Economist's View

Inequality: Echoes of the Past

This sounds familiar:

Should we care about inequality?, by David Stasavage, Monkey Cage, Washington Post: ...As a firm believer that commercial societies would witness an inexorable increase in inequality, [Jean-Jacques] Rousseau in his “Discourse on Political Economy” wrote of the corrupting influence of inequality and “luxury” and of the need to levy taxes on the rich to curb the problem. ...

Rousseau’s text was originally published in Denis Diderot’s famous Encyclopedia as the entry for “Political Economy.” ... Jean-François de Saint-Lambert was commissioned by Diderot to write the article on “Luxury” for the encyclopedia. The interest of such a text was obvious; at the time the pundits of the day were fiercely debating the virtues and vices of “luxury” and its potentially corrupting effect on nations. Take our 21st century debates, substitute the word “inequality” for “luxury,” and you get a sense of the tone.

Saint-Lambert was among the first to move the debate in a new direction. He suggested that luxury itself was not the problem; what mattered was how luxury was generated. If luxury was earned thanks to institutionalized privilege, or by those who had gamed the system, then it would inevitably have a corrupting influence. The effects for the nation would be disastrous. ...

Now in cases where luxury is instead acquired through industriousness, Saint-Lambert argued that it would not have these nefarious effects. ...

'What the Federal Reserve is Doing to Promote a Stronger Job Market'

Janet Yellen says the Fed cares about the unemployed:

What the Federal Reserve is Doing to Promote a Stronger Job Market, by Janet L. Yellen, Federal Reserve: ... The past six years have been difficult for many Americans, but the hardships faced by some have shattered lives and families. Too many people know firsthand how devastating it is to lose a job at which you had succeeded and be unable to find another; to run through your savings and even lose your home, as months and sometimes years pass trying to find work; to feel your marriage and other relationships strained and broken by financial difficulties. And yet many of those who have suffered the most find the will to keep trying. I will introduce you to three of these brave men and women, your neighbors here in the great city of Chicago. These individuals have benefited from just the kind of help from community groups that I highlighted a moment ago, and they recently shared their personal stories with me.

It might seem obvious, but the second thing that is needed to help people find jobs...is jobs. No amount of training will be enough if there are not enough jobs to fill. I have mentioned some of the things the Fed does to help communities, but the most important thing we do is to use monetary policy to promote a stronger economy. The Federal Reserve has taken extraordinary steps since the onset of the financial crisis to spur economic activity and create jobs, and I will explain why I believe those efforts are still needed.

The Fed provides this help by influencing interest rates. Although we work through financial markets, our goal is to help Main Street, not Wall Street. By keeping interest rates low, we are trying to make homes more affordable and revive the housing market. We are trying to make it cheaper for businesses to build, expand, and hire. We are trying to lower the costs of buying a car that can carry a worker to a new job and kids to school, and our policies are also spurring the revival of the auto industry. We are trying to help families afford things they need so that greater spending can drive job creation and even more spending, thereby strengthening the recovery.

When the Federal Reserve's policies are effective, they improve the welfare of everyone who benefits from a stronger economy, most of all those who have been hit hardest by the recession and the slow recovery.

Now let me offer my view of the state of the recovery, with particular attention to the labor market and conditions faced by workers. Nationwide, and in Chicago, the economy and the labor market have strengthened considerably from the depths of the Great Recession. Since the unemployment rate peaked at 10 percent in October 2009, the economy has added more than 7-1/2 million jobs and the unemployment rate has fallen more than 3 percentage points to 6.7 percent. That progress has been gradual but remarkably steady--February was the 41st consecutive month of payroll growth, one of the longest stretches ever. ...

But while there has been steady progress, there is also no doubt that the economy and the job market are not back to normal health. ...

The recovery still feels like a recession to many Americans, and it also looks that way in some economic statistics. At 6.7 percent, the national unemployment rate is still higher than it ever got during the 2001 recession. ... It certainly feels like a recession to many younger workers, to older workers who lost long-term jobs, and to African Americans, who are facing a job market today that is nearly as tough as it was during the two downturns that preceded the Great Recession.

