- Stop Voter Suppression - Robert Reich
- The Implications of Slow Growth for Monetary Policy - Charles Evans
- Who's Responsible for the Next Crisis - Narayana Kocherlakota
- The American Worker in the Age of Oversupply - Third Way
- A new age of econ imperialism is coming - Noahpinion
- What Progressive Tax Reform Should Look Like - Jason Furman
- Low-Skilled Immigrants Are Good for the Working Class - Noah Smith
- “It’s Difficult to Produce Good Policy in Thin Political Markets" - ProMarket
Wednesday, April 06, 2016
Tuesday, April 05, 2016
Fed Has Little Reason to Hike Rates, by Tim Duy: Despite some occasionally hawkish rhetoric from a handful of disaffected Federal Reserve bank presidents, expect the Fed to remain on hold until inflationary threats clearly emerge. In practice, that means the Fed is not likely to raise rates until the unemployment rate resumes its downward trajectory. Soft though generally positive data coupled with market turbulence over the winter scared most policymakers straight with regards to their overly-optimistic plans to normalize policy. The risks to the outlook are simply too one-sided too believe this is anything like the tightening cycles of the past.
Generally positive incoming data continues to defy the predictions of the recessionistas. ISM data, both manufacturing:
posted improved headline numbers with general solid internals. The worst of the manufacturing downturn may be behind us. The JOLTS numbers:
have remained fairly stable in recent months, suggesting no significant changes in dynamics in labor flows in and out of firms. Not surprisingly, nonfarm payroll growth remains on its steady path:
The unemployment rate ticked up in March as the labor force grew:
The Fed would like unemployment to settle somewhat below their estimates of the natural rate to promote further reduction of underemployment. So a stagnant unemployment rate at these levels argues for stable policy.
One red flag I see is that temporary employment has stalled, suggesting some loss of momentum:
Nothing to panic about, just something I am watching. Indeed, in many ways the current dynamic is not dissimilar to the mid-90s, when the economy sputtered in the wake of tighter monetary policy. Then, like now, the Fed need to back down in response. The economy subsequently gathered steam.
Moreover, declining estimates of first quarter growth also give the Fed reason to remain on hold. Soft consumption, weaker auto sales, still anemic manufacturing, and a rising trade deficit have all conspired to bring the latest Atlanta Fed estimate of first quarter growth to an anemic 0.4%. To be sure, this might just be the first quarter curse of recent years. As such, the Fed may be confident it does not represent the pace of underlying activity. And they expect that the worst impact of the rising dollar and falling oil prices on manufacturing will soon be behind us. But they don't know these things - and it will take another three months of data at least until they know these things. That pushes that date of another rate hike into the until June at the earliest, but don't be surprised if they want to see a more complete picture of the second quarter before acting.
A steady unemployment rate at or above the Fed's estimate of the natural rate also argues for a substantial policy pause. I am hard pressed to see a reason for the Fed to resume hiking rates until unemployment clearly resumes declining. This holds true even if a growing labor force drives a flattening unemployment rate. The Fed will see that as evidence that excess slack remains in the economy, hence inflationary pressures are less than feared when the unemployment rate was heading steadily lower.
Note also tamer inflation in February after a spike the previous month:
This supports Federal Reserve Chair Janet Yellen's caution over reading too much into any one inflation reading.
Financial indicators have firmed in recent months:
That said, the improvement for most indicators largely just offsets the damage done during the winter. And credit conditions for less than perfect debt remain less than perfect.
In short, while the data is not indicating a recession it upon us, and supportive of the case for improvement later this year, it also gives little reason to justify a rate hike anytime soon.
Furthermore, the Fed appears to have stopped - at least for the moment - pursuing rate hikes for the sake of hiking rates. The financial market turmoil made them realize that yes, the policy risks are asymmetric, and they need to take the asymmetries seriously. Chicago Federal Reserve President Charles Evans concisely summaries the challenges of being hit with a negative shock while near the zero bound:
Faced with such uncertainty, policymakers could make two potential policy mistakes. The first mistake is that the FOMC could raise rates too quickly, only to be hit by one or more of the downside surprises. In order to put the economy back on track, we would have to cut interest rates back to zero and possibly even resort to unconventional policy tools, such as more quantitative easing. I think unconventional policy tools have been effective, but they clearly are second-best alternatives to traditional policy and something we would all like to avoid. I should note, too, that with the economy facing a potentially lower growth rate and lower equilibrium interest rates, the likelihood of some shock forcing us back to the effective lower bound may be uncomfortably high. The difficulties experienced in Japan and Europe come to mind.
And compares it to the challenges of being hit with a positive shock:
The second (alternative) potential policy mistake the Committee could make is that sometime during the gradual normalization process the U.S. economy experiences upside surprises in growth and inflation. Well, policymakers have the experience and the appropriate tools to deal with such an outcome; we probably could keep inflation in check with only moderate increases in interest rates relative to current forecasts. Given how gradual the rate increases are in the baseline SEP, policy could be made a good deal more restrictive, for example, by simply increasing rates 25 basis points at every meeting — just as we did during the measured pace adjustments of 2004–06. A question for the audience: Who thinks those were fast? So, to me, concerns about the risks of rapid increases in rates in this scenario seem overblown.
Until now, the driving argument for raising rates was that they needed to do so to avoid a faster pace of rate hikes. But as Evans points out, why the rush? Would it really be so bad to raise rates at a "moderate" pace rather than a "gradual" or what has become now a "glacial" place? After all, they have better tools to reduce inflation than to raise it. Clearly, many Fed officials did not appreciate the asymmetry of risks until this past winter.
Separately, Boston Federal Reserve President Eric Rosengren argued that financial market participants are getting it wrong:
So, while problems could still arise, I would expect that the very slow removal of accommodation reflected in futures market pricing could prove too pessimistic. While it has been appropriate to pause while waiting for information that clarified the response of the U.S. economy to foreign turmoil, it increasingly appears that the U.S. has weathered foreign shocks quite well. As a consequence, if the incoming data continue to show a moderate recovery – as I expect they will – I believe it will likely be appropriate to resume the path of gradual tightening sooner than is implied by financial-market futures.
He seems to have learned little from Federal Reserve Vice-Chair Stanley Fisher's experience in January:
Well, we watch what the market thinks, but we can't be led by what the market thinks. We've got to make our own analysis. We make our own analysis and our analysis says that the market is underestimating where we are going to be. You know, you can't rule out that there is some probability they are right because there's uncertainty. But we think that they are too low .
They would probably be better off just stating their expectations as the baseline rather than appearing to challenge the markets so directly. But they can't seem to help themselves; they seem to view it as their job to warn that rate hikes are coming, that markets are getting it wrong, an unnecessarily hawkish message for a central bank trying to raise inflation while facing an asymmetric balance of risks. Not sure what the point is anyway - if Rosengren is at two rate hikes this year while the market is at one, is that difference really all that significant? Is he just priming us for Fed minutes that will also be more hawkish than current market expectations?
And the implied hawkish message has proven consistently wrong, for that matter. The history of this recovery is that while the Fed always sounds hawkish relative to market expectations, the Fed has consistently moved in the direction of market expectations.
Bottom Line: The Fed is on hold for at least a few months until the data provides a more definite reason to justify another hike. With any luck, if the Fed continues to hold steady now, maybe they will get the chance to chase the long-end of the curve higher later - which is exactly what they need to be able to "normalize" policy. Expect officials to remind us that they expect a faster pace of a rate hikes than markets anticipate. But I think the bar for further hikes has risen since December. An appreciation of the asymmetric policy risks will prod them to seek more definitive signs inflationary pressures are growing to justify the next rate hike.
I have a new column:
What Bernie Sanders Gets Right: A little over a year ago, Bernie Sanders expressed one of the themes of his presidential campaign in a speech at the Brookings Institution:
We are moving rapidly away from our democratic heritage into an oligarchic form of society… billionaire families are now able to spend hundreds and hundreds of millions of dollars to purchase the candidates of their choice. The billionaire class now owns the economy, and they are working day and night to make certain that they own the United States government.
This gets at the heart of the justification for our economic system. According to economic theory, one of the wonders of capitalism is that the pursuit of self-interest by individuals in society is guided, as if by an invisible hand, to maximize the collective social interest. Ruthless, cutthroat competition between individuals and businesses is magically transformed through the marketplace into a harmonious outcome that is best for society as a whole.
But there are important questions about the extent to which this describes how our economy actually works. ...
What is a "Good Job?": On the surface, it's easy to sketch what a "good job" means: having a job in the first place, along with good pay and access to benefits like health insurance. But that quick description is far from adequate, for several interrelated reasons. When most of us think about a "good job," we have more than the paycheck in mind. Jobs can vary a lot in working conditions and predictability of hours. Jobs also vary according to whether the job offers a chance to develop useful skills and a chance for a career path over time. In turn, the extent to which a worker develops skills at a given job will affect whether that worker worker is a replaceable cog who can expect only minimal pay increases over time, or whether the worker will be in a position to get pay raises--or have options to be a leading candidate for jobs with other employers. ...
When you start thinking about "good jobs" in these broader terms, the challenge of creating good jobs for a 21st century economy becomes more complex. A good job has what economists have called an element of "gift exchange," which means that a motivated worker stands ready to offer some extra effort and energy beyond the bare minimum, while a motivated employer stands ready to offer their workers at all skill levels some extra pay, training, and support beyond the bare minimum. A good job has a degree of stability and predictability in the present, along with prospects for growth of skills and corresponding pay raises in the future. We want good jobs to be available at all skill levels, so that there is a pathway in the job market for those with little experience or skill to work their way up. But in the current economy, the average time spent at a given job is declining and on-the-job training is in decline.
I certainly don't expect that we will ever reach a future in which jobs will be all about deep internal fulfillment, with a few giggles and some comradeship tossed in. As my wife and I remind each other when one of us has an especially tough day at the office, there's a reason they call it "work," which is closely related to the reason that you get paid for doing it.
But with the unemployment rate now under 5%, the main issue in the workforce isn't a raw lack of jobs--as it was in the depths of the Great Recession--but instead is about how to encourage the economy to develop more good jobs. I don't have a well-designed agenda to offer here. But what's needed goes well beyond our standard public arguments about whether firms should be required to offer certain minimum levels of wages and benefits.
- The real welfare queens are legislators - Catherine Rampell
- Women have made the difference for economic security - Equitable Growth
- Aggregate Supply and Depression Economics (Wonkish) - Paul Krugman
- Which Wage Growth Measure Best Indicates Labor Market Slack? - macroblog
- Supply-Side Policies in the Depression: Evidence from France - NBER
- Angre about Free Trade -- What is the Right Policy Response? - Ed Dolan
- The Future Role of Economics in the IPCC - Robert Stavins
- Differing Views on Long-Term Inflation Expectations - FRBSF
- Strengthening “Mario’s Plan” - EconoMonitor
- Animal Spirits in a Monetary Model - NBER
- Shadows of Smears Past - Paul Krugman
- An Empirical Exercise: Mariel – LaborEcon
- Economic consequences of Brexit - VoxEU
- Are Stress Tests Still Informative? - Liberty Street Economics
- Too Big to Fail: MetLife v. FSOC - Cecchetti & Schoenholtz
Monday, April 04, 2016
Data collection is the ultimate public good: On Wednesday I spoke at a World Bank conference on price statistics. While price statistics are not usually thought of as a scintillating subject, I got a great deal of satisfaction out of preparing and presenting my remarks. In part this was because my late father Robert Summers focused his economic research on International price comparisons. It was also because I am convinced that data is the ultimate public good and that we will soon have much more data than we do today. I made four primary observations.
First, scientific progress is driven more by new tools and new observations than by hypothesis construction and testing. ...
Second, if mathematics is the queen of the hard sciences than statistics is the queen of the social sciences. ...
Third, I urged that what “you count counts” and argued that we needed much more timely and complete data. ...
Fourth, I envisioned what might be possible in a world where there will soon be as many smart phones as adults. ...
This is the work of both governments and the private sector. It is fantasy to suppose data, the ultimate public good, will come into being without government effort. Equally, we will sell ourselves short if we stick with traditional collection methods and ignore innovative providers and methods such as the use of smart phones, drones, satellites and supercomputers. ...
Why the Fed has a wary eye on China's economy, by Mark Thoma: Uncertainty about the global economy is making the Federal Reserve more cautious about raising U.S. interest rates. That was Fed Chair Janet Yellen's message in a speech to the Economic Club of New York last week. This uncertainty is reflected in the Fed's dialed-back forecast for rate increases this year. In December, the central bank signaled that rates would go up by 1 percent over the course of the year, but that projection dropped to a half-percent at the Fed's most recent meeting.
And when the topic is the health of the global economy, the discussion is largely about the performance of the Chinese economy. From 2002 through 2011, China's average growth rate was a remarkable 10.6 percent, according to International Monetary Fund data. But that has fallen steadily to 6.8 percent in 2015, and it's projected to slide further to 6 percent by 2017 then level off in subsequent years.
But this forecast itself has quite a bit of uncertainty. China faces several challenges that it must overcome to avoid an even lower growth rate -- and perhaps a "crash landing." ...
"Real solutions to real problems":
Cities for Everyone, by Paul Krugman, Commentary, NY Times: Remember when Ted Cruz tried to take Donald Trump down by accusing him of having “New York values”? It didn’t work, of course, mainly because it addressed the wrong form of hatred. Mr. Cruz was trying to associate his rival with social liberalism — but among Republican voters distaste for, say, gay marriage runs a distant second to racial enmity, which the Trump campaign is catering to quite nicely, thank you.
But there was another reason...: Old-fashioned anti-urban rants don’t fit with the realities of modern American urbanism. Time was when big cities could be portrayed as arenas of dystopian social collapse, of rampant crime and drug addiction. These days, however, we’re experiencing an urban renaissance. ...
Upper-income Americans are moving into high-density areas, where they can benefit from city amenities; lower-income families are moving out of such areas... You may be tempted to say, so what else is new? Urban life has become desirable again, urban dwellings are in limited supply, so wouldn’t you expect the affluent to outbid the rest and move in? ...
But living in the city isn’t like living on the beach, because the shortage of urban dwellings is mainly artificial. Our big cities ... could comfortably hold quite a few more families... The reason they don’t is that rules and regulations block construction. Limits on building height, in particular, prevent us from making more use of the most efficient public transit system yet invented – the elevator. ... And that restrictiveness brings major economic costs. ...
