in a world obsessed by government debt.
I have talked about something similar in the past (first here, but later here and here), which I have called democratic helicopter money. This label also seems appropriate for Bernanke’s scheme, because the elected government decides on the form of fiscal expansion. The difference between what I had discussed earlier under this label and Bernanke’s suggestion is that in my scheme the fiscal authorities and the central bank talk to each other before deciding on how much money to create and what it will be spent on (although the initiative always comes from the central bank, and would only happen in a recession where interest rates were at their lower bound). The reason I think talking would be preferable is simply that it helps the central bank decide how much money it needs to create. ...
While democratic HM is not talked about much among economists (Bernanke excepted), I think there are good political economy reasons why it may be the form of HM that is eventually tried. As I have said, conventional HM of the cheque in the post kind almost certainly requires the involvement of government. Once governments realise what is going on, they may naturally think why set up something new when they could decide how the money is spent themselves in a more traditional manner. Democratic HM is essentially a method of doing a money financed fiscal expansion in a world of independent central banks.
Which brings me back to the quote at the head of this post. The straight macroeconomics of most versions of HM is clear: all the discussion is about institutional and distributional details. If it is beyond us to manage to set in place any of them before the next recession that would be a huge indictment of our collective imagination, and is probably a testament to the power of imaginary fears and taboos created in very different circumstances.

Monday, May 02, 2016

Paul Krugman: The Diabetic Economy

"How should we think about these incredibly low interest rates?":

The Diabetic Economy, by Paul Krugman, Commentary, NY Times: Things are terrible here in Portugal, but not quite as terrible as they were a couple of years ago. The same thing can be said about the European economy as a whole. That is, I guess, the good news.

The bad news is that eight years after what was supposed to be a temporary financial crisis, economic weakness just goes on and on... And that’s something that should worry everyone, in Europe and beyond. ...
Look at what financial markets are saying.
When long-term interest rates on safe assets are very low, that’s an indication that investors don’t see a strong recovery on the horizon. Well, German five-year bonds currently yield minus 0.3 percent...
How should we think about these incredibly low interest rates? Recently Narayana Kocherlakota ... offered a brilliant analogy. Responding to critics of easy money who denounce low rates as “artificial” ... he suggested that we compare low interest rates to the insulin injections that diabetics must take.
Such injections aren’t part of a normal lifestyle, and may have bad side effects, but they’re necessary to manage the symptoms of a chronic disease.
In the case of Europe, the chronic disease is persistent weakness in spending... The insulin of cheap money helps fight that weakness, even if it doesn’t provide a cure. ...
The thing is, it’s not hard to see what Europe should be doing to help cure its chronic disease. The case for more public spending, especially in Germany — but also in France, which is in much better fiscal shape than its own leaders seem to realize — is overwhelming. ...
But doing the right thing seems to be politically out of the question. Far from showing any willingness to change course, German politicians are sniping constantly at the central bank, the only major European institution that seems to have a clue...
Put it this way: Visiting Europe can make an American feel good about his own country.
Yes, one of our two major parties is poised to nominate a dangerous blowhard for president — but ... the odds are that he won’t actually end up in the White House.
Meanwhile, the overall economic and political situation in America gives ample grounds for hope, which is in very short supply over here.
I’d love to see Europe emerge from its funk. The world needs more vibrant democracies! But at the moment it’s hard to see any positive signs.

Saturday, April 30, 2016

When Europe Stumbled

Paul Krugman:

When Europe Stumbled: Doing some homework on the European economy...

... What was happening in 2011-2012? Europe was doing a lot of austerity. But so, actually, was the U.S., between the expiration of stimulus and cutbacks at the state and local level. The big difference was monetary: the ECB’s utterly wrong-headed interest rate hikes in 2011, and its refusal to do its job as lender of last resort as the debt crisis turned into a liquidity panic, even as the Fed was pursuing aggressive easing.
Policy improved after that... But I think you can make the case that the policy errors of 2011-2012 rocked the euro economy back on its heels...
Oh, and America might have turned European too if the Bernanke-bashers of the right had gotten what they wanted.

Wednesday, April 27, 2016

The World Needs More U.S. Government Debt

Narayana Kocherlakota:

The World Needs More U.S. Government Debt: ...The federal government is causing great harm by failing to issue enough debt. ...
To some, the idea that the U.S. government isn't issuing enough debt may seem counterintuitive -- after all, federal debt outstanding has more than doubled over the past 10 years. But scarcity is not about supply alone. In the wake of the financial crisis, households and businesses are demanding more safe assets to protect themselves against sudden downturns. Similarly, regulators are requiring banks to hold more safe assets. Market prices tell us that the government needs to produce more safety in order to meet this increased demand.
The scarcity of safety creates hardships... Retirees can’t get adequate returns on their nest eggs. Banks can't earn enough on safe, long-term investments to cover the costs of attracting deposits (interest rates on which can’t fall much below zero). ...
The inadequate provision of safe assets also has profound implications for financial stability. Without enough Treasury bonds to go around, investors “reach for yield” by buying apparently safe securities from the private sector (remember all those triple-A-rated subprime-mortgage investments of the 2000s?). If such behavior becomes widespread, it can create systemic risks that tip the financial system into crisis. ...
No private entity would behave like this. Imagine a corporation with such a safe cash flow and such low borrowing costs. It would issue debt to fund expansions or payouts to its shareholders.
Analogously, the U.S. government should issue more debt, using the proceeds to invest in infrastructure, cut taxes or both. Instead, political forces have imposed artificial constraints on debt -- constraints that punish savers, choke off economic growth and could sow the seeds of the next financial crisis.

Tuesday, April 26, 2016

On Multipliers

Chris Dillow:

On multipliers: Richard Murphy writes:

[The government and OBR] believe that austerity generates growth and so cuts the deficit. The trouble for them is that all the evidence shows that the opposite is true: cuts shrink national income and government spending increases it.

This has attracted cheap abuse from some... Such abuse is wrong, and misses the point. It’s wrong, because - in the context he is writing about – Richard is right to claim that fiscal multipliers are big. There’s widespread agreement (pdf) that multipliers are bigger in recessions (pdf) than in normal times. For example, Lawrence Christiano, Martin Eichenbaum, and Sergio Rebelo say (pdf):

The government-spending multiplier can be much larger than one when the zero lower bound on the nominal interest rate binds.

The fact that Osborne’s austerity has failed to cut the deficit as much as expected is wholly consistent with this. Bigger multipliers than Osborne assumed meant that austerity depressed output by more than he expected thus making it harder to reduce borrowing.

In this sense, Richard’s critics are plain wrong. However, multipliers aren’t always big. They vary. ... One important factor here is the monetary offset. ... If inflation is around its target, the Bank of England would respond to fiscal expansion by raising rates, resulting in a lower multiplier. This might or might not be a good thing – the appropriate fiscal-monetary policy mix is a legitimate matter of debate – but it would mean that the fiscal multiplier might be disappointingly small. ...

In this sense, advocates of a fiscal expansion after 2020 might be making the same error as advocates of expansionary fiscal contraction in 2010 – they are wrongly assuming that the same fiscal multiplier applies at all times. It doesn’t.

I’m making two points here, one about economics and one about politics. ...

The political point is that Labour supporters should not rely upon a big multiplier as a case for fiscal expansion. And not need they do so. Lots of leftist policies ... can be designed without reliance upon fragile claims about the macroeconomy.

[Note: link fixed.]

Friday, April 15, 2016

We Are so S---ed. Econ 1-Level Edition

Brad DeLong (the simple model he is using is in the original post):

We Are so S---ed. Econ 1-Level Edition: ...And as I am going to tell [my undegraduates] next Monday, real GDP Y will be equal to potential output Y* whenever "the" interest rate r is equal to the Wicksellian neutral rate r*...

If interest rates are low and inflation is not rising it is not because monetary policy is too easy, but because r* is low--and r* can be low because:

  • consumers are terrified (co low)
  • investors' animal spirits are depressed (Io low)
  • foreigners' demand for our exports inadequate (NX low)
  • or fiscal policy too contractionary (G low)

for the economy's productive potential Y*.

The central bank's task in the long run is to try to do what it can to stabilize psychology and so reduce fluctuations in r*. ...

One way of looking at it is that two things went wrong in 2008-9:

  • Asset prices collapsed.
  • And so spending collapsed and unemployment rose.

The collapse in asset prices impoverished the plutocracy. The collapse in spending and the rise in unemployment impoverished the working class. Central banks responded by reducing interest rates. That restored asset prices, so making the plutocracy whole. But while that helped, that did not do enough to restore the working class.

Then the plutocracy had a complaint: although their asset values and their wealth had been restored, the return on their assets and so their incomes had not been. And so they called for austerity: cut government spending so that governments can then cut our taxes and so restore our incomes as well as our wealth.

But, of course, cutting government spending further impoverished the working class, and put still more downward pressure on the Wicksellian neutral interest rate r* consistent with full employment and potential output.

And here we sit.

Thursday, March 17, 2016

'House Republicans Cling to False Promise of Austerity in their Budget Resolution'

The EPI's Hunter Blair:

House Republicans cling to false promise of austerity in their budget resolution: This week, the House Budget Committee reported out, on a party-line vote, their fiscal year 2017 budget resolution. Infighting between House Republicans, centered on the idea that proposed spending cuts should be even more drastic, suggests that this year’s budget resolution is unlikely to pass. However, with all the media attention focused on the House Republican’s inability to come to an agreement, we shouldn’t lose sight of just how austere their budget resolution already is, and how much damage the cuts it calls for would do to the economy over both the short and long run.
For example, the cuts over the first two years would impose a significantly larger fiscal drag on economic recovery than previous Republican budgets. ...
GOP House budget resolutions for the past several years have been obsessed with eliminating the budget deficit by the end of the ten year budget window. This was already a quixotic and damaging goal, and it has become even more so thanks to changes in the CBO’s baseline. And while deficits are created from revenue minus spending, congressional Republicans’ outright refusal to raise any taxes means that spending cuts—and thereby low- and middle- income people—must bear the entire brunt of the budget resolution’s burden. They bear this burden to the tune of $6.5 trillion in spending cuts to vital programs over ten years—programs that overwhelmingly serve those most in need. The cuts would take away affordable health insurance coverage from the millions that have gained it under the Affordable Care Act and then further erode the safety net with cuts to Medicaid, unemployment benefits, and nutrition assistance. Besides making the economic lives of vulnerable populations harder, focusing cuts on this group imposes a large fiscal drag, since these are households that tend to spend (not save) additional dollars of resources back into the economy. ...
In years beyond 2017, the fiscal drag would remain considerable (and would likely damage growth and job creation), but we’re unable to forecast these impacts precisely because the Fed may have regained some scope to (at least partially) offset fiscal cuts in later years. Looking forward, while it is hard to precisely quantify by how much, the deeper budget cuts throughout the ten year window in the House GOP budget resolution would almost surely further hinder and delay a full economic recovery, especially in the near-term.1 ...
1.The cuts in fiscal 2017 of the House GOP budget resolution total $186 billion. We assume a very conservative multiplier of 1.25—Medicaid and SNAP have very high multipliers (between 1.5-2 or even higher), so 1.25 strikes us as quite conservative. This 1.25 multiplier implies that the House budget cuts will place a 1.2 percent drag on a GDP growth in the next year. This loss in GDP means, all else equal, that job-growth in the next year will be 1.4 million less. Putting that in context, job-growth in 2015 was 2.7 million, so the pace of job-growth would be cut by more than half in the coming year. We should note that we are quite confident about this impact for 2017, given that there is little scope or obvious appetite for monetary policymakers to provide enough stimulus with their policy tools to offset this fiscal drag. Cuts totaling $321 billion in fiscal 2018 will also likely drag significantly on growth, but uncertainty about other economic influences on recovery (particularly the response of the Federal Reserve) makes calculating exactly how much hard to quantify.