In some ways, the job market is tougher now than in any recession. The numbers of people who have been trying to find work for more than six months or more than a year are much higher today than they ever were since records began decades ago. We know that the long-term unemployed face big challenges. Research shows employers are less willing to hire the long-term unemployed and often prefer other job candidates with less or even no relevant experience.³

That is what Dorine Poole learned, after she lost her job processing medical insurance claims, just as the recession was getting started. Like many others, she could not find any job, despite clerical skills and experience acquired over 15 years of steady employment. When employers started hiring again, two years of unemployment became a disqualification. Even those needing her skills and experience preferred less qualified workers without a long spell of unemployment. That career, that part of Dorine's life, had ended.

For Dorine and others, we know that workers displaced by layoffs and plant closures who manage to find work suffer long-lasting and often permanent wage reductions.⁴ Jermaine Brownlee was an apprentice plumber and skilled construction worker when the recession hit, and he saw his wages drop sharply as he scrambled for odd jobs and temporary work. He is doing better now, but still working for a lower wage than he earned before the recession.

Vicki Lira lost her full-time job of 20 years when the printing plant she worked in shut down in 2006. Then she lost a job processing mortgage applications when the housing market crashed. Vicki faced some very difficult years. At times she was homeless. Today she enjoys her part-time job serving food samples to customers at a grocery store but wishes she could get more hours.

Vicki Lira is one of many Americans who lost a full-time job in the recession and seem stuck working part time. The unemployment rate is down, but not included in that rate are more than seven million people who are working part time but want a full-time job. As a share of the workforce, that number is very high historically.

I have described the experiences of Dorine, Jermaine, and Vicki because they tell us important things that the unemployment rate alone cannot. First, they are a reminder that there are real people behind the statistics, struggling to get by and eager for the opportunity to build better lives. Second, their experiences show some of the uniquely challenging and lasting effects of the Great Recession. Recognizing and trying to understand these effects helps provide a clearer picture of the progress we have made in the recovery, as well as a view of just how far we still have to go.

And based on the evidence available, it is clear to me that the U.S. economy is still considerably short of the two goals assigned to the Federal Reserve by the Congress. The first of those goals is maximum sustainable employment, the highest level of employment that can be sustained while maintaining a stable inflation rate. Most of my colleagues on the Federal Open Market Committee and I estimate that the unemployment rate consistent with maximum sustainable employment is now between 5.2 percent and 5.6 percent, well below the 6.7 percent rate in February.

The other goal assigned by the Congress is stable prices, which means keeping inflation under control. In the past, there have been times when these two goals conflicted--fighting inflation often requires actions that slow the economy and raise the unemployment rate. But that is not a dilemma now, because inflation is well below 2 percent, the Fed's longer-term goal.

The Federal Reserve takes its inflation goal very seriously. One reason why I believe it is appropriate for the Federal Reserve to continue to provide substantial help to the labor market, without adding to the risks of inflation, is because of the evidence I see that there remains considerable slack in the economy and the labor market. Let me explain what I mean by that word "slack" and why it is so important.

Slack means that there are significantly more people willing and capable of filling a job than there are jobs for them to fill. During a period of little or no slack, there still may be vacant jobs and people who want to work, but a large share of those willing to work lack the skills or are otherwise not well suited for the jobs that are available. ...

But a lack of jobs is the heart of the problem when unemployment is caused by slack, which we also call "cyclical unemployment." The government has the tools to address cyclical unemployment. Monetary policy is one such tool, and the Federal Reserve has been actively using it to strengthen the recovery and create jobs, which brings me to why the amount of slack is so important.

If unemployment were mostly structural, if workers were unable to perform the jobs available, then the Federal Reserve's efforts to create jobs would not be very effective. Worse than that, without slack in the labor market, the economic stimulus from the Fed could put attaining our inflation goal at risk. In fact, judging how much slack there is in the labor market is one of the most important questions that my Federal Reserve colleagues and I consider when making monetary policy decisions, because our inflation goal is no less important than the goal of maximum employment.

This is not just an academic debate. For Dorine Poole, Jermaine Brownlee, and Vicki Lira, and for millions of others dislocated by the Great Recession who continue to struggle, the cause of the slow recovery is enormously important. As I said earlier, the powerful force that sustains them and others who keep trying to succeed in this recovery is the faith that their job prospects will improve and that their efforts will be rewarded.

Now let me explain why I believe there is still considerable slack in the labor market, why I think there is room for continued help from the Fed for workers, and why I believe Dorine Poole, Jermaine Brownlee, and Vicki Lira are right to hope for better days ahead.