So there’s a very strong case for allowing more building in our big cities. The question is, how can higher density be sold politically? The answer, surely, is to package a loosening of building restrictions with other measures. Which is why what’s happening in New York is so interesting.
In brief, Mayor Bill de Blasio has pushed through a program that would selectively loosen rules on density, height, and parking as long as developers include affordable and senior housing. ...
Not everyone likes this plan. ... But it’s a smart attempt to address the issue, in a way that could, among other things, at least slightly mitigate inequality.
And may I say how refreshing it is, in this ghastly year, to see a politician trying to offer real solutions to real problems? If this is an example of New York values in action, we need more of them.
- Productivity gains in U.S. shale oil - Econbrowser
- Helicopter Money is Permanent - Nick Rowe
- Do Rising Rents For The Poor Mean There's No Housing Bubble? - EconoSpeak
- The Recession Template, Except there Isn’t One - EconoSpeak
- The Return of Depression Economics - Robert Waldmann
- Port Talbot and Neoliberalism - mainly macro
Sunday, April 03, 2016
The internet and the productivity slump: How much would an average American, whose annual disposable income is $42,300, need to be paid in order to be persuaded to give up their mobile phone and access to the internet, for a full year? ... The question is relevant to a much more familiar issue. Why has productivity growth slowed down so much in all major economies...
Chad Syverson reckons that the unrecorded value of the digital economy to the average citizen would need to be $8400 per year in order to explain the entire productivity gap. This is one fifth of net disposable income per person. He suggests, on prima facie grounds, that few people would value their access to the digital economy at one fifth of their disposable income.
Maybe, but what is the appropriate figure? ... Faced with the choice, I doubt whether they would be prepared to be transported back to the obsolete technology of a decade ago in exchange for an annual payment of less than, say, a few thousand dollars a year...
If that conjecture (and it is no more than a conjecture) is valid, there might be something in the mismeasurement hypothesis after all. But the evidence suggests that it is not the main reason for the productivity debacle .
- Remembrances of Depression Economics - Paul Krugman
- Is There a Crisis in the Economic Theory of the Firm? - ProMarket
- California and New York’s bold $15 minimum wage proposals - EPI
- Tories & Communists - Stumbling and Mumbling
- Higher inflation target is key to UK problems Barwell and Yates
- The 1996 Welfare reform bill hits aga - Robert Waldmann
Saturday, April 02, 2016
The Schumpeter hotel: income inequality and social mobility: In one of his rare discussions of inequality, Joseph Schumpeter illustrated in a metaphor the difference between the inequality we observe at a moment in time and social (or inter-generational) mobility. Suppose, Schumpeter writes, that there is a multiple-story-high hotel with higher floors containing fewer people and having much nicer rooms. At any given moment, there would be lots of people on the ground floor living in cramped small rooms, and just a few people in the nice and comfortable top-floor rooms with a view. But then let the guests move around and change the rooms every night. This is what, Schumpeter said, social mobility will do: at every given moment of time there are rich and poor but as we extend the time period, today’s rich are yesterday’s poor and vice versa. The guests from the ground floors (or at least their children) have made it to the top, those from the top might have tumbled down to the bottom.
Now, Schumpeter’s metaphor was for a long time a metaphor for US inequality too. It was granted that in the 20th, and even in the 19th, century US income inequality might have been greater than inequality in Europe, but it was also held that US society was much more fluid, less class-bound and that there was greater social mobility. (That view of course conveniently overlooked the huge racial divide in the US.) In other words, inequality was the price that America paid for high social mobility.
This was a reassuring picture consonant with the idea of the American dream. But was it true? We actually never knew it, beyond anecdotal evidence of migrants’ lives, since no consistent empirical studies of inter-generational mobility existed until very recently. ...
The comforting picture of high inequality which does not impede mobility between generations turns out to be false. US does not behave any differently than other societies with high inequality. High income inequality today reinforces income differences between the generations and makes social mobility more difficult to achieve. This is also the point of my recent paper with Roy van der Weide. We use US micro data from 1960 to 2010 to show that poor people in US states with higher initial inequality experienced lower income growth in subsequent periods.
This important finding ... two important implications: (1) American exceptionalism in the matters of income distribution does not have a basis in reality, and (2) we can use, with a good degree of confidence, the easily available data on current inequality as predictors of social mobility. Thus one cannot argue that societies with high inequality in incomes are societies with high equality of opportunity. On the contrary, observed high inequality today implies low equality of opportunity.
- Feel the Math - Paul Krugman
- Helicopters are easy to fly - mainly macro
- If we really valued excellence, we would single it out - Larry Summers
- Blackouts and the Burden of Uncertainty - Narayana Kockerlakota
- Can the Fed stay independent in a polarized era? - Brookings Institution
- The productivity effects of importing inputs - Microeconomic Insights
- Hey, Economist! What Did You Make of “The Big Short”? - Liberty Street
- The Neo-Fisherian Counterfeiter - Nick Rowe
Friday, April 01, 2016
Yellen Pivots Toward Saving Her Legacy: As 2016 began to evolve, it quickly became apparent that Federal Reserve Chairman Janet Yellen faced the very real possibility that her legacy would amount to being just another central banker who failed miserably in their efforts to raise interest rates back into positive territory. The Federal Reserve was set to follow in the footsteps of the Bank of Japan and the Riksbank, seemingly oblivious to their errors. In September of last year, a confident Yellen declared the Fed would be different. From the transcript of her press conference:
ANN SAPHIR. Ann Saphir with Reuters. Just to piggyback on the global considerations—as you say, the U.S. economy has been growing. Are you worried that, given the global interconnectedness, the low inflation globally, all of the other concerns that you just spoke about, that you may never escape from this zero lower bound situation?
CHAIR YELLEN. So I would be very—I would be very surprised if that’s the case. That is not the way I see the outlook or the way the Committee sees the outlook. Can I completely rule it out? I can’t completely rule it out. But, really, that’s an extreme downside risk that in no way is near the center of my outlook.
Shuddering financial markets in the wake of the Fed’s first rate hike since 2006 certainty tested Yellen’s confidence that failure to exit the zero bound was nothing more than an “extreme” tail risk. Indeed, it looked all too possible, even as policymakers such as Federal Reserve Vice-Chair Stanley Fischer and San Francisco Federal Reserve President John Williams counseled dismissing financial market turbulence as something the economy could withstand as it has in the past (ignoring though the role the Fed play in such resilience).
Luckily for Yellen, she heeded the warnings of Federal Reserve Governor Lael Brainard, who has since last fall has cautioned that the Fed faced more danger than commonly believed within the confines of the Eccles Building. With her speech this week, Yellen clearly embraced Brainard’s warnings. She is choosing the risk of overheating the economy – and sending inflation above target – over the risk of failing at the one and perhaps only chance to leave the zero bound behind.
While the exit from the zero bound remains uncertain, Yellen’s new path is at least more likely to succeed than blindly ignoring financial market signals by following through with expected rate hikes. And that’s important for more than just Yellen’s legacy. Her legacy is intertwined with the health of the US economy.
There is much to be had in Yellen’s speech this week. Highlights include an awareness that the neutral rate of interest is not rising as quickly as expected, the global economy is a risk that cannot be ignored, the recent uptick in inflation might be less than meets the eye, and a recognition that falling long-rates represent an expectation of easier monetary policy, and the Fed needs to meet that expectation to ensure that financial market remain sufficiently accommodative.
But two points in particular caught me eye. The first was a deeper appreciation of the asymmetric risks facing policymakers. Yellen notes that although the Fed retains a litany of potential unconventional tools:
“…if the expansion was to falter or if inflation was to remain stubbornly low, the FOMC would be able to provide only a modest degree of additional stimulus by cutting the federal funds rate back to near zero.”
If you want to successful pull off the zero bound, you better make sure that you conditions give you some distance from that bound before you need to start cutting again. That distance is effectively almost none, and will likely remain limited for substantial time. Better to move glacially rather than gradually.
But more important was the role of deteriorating inflation expectations in her analysis. Recall that in her September speech, Yellen sought to emphasize her faith in the Phillips curve as a reason to begin rates hikes sooner than later. She noted the importance of anchored inflation expectations in her assessment, saying:
“…the presence of well-anchored inflation expectations greatly enhances a central bank's ability to pursue both of its objectives--namely, price stability and full employment...
… Although the evidence, on balance, suggests that inflation expectations are well anchored at present, policymakers would be unwise to take this situation for granted. Anchored inflation expectations were not won easily or quickly: Experience suggests that it takes many years of carefully conducted monetary policy to alter what households and firms perceive to be inflation's "normal" behavior, and, furthermore, that a persistent failure to keep inflation under control--by letting it drift either too high or too low for too long--could cause expectations to once again become unmoored.”
The stability of inflation expectations is now, however, less certain:
"The inflation outlook has also become somewhat more uncertain since the turn of the year, in part for reasons related to risks to the outlook for economic growth...
… Lately, however, there have been signs that inflation expectations may have drifted down. Market-based measures of longer-run inflation compensation have fallen markedly over the past year and half, although they have recently moved up modestly from their all-time lows. Similarly, the measure of longer-run inflation expectations reported in the University of Michigan Survey of Consumers has drifted down somewhat over the past few years and now stands at the lower end of the narrow range in which it has fluctuated since the late 1990s…
…Taken together, these results suggest that my baseline assumption of stable expectations is still justified. Nevertheless, the decline in some indicators has heightened the risk that this judgment could be wrong."
To be sure, Yellen recognizes that inflation may rebound more quickly than expected, but the overall thrust of her argument is that although labor markets have continues to improve and rising wages suggests the economy is reaching full employment, the risks to stable inflation expectations are now too on the downside. And if expectations become unanchored, the Fed will fail to meet it’s 2 percent inflation target anytime soon. Moreover, the Fed would be faced with trying to re-establish expectations in the absence of their conventional tools. That might be a tall order.
Bottom Line: Rising risks to the outlook placed Yellen’s legacy in danger. If the first rate hike wasn’t a mistake, certainly follow up hikes would be. And there is no room to run; if you want to “normalize” policy, Yellen needs to ensure that rates rise well above zero before the next recession hits. The incoming data suggests that means the economy needs to run hotter for longer if the Fed wants to leave the zero bound behind. Yellen is getting that message. But perhaps more than anything, the risk of deteriorating inflation expectations – the basis for the Fed’s credibility on its inflation target – signaled to Yellen that rates hike need to be put on hold. Continue to watch those survey-based measures; they could be key for the timing of the next rate hike.
Unemployment Rate Edges Higher as Prime-Age Workers Re-enter Labor Market: Self-employment has risen substantially since the ACA took effect.
The economy added 215,000 jobs in March, with the unemployment rate rounding up to 5.0 percent from February's 4.9 percent. However, the modest increase in unemployment was largely good news, since it was the result of another 396,000 people entering the labor force. There has been a large increase in the labor force over the last six months, especially among prime-age workers. Since September, the labor force participation rate for prime-age workers has increased by 0.8 percentage points. This seems to support the view that the people who left the labor market during the downturn will come back if they see jobs available. However, even with this recent rise, the employment-to-population ratio for prime-age workers is still down by more than two full percentage points from its pre-recession peak. Another positive item in the household survey was a large jump in the percentage of unemployment due to voluntary quits. This sign of confidence in the labor market rose to 10.5 percent, the highest level in the recovery to date, although it's still more than a percentage point below the pre-recession peaks and almost five percentage points below the peak reached in 2000.
Other items in the household survey were mixed. The number of people involuntarily working part-time rose by 135,000, reversing several months of declines. However, involuntary part-time work is still down by 550,000 from year-ago levels. The number of people voluntarily working part-time fell in March, but it is still 654,000 above its year-ago level.
One of the desired outcomes from the ACA was that it would free people from dependence on their employer for health care insurance, allowing them to work part-time or start a business if they so choose and get insurance through the exchanges. There has been a substantial rise in self-employment since the exchanges began operating in 2014. In the first quarter of 2016, incorporated self-employment was up by more than 400,000 (7.8 percent) from the same quarter of 2013. Unincorporated self-employment was also up by almost 360,000 (3.9 percent).
While the employment growth in the establishment survey was in line with expectations, average weekly hours remained at 34.4, down from 34.6 in January. This indicates that February’s drop in hours was not just a result of bad weather. As a result, the index of aggregate hours worked is down by 0.2 percent from the January level. This could be a sign of slower job growth in future months. ...
The average hourly wage rose modestly in March after a reported decline in February. There is zero evidence of any acceleration in wage growth. The average for the last three months increased at an annualized rate of 2.3 percent compared with the average of the prior three months. This is virtually identical to the increase over the last year.
On the whole this is a positive report, both because the economy continues to create jobs at a healthy pace and even more importantly because it indicates that people are returning to the labor market. The continuing weakness in wage growth is discouraging, but also should signal to the Fed that there is little reason to raise interest rates.
"The lesson of the Obama years":
Learning From Obama, by Paul Krugman, Commentary, NY Times: Like many political junkies, I’ve been spending far too much time looking at polls... But the primaries aren’t the only things being polled; we’re still getting updates on President Obama’s overall approval. And ... his approval has risen sharply while disapproval has plunged. ... What’s going on?
Well, one answer is that voters have lately been given a taste of what really bad leaders look like. But I’d like to think that the public is also starting to realize just how successful the Obama administration has been...
I know that it’s hard for many people on both sides to wrap their minds around the notion of Obama-as-success. On the left, those caught up in the enthusiasms of 2008 feel let down by the prosaic reality of governing in a deeply polarized political system. Meanwhile, conservative ideology predicts disaster from any attempt to tax the rich, help the less fortunate and rein in the excesses of the market...
But the successes are there for all to see.
Start with the economy..., it’s important news if the economy has performed well. And it has..., just imagine the boasting we’d be hearing if Mitt Romney occupied the White House.
Then there’s health reform, which has (don’t tell anyone) been meeting its goals. ...
Then there’s financial reform, which the left considers toothless and the right considers destructive. In fact, while the big banks haven’t been broken up, excessive leverage — the real threat to financial stability — has been greatly reduced. And as for the economic effects, have I mentioned how well we’ve done on job creation?