Wednesday, March 16, 2016

Balanced Budget Amendment 'Very Unsound Policy'

I hope you already know this, but just in case:

Balanced Budget Amendment “Very Unsound Policy,” Leading Economists Warn: A balanced budget amendment to the Constitution would be “very unsound policy” that would adversely affect the economy, a group of leading economists including four Nobel laureates explain in a letter today to President Obama and Congress, which the Economic Policy Institute and the Center on Budget and Policy Priorities spearheaded.  Several constitutional amendments requiring a balanced budget have been introduced in Congress, and the Senate Judiciary Committee is holding a hearing today on the issue.

“A balanced budget amendment would mandate perverse actions in the face of recessions,” the letter notes:

In economic downturns, tax revenues fall and some outlays, such as unemployment benefits, rise.  These built-in stabilizers increase the deficit but limit declines in after-tax income and purchasing power.  To keep the budget balanced every year would aggravate recessions.

A balanced budget amendment also would prevent federal borrowing to finance infrastructure, education, research and development, environmental protection, and other vital investments.  Adding arbitrary caps on federal spending — which some balanced budget proposals include — would make the amendment even more problematic, the letter says.

The signatories include Nobel laureates Peter Diamond, Eric Maskin, Christopher Sims, and Robert Solow...

Thursday, March 10, 2016

'China’s Trilemma—and a Possible Solution'

Just say no to monetary policy:

China’s trilemma—and a possible solution, by Ben Bernanke, Brookings Institution: China’s central banker, Zhou Xiaochuan of the People’s Bank of China (PBOC), and other top Chinese officials recently launched a communications offensive to persuade markets and foreign policymakers that no significant devaluation of the Chinese currency is planned.[1] Is the no-devaluation strategy a good one for China? If it is, what does China need to do to make its exchange-rate commitments credible? ...
China faces the classic policy trilemma of international economics, that a country cannot simultaneously have more than two of the following three: (1) a fixed exchange rate; (2) independent monetary policy; and (3) free international capital flows. Accordingly, China’s ability to manage its exchange rate may depend, among other factors, on its willingness and ability to adjust on other policy margins.

...[discussion of the costs and benefits of various options] ...
So what to do? An alternative worth exploring is targeted fiscal policy, by which I mean government spending and tax measures aimed specifically at aiding the transition in China’s growth model. (Spending on traditional infrastructure like roads and bridges is not what I have in mind; in the Chinese context, that’s part of the old growth model.) For example, as China observers have noted, the lack of a strong social safety net—the fact that Chinese citizens are mostly on their own when it comes to covering costs of health care, education, and retirement—is an important motivation for China’s extraordinarily high household saving rate. Fiscal policies aimed at increasing income security, such as strengthening the pension system, would help to promote consumer confidence and consumer spending. Likewise, tax cuts or credits could be used to enhance households’ disposable income, and government-financed training and relocation programs could help workers transition from slowing to expanding sectors. Whether subsidies to services industries are appropriate would need to be studied; but certainly, unwinding existing subsidies to heavy industry and state-owned enterprises, together with efforts to promote entrepreneurship and a more-level playing field, would be constructive.
There are recent indications China might be moving this direction. ...
Targeted fiscal action has a lot to recommend it, given China’s trilemma. Unlike monetary easing, which works by lowering domestic interest rates, fiscal policy can support aggregate demand and near-term growth without creating an incentive for capital to flow out of the country. At the same time, killing two birds with one stone, a targeted fiscal approach would also serve the goals of reform and rebalancing the economy in the longer term. Thus, in this way China could effectively pursue both its short-term and longer-term objectives without placing downward pressure on the currency and without new restrictions on capital flows. It’s an approach that China should consider.

Tuesday, March 08, 2016

The 'Strong Case' Against Central Bank Independence Critically Examined

Simon Wren-Lewis has a follow-up to his recent post on central bank independence:

The 'strong case' critically examined: Perhaps it was too unconventional setting out an argument (against independent central banks, ICBs) that I did not agree with, even though I made it abundantly clear that was what I was doing. It was too much for one blogger, who reacted by deciding that I did agree with the argument, and sent a series of tweets that are best forgotten. But my reason for doing it was also clear enough from the final paragraph. The problem it addresses is real enough, and the problem appears to be linked to the creation of ICBs.

The deficit obsession that governments have shown since 2010 has helped produce a recovery that has been far too slow, even in the US. It would be nice if we could treat that obsession as some kind of aberration, never to be repeated, but unfortunately that looks way too optimistic. The Zero Lower Bound (ZLB) raises an acute problem for what I call the consensus assignment (leaving macroeconomic stabilisation to an independent, inflation targeting central bank), but add in austerity and you get major macroeconomic costs. ICBs appear to rule out the one policy (money financed fiscal expansion) that could combat both the ZLB and deficit obsession. I wanted to put that point as strongly as I could. Miles Kimball does something similar here, although without the fiscal policy perspective ...

Skipping ahead (and omitting quite a bit of the argument):

... The basic flaw with my strong argument against ICBs is that the ultimate problem (in terms of not ending recessions quickly) lies with governments. There would be no problem if governments could only wait until the recession was over (and interest rates were safely above the ZLB) before tackling their deficit, but the recession was not over in 2010. Given this failure by governments, it seems odd to then suggest that the solution to this problem is to give governments back some of the power they have lost. Or to put the same point another way, imagine the Republican Congress in charge of US monetary policy.

But if abolishing ICBs is not the answer to the very real problem I set out, does that mean we have to be satisfied with the workarounds? One possibility that a few economists like Miles Kimball have argued for is to effectively abolish paper money as we know it, so central banks can set negative interest rates. Another possibility is that the government (in its saner moments) gives ICBs the power to undertake helicopter money. Both are complete solutions to the ZLB problem rather than workarounds. Both can be accused of endangering the value of money. But note also that both proposals gain strength from the existence of ICBs: governments are highly unlikely to ever have the courage to set negative rates, and ICBs stop the flight times of helicopters being linked to elections.       
These are big (important and complex) issues. There should be no taboos that mean certain issues cannot be raised in polite company. I still think blog posts are the best medium we have to discuss these issues, hopefully free from distractions like partisan politics.

Wednesday, March 02, 2016

'Four Common-Sense Ideas for Economic Growth'

Larry Summers:

Four common-sense ideas for economic growth: Let me begin with two facts that I think should be cause for concern. First, since the summer of 2009, the US economy has grown at about 2 percent. Two percent isn't a very good growth rate. Second, the 10-year interest rate at the end of trading today ... was just a bit below 1.8 percent. ...
What’s the way to think about these two facts together? I believe that we are dealing with a situation that goes beyond the usual cyclical issues associated with recession—and for many years the policy debate has been confounded by that. The Fed has been substantially too optimistic in its one-year-ahead forecast every year for the last six, and its forecasts are pretty close to the consensus forecasts. The prevailing expectation in markets has always been that significant tightening will take place in nine months. That’s been true for the last six years. It has not happened yet.
If you accept all of this, what should be done? I would suggest four things at a minimum. First, there is an overwhelming case in the United States for expanded public infrastructure investment. ... It’s hard to imagine a better time for expanded infrastructure investment, yet the rate of infrastructure investment is lower now than it’s been anytime since 1947. ...
Second, we should increase support for private investment in infrastructure. ...
Third, we should grow our effective labor force. ...
Fourth, our financial system requires continuing attention. ...
I would say to you that whatever you care about, if all you care about is that we’ve got an excessive federal debt, the most important determinant of the debt-to-GDP ratio in 2030 is how rapidly the economy grows between now and then. If what you care about is American national security, the most important determinant of how much we are respected and how much influence we have in the world is how well our economy performs. If what you care about is inequality and poverty, the most important determinant of the employment prospects of the poor is how rapidly the economy is growing.
I would suggest to you that there is no more important question for the American prospect than accelerating the rate of economic growth. It seems to me, whether you’re a demand sider or a supply sider, a Democrat or a Republican, there’s a great deal of common sense that should lead you to support increased economic growth.

[There is quite a bit of discussion of each point in the full post.]