One form of evidence for slack is found in other labor market data, beyond the unemployment rate or payrolls, some of which I have touched on already. For example, the seven million people who are working part time but would like a full-time job. This number is much larger than we would expect at 6.7 percent unemployment, based on past experience, and the existence of such a large pool of "partly unemployed" workers is a sign that labor conditions are worse than indicated by the unemployment rate. Statistics on job turnover also point to considerable slack in the labor market. Although firms are now laying off fewer workers, they have been reluctant to increase the pace of hiring. Likewise, the number of people who voluntarily quit their jobs is noticeably below levels before the recession; that is an indicator that people are reluctant to risk leaving their jobs because they worry that it will be hard to find another. It is also a sign that firms may not be recruiting very aggressively to hire workers away from their competitors.

A second form of evidence for slack is that the decline in unemployment has not helped raise wages for workers as in past recoveries. Workers in a slack market have little leverage to demand raises. Labor compensation has increased an average of only a little more than 2 percent per year since the recession, which is very low by historical standards.⁵ Wage growth for most workers was modest for a couple of decades before the recession due to globalization and other factors beyond the level of economic activity, and those forces are undoubtedly still relevant. But labor market slack has also surely been a factor in holding down compensation. The low rate of wage growth is, to me, another sign that the Fed's job is not yet done.

A third form of evidence related to slack concerns the characteristics of the extraordinarily large share of the unemployed who have been out of work for six months or more. These workers find it exceptionally hard to find steady, regular work, and they appear to be at a severe competitive disadvantage when trying to find a job. The concern is that the long-term unemployed may remain on the sidelines, ultimately dropping out of the workforce. But the data suggest that the long-term unemployed look basically the same as other unemployed people in terms of their occupations, educational attainment, and other characteristics. And, although they find jobs with lower frequency than the short-term jobless do, the rate at which job seekers are finding jobs has only marginally improved for both groups. That is, we have not yet seen clear indications that the short-term unemployed are finding it increasingly easier to find work relative to the long-term unemployed. This fact gives me hope that a significant share of the long-term unemployed will ultimately benefit from a stronger labor market.

A final piece of evidence of slack in the labor market has been the behavior of the participation rate--the proportion of working-age adults that hold or are seeking jobs. Participation falls in a slack job market when people who want a job give up trying to find one. When the recession began, 66 percent of the working-age population was part of the labor force. Participation dropped, as it normally does in a recession, but then kept dropping in the recovery. It now stands at 63 percent, the same level as in 1978, when a much smaller share of women were in the workforce. Lower participation could mean that the 6.7 percent unemployment rate is overstating the progress in the labor market.

One factor lowering participation is the aging of the population, which means that an increasing share of the population is retired. If demographics were the only or overwhelming reason for falling participation, then declining participation would not be a sign of labor market slack. But some "retirements" are not voluntary, and some of these workers may rejoin the labor force in a stronger economy. Participation rates have been falling broadly for workers of different ages, including many in the prime of their working lives. Based on the evidence, my own view is that a significant amount of the decline in participation during the recovery is due to slack, another sign that help from the Fed can still be effective.

Since late 2008, the Fed has taken extraordinary steps to revive the economy. At the height of the crisis, we provided liquidity to help avert a collapse of the financial system, which enabled banks and other institutions to continue to provide credit to people and businesses depending on it. We cut short-term interest rates as low as they can go and indicated that we would keep them low for as long as necessary to support a stronger economic recovery. And we have been purchasing large quantities of longer-term securities in order to put additional downward pressure on longer-term interest rates--the rates that matter to people shopping for a new car, looking to buy or renovate a home, or expand a business. There is little doubt that without these actions, the recession and slow recovery would have been far worse.

These different measures have the same goal--to encourage consumers to spend and businesses to invest, to promote a recovery in the housing market, and to put more people to work. Together they represent an unprecedentedly large and sustained commitment by the Fed to do what is necessary to help our nation recover from the Great Recession. For the many reasons I have noted today, I think this extraordinary commitment is still needed and will be for some time, and I believe that view is widely shared by my fellow policymakers at the Fed.

In this context, recent steps by the Fed to reduce the rate of new securities purchases are not a lessening of this commitment, only a judgment that recent progress in the labor market means our aid for the recovery need not grow as quickly. Earlier this month, the Fed reiterated its overall commitment to maintain extraordinary support for the recovery for some time to come.