Last but one hopes not least, the Obama administration has used executive authority to take ... very significant action on climate change.
All in all, it’s quite a record. ...
The 2008 election didn’t bring the political transformation Obama enthusiasts expected, nor did it destroy the power of the vested interests: Wall Street, the medical-industrial complex and the fossil fuel lobby are all still out there, using their money to buy influence. But they have been pushed back in ways that have made American lives better and more secure.
The lesson of the Obama years, in other words, is that success doesn’t have to be complete to be very real. You say you want a revolution? Well, you can’t always get what you want — but if you try sometimes, you just might find, you get what you need.
David Glasner (I cut quite a bit -- the original is more than twice as long):
What’s so Great about Free Trade?: Free trade is about as close to a sacred tenet as can be found in classical and neoclassical economic theory. ... Despite the love and devotion that the doctrine of free trade inspires in economists, the doctrine ... has never been popular among the masses. ...
The key to understanding that disconnect is, I suggest, the way in which economists have been trained to think about individual and social welfare, which, it seems to me, is totally different from how most people think about their well-being. In the standard utility-maximization framework, individual well-being is a monotonically increasing function of individual consumption, leisure being one of the “goods” being consumed, so that reductions in hours worked is, when consumption of everything else is held constant, welfare-increasing. Even at a superficial level, this seems totally wrong. ...
What people do is a far more important determinant of their overall estimation of how well-off they are than what they consume. When you meet someone, you are likely, if you are at all interested in finding out about the person, to ask him or her about what he or she does, not about what he or she consumes. Most of the waking hours of an adult person are spent in work-related activities. ... It seems to me that what matters to most people is the nature of their relationships with their family and friends and the people they work with, and whether they get satisfaction from their jobs or from a sense that they are accomplishing or are on their way to accomplish some important life goals. ...
Moreover, insofar as people depend on being employed in order to finance their routine consumption purchases..., the unplanned loss of their current job would be a personal disaster, which means that being employed is the dominant – the overwhelming – determinant of their well-being. Ordinary people seem to understand how closely their well-being is tied to the stability of their employment, which is why people are so viscerally opposed to policies that, they fear, could increase the likelihood of losing their jobs.
To think that an increased chance of losing one’s job in exchange for a slight gain in purchasing power owing to the availability of low-cost imports is an acceptable trade-off for most workers does not seem at all realistic. Questioning the acceptability of this trade-off doesn’t mean that ... in principle, the gains from free trade are[n't] large enough to provide monetary compensation to workers who lose their jobs, but I do question whether such compensation is possible in practice or that the compensation would be adequate for the loss of psychic well-being associated with losing one’s job, even if money income is maintained. ...
The psychic effects of losing a job (an increase in leisure!) are ignored by the standard calculations of welfare effects in which well-being is identified with, and measured by, consumption. And these losses are compounded and amplified when they are concentrated in specific communities and regions...
The goal of this post is not to make an argument for protectionist policies, let alone for any of the candidates arguing for protectionist policies. The aim is to show how inadequate the standard arguments for free trade are in responding to the concerns of the people who feel that they have been hurt by free-trade policies or feel that the jobs that they have now are vulnerable to continued free trade and ever-increasing globalization. I don’t say that responses can’t be made, just that they haven’t been made.
The larger philosophical or methodological point is that ... economic theory can tell us that an excise tax on sugar tends to cause an increase in the price, and a reduction in output, of sugar. But the idea that we can reliably make welfare comparisons between alternative states of the world when welfare is assumed to be a function of consumption, and that nothing else matters, is simply preposterous. And it’s about time that economists enlarged their notions of what constitutes well-being if they want to make useful recommendations about the welfare implications of public policy, especially trade policy.
- Debunking America’s Populist Narrative - J. Bradford DeLong
- The Economic Effects of Non-compete Agreements - Treasury Notes
- Imagine What Fiscal Policy Could Do For Innovation - iMFdirect
- The Economics of Radical Uncertainty - Bloomberg View
- African Americans are hurt more by the decline in union jobs - Equitable Growth
- An open letter to Senator Grassley from a high school student - Chris Blattman
- America's Missing $15 Billion in Corporate Taxes - David Cay Johnston
- When the media is biased against the facts - mainly macro
- This Is Your Brain on Risk - Bloomberg View
- When Things Fall Apart - Anatole Kaletsky
- Dynamic Inefficiency - Robert Waldmann
- Austerity vs the free market - Stumbling and Mumbling
Thursday, March 31, 2016
Interesting to go back nearly 20 years and ask how much things have changed (or not). This is Paul Krugman at the end of 1996:
The Spiral of Inequality, by Paul Krugman, November/December 1996 Issue, Mother Jones: Ever since the election of Ronald Reagan, right-wing radicals have insisted that they started a revolution in America. They are half right. If by a revolution we mean a change in politics, economics, and society that is so large as to transform the character of the nation, then there is indeed a revolution in progress. The radical right did not make this revolution, although it has done its best to help it along. If anything, we might say that the revolution created the new right. But whatever the cause, it has become urgent that we appreciate the depth and significance of this new American revolution—and try to stop it before it becomes irreversible.
The consequences of the revolution are obvious in cities across the nation. Since I know the area well, let me take you on a walk down University Avenue in Palo Alto, California. ...
You can confirm what your eyes see, in Palo Alto or in any American community, with dozens of statistics. The most straightforward are those on income shares supplied by the Bureau of the Census, whose statistics are among the most rigorously apolitical. In 1970, according to the bureau, the bottom 20 percent of US families received only 5.4 percent of the income, while the top 5 percent received 15.6 percent. By 1994, the bottom fifth had only 4.2 percent, while the top 5 percent had increased its share to 20.1 percent. That means that in 1994, the average income among the top 5 percent of families was more than 19 times that of the bottom 20 percent of families. In 1970, it had been only about 11.5 times as much. (Incidentally, while the change in distribution is most visible at the top and bottom, families in the middle have also lost: The income share of the middle 20 percent of families has fallen from 17.6 to 15.7 percent.) These are not abstract numbers. They are the statistical signature of a seismic shift in the character of our society.
The American notion of what constitutes the middle class has always been a bit strange, because both people who are quite poor and those who are objectively way up the scale tend to think of themselves as being in the middle. But if calling America a middle-class nation means anything, it means that we are a society in which most people live more or less the same kind of life.
In 1970 we were that kind of society. Today we are not, and we become less like one with each passing year. As politicians compete over who really stands for middle-class values, what the public should be asking them is, What middle class? How can we have common "middle-class" values if whole segments of society live in vastly different economic universes?
If this election was really about what the candidates claim, it would be devoted to two questions: Why has America ceased to be a middle-class nation? And, more important, what can be done to make it a middle-class nation again? ...
The Sources of Inequality...
Values, Power, and Wages ...
The Decline of Labor ...
Strategies for the Future ...
Here's a link to the article.
Job Growth in Last Decade Was in Temp and Contract: ...new research ... indicates the proportion of American workers who don’t have traditional jobs — who instead work as independent contractors, through temporary services or on-call — has soared in the last decade. ...
Most remarkably, the number of Americans using these alternate work arrangements rose 9.4 million from 2005 to 2015. That was greater than the rise in overall employment, meaning there was a small net decline in the number of workers with conventional jobs.
That, in turn, raises still bigger questions about how employers have succeeded at shifting much the burden of providing social insurance onto workers, and what technological and economic forces are driving the shift. ...
This change in behavior has profound implications on social insurance. ...
This is from the B of E's Bank Underground:
Modelling banking sector shocks and unconventional policy: new wine in old bottles?, by James Cloyne, Ryland Thomas, and Alex Tuckett: The financial crisis has thrown up a huge number of empirical challenges for academic and professional economists. The search is on for a framework with a rich enough variety of financial and real variables to examine both the financial shocks that caused the Great Recession and the unconventional policies, such as Quantitative Easing (QE), that were designed to combat it. In a new paper we show how using an older structural econometric modelling approach can be used to provide insights into these questions in ways other models currently cannot. So what are the advantages of going back to an older tradition of modelling? An ongoing issue for central bank economists is that they typically want to look at a wide range of financial sector variables and at a more granular, sector-based level of aggregation than typically found in macroeconomic models with credit and asset market frictions. For example, we often want to distinguish between the credit provided to firms separately from that provided to households or between secured lending and unsecured lending. We may also want to compare and contrast a number of policy instruments that work through different channels such as central bank asset purchases (QE) and macroprudential tools such as countercyclical capital requirements.
It is a tough challenge to incorporate all of these effects in the theoretical and empirical models that are typically used by macroeconomists, such as structural vector autoregression (SVAR) models and micro-founded general equilibrium (DSGE) models. For these reasons turning back to the older tradition of building structural econometric models (SEMs) – built from blocks of simultaneously estimated equations with structural identifying restrictions – can be useful. This approach can be thought of as a blend of the more theory-free VAR methods and a more structural model-based approach. The main advantage of the structural econometric frameworks are that they produce quantitative results at a sector level, which can still be aggregated up to produce a general equilibrium response. They also allow models to be built up in a modular way that allows replacing and improving sets of equations for particular blocks of the model without necessarily undermining the logic of the model as a whole. This older school approach to modelling has begun to appear in a variety of modern vintages. ...
- The Pathos of Republican Reformers - Paul Krugman
- Corporate profits are near record highs. That’s a problem. - Larry Summers
- Numbers too good to be true? Or: Thanks, Obama!? - Andrew Gelman
- Rethinking the measurement of economic activity - VoxEU
- Ask the Next President About the Fed - Narayana Kocherlakota
- The Federal Reserve Juggles Priceless Eggs in Variable Gravity... - Brad DeLong
- The Effect of Exchange Rate Shocks on Domestic Prices - Liberty Street
- Economists Are Warming to Government Intervention - Bloomberg View
- Royal Economic Society’s panel on Brexit - VoxEU
- When Workers Get More of the Income Pie - Justin Fox
- The EU as Qwerty keyboard - Stumbling and Mumbling
- The Trump-Sanders China Syndrome - WSJ
- A very simple neo-Fisherian model - John Cochrane
Wednesday, March 30, 2016
Time to end the shovel ready excuses on infrastructure spending:
It’s Time to Invest in Schools: The country is $46 billion a year behind what it should spend on building and repairing K-12 schools to provide healthy and safe modern facilities, a new report from the 21st Century School Fund, the National Council on School Facilities, and the U.S. Green Building Council finds. This neglect hurts students’ health and school performance — and by extension, weakens the country’s long-term prosperity, as we noted in our recent paper on the nation’s declining infrastructure investments.
And while underinvestment in school buildings has occurred nationwide, the disparity between low- and higher-income communities is pronounced. The wealthiest school districts spent almost three times as much per student on school facility improvements than the poorest districts between 1995 and 2004, according to a separate study of almost 150,000 school improvement projects. As a result, a higher percentage of public schools in poor areas need repair than those in wealthier places, the National Center for Education Statistics has noted...
In a tweet, Antonio Fatás says "I hope this does not sound too Neo-Fisherian":
Central Banks need to get real (not nominal): While the ECB and Bank of Japan are exploring negative interest rates, the US Federal Reserve is preparing us for a slow and cautious increase in short-term interest rates. Long-term rates remain at very low levels and inflation expectations have come under pressure and also remain below what they were a few months or years ago. And as this is going on markets are trying to figure out if they like low or high interest rates. And even if they decide that they like low rates, are negative rates too low?
In all these debates there seems to be an unusual amount of what economists call money illusion or lack of understanding of the difference between nominal and real interest rates. This confusion, in my view, is partly motivated by the communication strategy of central banks that seem to obsess with the asymmetric nature of their inflation targets (for both the ECB and US Fed, inflation targets are defined as close but below 2%) and are not clear enough on their final goal and its timing.
How do we want interest rates to react to aggressive monetary policy? The common answer is that we want interest rates to go down. This is correct if we think in real terms: given inflation expectations (or actual inflation), we want interest rates to move down relative to those inflation levels. But in some cases, in particular when inflation expectations are lower than what central banks would like them to be, the central bank by being aggressive is targeting higher inflation expectations and this can possibly lead to higher nominal (long-term) interest rates.
This is what happened in the three rounds of quantitative easing by the US Federal Reserve. 10-Year interest rates went up which was a signal of increasing inflation expectations (and even higher expectations of future real interest rates). This was seen as a success.
But the behavior of long-term interest rates or inflation expectations in response to recent communications by central banks has gone in the opposite direction. Long-term rates have come down (in particular in the Euro area). But don't we want lower interest rates? Isn't this the objective of massive purchases of long-term assets by central banks? Yes if we talk about real interest rates but not obvious if we talk about nominal ones. What we really want is inflation expectations (and inflation) to increase and this is likely to keep long-term interest rates from falling so much.
And here is where I feel the central banks are not helping themselves. There are two mistakes they are doing: in their messages about interest rates they do not distinguish clearly between nominal and real interest rates. What I want to do is to send a message that real interest rates will remain low for an extended period of time to ensure higher inflation ahead and to ensure that nominal interest rates increase in the future so that we can escape the zero lower bound. By talking only about nominal interest rates central banks are sending a signal that we will be stuck at the zero lower bound for a long time, a message that seems to be an admission of defeat. They cannot get out of this trap.
And this leads me to the second mistake of central banks: their asymmetric view of their inflation target. In the US, inflation and core inflation is slowly moving towards the 2% target. This is seen by some as a proof that the zero lower bound or the deflation trap has been defeated. But this is the wrong reading. The fact that the federal funds rate remains so close to 0% means that we are still at the zero lower bound or close enough to it and we should not be complacent with what we achieved. The US Federal Reserve should only call it a success when the federal funds rate is back to 3% or higher, safe away from 0%. But to get there we need to shoot for higher inflation, at least temporarily. The same message or even stronger applies to the ECB.
In summary, success in escaping the zero lower bound should be judged by how central bank interest rates manage to move away from 0% not by how long they stay at 0%. Central banks are not communicating this clearly because of the fear that this would be interpreted as a message of future tightening of monetary policy. But by doing so they are hurting their ability to escape the deflation/lowflation trap.