Friday, February 12, 2016

Paul Krugman: On Economic Stupidity

Going "off the deep end on macroeconomic policy":

On Economic Stupidity, by Paul Krugman, Commentary, NY Times: ... If you’ve been following the financial news, you know that there’s a lot of market turmoil out there. It’s nothing like 2008, at least so far, but it’s worrisome. ... So how well do we think the various presidential wannabes would deal with those challenges?
Well, on the Republican side, the answer is basically, God help us. ... Leading the charge of the utterly crazy is ... Donald Trump, who ... asserted that Janet Yellen ... hadn’t raised rates “because Obama told her not to.” ... Yet ... Mr. Trump’s position isn’t that far from the Republican mainstream. After all, Paul Ryan ... not only berated Ben Bernanke ... for policies that allegedly risked inflation (which never materialized), but he also dabbled in conspiracy theorizing, accusing Mr. Bernanke of acting to “bail out fiscal policy.”
And even superficially sensible-sounding Republicans go off the deep end on macroeconomic policy. John Kasich’s signature initiative is a balanced-budget amendment that would cripple the economy in a recession, but he’s also a monetary hawk, arguing, bizarrely, that the Fed’s low-interest-rate policy is responsible for wage stagnation.
On the Democratic side, both contenders talk sensibly about macroeconomic policy... But Mr. Sanders has also attacked the Federal Reserve in a way Mrs. Clinton has not — and that difference illustrates in miniature both the reasons for his appeal and the reasons to be very worried about his approach.
You see, Mr. Sanders argues that the financial industry has too much influence on the Fed, which is surely true. But his solution is more congressional oversight — and he was one of the few non-Republican senators to vote for a bill, sponsored by Rand Paul, that called for “audits” of Fed monetary policy decisions. ...
Now, the idea of making the Fed accountable sounds good. But ... such a bill would essentially empower the cranks — the gold-standard-loving, hyperinflation-is-coming types who dominate the modern G.O.P., and have spent the past five or six years trying to bully monetary policy makers into ceasing and desisting from their efforts to prevent economic disaster. Given the economic risks we face, it’s a very good thing that Mr. Sanders’s support wasn’t enough to push the bill over the top.
But even without Mr. Paul’s bill, one shudders to think about how U.S. policy would respond to another downturn if any of the surviving Republican candidates make it to the Oval Office.

Tuesday, February 09, 2016

'Negative Rates: A Gigantic Fiscal Policy Failure'

Narayana Kocherlakota:

Negative Rates: A Gigantic Fiscal Policy Failure: Since October 2015, I’ve argued that the Federal Open Market Committee (FOMC) should reduce the target range for the fed funds rate below zero. Such a move would be appropriate for three reasons:

  • It would facilitate a more rapid return of inflation to target.
  • It would help reduce labor market slack more rapidly.
  • It would slow and hopefully reverse the ongoing and dangerous slide in inflation expectations.

So, going negative is daring but appropriate monetary policy. But it is a sign of a terrible policy failure by fiscal policymakers.

The reason that the FOMC has to go negative is because the natural real rate of interest r* (defined to be the real interest rate consistent with the FOMC’s mandated inflation and employment goals) is so low. The low natural real interest rate is a signal that households and businesses around the world desperately want to buy and hold debt issued by the US government. (Yes, there is already a lot of that debt out there - but its high price is a clear signal that still more should be issued.) The US government should be issuing that debt that the public wants so desperately and using the proceeds to undertake investments of social value.

But maybe there are no such investments? That’s a tough argument to sustain... With a 30-year r* below 1%, our government can afford to make progress on a myriad of social problems. It is choosing not to.

If the government issued more debt and undertook these opportunities, it would push up r*. That would make life easier for monetary policymakers, because they could achieve their mandated objectives with higher nominal interest rates. But, more importantly, the change in fiscal policy would make life a lot better for all of us.

I don't think that Chair Yellen will say the above in her Humphrey-Hawkins testimony tomorrow - but I also think that it would be great if she did.

Monday, February 08, 2016

'Wealthy ‘Hand-to-Mouth’ Households: Key to Understanding the Impacts of Fiscal Stimulus'

 

Greg Kaplan and Giovanni Violante at Microeconomic Insights:

Wealthy ‘hand-to-mouth’ households: key to understanding the impacts of fiscal stimulus: Many families in Europe and North America have substantial assets in the form of housing and retirement accounts but little in the way of liquid wealth or credit facilities to offset short-term income falls. This research shows that these wealthy ‘hand-to-mouth’ households respond strongly to receiving temporary government transfers such as tax rebates, boosting the economy through their increased consumption. ...
Our research also draws attention to the fact that the aggregate macroeconomic conditions surrounding policy interventions will affect the fraction of the transfer consumed by households in non-trivial ways.
In a mild recession, where earnings drops are small and short-lived, it is not worthwhile for the wealthy hand-to-mouth households to pay the transaction costs of accessing some of their illiquid assets (or to use expensive credit) to smooth their consumption. As a result, liquidity constraints get amplified and their consumption response to the receipt of a fiscal stimulus payment is strong.
Counter-intuitively, the same stimulus policy may have stronger effects in a mild downturn than in a severe recession
Conversely, at the outset of a severe recession that induces a large and long-lasting fall in income, many wealthy hand-to-mouth households will choose to borrow or tap into their illiquid account to create a buffer of liquid assets that can be used to counteract the income loss. Consequently, fewer households are hand-to-mouth when they receive a government windfall. Thus, somewhat counter-intuitively, the effect of the stimulus on consumption can be lower than when the same policy is implemented in a mild downturn.
Acknowledging the existence of wealthy hand-to-mouth households also has implications for economic policy beyond fiscal stimulus. In further work (Kaplan et al, 2015), we show the importance of these households for the efficacy of both conventional monetary policy (changes in nominal interest rates) and unconventional monetary policy (forward guidance about future changes in nominal interest rates).

Wednesday, February 03, 2016

'How Successful Was the New Deal?'

From the NBER:

How Successful Was the New Deal? The Microeconomic Impact of New Deal Spending and Lending Policies in the 1930s, by Price V. Fishback, NBER Working Paper No. 21925 Issued in January 2016: Abstract The New Deal during the 1930s was arguably the largest peace-time expansion in federal government activity in American history. Until recently there had been very little quantitative testing of the microeconomic impact of the wide variety of New Deal programs. Over the past decade scholars have developed new panel databases for counties, cities, and states and then used panel data methods on them to examine the examine the impact of New Deal spending and lending policies for the major New Deal programs. In most cases the identification of the effect comes from changes across time within the same geographic location after controlling for national shocks to the economy. Many of the studies also use instrumental variable methods to control for endogeneity. The studies find that public works and relief spending had state income multipliers of around one, increased consumption activity, attracted internal migration, reduced crime rates, and lowered several types of mortality. The farm programs typically aided large farm owners but eliminated opportunities for share croppers, tenants, and farm workers. The Home Owners’ Loan Corporation’s purchases and refinancing of troubled mortgages staved off drops in housing prices and home ownership rates at relatively low ex post cost to taxpayers. The Reconstruction Finance Corporation’s loans to banks and railroads appear to have had little positive impact, although the banks were aided when the RFC took ownership stakes.

(I couldn't find an open link.)

Monday, January 11, 2016

'Overly Tight Macroeconomic Policy'

I missed this from Narayana Kocherlakota a little over a week ago:

Overly Tight Macroeconomic Policy: The level of public debt is high by historical standards in many countries.  Central banks have set their nominal interest rate targets to extraordinarily low - sometimes negative - levels.  Despite these historical comparisons, though, macroeconomic outcomes tell a clear story: Macroeconomic policy remains much too tight in the US and around the world.  
In terms of monetary policy, inflation remains low, and is expected to remain low for years.  Indeed, financial market participants are betting that most major central banks will fall short of their inflation targets over the next decade or two.  Nonetheless, those same central banks (including the Federal Reserve) continue to communicate a strong desire to "normalize" - that is, tighten - monetary policy over the medium term.   
In terms of fiscal policy, many governments are able to borrow long-term at unusually low real interest rates.  They could invest those funds in needed physical and human infrastructure. Or they could return the funds to their citizens through tax cuts - tax cuts that could be tailored to incentivize physical investment or R&D.   But the relevant governments instead continue to emphasize the need to further restrict the level of public debt.  
Economic policymakers can do better.   The key is to focus a lot more on the question of how to use available policy tools to achieve desirable macroeconomic outcomes, and a lot less on historical empirical regularities.   Just because debt is high by historical standards doesn't mean that governments cannot make their citizens better off by issuing more debt   Just because nominal interest rates are low by historical standards doesn't mean that central banks can't achieve their objectives more rapidly by lowering them still further.  
We are only beginning to see the impact of tight policy choices on our economies.  We all know what has been happening in Spanish and Greek labor markets.  But even in the US - which supposedly has a near-normal labor market - the fraction of men aged 25-34 who do not have a job is over 50%(!) higher than it was in 2007.   Given these kinds of macroeconomic outcomes, it should not be surprising that we see increasing signs of social fracturing and disengagement in many developed countries.
I've said that economic policymakers can do better.  Indeed, I increasingly believe that they must do better. 

See here for more of his thoughts on macroeconomic policy.

Monday, January 04, 2016

'Falling Interest Rates and Government Investment'

I guess we have to keep making this point, hoping against hope that Congress will hear it. This is from Cecchetti & Schoenholtz:

Falling Interest Rates and Government Investment: Switzerland is an amazing place, not least the skiing, the chocolate, and the punctual trains. The latter is part of the country’s exquisitely maintained infrastructure: there are no potholes, and no deferred maintenance of train tracks, tunnels, airports, or public buildings. Few countries go so far, but many can take a lesson: it pays to maintain infrastructure at least so that it doesn’t fail.
We bring this up now because financial markets are telling us that it’s a very good time to build and repair infrastructure: real (inflation-adjusted) interest rates have fallen so low that it has become exceptionally cheap to finance the improvement and repair of neglected roads, bridges, transport hubs, and public utilities. Yet, in the United States, we are doing less public investment than ever: net government investment has fallen to what is probably a record low. ...

Net Government Investment as a percentage of Net Domestic Product (annual data), 1959-2014

Static1.squarespace.com

Fixing the problem would be straightforward, and cheap in terms of finance. ...

To be clear, this argument need not be seen as one for a larger government, but for an efficient one that provides the public goods necessary for sustained economic growth at the lowest cost. For a country to remain prosperous, it needs an infrastructure that is constantly being renewed and improved. The alternative of postponing maintenance probably leads to higher costs—both from the direct impact on the economy from the deterioration of physical capital and from the need to finance future (larger) repair projects at potentially higher interest rates. Put differently, when fiscal policymakers choose to tighten the nation’s belt, they should not do so at the expense of future national income. ...

There is no need to be as obsessive as the Swiss; their outlays for public goods are surely greater than most Americans would wish to pay. But given today’s low hurdle rate of return, it is difficult to see how spending an extra 1% of NDP each year now to maintain and improve roads, bridges, airports, and buildings would be economically unsound. Even if the additional outlays are not self-financing, the social return is likely to be far greater than the cost. As monetary economists, we include as a valuable social benefit the reduced probability of hitting the zero lower bound in a world with a 2% inflation target.