This commitment is strong, and I believe the Fed's policies will continue to help sustain progress in the job market. But the scars from the Great Recession remain, and reaching our goals will take time. ...

It is my hope that the courageous and determined working people I have told you about today, and millions more, will get the chance they deserve to build better lives. ...

Paul Krugman: Jobs and Skills and Zombies

There is no skills gap:

Jobs and Skills and Zombies, by Paul krugman, Commentary, NY Times: A few months ago, Jamie Dimon, the chief executive of JPMorgan Chase, and Marlene Seltzer, the chief executive of Jobs for the Future, published an article in Politico titled “Closing the Skills Gap.” They began portentously: “Today, nearly 11 million Americans are unemployed. Yet, at the same time, 4 million jobs sit unfilled” — supposedly demonstrating “the gulf between the skills job seekers currently have and the skills employers need.”

Actually,... multiple careful studies have found no support for claims that inadequate worker skills explain high unemployment.

But the belief that America suffers from a severe “skills gap” is one of those things that everyone important knows must be true, because everyone they know says it’s true. It’s a prime example of a zombie idea — an idea that should have been killed by evidence, but refuses to die.

And it does a lot of harm. ...

So how does the myth of a skills shortage ... persist...? Well, there was a nice illustration of the process last fall, when some news media reported that 92 percent of top executives said that there was, indeed, a skills gap. The basis for this claim? A telephone survey in which executives were asked, “Which of the following do you feel best describes the ‘gap’ in the U.S. workforce skills gap?” followed by a list of alternatives. Given the loaded question, it’s actually amazing that 8 percent of the respondents were willing to declare that there was no gap.

The point is that influential people move in circles in which repeating the skills-gap story — or, better yet, writing about skill gaps in media outlets like Politico — is a badge of seriousness, an assertion of tribal identity. And the zombie shambles on.

Unfortunately, the skills myth — like the myth of a looming debt crisis — is having dire effects on real-world policy. Instead of focusing on the way disastrously wrongheaded fiscal policy and inadequate action by the Federal Reserve have crippled the economy and demanding action, important people piously wring their hands about the failings of American workers.

Moreover, by blaming workers for their own plight, the skills myth shifts attention away from the spectacle of soaring profits and bonuses even as employment and wages stagnate. Of course, that may be another reason corporate executives like the myth so much.

So we need to kill this zombie, if we can, and stop making excuses for an economy that punishes workers.

Links for 3-31-14

• Relevance of Marx? - Brad DeLong
• Tight oil making a difference - Econbrowser
• The ACA Surge Blackout - Paul Krugman
• Should We Be Worried? - David Beckworth
• The price of political uncertainty - vox
• Piketty, Veblen and Kalecki (for anne at Economist's View) - EconoSpeak
• Regime Switching at the Lower Bound: A Research Topic - Roger Farmer
• Effective demand, endogenous money, and debt - Thomas Palley
• Understanding the Underlying Asumptions - Dave Giles
• Two first year multipliers: their truth, beauty, and usefulness - Nick Rowe
• Private charity can't replace government social programs - latimes.com

The Two Percent *Ceiling* for Inflation

The Fed has consistently missed its inflation target:

Monetary Policy And Secular Stagnation, by Atif Mian and Amir Sufi: ...The Fed’s goal is to achieve the target of 2% inflation in the long-term, and its preferred price index is the core personal consumption expenditure price index that excludes the volatile food and energy sectors (or core PCE for short). So how has the Fed performed in achieving its target of 2% inflation in the past 15 years?

The chart above plots the implied core PCE index if inflation had met its 2% target (red line), and the actual core PCE index (blue line) starting from 1999. ... The divergence between target and actual inflation is all the more striking given the elevated rate of unemployment during the sample period. ...

It is hard to fault the Fed for not trying... The Fed’s difficulty in maintaining a 2% target is not just about the Great Recession. The divergence started in the 2000′s... In fact the only period when the blue line runs parallel to the red (implying a 2% rate of inflation for a while) is the 2004-2006 period when the economy witnessed an unprecedented growth in credit. ...

What we are witnessing is the limit of what monetary policy alone can do. Sometimes there is a tendency to assume that the Fed can “target” any inflation rate it wishes, or that it can target the overall price level – the so-called nominal GDP targeting. The evidence suggests that the Fed may not be so omnipotent. ...