- Nafta May Have Saved Autoworker Jobs - NYTimes
- “Economics” as Push Poll - The Baseline Scenario
- Kansas Tried Tax Cuts. Its Neighbor Didn't. Which Worked? - Bloomberg View
- Is HUD housing affordable? Not when you factor in costs to commute - EurekAlert!
- Global AD when Reserve Currencies are in a Liquidity Trap... - Robert Shelburne
- Why high house prices are partly down to austerity - mainly macro
- A pluralist economics mud map - Fresh economic thinking
- Savings, Savings, and More Savings - Dietrich Vollrath
- Finance, Growth and Inequality - OECD Insights
- The Economics of Pandemic Preparedness - Tim Taylor
- Money and inflation: US 2008 vs German 1920s - VoxEU
- Implications of shale oil for Arab producers - VoxEU
- Barriers to equal respect - Stumbling and Mumbling
Tuesday, March 29, 2016
The end of Janet Yellen's speech today:
...The FOMC left the target range for the federal funds rate unchanged in January and March, in large part reflecting the changes in baseline conditions that I noted earlier. In particular, developments abroad imply that meeting our objectives for employment and inflation will likely require a somewhat lower path for the federal funds rate than was anticipated in December.
Given the risks to the outlook, I consider it appropriate for the Committee to proceed cautiously in adjusting policy. This caution is especially warranted because, with the federal funds rate so low, the FOMC's ability to use conventional monetary policy to respond to economic disturbances is asymmetric. If economic conditions were to strengthen considerably more than currently expected, the FOMC could readily raise its target range for the federal funds rate to stabilize the economy. By contrast, if the expansion was to falter or if inflation was to remain stubbornly low, the FOMC would be able to provide only a modest degree of additional stimulus by cutting the federal funds rate back to near zero.9
One must be careful, however, not to overstate the asymmetries affecting monetary policy at the moment. Even if the federal funds rate were to return to near zero, the FOMC would still have considerable scope to provide additional accommodation. In particular, we could use the approaches that we and other central banks successfully employed in the wake of the financial crisis to put additional downward pressure on long-term interest rates and so support the economy--specifically, forward guidance about the future path of the federal funds rate and increases in the size or duration of our holdings of long-term securities.10 While these tools may entail some risks and costs that do not apply to the federal funds rate, we used them effectively to strengthen the recovery from the Great Recession, and we would do so again if needed.11
Of course, economic conditions may evolve quite differently than anticipated in the baseline outlook, both in the near term and over the longer run. If so, as I emphasized earlier, the FOMC will adjust monetary policy as warranted. As our March decision and the latest revisions to the Summary of Economic Projections demonstrate, the Committee has not embarked on a preset course of tightening. Rather, our actions are data dependent, and the FOMC will adjust policy as needed to achieve its dual objectives.
Financial market participants appear to recognize the FOMC's data-dependent approach because incoming data surprises typically induce changes in market expectations about the likely future path of policy, resulting in movements in bond yields that act to buffer the economy from shocks. This mechanism serves as an important "automatic stabilizer" for the economy. As I have already noted, the decline in market expectations since December for the future path of the federal funds rate and accompanying downward pressure on long-term interest rates have helped to offset the contractionary effects of somewhat less favorable financial conditions and slower foreign growth. In addition, the public's expectation that the Fed will respond to economic disturbances in a predictable manner to reduce or offset their potential harmful effects means that the public is apt to react less adversely to such shocks--a response which serves to stabilize the expectations underpinning hiring and spending decisions.12
Such a stabilizing effect is one consequence of effective communication by the FOMC about its outlook for the economy and how, based on that outlook, policy is expected to evolve to achieve our economic objectives. I continue to strongly believe that monetary policy is most effective when the FOMC is forthcoming in addressing economic and financial developments such as those I have discussed in these remarks, and when we speak clearly about how such developments may affect the outlook and the expected path of policy. I have done my best to do so today, in the time you have kindly granted me.
From the CBPP:
Trump, Cruz Tax-Cut Plans Would Force Historically Dramatic Cuts: The tax-cut proposals from Republican presidential candidates Donald Trump and Ted Cruz, in conjunction with their calls for balancing the budget, would dictate low levels of government spending not seen since about 1950, as we explain in a new paper. Programs that receive support across the political spectrum and are important to the well-being of most Americans would dramatically shrink or disappear altogether. Even if policymakers didn’t achieve budget balance under their tax-cut plans but simply offset the costs of the plans themselves, the consequences to essential programs — and to low- and middle-income Americans — would be severe.
These conclusions emerge from an analysis of the Urban-Brookings Tax Policy Center’s (TPC) revenue estimates of the Trump and Cruz tax plans — which would reduce revenues by $9.5 trillion and $8.7 trillion over the next ten years, respectively, according to TPC — and CBPP estimates of what such revenue levels imply for government spending. This analysis examines only the Trump and Cruz plans because TPC has not analyzed John Kasich’s proposals and because the proposals of Democratic candidates Hillary Clinton and Bernie Sanders would raise revenues, not reduce them. The specific findings include...
As dramatic as these figures are, they understate the pressure that the two candidates’ proposals would place on many government programs. Both have proposed large spending increases in certain areas, including Senator Cruz’s proposal to increase defense spending by $2.7 trillion over the next decade and Mr. Trump’s proposal to increase spending on veterans by $500 billion to $1 trillion over this period. Offsetting the cost of such increases, as well as the tax cuts, would require even deeper cuts to other programs. ...
There are big reasons to be for "mercantilist" policies:
- In a world in which a country suffers from a shortage of risk-bearing capacity or a savings glut, exports are a very valuable source of aggregate demand.
- In a world in which there are substantial spillovers from the creation and maintenance of communities of engineering practice, exports in associated industries are a powerful nurturant and imports a powerful retardant of such communities.
- To the claim that subsidies to such communities are better, the proper rebuttal is "subsidies to whom?" Export champions reveal themselves to be competent productive organizations, and policies that encourage competent productive organizations are likely to do more to nurture communities of engineering practice than policies that encourage competent lobbying organizations.
The arguments against "mercantilist" policies are two:
- The little one: such policies are inefficient, in that the losers lose more than the winners win.
- The big one: such policies are not win-win, and economic policy energy is best devoted to things that are win-win--at least in the behind-the-veil-of-ignorance sense of win-win.
Paul Krugman: Trade Deficits: These Times are Different: "In normal times, the counterpart of a trade deficit is capital inflows...
- Trade Deficits: These Times are Different - Paul Krugman
- The Trouble With Predictions - Narayana Kocherlakota
- House GOP Gets 62% of Cuts From Low/Moderate-Income Programs - CBPP
- The labor share, the ongoing recovery, and structural forces - Equitable Growth
- The rise of the ‘gentleman’s A’ and the GPA arms race - The Washington Post
- The Repercussions of Financial Booms and Crises - Capital Ebbs and Flows
- How the Fed Smoothed Quarter-End Volatility in the Fed Funds - Liberty Street
- Making Markets Safe: The Role of Central Clearing - Cecchetti & Schoenholtz
- Do Local Bond Markets Help Fight Inflation? - FRBSF
- Decline of the U.S. Middle Class - Bloomberg View
- Is Bitcoin a Safe Asset? - MacroMania
Monday, March 28, 2016
Why have Republican been more protectionist than Democrats?:
Trade, Labor, and Politics, by Paul Krugman, Commentary, NY Times: There’s a lot of things about the 2016 election that nobody saw coming, and one of them is that international trade policy is likely to be a major issue... What’s more, the positions of the parties will be the reverse of what you might have expected: Republicans, who claim to stand for free markets, are likely to nominate a crude protectionist, leaving Democrats, with their skepticism about untrammeled markets, as the de facto defenders of relatively open trade.
But this isn’t as peculiar a development as it seems. ... It’s true that globalization puts downward pressure on the wages of many workers — but progressives can offer a variety of responses to that pressure, whereas on the right, protectionism is all they’ve got.
When I say that Republicans have been more protectionist than Democrats, I’m not talking about the distant past... Reagan, after all, imposed an import quota on automobiles that ended up costing consumers billions of dollars. And Mr. Bush imposed tariffs on steel that were in clear violation of international agreements, only to back down after the European Union threatened to impose retaliatory sanctions. ...
But protectionism isn’t the only way to fight that downward pressure. ... Consider, for example, the case of Denmark... As a member of the European Union, Denmark is subject to the same global trade agreements as we are... Yet Denmark has much lower inequality than we do. Why?
Part of the answer is that workers in Denmark, two-thirds of whom are unionized, still have a lot of bargaining power. If U.S. corporations were able to use the threat of imports to smash unions, it was only because our political environment supported union-busting. Even Canada, right next door, has seen nothing like the union collapse that took place here.
And the rest of the answer is that Denmark (and, to a lesser extent, Canada) has a much stronger social safety net than we do. In America, we’re constantly told ... we can’t even afford even the safety net we have; strange to say, other rich countries don’t seem to have that problem. ...
And there’s a lesson here that goes beyond this election. If you’re generally a supporter of open world markets — which you should be, mainly because market access is so important to poor countries — you need to know that whatever they may say, politicians who espouse rigid free-market ideology are not on your side.
Oil, Inflation Expectations, and Credibility, by Tim Duy: In an IMF blog post, Maurice Obstfeld, Gian Maria Milesi-Ferretti, and Rabah Arezki offer a solution to the "puzzle" of the weak positive macroeconomic response to low oil prices. Specifically, they posit a sharp rise in real interest rates due to falling inflation expectations is the culprit:
Even though oil is a less important production input than it was three decades ago, that reasoning should work in reverse when oil prices fall, leading to lower production costs, more hiring, and reduced inflation. But this channel causes a problem when central banks cannot lower interest rates. Because the policy interest rate cannot fall further, the decline in inflation (actual and expected) owing to lower production costs raises the real rate of interest, compressing demand and very possibly stifling any increase in output and employment. Indeed, those aggregates may both actually fall. Something like this may be going on at the present time in some economies. Chart 3 is suggestive of a depressing effect of low expected oil prices on expected inflation: it shows the strong recent direct relationship between U.S. oil futures prices and a market-based measure of long-term inflation expectations.
Initially, I was a bit enamored with this idea. As I thought on it more, however, I came to see it as a cautionary tale of chart crime. But digging underneath the surface a bit uncovered some interesting questions about monetary policy and credibility. Specifically, how worried should we be that inflation expectations will soon become unanchored?
Obstfeld et al. rely on a version of this widely publicized chart to support their contention:
The first and most obvious problem is that this chart really proves nothing. For example, I could just as easily presented this chart:
Now I can tell a story that the rising dollar (note the inverted scale) is driving down inflation expectations and thus driving up the real interest rate. Oil, on the other hand, is having exactly the effect we might expect - just look at sales of light trucks and SUVs, not to mention vehicle miles traveled:
Hence, there is no paradox of oil. Lower oil prices are triggering the expected positive impacts. It's about the dollar weighing on inflation expectations that is creating the offsetting impact. Obstfeld et al. apparently do not try to distinguish their story from this one.
(Warning: wonkishness ahead.)
This problem, however, just scratches the surface. Look at either of the first two charts above and two red flags should leap off the screen. The first is the different scales, often used to overemphasize the strength of a correlation. The second is the short time span, often used to disguise the lack of any real long term relationship (I hope I remember these two points the next time I am inclined to post such a chart).
Consider a time span that encompassed the entirety of the 5-year, 5-year forward inflation expectations:
The correlation is less obvious to say the least (note too that changing the scale also suggests less correlation). Why does the correlation appear and disappear? Could any supposed correlation across selected time periods be spurious?
That gets to another issue. When you show me this chart
and claim there is a meaningful relationship, I see two nonstationary variables you are claiming to be cointegrated. The trouble with that is that while oil is a nonstationary process - it is not mean reverting, nor is there reason to believe it should be a mean reverting series. Inflation expectations, however, should be a mean reverting series.
Or more specifically, it should be mean reverting if the central bank is credibly committed to their inflation target. If the central bank is credible, then we anticipate that policymakers will respond with policy that offsets inflation shocks to maintain their inflation target. Hence, inflation expectations should revert to that target and we would expect the series to be stationary.
If inflation expectations are a nonstationary series, then shocks build in the series and inflation expectations would drift persistently away from the central bank's inflation target. Inflation expectations would be unanchored. In other words, if inflation expectations are nonstationary, then we have a problem. More on that in a bit.
It appears that oil prices are nonstationary:
Dickey-Fuller Unit Root Test, Series DCOILBRENTEU
Regression Run From 1987:05:22 to 2016:03:21
With 1 lags chosen from 9 by AIC
Sig Level Crit Value
while, luckily, inflation expectations are stationary:
Dickey-Fuller Unit Root Test, Series T5YIFR
Regression Run From 2003:01:14 to 2016:03:24
With 7 lags chosen from 7 by AIC
Sig Level Crit Value
Which leads me to conclude that the recent correlation between oil prices and 5-year, 5-year forward inflation expectations is not indicative of an underlying relationship and hence policymakers should be wary of accepting the Obstfeld at al. hypothesis. Of course, this should not be a surprise as the theoretical underpinnings for such a relationship are weak. A level shock to the price of oil should not change inflation expectations five years from now.
(The same is true for the dollar as well. And while both the dollar index and oil prices are nonstationary, they don't appear cointegrated, suggesting that instances of high correlation are more spurious than anything else.)
Digging a little deeper, note the University of Michigan Survey of Consumers has a longer series of 5-year inflation expectations which shows less variability than 5-year, 5-year forward inflation expectations:
The UMich inflation series also appears to be stationary:
Dickey-Fuller Unit Root Test, Series UMICH5YEAREX
Regression Run From 1990:08 to 2016:03
With 3 lags chosen from 4 by AIC
Sig Level Crit Value
Consequently, I think we have evidence to support the claim that the Federal Reserve is a credible policymaker in the most important arena, that of maintaining stable inflation expectations.