Tuesday, December 22, 2015

Summers: My Views and the Fed’s Views on Secular Stagnation

Larry Summers:

My views and the Fed’s views on secular stagnation: It has been two years since I resurrected Alvin Hansen’s secular stagnation idea and suggested its relevance to current conditions in the industrial world. Unfortunately experience since that time has tended to confirm the secular stagnation hypothesis. Secular stagnation is a possibility. It is not an inevitability and it can be avoided with strong policy. Unfortunately, the Fed and other policy setters remain committed to traditional paradigms and so are acting in ways that make secular stagnation more likely. ... Indeed I would judge that there is at least a two-thirds chance that we will experience zero or negative rates again in the next five years. ...

I believe its decision to raise rates last week reflected four consequential misjudgments.
First, the Fed assigns a much greater chance that we will reach 2 percent core inflation than is suggested by most available data. ...
Second, the Fed seems to mistakenly regard 2 percent inflation as a ceiling not a target. ...
Third... It is suggested that by raising rates the Fed gives itself room to lower them. ... I would say the argument that the Fed should raise rates so as to have room to lower them is in the category with the argument that I should starve myself in order to have the pleasure of relieving my hunger pangs.
Fourth, the Fed is likely underestimating secular stagnation. It is ... overestimating the neutral rate. ...
Why is the Fed making these mistakes if indeed they are mistakes? It is not because its leaders are not thoughtful or open minded or concerned with growth and employment. Rather I suspect it is because of an excessive commitment to existing models and modes of thought. Usually it takes disaster to shatter orthodoxy. We can all hope that either my worries prove misplaced or the Fed shows itself to be less in the thrall of orthodoxy than it has been of late.

The Fed's job would have been, and will be a lot easier if fiscal policy makers would help. I disagree with Charles Plosser's view on monetary policy, but I have some sympathy for the view that many people have come to expect too much from monetary policy:

... On the monetary policy side central banks have clearly pushed the envelope in an effort to stabilize and then promote real economic growth.  The pressure to do so has come from inside and outside the central banks.  These actions have raised expectations of what the central bank can do.  For the last three or four decades, it has been widely accepted among academics and central bankers that monetary policy is primarily responsible for anchoring inflation and inflation expectations at some low level.  In the United States, where the Fed operates under the so-called dual mandate to promote both price stability and maximum employment, monetary policy has also attempted to stabilize economic growth and employment.  Yet it has also been widely accepted that monetary policy’s impact on real variables was limited and temporary, thus in the long-run changes in money were neutral for real variables.

The behavior of central banks during the crisis and subsequent recession has turned much of this conventional wisdom on its head.  It is not clear that this is wise or prudent.  Many have come to fear that without substantial support from monetary policy our economies will slump into stagnation. This would seem to fly in the face of nearly two centuries of economic thinking. ...

If secular stagnation is real, the Fed cannot overcome it by itself. Fiscal policy will have to be part of the solution. (I do think one statement above is wrong, and it gets at the heart of Summer's recent work reviving hysteresis and his statement above about commitment to orthodoxy. When Plosser says "monetary policy’s impact on real variables was limited and temporary, thus in the long-run changes in money were neutral for real variables," he is ignoring recent work by Summers, Blanchard, and Fatas showing that recessions can permanently  lower our productive capacity, and it is worse when the recession lasts longer. This means that monetary policy -- and fiscal policy too -- can have a permanent impact on the natural rate of output by helping the economy to recover faster. The faster the recovery, the less the natural rate is lowered. So I agree with Summers that monetary policy needs to take the possibility of secular stagnation into account, I just wish he'd put more emphasis on the essential role of fiscal policy -- something he has certainly done in the past, e.g., "I believe that it is appropriate that we go back to an earlier tradition that has largely passed out of macroeconomics of thinking about fiscal policy as having a major role in economic stabilization.")

Sunday, December 20, 2015

'The FTPL Version of the Neo-Fisherian Proposition'

I've never paid much attention to the fiscal theory of the price level:

The FTPL version of the Neo-Fisherian proposition: The Neo-Fisherian doctrine is the idea that a permanent increase in a flat nominal interest rate path will (eventually) raise the inflation rate. It is then suggested that current below target inflation is a consequence of fixing rates at their lower bound, and rates should be raised to increase inflation. David Andolfatto says there are two versions of this doctrine. The first he associates with the work of Stephanie Schmitt-Grohe and Martin Uribe, which I discussed here. He like me is not sold on this interpretation, for I think much the same reason. ... But he favours a different interpretation, based on the Fiscal Theory of the Price Level (FTPL).

Let me first briefly outline my own interpretation of the FTPL. This looks at the possibility of a fiscal regime where there is no attempt to stabilize debt. Government spending and taxes are set independently of the level or sustainability of government debt. The conventional and quite natural response to the possibility of that regime is to say it is unstable. But there is another possibility, which is that monetary policy stabilizes debt. Again a natural response would be to say that such a monetary policy regime is bound to be inconsistent with hitting an inflation target in the long run, but that is incorrect. ...

A constant nominal interest rate policy is normally thought to be indeterminate because the price level is not pinned down, even though the expected level of inflation is. In the FTPL, the price level is pinned down by the need for the government budget to balance at arbitrary and constant levels for taxes and spending. ...

I have a ... serious problem with this FTPL interpretation in the current environment. The belief that people would need to have for the FTPL to be relevant - that the government would not react to higher deficits by reducing government spending or raising taxes - does not seem to be credible, given that austerity is all about them doing exactly this despite being in a recession. As a result, I still find the Neo-Fisherian proposition, with either interpretation, somewhat unrealistic.

Sunday, December 06, 2015

'Central Bankers Do Not Have as Many Tools as They Think'

Larry Summers:

Central bankers do not have as many tools as they think: ... While recession risks may seem remote.., no postwar recession has been predicted a year ahead... History suggests that when recession comes it is necessary to cut rates more than 300 basis points..., the chances are very high that recession will come before there is room to cut rates enough to offset it. ...
Central bankers bravely assert that they can always use unconventional tools. But there may be less in the cupboard than they suppose. The efficacy of further quantitative easing ... is highly questionable. There are severe limits on how negative rates can become. A central bank forced back to the zero lower bound is not likely to have great credibility if it engages in forward guidance.
The Fed will in all likelihood raise rates this month. ... But the unresolved question that will hang over the economy is how policy can delay and ultimately contain the next recession. It demands urgent attention from fiscal as well as monetary policymakers.

Tuesday, December 01, 2015

The New Supply-Side Economics

New column:

The New Supply-Side Economics: Traditionally, macroeconomic policy has been divided into two distinct types. The first type, stabilization policy, attempts to keep output and employment as close to their full employment levels as possible. The idea behind these policies is to minimize, or even eliminate, short-term boom-bust cycles around the natural rates of output and employment caused by fluctuations in aggregate demand. 
The second type of policy, growth policy, works on the supply-side and attempts to keep the long-term natural rates of output and employment growing as fast as possible. Thus, if the long-term natural growth rate of output is, say, 2.5 percent, supply-side policy would try to increase this rate, while demand-side stabilization would try to keep us from deviating from it, whatever it might be. 
Importantly, these policies were believed to be independent. Monetary and fiscal policy used to stabilize the economy could change how fast the economy returns to the natural rate after a positive or negative shock, but the policy would have no impact at all on the natural rate itself. 
But what if this is wrong, as data from the Great Recession suggests? What if demand-side policies impact the natural rate after all? What does this mean for monetary and fiscal policy? It turns out to have important implications. ...

Friday, November 27, 2015

'What Is Holding Back the Economy?'

The rise of the crazies is not unrelated:

What Is Holding Back the Economy?: ...for many if not most people, the standard of living that can be achieved by working has been permanently reduced — by long bouts of unemployment and underemployment, by unstable and insecure employment, by long-term stagnation of wages and, perhaps most significantly, by the failure of Congress to use fiscal policy, consistently and aggressively, to counteract the devastation of the recession and its corrosive effects on the economy.
For some people in some places, steady work is simply no longer a way of life, if it ever was. In several states where jobless rates have fallen to pre-recession levels, including Illinois and Ohio, the drop is due mainly to shrinking labor forces, not increases in hiring. When unemployment rates go down because people have despaired of ever finding a job, the economy is not really improving. Rather, it is downshifting to a less prosperous level.
There are two related ways to counter that downshift. One is to make productivity-enhancing investments that create jobs today and lay the foundation for future growth. Such investments would include bolstered spending for education, transportation, environmental protection, basic science and other fields that are the purview of government. The other is to enact policies to ensure that pay and profits from enhanced productivity are broadly shared, rather than concentrated at the top of the income-and-wealth ladder. Such policies would include strict anti-trust enforcement, steeply progressive taxes, a higher minimum wage and support for labor unions. ...
But for now, there is mostly talk..., and much of the talk, especially from Republicans, is about how government should not step up to the nation’s economic challenges. The economy has recovered from the worst and proven resilient, but it is being held back by what government at all levels has failed to do.

Not the first to say this, but the problem is that Republicans have misrepresented the causes of the distress so many households feel, in particular scapegoating those who have it even worse as somehow responsible for their problems (and the decline of America more generally). And then they sell the solutions as benefiting the middle class (trickle down anyone?) when they are really directed at reducing taxes for those at the top, and reducing the government services that people rely upon to survive in this economy to support the tax cuts.

But there is something else I'd like to note. The problem is blamed on government at all levels, and fiscal policy. We hear, when Republicans are named at all, that it is "especially" Republicans as though the balance only tilts in one direction. No, it's not especially Republicans, or even mostly Republicans that are standing in the way of doing more to help those who are struggling to make ends meet. It is Republicans. It's not congressional gridlock based upon reasonable differences over policy that cannot be resolved through compromise, it's an active attempt by one party to block anything the other party tries to do, even if it might help people economically. So long as the political benefits of this behavior -- benefits based upon selling snake oil for the most part -- exceed the economic costs of inaction, Republicans will stand in the way (all the while trying to convince those who are hurt the most by their actions that they will actually be helped). It's time to stop blaming "government" as though that is what is dysfunctional. The dysfunction, as evidenced by the slate of, and preferences over Republican presidential candidates, is in the Republican party. Their actions since the onset of the Great Recession have, in my view, hurt people who should have been helped, slowed the recovery, and diverted our attention from the true problems we face making it impossible to solve them (not that Republicans would have gone along with the solutions anyway). If this election tears Republicans apart and strips them of this ability to stand in the way of helping the working class, a dream I know, I will not be shedding tears. Quite the opposite.