Another interpretation is that, at least during normal times, the Fed does have quite a bit of control over the inflation rate, but it treats 2% inflation as a ceiling (i.e. inflation must never rise above 2%) rather than a central tendency (i.e. inflation is allowed to fluctuate both above and below the 2% target so that, on average, inflation is 2%).

Links for 3-30-14

• Obamacare Makes Progress - Jeffrey Toobin
• Measuring Wealth Inequality - House of Debt
• Delivering the Eurozone ‘Consistent Trinity’ - vox
• Economists and Philosophy - NYTimes.com
• Costs, Benefits and Masterpieces in Detroit - Robert Frank
• War and calculation - Understanding Society
• Keynes: Cultural Rebel - EconoSpeak
• The Quit Rate, the Fed, and Braindead Employers - Beat the Press
• A Quick Note on Two Claims Re Productivity Growth - Jared Bernstein
• Pensions and neoliberal fantasies - mainly macro
• Where Do Policy Rules Come From? - John Taylor

'The Skills Zombie'

Paul Krugman:

The Skills Zombie: One of the most frustrating aspects of economic debate since 2008 has been the preference of influential people for stories about our troubles that sound serious as opposed to those that actually are serious. The reality, all along, has been that our economy is depressed because there isn’t enough spending... But policymakers and pundits want to hear about tough decisions and hard choices, and they just recoil from any suggestion that terrible problems might have easy answers.

The most destructive example is, of course, the deficit obsession... The deficit obsession has faded a bit; but we still have others..., namely, the notion that we have big problems because our work force lacks essential skills.

This is very much a zombie doctrine — that is, a doctrine that should be dead by now, having been repeatedly refuted by evidence...

Yet the skills story just keeps showing up in supposedly informed discussion. Again, I think that this is because it sounds like the kind of thing serious people should say.

The sad truth is that while disasters brought on by inadequate demand have an easy economic answer — just spend more! — the psychology of policy elites is such that they generally refuse to believe in this answer, and look for tough choices to make instead. And the result is that unless something comes along to jolt them out of that mindset — something like a war — the slump goes on for a very long time.

I think there is also a prefeence for explanations and policies that won't take money out of their (VSP's) pockets. "Tough choices" = things that are hard for other people.

Links for 3-29-14

• Economic Realism (Wonkish) - Paul Krugman
• Time inconsistency and debt - mainly macro
• Monetary Policy And Secular Stagnation - House of Debt
• What I Mean When I Talk About IS-LM (Wonkish) - Paul Krugman
• Europe’s banking problems and secular stagnation - vox
• Stress Tests, Lending, and Capital Requirements - Baseline Scenario
• The Anatomy of Imitation - Digitopoly
• “Incentives to produce” are incentives to rig the game - interfluidity
• Higher food prices are good for the poor ... in the long run - Derek Headey
• There can be an excess supply of commercial bank money - Nick Rowe
• Back to Econ 101: Costs versus Transfers - EconoSpeak
• Growth Versus Distribution: Hunger Games - Paul Krugman

'Save Capitalism from the Capitalists by Taxing Wealth'

Thomas Piketty:

Save capitalism from the capitalists by taxing wealth, by Thomas Piketty, Commentary, FT: The distribution of income and wealth is one of the most controversial issues of the day. ...

America ... was conceived as the antithesis of the patrimonial societies of old Europe. ... Until the first world war, the concentration of wealth in the hands of the rich was far less extreme in the US than Europe. In the 20th century, however, the situation was reversed.  ... US income inequality has sharpened since the 1980s, largely reflecting the huge incomes of people at the top. ...

The ideal solution would be a global progressive tax on individual net worth. ... This would keep inequality under control and make it easier to climb the ladder. And it would put global wealth dynamics under public scrutiny. The lack of financial transparency and reliable wealth statistics is one of the main challenges for modern democracies. ...

There's quite a bit more in the article.