I suspect the high variability of the 5-year, 5-year forward measure is attributable to financial market structural issues (depth of the market for TIPS, for example) rather than rapidly shifting inflation expectations. Hence, we would expect that should those structural issues lessen in importance, the measure will revert to its mean (assuming the Fed remains a credible policymaker). Nor should we read too much about inflation expectations in this measure. Federal Reserve Chair Janet Yellen has reached the same conclusion, which is why she is wary of claims that shifts in the 5-year, 5-year forward measure reflect inflation expectations - and why she refers to these measures as inflation "compensation" not "expectations." From the March 2016 press conference:
In addition, the Phillips curve theory suggests that inflation expectations are also an important driver of actual wage- and price-setting decisions and inflation behavior, and I believe there’s also solid empirical evidence for that. And it’s one of the reasons that I highlighted in my statement, and we continue to highlight in the FOMC statement, that we are tracking indicators of the inflation expectations that matter to wage and price setting.Now, unfortunately, we don’t have perfect measures of these things. We have survey measures. We know that household measures, even when households are asked about longer- term inflation—at longer-term inflation, they tend to move in response to salient changes in prices that they see every day. In particular, when gas prices go down, which is very noticeable to most households, you tend to see a view—you tend to see responses about long-term inflation marked down. So that’s kind of an overresponse to something that’s transitory. So it’s difficult to get a clear read from those survey measures.
Inflation compensation as measured in financial markets also embodies a variety of risk premia and liquidity premia. And so, it’s also—we monitor those closely and discuss them in the statement in paragraph one, but, again, there’s not a straight read on what’s happening to the expectations that influence wage and price setting. But this model continues to at least influence my own thinking, and it certainly is a factor that I and at least some of my colleagues are incorporating in these projections.
Note too that she also questions the importance of the recent slight downward drift in survey-based measures. I would place more weight on those measures (I think others on the FOMC, such as Governor Lael Brainard, are similarly inclined). In any event, I think the Fed is moving in a credible way to either measure by moving more cautiously than anticipated in December. Hence, we should expect inflation expectation measures to remain stationary.
Of course, if expectations devolve into nonstationary processes (it is a long-period property of the data, hence we cannot definitely declare the answer in any finite time period), we should be very worried that policymakers have lost control of inflationary expectations. And at the present time, they would be unanchored to the downside, not the upside as often feared.
Bottom Line: Be wary of claims that oil prices are influencing inflation expectations; the recent correlation is likely spurious. Inflation expectations look to be following a mean reverting process, indicating that the Federal Reserve's has credibly committed to their inflation target. We should expect policymakers will maintain such credibility if they continue to react to inflation shocks with offsetting policy.
Sunday, March 27, 2016
Jonathan Rothwell at Brookings:
... In his “defense of the one percent,” economist Greg Mankiw argues that elite earnings are based on their higher levels of IQ, skills, and valuable contributions to the economy. The globally-integrated, technologically-powered economy has shifted so that very highly-talented people can generate very high incomes.
It is certainly true that rising relative returns to education have driven up inequality. But as I have written earlier, this is true among the bottom 99 percent. There is no evidence to support the idea that the top 1 percent consists mostly of people of “exceptional talent.” In fact, there is quite a bit of evidence to the contrary.
Drawing on state administrative records for millions of individual Americans and their employers from 1990 to 2011, John Abowd and co-authors have estimated how far individual skills influence earnings in particular industries. They find that people working in the securities industry (which includes investment banks and hedge funds) earn 26 percent more, regardless of skill. Those working in legal services get a 23 percent pay raise. These are among the two industries with the highest levels of “gratuitous pay”—pay in excess of skill (or “rents” in the economics literature). At the other end of the spectrum, people working in eating and drinking establishments earn 40 percent below their skill level. ...
Much more here.
Saturday, March 26, 2016
Reflections on Macroeconomics Then and Now: I am grateful to the National Association for Business Economics (NABE) for conferring the fourth annual NABE Paul A. Volcker Lifetime Achievement Award for Economic Policy on me, thereby allowing me the honor of following in the footsteps of Paul Volcker, Jean-Claude Trichet, and Alice Rivlin.1 The honor of receiving the award is enhanced by its bearing the name of Paul Volcker, a model citizen and public servant, and a giant in every sense among central bankers.
One thinks of many things on an occasion such as this one. My mind goes back first to growing up in a very small town in Zambia, then Northern Rhodesia, and to the surprise and delight my parents would have felt at seeing me standing where I am now. They would have been even more delighted that my girlfriend, Rhoda, whom I met when my parents moved to a bigger town in Zimbabwe, and I have been happily married for 50 years. But that is not the story I will tell today. Rather, I want to talk about our field, macroeconomics, and some of the lessons we have learned in the course of the last 55 years--and I say 55 years, because in 1961, at the end of my school years, on the advice of a friend, I read Keynes's General Theory for the first time.
Did I understand it? Certainly not. Was I captivated by it? Certainly, though "captured" is a more appropriate word than "captivated." Does it remain relevant? Certainly. Just a week ago I took it off the bookshelf to read parts of chapter 23, "Notes on Mercantilism, the Usury Laws, Stamped Money and Theories of Under-Consumption." Today that chapter would be headed "Protectionism, the Zero Lower Bound, and Secular Stagnation," with the importance of usury laws having diminished since 1936.
There is an old joke about our field--not the one about the one-handed economist, nor the one about "assume you have a can opener," nor the one that ends, "If I were you, I wouldn't start from here." Rather it's the one about the Ph.D. economist who returns to his university for his class's 50th reunion. He asks if he can see the most recent Ph.D. generals exam. After a while it is brought to him. He reads it carefully, looking perplexed, and then says, "But this is exactly the same as the exam I wrote over 50 years ago." "Ah yes," says the professor. "It is the same, but all the answers are different."
Is that really the case? Not really, though it is true to some extent in the realm of policy. To discuss the question of whether the answers to the questions of how to deal with macroeconomic policy problems have changed markedly over the past half-century or so, I will start by briefly sketching the structure of a basic macro model. The building blocks of this model are similar to those used in many macro models, including FRB/US, the Fed staff's large-scale model, and a variety of DSGE (dynamic stochastic general equilibrium) models used at the Fed and other central banks and by academic researchers.
The structure of the model starts with the standard textbook equation for aggregate demand for domestically produced goods, namely:2
- AD = C + I + G + NX;
- Next is the wage-price block, which is based on a wage or price Phillips curve. Okun's law is included to make the transition between output and employment;
- Monetary policy is described by a money supply or interest rate rule;
- The credit markets and financial intermediation are built off links between the policy interest rate and the rates of return on, and/or demand and supply functions for, other assets;
- The balance of payments and the exchange rate enter through the balance of payments identity, namely that the current account surplus must be equal to the capital account deficit, corrected for official intervention;
- Dynamics of stocks: There are dynamic equations for the capital stock, the stock of government debt, and the external debt.
When I was an undergraduate at the London School of Economics (LSE) between 1962 and 1965, we learned the IS-LM model, which combined the aggregate demand equation (1) with the money market equilibrium condition set out in (3). That was the basic understanding of the Keynesian model as crystallized by John Hicks, Franco Modigliani, and others, in which it was easy to add detail to the demand functions for private-sector consumption, C; for investment, I; for government spending, G; and for net exports. The Keynesian emphasis on aggregate demand and its determinants is one of the basic innovations of the Keynesian revolution, and one that makes it far easier to understand and explain what factors are determining output and employment.
Continuing down the list, on price and wage dynamics, the Phillips curve has flattened somewhat since the 1950s and 1960s.3 Further, the role of expectations of inflation in the Phillips curve has been developed far beyond what was understood when A.W. Phillips--who was a New Zealander, an LSE faculty member, and a statistician and former engineer--discovered what later became the Phillips curve. The difference between the short- and long-run Phillips curves, which is now a staple of textbooks, was developed by Milton Friedman and Edmund Phelps, and the effect of making expectations rational or model consistent was emphasized by Robert Lucas, whose islands model provided an imperfect information reason for a nonvertical short-run Phillips curve. In Okun's law, the Okun coefficient--the coefficient specifying how much a change in the unemployment rate affects output--appears to have declined over time. So has the trend rate of productivity growth, which is a critical determinant of future levels of per capita income.
In (3), the monetary equilibrium condition, the monetary policy decision was typically represented by the money stock at the LSE and perhaps also at the Massachusetts Institute of Technology (MIT) after the Keynesian revolution (after all, "L" represents the liquidity preference function and "M" the supply of money); now the money supply rule is replaced by an interest-rate setting rule, for instance a reaction function of some form, or by a calculated "optimal" policy based on a loss function.
The development of the flexible inflation-targeting approach to monetary policy is one of the major achievements of modern macroeconomics. Flexible inflation targeting allows for flexibility in the speed with which the monetary authority plans on returning to the target inflation rate, and is thereby close to the dual mandate that the law assigns to the Fed.
A great deal of progress has been made in developing the credit and financial intermediation block. As early as the 1960s, each of James Tobin, Milton Friedman, and Karl Brunner and Alan Meltzer wrote out models with more fully explicated financial sectors, based on demand functions for assets other than money. Later the demand functions were often replaced by pricing equations derived from the capital asset pricing model. Researchers at the Fed have been bold enough to add estimated term and risk premiums to the determination of the returns on some assets.4 They have concluded, inter alia, that the arguments we used to make about how easy it would be to measure expected inflation if the government would introduce inflation-indexed bonds failed to take into account that returns on bonds are affected by liquidity and risk premiums. This means that one of the major benefits that were expected from the introduction of inflation-indexed bonds (Treasury Inflation-Protected Securities, generally called TIPS), namely that they would provide a quick and reliable measure of inflation expectations, has not been borne out, and that we still have to struggle to get reasonable estimates of expected inflation.
As students, we included NX, net exports, in the aggregate demand equation, but we did not generally solve for the exchange rate, possibly because the exchange rate was typically fixed. Later, in 1976, Rudi Dornbusch inaugurated modern international macroeconomics--and here I'm quoting from a speech by Ken Rogoff--in his famous overshooting model.5 As globalization of both goods and asset markets intensified over the next 40 years, the international aspects of trade in goods and assets occupied an increasingly important role in the economies of virtually all countries, not least the United States, and in macroeconomics.
At the LSE, we took a course on the British economy from Frank Paish, whose lectures consisted of a series of charts, accompanied by narrative from the professor. He made a strong impression on me in a lecture in 1963, in which he said, "You see, it (the balance of payments deficit) goes up and it goes down, and it is clear that we are moving toward a balance of payments crisis in 1964." I waited and I watched, and the crisis appeared on schedule, as predicted. But Paish also warned us that forecasting was difficult, and gave us the advice "Never look back at your forecasts--you may lose your nerve." I pass that wisdom on to those of you who need it.
I remember also my excitement at being told by a friend in a more senior class about the existence of econometric models of the entire economy. It was a wonderful moment. I understood that economic policy would from then on be easy: All that was necessary was to feed the data into the model and work out at what level to set the policy parameters. Unfortunately, it hasn't worked out that way. On the use of econometric models, I think often of something Paul Samuelson once said: "I'd rather have Bob Solow's views than the predictions of a model. But I'd rather have Solow with a model than without one."
We learned a lot at the LSE. But wonderful as it was to be in London, and to meet people from all over the world for the first time, and to be able to travel to Europe and even to the Soviet Union with a student group, and to ski for the first time in my life in Austria, it gradually became clear to me that the center of the academic economics profession was not in London or Oxford or Cambridge, but in the United States.
There was then the delicate business of applying to graduate school. There was a strong Chicago tendency among many of the lecturers at the LSE, but I wanted to go to MIT. When asked why, I gave a simple answer: "Samuelson and Solow." Fortunately, I got into MIT and had the opportunity of getting to know Samuelson and Solow and other great professors. And I also met the many outstanding students who were there at the time, among them Robert Merton. I took courses from Samuelson and Solow and other MIT stars, and I wrote my thesis under the guidance of Paul Samuelson and Frank Fisher. From there, my first job was at the University of Chicago--and I understood that I was very lucky to have been able to learn from the great economists at both MIT and Chicago. Among the many things I learned at Chicago was a Milton Friedman saying: "Man may not be rational, but he's a great rationalizer," which is a quote that often comes to mind when listening to stock market analysts.
After four years at Chicago, I returned to the MIT Department of Economics, and thought that I would never leave--even more so when MIT succeeded in persuading Rudi Dornbusch, whom I had met when he was a student at Chicago, to move to MIT--thus giving him too the benefit of having learned his economics at both Chicago and MIT, and giving MIT the pleasure and benefit of having added a superb economist and human being to the collection of such people already present.
MIT was still heavily involved in developing growth theory at the time I was a Ph.D. student there, from 1966 to 1969. We students were made aware of Kaldor's stylized facts about the process of growth, presented in his 1957 article "A Model of Economic Growth." They were:
- The shares of national income received by labor and capital are roughly constant over long periods of time.
- The rate of growth of the capital stock per worker is roughly constant over long periods of time.
- The rate of growth of output per worker is roughly constant over long periods of time.
- The capital/output ratio is roughly constant over long periods of time.
- The rate of return on investment is roughly constant over long periods of time.
- The real wage grows over time.
Well, that was then, and many of the problems we face in our economy now relate to the changes in the stylized facts about the behavior of the economy: Every one of Kaldor's stylized facts is no longer true, and unfortunately the changes are mostly in a direction that complicates the formulation of economic policy.6
While the basic approach outlined so far remains valid, and can be used to address many macroeconomic policy issues, I would like briefly to take up several topics in more detail. Some of them are issues that have remained central to the macroeconomic agenda over the past 50 years, some have to my regret fallen off the agenda, and others are new to the agenda.
- Inflation and unemployment: Estimated Phillips curves appear to be flatter than they were estimated to be many years ago--in terms of the textbooks, Phillips curves appear to be closer to what used to be called the Keynesian case (flat Phillips curve) than to the classical case (vertical Phillips curve). Since the U.S. economy is now below our 2 percent inflation target, and since unemployment is in the vicinity of full employment, it is sometimes argued that the link between unemployment and inflation must have been broken. I don't believe that. Rather the link has never been very strong, but it exists, and we may well at present be seeing the first stirrings of an increase in the inflation rate--something that we would like to happen.
- Productivity and growth: The rate of productivity growth in the United States and in much of the world has fallen dramatically in the past 20 years. The table shows calculated rates of annual productivity growth for the United States over three periods: 1952 to 1973; 1974 to 2007; and the most recent period, 2008 to 2015. After having been 3 percent and 2.1 percent in the first two periods, the annual rate of productivity growth has fallen to 1.2 percent in the period since the start of the global financial crisis.