Thursday, November 19, 2015

'The Effects of Stimulus Spending on Surrounding Areas'

This is from the St. Louis Fed's On the Economy blog:

The Effects of Stimulus Spending on Surrounding Areas: Government spending on goods and services from the American Recovery and Reinvestment Act of 2009 (ARRA) reached around $350 billion.1 Some of this spending impacted not just the areas receiving the money, but surrounding areas as well, thanks to commuters. ...
Dupor and McCrory found substantial direct and spillover effects within regions interconnected by commuter flows. As noted in the article, stimulus spending in one county increased employment and wage payments in places two to three counties away, as long as the areas were sufficiently connected, as measured by commuting patterns. They found that:
  • One dollar of ARRA spending in a subregion increased wage payments by $0.64 in that subregion.
  • It increased wage payments in the neighboring subregion by $0.50.
In his article, Dupor wrote: “Thus, combining both the direct and spillover effects, there is a greater than one-for-one increase in the wage bill with respect to an increase in the stimulus spending.”
Dupor and McCrory also examined changes in the employment level to gauge economic activity. They found that, following the first two years after ARRA’s enactment, $1 million of stimulus in one part of a local labor market increased employment by 10.3 persons and increased employment in the rest of the local labor market by 8.5 persons.4
Dupor concluded in his article: “Besides providing evidence in favor of a government spending multiplier, our results should provide caution to other researchers, as well as to policymakers. Failing to take into account positive spillovers could lead policymakers to underestimate the total social benefit of government fiscal intervention.”

Wednesday, November 11, 2015

Trickle Down, Starve the Beast, Supply-Side, and Sound Money Fantasies

From the WSJ editorial page:

...On the other hand, Mr. Cruz’s pitch for “sound money” that helps the middle class stands out in the GOP field and deserves more elaboration. It’s also notable that nearly all of the GOP candidates identify the Federal Reserve’s post-crisis monetary policy as a source of rising inequality that has favored the wealthy. This is a populist note that has the added benefit of being true. ...

Rising inequality for four decades can be blamed on the Fed's response to the financial crisis? Seriously? On taxes:

Then there’s tax policy, in which all of the candidates offered up reform plans that would be an improvement over the status quo.

But it has to be the right kind of tax policy (tax cuts or credits for the wealthy:

Marco Rubio was challenged on his child tax credit, which he would increase to $2,500 from $1,000. ... Mr. Rubio’s diagnosis of the changing economy has particular appeal to anxious voters. It’s too bad his tax credit is such an expensive political pander.

But of course cutting taxes on the wealthy is not an expensive pander, it will generate growth!!! Tax revenue will rise and the deficit will fall!!! The benefits will trickle down to the middle class (unless that evil Fed gets in the way decades later)!!! None of which has actually happened according to the empirical evidence. Republicans seem to have a talent for telling economic stories about how their policies will benefit the middle class all the while disguising the true intent of the legislation. So long as it can be true in theory (the confidence fairy comes to mind), the actual evidence doesn't matter.

James Pethokoukis says it's time to end the supply-side charade:

A last hurrah for Republican tax slashers: The Republican party’s raison d’être is cutting taxes. ... Republicans should pray for a new purpose. Their standing with middle-class voters is little improved from 2012. ... Their “supply-side” orthodoxy would merit much of the blame. Big tax cuts, particularly for the wealthiest, do not work in an age of high inequality and heavy debt. ...
Many of the party’s 2016 candidates seem to disagree that change is needed. ... Almost all have released economic plans built around “pro-growth” tax cuts costing trillions. ... But there are good reasons to view the next election as a last hurrah for Republican-style supply-side policy.
First, voters do not much care about taxes. ... Second, America’s fiscal situation makes deep tax cuts implausible. ... Third, tax cuts look like an answer desperately searching for a problem. Today’s top US marginal tax rate is 39.6 per cent...
There are signs candidates are starting to wriggle out of the supply-side straitjacket. At this week’s Republican presidential debate in Wisconsin, Marco Rubio said a larger tax credit for families was just as important as tax cuts for business. ... While 1980s-style supply-side doctrine still rules the Republican roost, it may not beyond November 2016.

There are also signs that these proposals, while perhaps helping candidates draw votes, have little chance of success in Congress. Republicans may need a new cover story -- a new "economic" argument or the middle class that obscures the true intent of the policy -- but it's not clear there's anything as magical as trickle down, starve the beast, supply-side, sound money fantasies that have served them so well.

Update: From Kevin Drum:

...Well, the Tax Foundation is a right-leaning outfit, so you have to figure they're going to give Republican plans a fair shake. And their distributional analysis of Rubio, Bush, Trump, and Cruz shows that their tax plans are all pretty similar: tiny gains for middle-income workers and huge gains for the top 1 percent. I've used the static analysis, since it's the most tethered to reality, but even if you use the magic dynamic estimates you get roughly the same result: the rich make out a whole lot better than the middle class.
That said, you really have to give Ted Cruz credit. When it comes to giving huge handouts to the rich, he's the true Republican leader.

Blog_gop_tax_plans_middle_class

Friday, November 06, 2015

Paul Krugman: Austerity’s Grim Legacy

Austerity did not lead to prosperity:

Austerity’s Grim Legacy, by Paul Krugman, Commentary, NY Times: When economic crisis struck in 2008, policy makers by and large did the right thing. The Federal Reserve and other central banks realized that supporting the financial system took priority over conventional notions of monetary prudence. The Obama administration and its counterparts realized that in a slumping economy budget deficits were helpful, not harmful. And the money-printing and borrowing worked: A repeat of the Great Depression, which seemed all too possible..., was avoided.
Then it all went wrong. ... In 2010, more or less suddenly, the policy elite on both sides of the Atlantic decided to stop worrying about unemployment and start worrying about budget deficits instead.
This ... was very much at odds with basic economics. Yet ominous talk about the dangers of deficits became something everyone said because everyone else was saying it, and dissenters were no longer considered respectable...
Yet there’s growing evidence that we critics actually underestimated just how destructive the turn to austerity would be. Specifically, it now looks as if austerity policies didn’t just impose short-term losses of jobs and output, but they also crippled long-run growth. ...
What this suggests is that ... austerity had truly catastrophic effects, going far beyond the jobs and income lost in the first few years. In fact, the long-run damage ... is easily big enough to make austerity a self-defeating policy even in purely fiscal terms: Governments that slashed spending ... hurt their economies, and hence their future tax receipts, so much that even their debt will end up higher...
And the bitter irony ... is that this catastrophic policy was undertaken in the name of long-run responsibility, that those who protested ... were dismissed as feckless.
There are a few obvious lessons from this debacle. “All the important people say so” is not, it turns out, a good way to decide on policy... Also, calling for sacrifice (by other people, of course) doesn’t mean you’re tough-minded.
But will these lessons sink in? Past economic troubles, like the stagflation of the 1970s, led to widespread reconsideration of economic orthodoxy. But one striking aspect of the past few years has been how few people are willing to admit having been wrong about anything. It seems all too possible that the Very Serious People who cheered on disastrous policies will learn nothing from the experience. And that is, in its own way, as scary as the economic outlook.

Thursday, November 05, 2015

'Public Investment: has George Started listening to Economists?'

[Running very late today, so three quick posts to get something up besides links -- I probably chose this one because my name was mentioned. See the sidebar for more new links.]

Simon Wren-Lewis:

Public investment: has George started listening to economists?: I have in the past wondered just how large the majority among academic economists would be for additional public investment right now. The economic case for investing when the cost of borrowing is so cheap (particularly when the government can issue 30 year fixed interest debt) is overwhelming. I had guessed the majority would be pretty large just by personal observation. Economists who are not known for their anti-austerity views, like Ken Rogoff, tend to support additional public investment.
Thanks to a piece by Mark Thoma I now have some evidence. His article is actually about ideological bias in economics, and is well worth reading on that account, but it uses results from the ChicagoBooth survey of leading US economists. I have used this survey’s results on the impact of fiscal policy before, but they have asked a similar question about public investment. It is
“Because the US has underspent on new projects, maintenance, or both, the federal government has an opportunity to increase average incomes by spending more on roads, railways, bridges and airports.”
Not one of the nearly 50 economists surveyed disagreed with this statement. What was interesting was that the economists were under no illusions that the political process in the US would be such that some bad projects would be undertaken as a result (see the follow-up question). Despite this, they still thought increasing investment would raise incomes.
The case for additional public investment is as strong in the UK (and Germany) as it is in the US. Yet since 2010 it appeared the government thought otherwise. ...
However since the election George Osborne seems to have had a change of heart. ...

Saturday, October 24, 2015

'Are Canadian Progressives Showing Americans the Way?'

Miles Corak:

Are Canadian progressives showing Americans the way?: Reflecting on the recent outcome of the Canadian election, in which the Liberal Party of Canada cast itself as a progressive left of center party and reversed its fortunes in a major way to win a strong majority government, Larry Summers wrote in the Washington Post that “More infrastructure investment is not just good economics. It is good politics. Let us hope that American presidential candidates get the word!” ...
Paul Krugman echoes the same sentiment in a New York Times column entitled, somewhat inappropriately, “Keynes Comes to Canada.” ...
There is something ... that both countries share, and something they don’t, that sets an important backdrop.
Both countries have a significant need for important public sector investments in physical, and I would also say social, infrastructure. The populace sees this need as much in Canada as in the United States.
In Montreal, concrete slabs have fallen off of expressway overpasses, and killed unfortunate commuters. In Toronto, the gridlock associated with the commute to work is more than just a daily aggravation; it is a significant block to economic growth. In Vancouver, expansions in public transit are in need of significant funding. And the majors and city councils in countless municipalities battle with the need to update sewers and roads.
Both countries have this need, but in the US it is a harder sell. In a poll that I conducted with EKOS and The Pew Charitable Trusts, we found that the most significant difference in values on the two sides of the borders has less to do with philosophical issues associated with how to define a good life, but rather the role of government. Americans are much more likely to see government as hindering rather than helping them to achieve their personal goals.
My own view is that this comes down to a different view on the efficiency of government by a significant fraction of the population in the two countries. Canadians are much more likely to see government as a tool or a means to an end, Americans to see it as too inefficient and incapable of helping them accomplish their goals. A significant fraction of Canadians continue to have—in spite being told otherwise for a decade by their out-going conservative Prime Minister—a certain trust in the capacity for collective action through the public sector. Americans have seen too many failures to feel otherwise.
So in fundamental ways, Canadians may be more receptive to the message that Mr. Summers and Mr. Krugman would like to send Americans. ...