Links for 3-28-14

• The Growth of Murky Finance - Liberty Street Economics
• Expect Surge in Temp Jobs to Continue - Real Time Economics
• The Dollar Value of an Extra Year of Life - NYTimes.com
• Thoughts on Accommodative Monetary Policy... - Charles Evans
• Too Much Faith In Models, Capital Taxation Edition - Paul Krugman
• Coming into econ from physics (and other fields) - Noahpinion
• Some Macro Implications of a Minimum Wage Hike - Econbrowser
• What’s good for GM may no longer depend on the US - Rampage
• The Republic of Science - Magic, maths and money
• Ad Hoc Monetary Policy - David Beckworth
• Corporate Profits, Proprietors’ Income, and Labor Compensation - owenzidar
• U.S. Monetary Policy and Emerging Market Economies - William Dudley
• Obamacare Fails to Fail - Paul Krugman
• Independent within—not of—Government: The Fed - Owen Humpage
• Raise earnings, but go beyond the minumum wage to do it - Edward Glaeser
• Osborne's spending paradox - Stumbling and Mumbling
• SSI Should Be Strengthened, Not Cut - CBPP
• Q4 GDP Revised up to 2.6%, Unemployment Claims decline - Calculated Risk
• Another Reason Why the Realism of Assumptions Matters - EconoSpeak
• Can economists forecast technological progress? - Digitopoly

Paul Krugman: America’s Taxation Tradition

"Confiscatory taxation" was an "American invention":

America’s Taxation Tradition, by Paul Krugman, Commentary, NY Times: ...Some conservatives argue that focusing on inequality is ... un-American — that we’ve always celebrated those who achieve wealth...

And they’re right. No true American would say this: “The absence of effective State, and, especially, national, restraint upon unfair money-getting has tended to create a small class of enormously wealthy and economically powerful men, whose chief object is to hold and increase their power,” and follow that statement with a call for “a graduated inheritance tax on big fortunes ... increasing rapidly in amount with the size of the estate.” 

Who was this left-winger? Theodore Roosevelt, in ... 1910...

The truth is that, in the early 20th century, many leading Americans warned about the dangers of extreme wealth concentration, and urged that tax policy be used to limit the growth of great fortunes. Here’s another example: In 1919, the great economist Irving Fisher ... devoted his presidential address to the American Economic Association largely to warning against the effects of “an undemocratic distribution of wealth.” And he spoke favorably of proposals to limit inherited wealth through heavy taxation of estates.

Nor was the notion of limiting the concentration of wealth, especially inherited wealth, just talk..., “confiscatory taxation of excessive incomes” — that is, taxation ... to reduce income and wealth disparities, rather than to raise money — was an “American invention.”...

Back when Teddy Roosevelt gave his speech, many thoughtful Americans realized ... that the New World was at risk of turning into Old Europe. And they were forthright in arguing that public policy should seek to limit inequality for political as well as economic reasons, that great wealth posed a danger to democracy. ...

You sometimes hear the argument that concentrated wealth is no longer an important issue... But ...... the share of wealth held at the very top ... has doubled since the 1980s, and is now as high as it was when Teddy Roosevelt and Irving Fisher issued their warnings. ...

We aren’t yet a society with a hereditary aristocracy of wealth, but, if nothing changes, we’ll become that kind of society over the next couple of decades.

In short, the demonization of anyone who talks about the dangers of concentrated wealth is based on a misreading of both the past and the present. Such talk isn’t un-American; it’s very much in the American tradition. And it’s not at all irrelevant to the modern world. So who will be this generation’s Teddy Roosevelt?

'The Misuse of Theoretical Models in Finance and Economics'

 Stanford University's Paul Pfleiderer:

Chameleons: The Misuse of Theoretical Models in Finance and Economics, by Paul Pfleiderer, March 2014: Abstract In this essay I discuss how theoretical models in finance and economics are used in ways that make them “chameleons” and how chameleons devalue the intellectual currency and muddy policy debates. A model becomes a chameleon when it is built on assumptions with dubious connections to the real world but nevertheless has conclusions that are uncritically (or not critically enough) applied to understanding our economy. I discuss how chameleons are created and nurtured by the mistaken notion that one should not judge a model by its assumptions, by the unfounded argument that models should have equal standing until definitive empirical tests are conducted, and by misplaced appeals to “as-if” arguments, mathematical elegance, subtlety, references to assumptions that are “standard in the literature,” and the need for tractability.

'Nafta Still Bedevils Unions'

I still believe international trade makes us better off on net, but there are winners and losers from these agreements and we don't do anywhere near enough to help those who are hurt by these deals -- no wonder they are opposed:

Nafta Still Bedevils Unions, by Annie Lowrey, NY Times: Two decades after its enactment, the North American Free Trade Agreement — better known as Nafta — remains a source of deep disagreement among economists.