The right guide to thinking in this case is given by a famous Herbert Stein line: "The difference between a growth rate of 1 percent and 2 percent is 100 percent." Why? Productivity growth is a major determinant of long-term growth. At a 1 percent growth rate, it takes income 70 years to double. At a 2 percent growth rate, it takes 35 years to double. That is to say, that with a growth rate of 1 percent per capita, it takes two generations for per capita income to double; at a 2 percent per capita growth rate, it takes one generation for per capita income to double. That is a massive difference, one that would very likely have severe consequences for the national mood, and possibly for economic policy. That is to say, there are few issues more important for the future of our economy, and those of every other country, than the rate of productivity growth.
At this stage, we simply do not know what will happen to productivity growth. Robert Gordon of Northwestern University has just published an extremely interesting and pessimistic book that argues we will have to accept the fact that productivity will not grow in future at anything like the rates of the period before 1973. Others look around and see impressive changes in technology and cannot believe that productivity growth will not move back closer to the higher levels of yesteryear.7 A great deal of work is taking place to evaluate the data, but so far there is little evidence that data difficulties account for a significant part of the decline in productivity growth as calculated by the Bureau of Labor Statistics.8
- The ZLB and the effectiveness of monetary policy: From December 2008 to December 2015, the federal funds rate target set by the Fed was a range of 0 to 1/4 percent, a range of rates that was described as the ZLB (zero lower bound).9 Between December 2008 and December 2014, the Fed engaged in QE--quantitative easing--through a variety of programs. Empirical work done at the Fed and elsewhere suggests that QE worked in the sense that it reduced interest rates other than the federal funds rate, and particularly seems to have succeeded in driving down longer-term rates, which are the rates most relevant to spending decisions.
Critics have argued that QE has gradually become less effective over the years, and should no longer be used. It is extremely difficult to appraise the effectiveness of a program all of whose parameters have been announced at the beginning of the program. But I regard it as significant with respect to the effectiveness of QE that the taper tantrum in 2013, apparently caused by a belief that the Fed was going to wind down its purchases sooner than expected, had a major effect on interest rates.
More recently, critics have argued that QE, together with negative interest rates, is no longer effective in either Japan or in the euro zone. That case has not yet been empirically established, and I believe that central banks still have the capacity through QE and other measures to run expansionary monetary policies, even at the zero lower bound.
- The monetary-fiscal policy mix: There was once a great deal of work on the optimal monetary-fiscal policy mix. The topic was interesting and the analysis persuasive. Nonetheless the subject seems to be disappearing from the public dialogue; perhaps in ascendance is the notion that--except in extremis, as in 2009--activist fiscal policy should not be used at all. Certainly, it is easier for a central bank to change its policies than for a Treasury or Finance Ministry to do so, but it remains a pity that the fiscal lever seems to have been disabled.
- The financial sector: Carmen Reinhart and Ken Rogoff's book, This Time Is Different, must have been written largely before the start of the great financial crisis. I find their evidence that a recession accompanied by a financial crisis is likely to be much more serious than an ordinary recession persuasive, but the point remains contentious. Even in the case of the Great Recession, it is possible that the U.S. recession got a second wind when the euro-zone crisis worsened in 2011. But no one should forget the immensity of the financial crisis that the U.S. economy and the world went through following the bankruptcy of Lehman Brothers--and no one should forget that such things could happen again.
The subsequent tightening of the financial regulatory system under the Dodd-Frank Act was essential, and the complaints about excessive regulation and excessive demands for banks to hold capital betray at best a very short memory. We, the official sector and particularly the regulatory authorities, do have an obligation to try to minimize the regulatory and other burdens placed on the private sector by the official sector--but we have a no less important obligation to try to prevent another financial crisis. And we should also remember that the shadow banking system played an important role in the propagation of the financial crisis, and endeavor to reduce the riskiness of that system.
- The economy and the price of oil: For some time, at least since the United States became an oil importer, it has been believed that a low price of oil is good for the economy. So when the price of oil began its descent below $100 a barrel, we kept looking for an oil-price-cut dividend. But that dividend has been hard to discern in the macroeconomic data. Part of the reason is that as a result of the rapid expansion of the production of oil from shale, total U.S. oil production had risen rapidly, and so a larger part of the economy was adversely affected by the decline in the price of oil. Another part is that investment in the equipment and structures needed for shale oil production had become an important component of aggregate U.S. investment, and that component began a rapid decline. For these reasons, although the United States has remained an oil importer, the decrease in the world price of oil had a mixed effect on U.S. gross domestic product. There is reason to believe that when the price of oil stabilizes, and U.S. shale oil production reaches its new equilibrium, the overall effect of the decline in the price of oil will be seen to have had a positive effect on aggregate demand in the United States, since lower energy prices are providing a noticeable boost to the real incomes of households.
- Secular stagnation: During World War II in the United States, many economists feared that at the end of the war, the economy would return to high pre-war levels of unemployment--because with the end of the war, demobilization, and the massive reduction that would take place in the defense budget, there would not be enough demand to maintain full employment.
Thus was born or renewed the concept of secular stagnation--the view that the economy could find itself permanently in a situation of low demand, less than full employment, and low growth.10 That is not what happened after World War II, and the thought of secular stagnation was correspondingly laid aside, in part because of the growing confidence that intelligent economic policies--fiscal and monetary--could be relied on to help keep the economy at full employment with a reasonable growth rate.
Recently, Larry Summers has forcefully restated the secular stagnation hypothesis, and argued that it accounts for the current slowness of economic growth in the United States and the rest of the industrialized world. The theoretical case for secular stagnation in the sense of a shortage of demand is tied to the question of the level of the interest rate that would be needed to generate a situation of full employment. If the equilibrium interest rate is negative, or very small, the economy is likely to find itself growing slowly, and frequently encountering the zero lower bound on the interest rate.
Research has shown a declining trend in estimates of the equilibrium interest rate. That finding has become more firmly established since the start of the Great Recession and the global financial crisis.11 Moreover, the level of the equilibrium interest rate seems likely to rise only gradually to a longer-run level that would still be quite low by historical standards.
What factors determine the equilibrium interest rate? Fundamentally, the balance of saving and investment demands. Several trends have been cited as possible factors contributing to a decline in the long-run equilibrium real rate. One likely factor is persistent weakness in aggregate demand. Among the many reasons for that, as Larry Summers has noted, is that the amount of physical capital that the revolutionary information technology firms with high stock market valuations have needed is remarkably small. The slowdown of productivity growth, which as already mentioned has been a prominent and deeply concerning feature of the past six years, is another important factor.12 Others have pointed to demographic trends resulting in there being a larger share of the population in age cohorts with high saving rates.13 Some have also pointed to high saving rates in many emerging market countries, coupled with a lack of suitable domestic investment opportunities in those countries, as putting downward pressure on rates in advanced economies--the global savings glut hypothesis advanced by Ben Bernanke and others at the Fed about a decade ago.14
Whatever the cause, other things being equal, a lower level of the long-run equilibrium real rate suggests that the frequency and duration of future episodes in which monetary policy is constrained by the ZLB will be higher than in the past. Prior to the crisis, some research suggested that such episodes were likely to be relatively infrequent and generally short lived.15 The past several years certainly require us to reconsider that basic assumption. Moreover, recent experience in the United States and other countries has taught us that conducting monetary policy at the effective lower bound is challenging.16 And while unconventional policy tools such as forward guidance and asset purchases have been extremely helpful and effective, all central banks would prefer a situation with positive interest rates, restoring their ability to use the more traditional interest rate tool of monetary policy.17
The answer to the question "Will the equilibrium interest rate remain at today's low levels permanently?" is also that we do not know. Many of the factors that determine the equilibrium interest rate, particularly productivity growth, are extremely difficult to forecast. At present, it looks likely that the equilibrium interest rate will remain low for the policy-relevant future, but there have in the past been both long swings and short-term changes in what can be thought of as equilibrium real rates.
Eventually, history will give us the answer. But it is critical to emphasize that history's answer will depend also on future policies, monetary and other, notably including fiscal policy.
Well, are the answers all different than they were 50 years ago? No. The basic framework we learned a half-century ago remains extremely useful. But also yes: Some of the answers are different because they were not on previous exams because the problems they deal with were not evident fifty years ago. So the advice to potential policymakers is simple: Learn as much as you can, for most of it will come in useful at some stage of your career; but never forget that identifying what is happening in the economy is essential to your ability to do your job, and for that you need to keep your eyes, your ears, and your mind open, and with regard to your mouth--to use it with caution.
Many thanks again for this award and this opportunity to speak with you.
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Blanchard, Olivier, Eugenio Cerutti, and Lawrence Summers (2015). "Inflation and Activity--Two Explorations and Their Monetary Policy Implications (PDF)," IMF Working Paper WP/15/230. Washington: International Monetary Fund, November.
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Dornbusch, Rudiger, Stanley Fischer, and Richard Startz (2014). Macroeconomics, 12th ed. New York: McGraw-Hill Education.
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Gordon, Robert J. (2014). "The Demise of U.S. Economic Growth: Restatement, Rebuttal, and Reflections," NBER Working Paper Series 19895. Cambridge, Mass.: National Bureau of Economic Research, February.
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1. I am grateful to David Lopez-Salido, Andrea Ajello, Elmar Mertens, Stacey Tevlin, and Bill English of the Federal Reserve Board for their assistance. Views expressed are mine, and are not necessarily those of the Federal Reserve Board or the Federal Open Market Committee.
2. A fuller description of the equations is contained in the appendix.
3. See Blanchard (2016).
4. See D'Amico, Kim, and Wei (2014).
5. See Dornbusch (1976) and Rogoff (2001).
6. See Jones and Romer (2010).
7. See, for instance, Mokyr, Vickers, and Ziebarth (2015).
8. See Byrne, Fernald, and Reinsdorf (forthcoming).
9. Inside the Fed, the range of 0 to 1/4 percent is generally called the ELB, the effective lower bound.
10. I am distinguishing in this section between secular stagnation as being caused by a deficiency of aggregate demand and another view, that output growth will be very slow in future because productivity growth will be very low. The view that future productivity growth will be very low has already been discussed, with the conclusion that we do not have a good basis for predictions of its future level, and that we simply do not know whether future productivity growth will be extremely low or higher than it has been recently. There is no shortage of views on this issue among economists, but the views to some extent appear to depend on whether the economist making the prediction is an optimist or a pessimist.
11. This research includes recent work by Johannsen and Mertens (2015) and Kiley (2015) that uses extensions of the original Laubach and Williams (2003) framework. An international perspective on medium-to-long-run real interest rates is provided by U.S. Executive Office of the President (2015). Reinhart and Rogoff (2009) and Hall (2014) discuss the long-lived effects of financial crises on economic performance. See also Hamilton and others (2015). I have, in addition, drawn on Fischer (forthcoming).
12. It is also a major factor explaining the phenomenon of the economy's impressive performance on the jobs front during a period of historically slow growth.
13. See, for instance, Gordon (2014, 2016).
14. See Bernanke (2005). See also the recent work by Caballero, Farhi, and Gourinchas (2008); and Mendoza, Quadrini, and Rios-Rull (2009).
15. See, for instance, Reifschneider and Williams (2000), Blanchard and Simon (2001), and Stock and Watson (2003).
16. For a discussion of various issues reviewed by the Federal Open Market Committee in late 2008 and 2009 regarding the complications of unconventional monetary policy at the ZLB, see the set of staff memos on the Board's website.
17. See Williams (2013).
- What Reagan Didn't Do - Paul Krugman
- A Former Investment Banker: Clients are Being Sucker-Punched - ProMarket
- Growing Up in a Bad Neighborhood Does More Harm Than We Thought - NYTimes
- Economics can't be encapsulated into knowledge pills - Frances Woolley
- Another (great) source of non-inflationary wage growth - Jared Bernstein
- Economics is more a craft than a science - The Washington Post
- Why the U.S. Economy Might Never Get Better - TIME
- Clarification of ‘Helicopter’ Money Column - Narayana Kocherlakota
- Reviewing the Rise and Fall of American Growth - Dietrich Vollrath
Friday, March 25, 2016
Putting the Client Last: A Former Investment Banker Explains How Clients are Being Systemically Sucker-Punched
Putting the Client Last: A Former Investment Banker Explains How Clients are Being Systemically Sucker-Punched: As a former London employee of a major investment bank, I am often puzzled by the tone that top managers of investment banks use when speaking to the public. There is indeed a striking gap between the official communication and the internal behaviors I have observed (and taken part in). To me, banks are experts at exploiting asymmetries of information. Furthermore, they often amplify this asymmetry themselves by complexifying the products they offer or by disclosing only fractions of the information they have.
Of course, investment banks’ clients are the principal target of this type of strategy. While banks typically claim as their main value that their clients’ interests always come first, the reality is usually quite different. ...
"Mr. Cruz has staked out positions on crucial issues that are, not to put too fine a point on it, crazy":
Crazy About Money, by Paul Krugman, Commentary, NY Times: In this year of Trump, the land is loud with the wails of political commentators ... crying out, “How can this be happening?” But a few brave souls are willing to whisper the awful truth: Many voters support Donald Trump because they actually agree with his ideas.
This is not, however, a column about Mr. Trump. It is, instead, about Ted Cruz, who has emerged as the favored candidate of the G.O.P. elite...
In a way, that’s quite a remarkable development. For Mr. Cruz has staked out positions on crucial issues that are, not to put too fine a point on it, crazy. How can elite Republicans back him?
The answer is the same for Mr. Cruz and the elite as it is for Mr. Trump and the base: Leading Republicans support Mr. Cruz, not despite his policy positions, but because of them. ... Establishment Republicans may wince at the candidate’s fondness for talking about “carpet bombing” or his choice of a noted anti-Muslim bigot and conspiracy theorist as an adviser.
But both Jeb Bush and Marco Rubio chose foreign policy teams dominated by the very people who pushed America into the Iraq debacle, and learned nothing from the experience. ...
And then there’s ... monetary policy. ... Mr. Cruz has staked out a distinctive position, by calling for a return to the gold standard. .... Mr. Cruz’s obsession with gold is one reason to believe that he would do even more economic damage in the White House than Mr. Trump...