[In the full post, which is much longer, he discusses other important differences as well.]

Friday, October 23, 2015

'A Bridge Too Far?'

Roger Farmer:

A Bridge Too Far?: There is much current angst on the difficult problem of how to escape a liquidity trap. Paul Krugman points out that in Japan, the ratio of debt to GDP is growing, leaving little room for a further tame fiscal expansion. He favors something more aggressive.
Tony Yates argues instead for a helicopter drop. Print money and give it to Japanese citizens. The benefit of that approach is that it does not leave the government with an increase in interest bearing debt. Simon Wren Lewis looks more closely at the technical aspects of this idea.
What are the differences between aggressive fiscal expansion financed by debt creation; and printing money and giving it to citizens? There are two.
First, an aggressive fiscal expansion, as envisaged by Keynesians, would be spent on infrastructure. A money financed transfer would be spent by citizens.
Second, an aggressive fiscal expansion, as envisaged by Keynesians, would be financed by issuing long term bonds. A money financed transfer would be financed by printing money.
While infrastructure expenditure is sorely needed, at least in the U.S., I see no reason to give up on sound cost benefit analysis to decide which projects are worth pursuing and which are not. That’s why I favor giving checks to citizens over building a bridge to nowhere. ...
I prefer private sector investment over government sector investment. But there are also good arguments for more public infrastructure projects. Build a bridge if it is needed; but make sure that it goes somewhere first. More importantly; finance the project by printing money: not by issuing thirty year bonds.

Monday, October 19, 2015

Paul Krugman: Something Not Rotten in Denmark

The important lessons we can learn from Denmark:

Something Not Rotten in Denmark, by Paul Krugman, Commentary, NY Times: No doubt surprising many of the people watching the Democratic presidential debate, Bernie Sanders cited Denmark as a role model for how to help working people. Hillary Clinton demurred slightly, declaring that “we are not Denmark,” but agreed that Denmark is an inspiring example. ... But how great are the Danes, really? ...
Denmark maintains a welfare state ... that is beyond the wildest dreams of American liberals. ... To pay for these programs, Denmark collects a lot of taxes..., almost half of national income, compared with 25 percent in the United States. Describe these policies to any American conservative, and he would predict ruin. Surely those generous benefits must destroy the incentive to work, while those high taxes drive job creators into hiding or exile.
Strange to say, however, Denmark ...is ... a prosperous nation that does quite well on job creation. ... It’s hard to imagine a better refutation of anti-tax, anti-government economic doctrine...
But ... is everything copacetic in Copenhagen? Actually, no..., its ... recovery from the global financial crisis has been slow and incomplete. ...
What explains this poor recent performance? The answer, mainly, is bad monetary and fiscal policy. Denmark hasn’t adopted the euro, but it manages its currency as if it had... And while the country has faced no market pressure to slash spending ... it has adopted fiscal austerity anyway.
The result is a sharp contrast with neighboring Sweden, which doesn’t shadow the euro (although it has made some mistakes on its own), hasn’t done much austerity, and has seen real G.D.P. per capita rise while Denmark’s falls.
But Denmark’s monetary and fiscal errors don’t say anything about the sustainability of a strong welfare state. In fact, people who denounce things like universal health coverage and subsidized child care tend also to be people who demand higher interest rates and spending cuts in a depressed economy. (Remember all the talk about “debasing” the dollar?) That is, U.S. conservatives actually approve of some Danish policies — but only the ones that have proved to be badly misguided.
So yes, we can learn a lot from Denmark, both its successes and its failures. And let me say that it was both a pleasure and a relief to hear people who might become president talk seriously about how we can learn from the experience of other countries, as opposed to just chanting “U.S.A.! U.S.A.! U.S.A.!”

Friday, October 16, 2015

The Financial Crisis: Lessons for the Next One

Alan S. Blinder and Mark Zandi:

The Financial Crisis: Lessons for the Next One: The massive and multifaceted policy responses to the financial crisis and Great Recession -- ranging from traditional fiscal stimulus to tools that policymakers invented on the fly -- dramatically reduced the severity and length of the meltdown that began in 2008; its effects on jobs, unemployment, and budget deficits; and its lasting impact on today's economy.

Without the policy responses of late 2008 and early 2009, we estimate that:

  • The peak-to-trough decline in real gross domestic product (GDP), which was barely over 4%, would have been close to a stunning 14%;
  • The economy would have contracted for more than three years, more than twice as long as it did;
  • More than 17 million jobs would have been lost, about twice the actual number.
  • Unemployment would have peaked at just under 16%, rather than the actual 10%;
  • The budget deficit would have grown to more than 20 percent of GDP, about double its actual peak of 10 percent, topping off at $2.8 trillion in fiscal 2011.
  • Today's economy might be far weaker than it is -- with real GDP in the second quarter of 2015 about $800 billion lower than its actual level, 3.6 million fewer jobs, and unemployment at a still-dizzying 7.6%.

We estimate that, due to the fiscal and financial responses of policymakers (the latter of which includes the Federal Reserve), real GDP was 16.3% higher in 2011 than it would have been. Unemployment was almost seven percentage points lower that year than it would have been, with about 10 million more jobs.

To be sure, while some aspects of the policy responses worked splendidly, others fell far short of hopes. Many policy responses were controversial at the time and remain so in retrospect. Indeed, certain financial responses were deeply unpopular, like the bank bailouts in the Troubled Asset Relief Program (TARP). Nevertheless, these unpopular responses had a larger combined impact on growth and jobs than the fiscal interventions. All told, the policy responses -- the 2009 Recovery Act, financial interventions, Federal Reserve initiatives, auto rescue, and more -- were a resounding success.

Our findings have important implications for how policymakers should respond to the next financial crisis, which will inevitably occur at some point because crises are an inherent part of our financial system. As explained in greater detail in Section 5:

  • It is essential that policymakers employ "macroprudential tools" (oversight of financial markets) before the next financial crisis to avoid or minimize asset bubbles and the increased leverage that are the fodder of financial catastrophes.
  • When financial panics do come, regulators should be as consistent as possible in their responses to troubled financial institutions, ensuring that creditors know where their investments stand and thus don't run to dump them when good times give way to bad.
  • Policymakers should not respond to every financial event, but they should respond aggressively to potential crises -- and the greater the uncertainty, the more policymakers should err on the side of a bigger response.
  • Policymakers should recognize that the first step in fighting a crisis is to stabilize the financial system because without credit, the real economy will suffocate regardless of almost any other policy response.
  • To minimize moral hazard, bailouts of companies should be avoided. If they are unavoidable, shareholders should take whatever losses the market doles out and creditors should be heavily penalized. Furthermore, taxpayers should ultimately be made financially whole and better communication with the public should be considered an integral part of any bailout operation.
  • Because fiscal and monetary policy interactions are large, policymakers should use a "two-handed" approach (monetary and fiscal) to fight recessions -- and, if possible, they should select specific monetary and fiscal tools that reinforce each other.
  • Because conventional monetary policy -- e.g., lowering the overnight interest rate -- may be insufficient to forestall or cure a severe recession, policymakers should be open to supplementing conventional monetary policy with unconventional monetary policies, such as the Federal Reserve's quantitative easing (QE) program of large-scale financial asset purchases, especially once short-term nominal interest rates approach zero.
  • Discretionary fiscal policy, which has been a standard way to fight recessions since the Great Depression, remains an effective way to do so, and the size of the stimulus should be proportionate to the magnitude of the expected decline in economic activity.
  • Policymakers should not move fiscal policy from stimulus to austerity until the financial system is clearly stable and the economy is enjoying self-sustaining growth.

The worldwide financial crisis and global recession of 2007-2009 were the worst since the 1930s. With luck, we will not see their likes again for many decades. But we will see a variety of financial crises and recessions, and we should be better prepared for them than we were in 2007. That's why we examined the policy responses to this most recent crisis closely, and why we wrote this paper.

We provide details of the methods we used to generate the findings summarized above....

Thursday, October 15, 2015

'GDP Growth is Not Exogenous'

Antonio Fatás:

GDP growth is not exogenous: Ken Rogoff in the Financial Times argues that the world economy is suffering from a debt hangover rather than deficient demand. The argument and the evidence are partly there: financial crises tend to be more persistent. However, there is still an open question whether this is the fundamental reason why growth has been so anemic and whether other potential reasons (deficient demand, secular stagnation,…) matter as much or even more.
In the article, Rogoff dismisses calls for policies to stimulate demand as the wrong actions to deal with debt, the ultimate cause of the crisis. ... But there is a perspective that is missing in that logic. The ratio of debt or government spending to GDP depends on GDP and GDP growth cannot be considered as exogenous. ...
In a recent paper Olivier Blanchard, Eugenio Cerutti and Larry Summers show that persistence and long-term effects on GDP is a feature of any crisis, regardless of the cause. Even crises that were initiated by tight monetary policy leave permanent effects on trend GDP. Their paper concludes that under this scenario, monetary and fiscal policy need to be more aggressive given the permanent costs of recessions
Using the same logic, in an ongoing project with Larry Summers we have explored the extent to which fiscal policy consolidations can be responsible for the persistence and permanent effects on GDP during the Great Recession. Our empirical evidence very much supports this hypothesis: countries that implemented the largest fiscal consolidating have seen a large permanent decrease in GDP. [And this is true taking into account the possibility of reverse causality (i.e. governments that believed that the trend was falling the most could have applied stronger contractionary policy).
While we recognize that there is always uncertainty..., the size of the effects that we find are large enough so that they cannot be easily ignored... In fact, using our estimates we calibrate the model of a recent paper by Larry Summers and Brad DeLong to show that fiscal contractions in Europe were very likely self-defeating. In other words, the resulting (permanent) fall in GDP led to a increase in debt to GDP ratios as opposed to a decline, which was the original objective of the fiscal consolidation.
The evidence from both of these papers strongly suggests that policy advice cannot ignore this possibility, that crises and monetary and fiscal actions can have permanent effects on GDP. Once we look at the world through this lens what might sound like obvious and solid policy advice can end up producing the opposite outcome of what was desired.