Maybe it has led employers to add tens of thousands of jobs. Or perhaps it has caused the loss of 700,000 jobs. Maybe it has been “a bonanza for U.S. farmers and ranchers,” as the United States Chamber of Commerce has said. But perhaps it has depressed wages for millions of working families. Then again, maybe all sides are wrong: “Nafta brought neither the huge gains its proponents promised nor the dramatic losses its adversaries warned of,” wrote Jorge G. Castañeda in an essay for Foreign Affairs this winter. “Everything else is debatable.”

But for labor groups, there is no debate: Nafta hurt American jobs and household earnings. And the sweeping trade agreement cast a shadow that persists today, spurring deep skepticism of the major trade deals the Obama administration is negotiating with Europe and a dozen Pacific Rim countries. ...

On Thursday, the A.F.L.-C.I.O. released a report excoriating Nafta... Among its conclusions: That Nafta increased corporate profits while depressing wages; that its labor-protection provisions have not improved labor conditions on the ground; that its environmental standards have not protected the environment; and that higher trade flows have not meant shared prosperity. ...

'Why the Income Distribution Matters for Macroeconomics'

Atif Mian and Amir Sufi:

Why the Income Distribution Matters for Macroeconomics, by Atif Mian and Amir Sufi: A central argument we have made on this blog and in our book is that the distribution of income/wealth matters a great deal for thinking about the macro-economy. Convincing some of this fact is not easy...

Perhaps the easiest way to see the importance of the income distribution is to examine how households respond to a windfall of cash or wealth. Do they spend the money, or do they save it? And does the spending response to a windfall of cash depend on the income of the household?

The answer is a resounding yes: low income households spend a much higher fraction of cash windfalls than high income households. In the parlance of economics, low income households have a much higher marginal propensity to consume, or MPC, than high income households.

This is one of the most well-established facts in empirical research in macroeconomics. Here is a summary: ...[reviews evidence]...

The implications of the differences in spending propensities across the population are enormous, especially if we believe that inadequate demand explains economic weakness during severe recessions. For example, facilitating debt forgiveness or progressive fiscal stimulus rebates will likely boost spending during the most severe part of a recession.

But perhaps even more interesting are the implications for the secular stagnation hypothesis, which holds that we are in a long-run stagnating economy because of inadequate demand. Is it a coincidence that the secular stagnation hypothesis is being revived exactly when income inequality is accelerating? If a higher share of income goes to the wealthiest households who spend very little of it, then perhaps these two trends are closely related.

'Redistribution is ... as American as Apple Pie'

Paul Krugman:

What America Isn’t, Or Anyway Wasn’t: ...one point Piketty makes is that the modern notion that redistribution and “penalizing success” is un- and anti-American is completely at odds with our country’s actual history. ... America actually pioneered very high taxes on the rich...

Why...? Piketty points to the American egalitarian ideal, which went along with fear of creating a hereditary aristocracy. High taxes, especially on estates, were motivated in part by “fear of coming to resemble Old Europe.” Among those who called for high estate taxation on social and political grounds was the great economist Irving Fisher.

Just to reemphasize the point: during the Progressive Era, it was commonplace and widely accepted to support high taxes on the rich specifically in order to keep the rich from getting richer — a position that few people in politics today would dare espouse.

...redistribution is ... as American as apple pie.

Links for 3-27-14

• Dare To Be Silly - Paul Krugman
• A Nation of Takers? - Nicholas Kristof
• Piketty's Inequality Story in Six Charts - John Cassidy
• Proposed Housing Bill Would Create a Co-op of Mortgage Lenders - NYT
• Bullard: Limited Value In Central Bank International Coordination - WSJ
• Evidence on Banks’ “Too-Big-to-Fail” Subsidy - Liberty Street Economics
• Do “Too-Big-to-Fail” Banks Take On More Risk? - Liberty Street Economics
• MCMC for Econometrics Students - Part IV - Dave Giles
• A Book That Needed To Be Written - The Baseline Scenario
• Using big data in finance: Example of sentiment-extraction - FEDS Notes
• It’s the economics, not the politics - mainly macro
• China's Shadow Banking Malaise - Boone and Johnson
• What Is the Fed's Credibility Worth? - Dean Baker
• A scholar who thinks globally and acts locally - MIT News
• Q&A: Why the Dollar Remains the Reserve Currency - NYTimes.com