Take, as a not at all arbitrary example, Paul Ryan,... the de facto leader of the Republican establishment ...Mr. Ryan is fundamentally a con man on his signature issue, fiscal policy. Incidentally, for what it’s worth, Mr. Cruz has been relatively honest by his party’s standards..., openly declaring his intention to raise taxes that hit the poor and the middle class even as he slashes them on the rich.
But Mr. Ryan seems to be a true believer on monetary policy... But what, exactly, is the nature of his monetary faith? The same as ... Mr. Cruz’s beliefs: Both men are devotees of Ayn Rand ...
The moral here is that we shouldn’t be surprised by the Republican establishment’s willingness to rally behind Mr. Cruz..., while his policy ideas are extreme, they reflect the same extremism that pervades the party’s elite.
There are no moderates, or for that matter, sensible people, anywhere in this story.
I have something at MoneyWatch:
Will Election 2016 Soothe Americans' Fears?:... The extent to which employment can recover further depends in large part on the availability of jobs and the wage rate, both of which will be affected by the course of monetary and fiscal policy. If the Fed raises interest rates too fast and too soon, wages and employment will be suppressed, and valuable members of the workforce will never return.
If Congress continues to serve the interests of the donor class rather than the working class, fails to provide the economy with the infrastructure it needs and the jobs that come with it, and forces further reductions in social services through tax cuts and demagoguery over the national debt, the discouragement so many people feel will only get worse. ...
Events in this year's presidential campaign have made it clear that people are unhappy with the present state of the economy. They believe policy has been tilted too much toward the interests of the financial industry, big business and the wealthy -- and that they've been forgotten.
But these problems won't be solved by closing the door to international trade and immigration, by enacting huge tax cuts for the wealthy or by embracing politics that divide us as a nation.
Policymakers at the Fed and in Congress must do all that they can to create jobs and opportunity for those who feel overlooked and forgotten. People are speaking clearly this election cycle: They want jobs, they want opportunity, they want wages to go up and they want inequality in to go down. ...
[The beginning was changed by the editor...]
I break the issue of credibility of monetary policy into two parts. The first I think of as “soft” credibility, or the perception that policy needs to follow a proscribed course due to some perceived promise. The second I think of as “hard” credibility, or the expectation that policymakers will pursue policies that maximize its odds of achieving its goals over the long run, price stability with maximum sustainable employment, regardless of perceived promises. We should encourage policymakers to pursue “hard” credibility and avoid communications or actions that lead to policy directed at achieving “soft” credibility.
Let’s step back to last summer. It was widely anticipated that the Fed would hike interest rates at the September 2015 FOMC meeting. Market turmoil in August, however, made the Fed think twice. It also encouraged no shortage of commentary urging the Fed to pursue what I consider “soft” credibility. Via Jon Hilsenrath at the Wall Street Journal:
After months of forewarning by Federal Reserve officials that they are preparing to raise short-term interest rates, some international officials attending the Fed’s annual retreat here this week have a message: Get on with it already.
Fed policy makers are wavering on whether to move rates up in September. Volatile stock prices, falling commodities, a strong dollar and signs of a deepening economic slowdown in China have created doubts at the U.S. central bank about the outlook for global growth.
International officials have been saying for months they will be prepared when the Fed moves rates higher, a message that is being echoed as central bankers, academics, journalists and others converge now in Jackson Hole for the Federal Reserve Bank of Kansas City’s annual symposium.
“If you delay something that you were planning to do, then you leave the impression that your compass is different than what you led markets to believe,” Jacob Frenkel, chairman of J.P. Morgan Chase International and former head of the Bank of Israel, said in an interview Thursday. Market drama is increased by delay, he added.
What I wrote:
Hey, it's been a hard couple of weeks. Things changed. That certain rate hike became a lot less certain. Maybe that changes back by September 17. Maybe not. All of us Fed watchers probably won't come to agreement until September 16. Getting emotional and moralizing about change isn't going to stop it…Stocks dropped sharply. It is a clear sign, on top of other signs, that financial conditions are tightening ahead of the Fed, and arguably too much ahead of the Fed. If the Fed heeds that warning you have to remember that's their job. Smoothly functioning financial markets. Lender of last resort. All that stuff. Maybe things work out just fine if they don't heed that warning. I am not interested in taking that risk. Not enough upside for me.
Ultimately, the Fed took a pass on the September meeting. That I consider favoring “hard” credibility over “soft” credibility. Rather than meet a perceived promise to hike, Yellen & Co. stood down in response to changing economic and financial conditions.
Unfortunately, I fear the Fed took a wrong turn in the October meeting, setting up an expectation that a December hike was a certainty. Fed officials took much grief over their decision to skip September. Market participants subsequently priced out rate hikes for 2015. But the Fed had promised a hike, and they were damn well going to deliver. And they drove the message home in October with this line:
In determining whether it will be appropriate to raise the target range at its next meeting, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation.
According to some excellent reporting by Jonathan Spicer, Ann Saphir and Howard Schneider at Reuters:
When the U.S. Federal Reserve tweaked its policy statement last week and put a December rate rise squarely back in play, it took a calculated gamble that reaching for an old and controversial policy tool would get financial markets' attention.
That gamble was to specifically reference the next policy meeting as a date of a possible lift-off, and it had the desired effect: investors quickly rolled back bets that rates would stay near zero until next year.
But interviews with current and former Fed officials, and with those close to policymakers, show the decision to use what is called calendar guidance in central bank parlance and what some described as a "hammer" did not come easy. Some officials felt that even mentioning a date in the context of a potential policy change would be taken not as a contingent expectation but as a promise that would be painful to break...
...Yet Fed Chair Janet Yellen and her deputies got so frustrated that investors virtually ignored their message that a rate rise before the year end was probable that they decided last month it was a risk worth taking, the interviews show.
As a result, futures markets are now giving slightly better-than-even odds that rates will rise from near zero next month, compared with mid-October when the odds were less than 30 percent. In contrast, economists polled by Reuters have been leaning towards a December rate hike even before the Fed's last meeting.
So the Fed wanted to raise rates just to teach markets a lesson? Maybe the message was ignored because it was the wrong thing to do and market participants expected the Fed to pursue "hard" over "soft" credibility? More telling was this line:
On Oct. 16, Dudley got an earful from Wall Street bankers and economists on a New York Fed advisory panel criticizing the Fed for its muddled message, according to three people who attended the meeting.
The interviews with Fed officials and those close to the central bank suggest that it was around this time that the plan to hint at December in the next policy statement started taking shape.
That sounds as if Dudley was falling prey to the fetish of “soft” credibility. We need to pick a message and stick with it. That's what the guys on Wall Street say. They say we are going to loose our credibility. We need to get ahead of that.
And perhaps this is why the Fed’s decision in December always felt forced. Me, in December:
Given that the Fed likely only gets one chance to lift-off from the zero bound on a sustained basis, it is reasonable to think they would wait until they were absolutely sure inflation was coming. Even more so given the poor performance of their inflation forecasts. But the Fed thinks there is now more danger in waiting than moving. And so into the darkness we go.
I don’t think the Fed would ever admit December was a mistake, but at a minimum the decision to hold pat in March and dramatically mark down their rate expectations for further rate hikes in 2016 tells me the Fed thought they were certainly on the verge of making a major policy error and pulled back quickly. In my framework, the Fed shifted back to seeking to preserve “hard” credibility.
That said, note the tendency to try to goad the Fed right back into seeking “soft” credibility. From the March press conference:
Steve Liesman, CNBC. Madam Chair, as you know, inflation has gone up the last two months. We had another strong jobs report, the tracking forecasts for GDP have returned to 2 percent, and yet the Fed stands pat while it’s in a process of what it said it launched in December was a “process of normalization.” So I have two questions about this: Does the Fed have a credibility problem, in the sense that it says it will do some—one thing under certain conditions but doesn’t end up doing it? And then, frankly, if the current conditions are not sufficient for the Fed to raise rates, well, what would those conditions ever look like?
I hope Fed policymakers remain resistant to such taunts.
The Fed is especially vulnerable to the problem of “soft” credibility when they lay down specific markers. The infamous dot-plot is one such marker. Policymakers have difficulty explaining the dot-plot is not a promise of future action; it is nothing more than a guideline. But the instant they establish that guideline, the mere fact that it induces some market participants to believe a promise has been made creates the belief that not meeting that promise will cost the Fed credibility. “Soft” credibility. The Fed needs to distinguish between this and “hard” credibility.
Another such marker is the 2 percent inflation target. Although Fed officials have repeatedly warned that they assume there will be symmetric errors around the target, we don’t know that until we actually have above-target inflation. The rule was created in an era of below-target inflation, so it is easy to say the Fed lacks credibility on the inflation target. I have said so. But I have come to perceive this as another instance of “soft” credibility. I worry that if the Fed becomes concerned about their supposed credibility from inflation at 50bp below target, they will overreact to inflation that is 50bp above target. What we really want is the Fed to maintain inflation within 50bp of target without triggering a recession. That would be the “hard” credibility of meeting the Fed’s mandate over the long run.
Bottom Line: The Fed should be playing the long game. In my opinion, that means pursuing the “hard” credibility of choosing the path most likely to meet their mandate over the long run. This may require sacrificing some “soft” credibility along the way. That means not hiking rates – or hiking rates – despite a perceived promise to do the opposite. The Fed should not fret over those costs. They are minor and quickly forgotten. And worse yet, being a slave to the fetish of “soft” credibility only raises the odds of a policy error. They will do less harm by breaking their “promise” than by keeping that promise via a poor decision.
- Who will speak for the American white working class? - Chris Arnade
- The Share of Older Workers in Physically Demanding Jobs - Dean Baker
- 'Helicopter Money' Won't Provide Much Lift - Narayana Kocherlakota
- Lunch with the FT: Yanis Varoufakis - FT.com
- Bubbles Spread Like a Zombie Virus - Bloomberg View
- Dissecting the Concept of Opportunity Cost - Tim Taylor
- Causes and consequences of China’s shadow banking - Vox EU
- Does the Fed have a credibility problem? - MacroMania
- Pigou, Uber & Lyft (Wonkish) - The Leisure of the Theory Class
- Bloomberg getting dotty - longandvariable
- Is evidence based policy left wing? - mainly macro
Thursday, March 24, 2016
Lifted from Brad DeLong at Equitablog:
Why Is the CBO Concocting a Phony Debt Crisis?: Must-Read: Ari Rabin-Havt: Why Is the CBO Concocting a Phony Debt Crisis?: “The CBO assumes that Social Security and Medicare Part A will draw on the general fund of the US Treasury…
…to cover benefit shortfalls following the depletion of their trust funds, which at the current rate will occur in 2034. That would obviously lead to an exploding debt, but it’s a scenario prohibited by law. In the case of both programs, benefits must be paid either from revenue collected via payroll taxes or from accumulated savings in the programs’ trust funds. When those funds run out, full benefits will simply not be paid. ‘Because there is no borrowing authority, there is really a hard stop,’ said Goss.
Congress could pass a law saying that Social Security and Medicare Part A would begin drawing on the US Treasury general fund after 2034. Or, Congress could preemptively pass laws to avert the situation before the deadline; it could take the approach favored by progressives and increase revenue to the programs by lifting the payroll tax cap, or alternatively raise the retirement age and lower benefits. But the bottom line is the CBO projections disregard the actual law and assume a worst-case legislative scenario—and one that is politically unlikely, to boot…
Maurice Obstfeld, Gian Maria Milesi-Ferretti, and Rabah Arezki::
Oil Prices and the Global Economy: It’s Complicated: Oil prices have been persistently low for well over a year and a half now, but as the April 2016 World Economic Outlook will document, the widely anticipated “shot in the arm” for the global economy has yet to materialize. We argue that, paradoxically, global benefits from low prices will likely appear only after prices have recovered somewhat, and advanced economies have made more progress surmounting the current low interest rate environment. ...
This outcome has puzzled many observers including us at the Fund, who had believed that oil-price declines would be a net plus for the world economy, obviously hurting exporters but delivering more-than-offsetting gains to importers. The key assumption behind that belief is a specific difference in saving behavior between oil importers and oil exporters: consumers in oil importing regions such as Europe have a higher marginal propensity to consume out of income than those in exporters such as Saudi Arabia. ...
To address this question, the forthcoming April 2016 World Economic Outlook compares 2015 domestic demand growth in oil importers and oil exporters to what we expected in April 2015—after the first substantial decline in oil prices. The lion’s share of the downward revision for global demand comes from oil exporters—despite their relatively small share of global GDP (about 12 percent). But domestic demand in oil importers was also no better than we had forecast, despite a fall in oil prices that was bigger than anticipated. ...
Skipping forward to the final paragraph:
Persistently low oil prices complicate the conduct of monetary policy, risking further inroads by unanchored inflation expectations. What is more, the current episode of historically low oil prices could ignite a variety of dislocations including corporate and sovereign defaults, dislocations that can feed back into already jittery financial markets. The possibility of such negative feedback loops makes demand support by the global community—along with a range of country-specific structural and financial-sector reforms—all the more urgent.
Misnomers, by Thorvaldur Gylfason, Helgi Tomasson, Gylfi Zoega: In economics, as in other disciplines, it is common practice to name models, theorems, and empirical results after their originators. In macroeconomics, we have the Phillips curve, an empirical relationship between inflation and unemployment first documented for the UK by A W Phillips, an engineer from New Zealand. And we have Okun’s law, an empirical relationship between unemployment and the gap between actual and potential output first laid out for the US by Arthur M. Okun at Yale. Moreover, we have the Solow model that bears the name of Nobel laureate Robert M Solow at MIT, who presented his seminal growth model in 1956. The list also includes the Heckscher-Ohlin and Stolper-Samuelson theorems in trade theory, the Baumol-Tobin and Modigliani-Miller theorems in monetary theory, the Mundell-Fleming model in international finance, and even the relatively recent Taylor and Giudotti-Greenspan rules of monetary policy.
The pattern is pretty clear – you make a discovery (or perhaps you just make a point!) and it may become irretrievably associated with your name.
Or it may not.
Or something completely different can happen. Just ask David Ricardo and Irving Fisher.
Ricardian equivalence: When you cross it
Innocent readers may be excused for thinking that David Ricardo (1772-1823) originated the idea that it makes no difference whether government expenditures are financed by taxation or by borrowing, on the grounds that taxpayers anticipate the increased future tax burden that arises from increased borrowing today, making them indifferent between the two. This simple idea requires you to think that ordinary taxpayers reduce their consumption today to prepare for a heavier tax burden decades from now. If true, this proposition greatly reduces the efficacy of fiscal policy.