Tuesday, October 13, 2015

'A Stimulus Junkie's Lament'

Simon Wren-Lewis:

One ‘stimulus junkie’ has already had a go at this FT piece by the chief economist of the German finance ministry ...
German officials need to be very careful before they claim that recent German macro performance justifies their anti-Keynesian views, because it might just prompt people to look at what has actually happened. Germany did undertake a stimulus package in 2009. But more importantly, in the years preceding that, it built up a huge competitive advantage by undercutting its Eurozone neighbors via low wage increases. This is little different in effect from beggar my neighbor devaluation. It is a demand stimulus, but (unlike fiscal stimulus) one that steals demand from other countries. This may or may not have been intended, but it should make German officials think twice before they laud their own performance to their Eurozone neighbors. If these neighbors start getting decent macro advice and some political courage, they might start replying that Germany’s current prosperity is a result of theft. ...

Sunday, October 11, 2015

'One Reason Why Monetary Policy is Preferred by New Keynesians'

Simon Wren-Lewis:

One reason why monetary policy is preferred by New Keynesians: ...Suppose, for example, individuals decide for some reason that they want to hold more money. They expect to sell their output, but plan to buy less. If everyone does this, aggregate demand will fall, and producers will not sell all their output. If goods cannot be stored, and if producers cannot consume their own good, this could lead to pure waste: some goods remain unsold and rot away. (If all producers immediately cut their prices, then a new equilibrium is possible where producers’ desire to hold more real money balances is achieved by a fall in prices. So we need to rule this possibility out by having some form of price rigidity.)
The government could prevent waste in two ways. It could persuade consumers to hold less money and buy more goods, which we can call monetary policy. Or it could buy up all the surplus production and produce more public goods, which we could call fiscal policy. Both solutions eliminate waste, but monetary policy is preferable to fiscal policy because the public/private good mix remains optimal.
Three comments on this reason for preferring monetary policy. First, if for some reason monetary policy cannot do this job, clearly using fiscal policy is better than doing nothing. It is better to produce something useful with goods rather than letting them rot. We could extend this further. If for some reason the impact of monetary policy was uncertain, then that could also be a reason to prefer fiscal policy, which in this example is sure to eliminate waste. Second, the cost of using fiscal rather than monetary policy obviously depends on the form of public spending. If the public good was repairing the streets the market was held in one year earlier than originally planned the 'distortion' involved is pretty small. Third, another means of achieving the optimal solution, besides monetary policy, is for the government to give everyone the extra money they desire.

Wednesday, October 07, 2015

Summers: Global Economy: The Case for Expansion

Larry Summers continues his call for fiscal expansion:

Global economy: The case for expansion: ...The problem of secular stagnation — the inability of the industrial world to grow at satisfactory rates even with very loose monetary policies — is growing worse in the wake of problems in most big emerging markets, starting with China. ... Industrialised economies that are barely running above stall speed can ill-afford a negative global shock. Policymakers badly underestimate the risks... If a recession were to occur, monetary policymakers lack the tools to respond. ...
This is no time for complacency. The idea that slow growth is only a temporary consequence of the 2008 financial crisis is absurd. ...
Long-term low interest rates radically alter how we should think about fiscal policy. Just as homeowners can afford larger mortgages when rates are low, government can also sustain higher deficits. ...
The case for more expansionary fiscal policy is especially strong when it is spent on investment or maintenance. ... While the problem before 2008 was too much lending, many more of today’s problems have to do with too little lending for productive investment.
Inevitably, there will be discussion of the need for structural reform... — there always is. ...
Traditional approaches of focusing on sound government finance, increased supply potential and the avoidance of inflation court disaster. ... It is an irony of today’s secular stagnation that what is conventionally regarded as imprudent offers the only prudent way forward.

[The full post is much, much longer.]

Thursday, October 01, 2015

'The Costs of Interest Rate Liftoff for Homeowner'

Two posts on housing. First, how will an increase in interest rates impact mortgage markets?:

The costs of interest rate liftoff for homeowners: Why central bankers should focus on inflation, by Carlos Garriga, Finn Kydland, and Roman Šustek: The Federal Reserve Bank and the Bank of England left their policy interest rates unchanged this month... But an interest rate liftoff in the near future remains on the table in both the US and the UK, provided the headwinds from China ease off and there is further evidence of improvements in the domestic economy. Inflation, however, still hovers in both economies stubbornly around zero percent. 
Interest rates set by central banks influence the economy through various transmission mechanisms. But one channel affects the typical household directly – the cost of servicing mortgage debt. ... Changes in the interest rate set by the central bank affect the size of mortgage payments, but differently for different types of loans. In addition, the real value of these payments depends on inflation. ...
Policy implications
To sum up, the effects of the liftoff on homeowners depend on three factors:
  • The prevalent mortgage type in the economy (fixed or adjustable rate mortgages);
  • The speed of the liftoff; and
  • What happens to inflation during the course of the liftoff.
If inflation stays constant at near zero then in the US, where fixed rate mortgage loans dominate, the liftoff will affect only new homeowners. In the UK, where adjustable rate mortgage loans dominate, the negative effects will in contrast be felt strongly by both new and existing homeowners.
However, if the liftoff is accompanied by sufficiently high inflation as in our examples, the negative effects will be weaker in both countries. In the US, the initial negative effect on new homeowners will be compensated by gradual positive effects on existing homeowners. And in the UK, provided the liftoff is sufficiently slow, neither existing nor new homeowners may face significantly higher real costs of servicing their mortgage debt. But if the liftoff is too fast, both types of homeowners in the UK will face higher real mortgage costs in the medium term, even if the liftoff is accompanied by positive inflation with no change in real rates.
Therefore, if the purpose of the liftoff is to ‘normalize’ nominal interest rates without derailing the recovery, central bankers in both the US and the UK should wait until the economies convincingly show signs of inflation taking off. Furthermore, the liftoff should be gradual and in line with inflation.

Second, allowing less creditworthy borrowers to refinance could stimulate the economy:

‘Home Affordable Refinancing Program’: Impact on borrowers, by Sumit Agarwal, Gene Amromin, Souphala Chomsisengphet, Tomasz Piskorski, Amit Seru, and Vincent Yao: Mortgage refinancing is one of the main ways households can benefit from a decline in the cost of credit. This column uses the US Government’s Home Affordable Refinancing Program (HARP) as a laboratory to examine the government’s ability to impact refinancing activity and spur household consumption. The results suggest that less creditworthy borrowers significantly increase their spending following refinancing. To the extent that such borrowers have the largest marginal propensity to consume, allowing them to refinance under the program could increase overall consumption and alleviate uneven economic outcomes across the country.

Tuesday, September 22, 2015

'Central Banks Have Made the Rich Richer'

Paul Marshall, chairman of London-based hedge fund Marshall Wace, in the FT:

Central banks have made the rich richer: Labour’s new shadow chancellor has got at least one thing right. ... Quantitative easing ... has bailed out bonus-happy banks and made the rich richer. ...
It is no surprise that the left is angry about this, nor that they are looking for other versions of QE that do not so directly benefit bankers and the rich. Instead of increasing the money supply by buying sovereign bonds from banks, central banks could spread the love evenly by depositing extra money in every person’s bank account..., it might have been fairer.
Mr McDonnell and Jeremy Corbyn, the new Labour leader, advocate a second approach: targeting QE at infrastructure projects. The central bank would buy bonds direct from the Treasury on the understanding that the funds would be used to improve housing and transport infrastructure. ...
QE had clear wealth effects, which could have been offset by fiscal measures. All political parties should acknowledge this. So should those of us who want free markets to retain their legitimacy.

Saturday, September 19, 2015

Unemployment Insurance and Progressive Taxation as Automatic Stabilizers

Some preliminary results from a working paper by Alisdair Mckay and Ricardo Reis:

Optimal Automatic Stabilizers, by Alisdair McKay and Ricardo Reis: 1 Introduction How generous should the unemployment insurance system be? How progressive should the tax system be? These questions have been studied extensively and there are well-known trade-offs between social insurance and incentives. Typically these issues are explored in the context of a stationary economy. These policies, however, also serve as automatic stabilizers that alter the dynamics of the business cycle. The purpose of this paper is to ask how and when aggregate stabilization objectives call for, say, more generous unemployment benefits or a more progressive tax system than would be desirable in a stationary economy. ...
We consider two classic automatic stabilizers: unemployment benefits and progressive taxation. Both of these policies have roles in redistributing income and in providing social insurance. Redistribution affects aggregate demand in our model because households differ in their marginal propensities to consume. Social insurance affects aggregate demand through precautionary savings decisions because markets are incomplete. In addition to unemployment insurance and progressive taxation, we also consider a fiscal rule that makes government spending respond automatically to the state of the economy.
Our focus is on the manner in which the optimal fiscal structure of the economy is altered by aggregate stabilization concerns. Increasing the scope of the automatic stabilizers can lead to welfare gains if they raise equilibrium output when it would otherwise be inefficiently low and vice versa. Therefore, it is not stabilization per se that is the objective but rather eliminating inefficient fluctuations. An important aspect of the model specification is therefore the extent of inefficient business cycle fluctuations. Our model generates inefficient fluctuations because prices are sticky and monetary policy cannot fully eliminate the distortions. We show that in a reasonable calibration, more generous unemployment benefits and more progressive taxation are helpful in reducing these inefficiencies. Simply put, if unemployment is high when there is a negative output gap, a larger unemployment benefit will stimulate aggregate demand when it is inefficiently low thereby raising welfare. Similarly, if idiosyncratic risk is high when there is a negative output gap,1 providing social insurance through more progressive taxation will also increase welfare....