The attribution of this proposition to Ricardo is unfair to him because, even if he exposited the logic behind it, he found the proposition unconvincing. In the words of Ricardo (1817): “… it must not be inferred that I consider the system of borrowing as the best calculated to defray the extraordinary expenses of the State. It is a system which tends to make us less thrifty – to blind us to our real situation”. Like modern behavioural economists, Ricardo understood that in their daily lives most people abide by the old saying, "worry about that bridge when you cross it".
Here is how three modern macroeconomics textbooks handle Ricardo:
- N Gregory Mankiw (2013) writes: “Hence, financing the government by debt is equivalent to financing it by taxes. This view is called Ricardian equivalence after the famous nineteenth-century economist David Ricardo because he first noticed the theoretical argument”.
- Olivier Blanchard (2006) writes: “One extreme view is that once the government budget constraint is taken into account, neither deficits nor debt have an effect on economic activity. This argument is known as the Ricardian equivalence proposition. David Ricardo, a nineteenth-century English economist, was the first to articulate its logic. His argument was further developed and given prominence in the 1970s by Robert Barro, then at Chicago, now at Harvard University. For this reason, the argument is also known as the Ricardo-Barro proposition”.
- J Bradford DeLong and Martha L Olney (2006) get it right: “this alternative view of the long-run (and also the short-run) effects of debt and deficits is called ‘Ricardian equivalence’, after David Ricardo, who does not seem to have held the view; it should be called ‘Barrovian equivalence’, after its most effective and powerful advocate, Harvard macroeconomist Robert Barro” (see Barro 1974).
The Fisher effect: When contracts are made in unstable money
Many writers continue to attribute to Irving Fisher the idea that real interest rates are insensitive to changes in inflation and to suggest that Fisher regarded such insensitivity as somehow natural. For example, Okun (1981) states: “As Fisher saw it, an extra 1 percentage point of expected inflation raises the nominal expected rate of return on real capital assets by 1 percentage point and induces a parallel increase of 1 percentage point in bond and bill yields to keep expected returns in balance”. Further, using quarterly US data for 1954-1969, Feldstein and Eckstein (1970, 366) write: “the data thus confirm the two basic Fisherian hypotheses: (1) in the long run, the real rate of interest is (approximately) unaffected by the rate of inflation, but (2) in the short run, the real rate of interest falls as the rate of inflation increases”. If true, this proposition reduces the effectiveness of both monetary and fiscal policy by making real interest rates and hence also investment, saving, and other macroeconomic aggregates immune to changes in inflation via real interest, at least in the short run.
Here is how the three textbooks cited above handle Fisher.
- Mankiw (2013) writes: “The one-for-one relation between the inflation rate and the nominal interest rate is called the Fisher effect… In data from the late nineteenth and early twentieth centuries, high nominal interest rates did not accompany high inflation. The apparent absence of any Fisher effect during this time puzzled Irving Fisher. He suggested that inflation ‘caught merchants napping’”.
- Blanchard (2006) writes: “The result that, in the medium run, the nominal interest rate increases one for one with inflation is known as the Fisher effect, or the Fisher hypothesis, after Irving Fisher, an economist at Yale University, who first stated it and its logic at the beginning of the twentieth century”.
- DeLong and Olney (2006) write: “Thus when the expected inflation rate rises, we would expect in the long run to see the nominal interest rate rise with it, point-for-point. This theoretical prediction – and rough empirical regularity – is called the Fisher effect”.
The Fisher effect, if described as an empirical relationship, is a misnomer because Fisher’s (1930) own data on interest rates and inflation covering New York, London (see Figure 1), Paris, Berlin, Calcutta, and Tokyo from 1825 to 1927 suggest that nominal interest rates do not come close to mirroring the movements in inflation, as Mankiw (2013) points out, even in the long run. As shown by Gylfason (2016), all of Fisher’s data show interest rates to evolve less rapidly than inflation and to change less than inflation. The assumption of a common dynamic structure in Fisher’s six cities suggests inflation cycles of about six years, cycles that do not show up in the interest rate series. The failure of nominal interest rates to imitate the inflation cycles underlines the lack of sensitivity of nominal interest rates to inflation. The Fisher effect, defined as a point-for-point effect of inflation on nominal interest rates, is a misnomer as an empirical result and must rather be understood as a theoretical possibility that is not supported by Fisher´s data.
Figure 1. Irving Fisher’s data: Nominal interest rates and inflation, London, 1825-1927
In Fisher’s time, as Figure 1 shows, while inflation did not hesitate to move into negative territory, nominal interest rates did not follow. In London, wholesale prices rose merely by 9% from 1820 to 1927, while in New York they remained unchanged from 1867 to 1926, as they did in Berlin from 1866 to 1911; in Paris, wholesale prices fell by 18% from 1872 to 1914 (Fisher 1930). In Fisher’s data, deflation was nearly as common as inflation, reaffirming his inference that deflation makes both real interest rates and debt burdens rise, leading to distrust, distress selling, bankruptcies, bank runs, reduced output and trade, and unemployment (Fisher 1896, 1933). There can be no controversy about deflation making real interest rates rise when nominal interest rates refuse to go below zero, as was the case in Fisher’s data. It may have been natural in those days to expect nominal interest not to follow inflation because bouts of inflation were often followed by deflation, since inflation expectations were well anchored by the gold standard.
These results are consistent with those of Fisher himself. As Tobin (1987) and Dimand (1999), among others, point out, both Fisher’s theory of interest and his reading of the historical record suggested to him that real interest rates varied inversely with inflation, and that the adjustment of nominal interest rates to changes in inflation took a very long time (Fisher 1896). In Fisher’s (1930) words: “… when prices are rising, the rate of interest tends to be high but not so high as it should be to compensate for the rise; and when prices are falling, the rate of interest tends to be low, but not so low as it should be to compensate for the fall”. Fisher (1930) describes the relationship between interest rates and inflation also thus: “When the price level falls, the rate of interest nominally falls slightly, but really rises greatly and when the price level rises, the rate of interest nominally rises slightly, but really falls greatly”. Here Fisher means the rate of change of the price level even if he says only “price level”. Fisher (1907) made a clear distinction between the two: “Falling prices are as different from low prices as a waterfall is from sea level.”
There is a lot in a name. Irving Fisher has suffered similar treatment as David Ricardo when different authors have attached his name to an empirical relationship that he rejected. The prestigious names of Ricardo and Fisher have been used to justify inattentive fiscal and monetary policies. Fisher’s (1930) view was that “… men are unable or unwilling to adjust at all accurately or promptly the money interest rates to changed price levels. Negative real interest rates could scarcely occur if contracts were made in a composite commodity standard. The erratic behaviour of real interest is evidently a trick played on the money market by the ‘money illusion’ when contracts are made in unstable money”. A few pages earlier, Fisher (1930) had written: “Most people are subject to what may be called “the money illusion,” and think instinctively of money as constant and incapable of appreciation or depreciation”. Fisher understood that under certain circumstances, including perfect foresight, real interest rates might be immune to changes in inflation, at least over the long haul, but he rejected the premises needed to erect such a theory.
- The Fed's Misunderstood Dots - Narayana Kocherlakota
- Is Bitcoin Really Frictionless? - Liberty Street Economics
- The hidden victims of the Global Crisis - VoxEU
- Social Science Knowledge and Public Policy - Brad DeLong
- Financial market wrongdoing: Fines vs reputational sanctions - VoxEU
- Does money make you happy? - 80,000 Hours
- Patent Law Holds Back Science - Noah Smith
- An America that Sees Only Itself - EconoSpeak
- Time to rewrite a bit of oral history - mainly macro
Wednesday, March 23, 2016
Some people look at subprime lending and see evil. I look at subprime lending and I see the American dream in action. -- former U.S. Senator Phil Gramm, Nov. 16, 2008
...Gramm has been brought on as a senior economic adviser to Republican presidential candidate Ted Cruz. This isn't a promising development for Cruz... Not to put too fine a point on it, but I believe -- as do many others -- that Gramm was one of the major figures who helped set the stage for the crisis. ...
Gramm was a key sponsor of the ... Gramm-Leach-Bliley Act, which effectively repealed the piece of the Glass-Steagall Act... The damage caused by rolling back Glass-Steagall pales compared with ... the Commodity Futures Modernization Act of 2000. Gramm was a co-sponsor of the legislation, which exempted many derivatives and swaps from regulation. Not only was the law problematic, but it veered into potential conflict-of-interest territory. ...
We got a chance to see those consequences a few years later when American International Group failed, thanks in part to swaps ... on $441 billion of securities that turned out to be junk. AIG wasn't required to put up much in the way of collateral, set aside capital or hedge its risk on the swaps. Why would it, when the law said it didn’t have to? The taxpayers were then called upon to bailout AIG to the tune of more than $180 billion.
Maybe it isn't too surprising that Cruz would seek advice from Gramm. Cruz, after all, seems to want to hobble modern economic policy by returning to the gold standard. ... We have seen these movies before, and they end in tragedy and tears.
He also talks about Gramm's sad performance in his brief appearance as one of McCain's advisors in 2008.
Paul Ryan, in a speech on the state of American politics, says:
We don’t lock ourselves in an echo chamber, where we take comfort in the dogmas and opinions we already hold.
... in 1981 the Kemp-Roth bill was signed into law, lowering tax rates, spurring growth, and putting millions of Americans back to work.
... I was the staff economist for Rep. Jack Kemp (R-N.Y.) in 1977, and it was my job to draft what came to be the Kemp-Roth tax bill, which Reagan endorsed in 1980 and enacted the following year. ...
Republicans like to say that massive growth followed the Reagan tax cut. But average real GDP growth during Reagan’s eight years in the White House was only slightly above the rate of the previous eight years: 3.4 percent per year vs. 2.9 percent. The average unemployment rate was actually higher under Reagan than it was during the previous eight years: 7.5 percent vs. 6.6 percent. ...
- The Fed's Credibility Dilemma - Narayana Kochelakota
- To reach full employment we need fiscal policy - EPI
- Reckoning With Inequality - Jeffrey Frankel
- A World Off-Balance on Monetary Policy - Brad DeLong
- Shouldn’t Congress Tell Us How We’ll Pay for Tax Cuts? - Nancy Pelosi
- “The US Has Lost the Will to Prosecute Corporate Executives” - ProMarket
- The Natural Rate of Interest in Taylor Rules - Cleveland Fed
- Is the Essence of Globalization Shifting? - Tim Taylor
- New CEPR Press eBook: Moving to the Innovation Frontier - VoxEU
- Firm wage setting and the rise of U.S. income inequality - Equitable Growth
- Fiscal policy at the zero lower bound - Bank Underground
- Causes of the Eurozone Crisis: A nuanced view - VoxEU
Tuesday, March 22, 2016
MMT and mainstream macro: There were a lot of interesting and useful comments on my last post on MMT, plus helpful (for me) follow-up conversations. Many thanks to everyone concerned for taking the time. Before I say anything more let me make it clear where I am coming from. I’m on the same page as far as policy’s current obsession with debt is concerned. Where I seem to differ from some who comment on my blog, people who say they are following MMT, is whether you need to be concerned about debt when monetary policy is not constrained by the Zero Lower Bound. I say yes, they say no, but for reasons I could not easily understand.
This was the point of the ‘nothing new’ comment. It was not meant to be a put down. It was meant to suggest that a mainstream economist like myself could come to some of the same conclusions as MMT writers, and more to the point, just because I was a mainstream economist does not mean I misunderstood how government financing works. It was because I was getting comments from MMT followers that seemed nonsensical to me, but which should not have been nonsensical because the basics of MMT are understandable using mainstream theory. ...
What mainstream theory says is that some combination of monetary and fiscal policy can always end a recession caused by demand deficiency. Full stop: no ifs or buts. That is why we had fiscal expansion in 2009 in the US, UK, Germany, China and elsewhere. The contribution of some influential mainstream economists to this switch from fiscal stimulus to austerity in 2010 was minor at most, and to imagine otherwise does nobody any favours. The fact that policymakers went against basic macro theory tells us important things about the transmission mechanism of economic knowledge, which all economists have to address.
Yes, Expansionary Fiscal Policy in the North Atlantic Would Solve Many of Our Problems. Why Do You Ask?: ... In my view, the economics of Abba Lerner—what is now called MMT—is not always right: It is not always possible for the government to spend freely to attain full employment, use monetary policy to keep the debt under control, and rely on rising inflation as the only signal needed of whether and when policy needs to be tightened. Why not? Because it is possible that the bond market can get itself into an unsustainable position, in which underlying inflationary pressures are masked until it is too late to rebalance government finances without a financial crisis.
But, in my view, right now the economics of Abba Lerner is 100% correct. The U.S. (and Europe!) should use expansionary fiscal policy to rebalance the economy at full employment and potential output. And interest rates are so low that doing so does not require any additional monetary policy steps to keep the debt under control.
Japan, alas, confronts us with a difficult and much more devilish program of economic policy. Partial and nearly painless debt repudiation via inflation and financial repression seems to me to be the best way forward—if that can be attained. But more on that anon.
Trumpism, the Economic Wrecking Ball: For much of the past six months, I’ve tried to ignore the political ascent of Donald Trump. Too horrible to be true, I assured myself. But the unthinkable has happened, and Mr. Trump is now the likely nominee of the Republican Party. So what might a Trump presidency bring?
To be frank, the most horrifying aspects of Trumpism are not his economic policies. The worst he could do there would be to precipitate a global depression. It’s far scarier to contemplate an erratic, blustering demagogue taking command of the most powerful military force on earth. Or the foreign-policy calamities that might befall us.
But I’m an economist, so I’ll stick with economics. ...
Let’s tote up the score. Mr. Trump’s tax plan is doable, if Congress is sufficiently pliant. But it would exacerbate income inequality and explode the federal deficit. Mr. Trump’s immigration plans are heartless, hugely expensive and incredibly disruptive to the U.S. economy. His positions on international trade display abysmal ignorance, are economically harmful and threaten America’s standing in the world.
And remember: These are the best parts of what Mr. Trump has to offer.