Monday, August 10, 2015

Job Training and Government Multipliers

Two new papers from the NBER:

What Works? A Meta Analysis of Recent Active Labor Market Program Evaluations, by David Card, Jochen Kluve, and Andrea Weber, NBER Working Paper No. 21431 Issued in July 2015: We present a meta-analysis of impact estimates from over 200 recent econometric evaluations of active labor market programs from around the world. We classify estimates by program type and participant group, and distinguish between three different post-program time horizons. Using meta-analytic models for the effect size of a given estimate (for studies that model the probability of employment) and for the sign and significance of the estimate (for all the studies in our sample) we conclude that: (1) average impacts are close to zero in the short run, but become more positive 2-3 years after completion of the program; (2) the time profile of impacts varies by type of program, with larger gains for programs that emphasize human capital accumulation; (3) there is systematic heterogeneity across participant groups, with larger impacts for females and participants who enter from long term unemployment; (4) active labor market programs are more likely to show positive impacts in a recession. [open link]

And:

Clearing Up the Fiscal Multiplier Morass: Prior and Posterior Analysis, by Eric M. Leeper, Nora Traum, and Todd B. Walker, NBER Working Paper No. 21433 Issued in July 2015: We use Bayesian prior and posterior analysis of a monetary DSGE model, extended to include fiscal details and two distinct monetary-fiscal policy regimes, to quantify government spending multipliers in U.S. data. The combination of model specification, observable data, and relatively diffuse priors for some parameters lands posterior estimates in regions of the parameter space that yield fresh perspectives on the transmission mechanisms that underlie government spending multipliers. Posterior mean estimates of short-run output multipliers are comparable across regimes—about 1.4 on impact—but much larger after 10 years under passive money/active fiscal than under active money/passive fiscal—means of 1.9 versus 0.7 in present value. [open link]

Friday, July 31, 2015

Pictures of Austerity

Brendan Mochoruk and Louise Sheiner of the Brookings Institution say that Fiscal Headwinds are Abating:

Tight fiscal policy by local, state, and federal governments held down economic growth for more than four years, but that restraint finally appears to be over...

This is a pretty good summary of the charts:

Fiscal policy is no longer a source of contraction for the economy, but neither is it a source of strength.

But in my view the statement "neither is it a source of strength" understates how poorly fiscal policy has been managed. The strong headwinds never should have been there to begin with, and we have yet to feel the wind at our backs:

Fiscalimpact1

Monthly-employment-change

State-spending

Monthly-federal-emplyment

Wednesday, July 22, 2015

'You Can’t Reform Your Way to Rapid Growth'

Dietz Vollrath:

You Can’t Reform Your Way to Rapid Growth: ...in response to the small back-and-forth that Noah Smith (also here) and John Cochrane had regarding Jeb! Bush’s suggestion/idea/hope to push the growth of GDP up to 4% per year. Cochrane asked “why not?”, and offered several proposals for structural reforms (e.g. reforming occupational licensing) that could contribute to growth. Smith was skeptical...
Oddly enough, the discussion of Jeb!’s 4% target is also a good entry point to talking about Greece, and the possibility that the various structural reforms insisted on by the Germans will manage to materially change their situation. But we’ll get to that.
First, what are the possibilities of generating 4% GDP growth in the U.S.? I’m presuming that we’re talking about whether we can boost per capita growth up to 4% per year for some relatively short time frame, because history suggests that sustained 4% growth in GDP is incredibly unlikely. From Jeb!’s perspective, I’m guessing either 4 or 8 years is the right window to look at, but let’s say we’re trying to achieve this for just 5 years. ...[discusses and illustrates the conclusions of a standard growth model]...
You can just scrape 4% growth if you continue to assume that structural reforms to the U.S. economy can add $3 trillion to potential GDP and that the convergence parameter is ... more than twice as big as any reliable empirical estimate. Or you could ... assume that structural reforms were capable of pushing potential GDP to $26 trillion, a 53% increase over potential GDP today. Both are huge stretches, and almost certainly wrong.
It is this same logic that is at play in Greece, by the way. ...
Massive structural reforms are not capable of generating immediate short-run jumps in growth rates in the U.S., Greece, or any other relatively developed economy. They play out over long periods of time, and the empirics we have suggest that by long periods we mean decades and decades of slightly above average growth. ...
Structural reforms don’t generate massive short-term changes in growth rates because they are fiddling with marginal decisions, making people marginally more likely to invest, or change jobs, or get an education, or start a company. By permanently changing those marginal decisions, structural reforms act like glaciers, slowly carving the economy into a new shape over long periods of time. ...
If you want to radically boost GDP growth now, then someone has to spend money now. Take infrastructure spending..., the beauty of infrastructure spending is that is doesn’t just push us closer to potential, it almost certainly raises potential GDP as well, and keeps the growth rate above average for longer. ...
The difference with infrastructure spending is that it does not nibble around the edges or play with marginal decisions. It dumps a bunch of new spending into the economy. And that is the only way to juice the growth rate appreciably in the short run. Structural reforms will raise GDP, and in the long run may raise GDP by far more than immediate infrastructure spending. But that increase in GDP will take decades, and the change in growth will be barely noticeable. You want demonstrably faster growth right now? Then be prepared to spend lots of money right now.
In the Greek situation, the implication is that without some kind of boost to spending now, they are unlikely to ever grow fast enough to ever get out of this hole they are in. ...

Tuesday, July 14, 2015

'Needed: More Government, More Government Debt, Less Worry'

Brad DeLong (the full post is much, much longer):

Needed: More Government, More Government Debt, Less Worry: **Introduction**
Olivier Blanchard, when he parachuted me into this panel, asked me to “be provocative”.
So let me provoke:...
It makes sense to distinguish the medium from the short term only if the North Atlantic economies will relatively soon enter a régime in which the economy is not at the zero lower bound on safe nominal interest rates. The medium term is at a horizon at which monetary policy can adequately handle all of the demand-stabilization role. ...
As I see it, there are three major medium-run questions that then remain...:
* What is the proper size of the 21st-century public sector?
* What is the proper level of the 21st-century public debt for growth and prosperity?
* What are the systemic risks caused by government debt, and what adjustment to the proper level of 21st-century public debt is advisable because of systemic risk considerations?
To me at least, the answer to the first question–what is the proper size of the 21st-century public sector?–appears very clear.
The optimal size of the 21st-century public sector will be significantly larger than the optimal size of the 20th-century public sector. Changes in technology and social organization are moving us away from a “Smithian” economy, one in which the presumption is that the free market or the Pigovian-adjusted market does well, to one that requires more economic activity to be regulated by differently-tuned social and economic arrangements (see DeLong and Froomkin (2000)). One such is the government. Thus there should be more public sector and less private sector in the 21st-century than there was in the 20th.
Similarly, the answer to the second question appears clear, to me at least.
The proper level of the 21st century public debt should be significantly higher than typical debt levels we have seen in the 20th century ... *unless interest rates in the 21st century reverse the pattern we have seen in the 20th century, and mount to levels greater than economic growth rates*.
This consideration is strengthened by observing that the North Atlantic economies have now moved into a régime in which the opposite has taken place. Real interest rates on government debt are not higher but even lower relative to growth rates than they have been in the past century. Financial market participants now appear to expect this now ultra-low interest-rate régime to continue indefinitely (see Summers (2014)).
The answer to the third question–what are the systemic risks caused by government debt?–is much more murky. ...
The question ... is:... How much more likely does higher debt make it that interest rates will spike in the absence of fundamental reasons? How much would they spike? What would government policy be in response to such a spike? And what would be the effect on the economy?
The answer thus hinges on:
* the risk of a large sudden upward shift in the willingness to hold government debt, even absent substantial fundamental news.
* the ability of governments to deal with such a risk that threatens to push economies far enough up the Laffer curve to turn a sustainable into an unsustainable debt.
I believe the risk in such a panicked flight from an otherwise sustainable debt is small. I hold, along with Rinehart and Rogoff (2013), that the government’s legal tools to finance its debt via financial repression are very powerful, Thus I think this consideration has little weight. I believe that little adjustment to one’s view of the proper level of 21st-century public debt of *reserve currency-issuing sovereigns with exorbitant privilege* is called for because of systemic risk considerations.
But my belief here is fragile. And my comprehension of the issues is inadequate.
Let me expand on these three answers...

Thursday, July 09, 2015

'Fiscal Policy and the Long-Run Neutral Real Interest Rate'

Narayana Kocherlakota, President of the Federal Reserve Bank of Minneapolis, says more government debt would help the Fed:

Fiscal Policy and the Long-Run Neutral Real Interest Rate: Thanks for the introduction and the invitation to be here today.
In my remarks today, I will make three points about the U.S. economy.
First, there has been a significant decline in the long-run real interest rate, reflecting (in large part) a decline in what is sometimes called the long-run neutral real interest rate. (By the long-run neutral real interest rate, I mean the real interest rate that I expect to prevail when the economy is at maximum employment and inflation is at the central bank’s target.) Second, this decline in the long-run neutral real interest rate is likely to mean that monetary policymakers will be more constrained by the lower bound on the nominal interest rate in the future than they have been in the past. 
My third point concerns an important connection between monetary and fiscal policy. I consider a permanent increase in the market value of the public debt, financed by an increase in taxes or reduction in transfers. This policy change increases the supply of assets available to investors. I argue that, in a wide class of plausible economic models, such an increase in supply would push downward on debt prices, and so upward on the long-run neutral real interest rate. 
When I put these three points together, I reach my main conclusion. The decline in the long-run neutral real interest rate increases the likelihood that the economy will run into the lower bound on nominal interest rates. Accordingly, there is an enhanced risk that the Federal Open Market Committee (FOMC) will undershoot its maximum employment and 2 percent inflation objectives. Fiscal policymakers can mitigate this risk by choosing to maintain higher levels of public debt than markets currently anticipate.
I want to be clear at the outset that I am not saying that it is appropriate for fiscal policymakers to increase the long-run level of public debt. I am simply pointing to one benefit associated with such an increase: It allows the central bank to be more effective in mitigating the impact of adverse shocks to aggregate demand. I will point to other costs (and benefits) associated with increasing the level of public debt. Sorting through them is outside the scope of my remarks today, and really outside of my purview as a monetary policymaker. ...

Wednesday, July 08, 2015

'Policy Lessons From The Eurodebacle'

Paul Krugman:

Policy Lessons From The Eurodebacle: ...there’s a broader lesson from Greece that is relevant to all of us — and it’s not the usual one about mending our free-spending ways lest we become Greece, Greece I tell you. What we learn, instead, is that fiscal austerity plus hard money is a deeply toxic mix. The fiscal austerity depresses the economy, and pushes it toward deflation; if it’s accompanied by hard money (in Greece’s case the euro, but a fixed exchange rate, a gold standard, or any kind of obsessive fear of inflation would do the trick), the result is not just a depression and deflation, but quite likely a failure even to reduce the debt ratio. ...
So, how does this play into U.S. policy debates? Well, Republicans love to warn that America might turn into Greece any day now. But look at the policy mix that is now de facto GOP orthodoxy: sharp cuts in government spending (maybe offset by tax cuts for the rich, but these won’t provide much stimulus), combined with a monetary policy obsessed with fears of dollar “debasement”. That is, the conservative side of the US political spectrum, while holding up Greece as a cautionary tale, is actually demanding that we emulate the policy mix that turned Greek debt into a complete disaster.