'The EITC Is No Substitute for the Safety Net'

From the CBPP:

Why the EITC Is No Substitute for the Safety Net, CBPP: The Earned Income Tax Credit is a critically important and highly effective part of the safety net, but it can’t — and wasn’t meant to — stand alone as our answer to poverty, according to our new commentary.  Here’s the opening:

House Budget Committee Chair Paul Ryan’s recent report on safety net programs rightly praised the Earned Income Tax Credit (EITC) for reducing poverty and promoting work.  But, Ryan’s report criticizes much of the rest of the safety net.  And, over the past several years, Chairman Ryan’s budget plans have targeted low-income programs such as SNAP (formerly food stamps) and Medicaid for extremely deep cuts.  While it’s heartening to hear Chairman Ryan trumpet the EITC’s success, the EITC alone can’t do what’s needed to ameliorate poverty and hardship./p>

The things that the EITC — and its sibling the Child Tax Credit, which helps offset the cost of raising children — can’t do without other safety net programs include:

• help people who are out of work or can’t work;
• help families get health care;
• help families on a monthly basis;
• serve as an effective automatic stabilizer for the economy in recessions; and
• keep large numbers of people out of “deep poverty,” or above half the poverty line.

...

Video: Robert Shiller on Market Bubbles – And Busts

Links for 3-26-14

• Eleven Reflections on Piketty’s “Capital...” - Brad DeLong
• Things Go Better With Kochs - Paul Krugman
• More thoughts on ‘expectations driven’ liquidity traps - mainly macro
• Do Big Banks Have Lower Operating Costs? - Liberty Street Economics
• A Dialogue on the Resolution of the Financial Crisis... - Brad DeLong
• Should Federal IT Spending be Flat? - Tim Taylor
• What It Would Have Taken - Paul Krugman
• Is the Tide Turning Back? - Dallas Fed
• Jobless Recoveries in One Chart - House of Debt
• Q&A: A Sociologist on Inequality - NYTimes.com
• What America Isn't, Or Anyway Wasn't - Paul Krugman
• Self Help is no help for inequality - Helaine Olen
• Randomness in decision-making - Stumbling and Mumbling
• "Data" the buzzword vs. data the actual thing - Noahpinion
• Krugman and DeLong on Avoiding Secular Stagnation - Beat the Press
• The Jobs-Currency Connection in Greece - Dimitri Papadimitriou
• Mankiw’s Philosophical Case Against Taxing Capital Income - EconoSpeak
• The Second Machine Age Book Review Part I - Richard Serlin
• No business built on teenager demand is sustainable - Digitopoly

Stop Long-term Unemployment Before It Starts

Catherine Rampell:

When long-term unemployment becomes self-perpetuating, by Catherine Rampell, Commentary, Washington Post: Say it with me: The long-term unemployed are not lazy. Nor are they coddled, hammocked or enjoying a coordinated, taxpayer-funded vacation.

They are, however, extremely unlucky — and getting unluckier by the day. ...

It was already known that the longer workers have been out of a job, the lower their chance of finding work in the coming month. The Brookings paper — by the former Obama administration economist Alan Krueger and his Princeton colleagues Judd Cramer and David Cho — took this analysis a step further: What about (gulp) these workers’ longer-run prospects?

It turns out that from 2008 to 2012, only one in 10 people who were already long-term unemployed in a given month had returned to “steady, full-time employment” ... a little more than a year later. “Steady” in this case means that they were working for at least four consecutive months. And the other nine in 10 workers? They were still out of work, toiling in part-time or transitory jobs or had dropped out of the labor force altogether.  ...

One implication of the Brookings research is that policymakers should have done more to prevent the short-term jobless from falling into long-term joblessness in the first place. ...

'Democracy, What Is It Good For?'

Democracy is good for growth:

Democracy, What Is It Good For?, by Daron Acemoglu and James Robinson: ...[There is] a consensus engulfing both academia and the popular press that democracy is at its best irrelevant for growth, and perhaps even a hindrance. ...

A recent survey of the recent literature ... concludes:

The net effect of democracy on growth performance cross-nationally over the last five decades is negative or null.

... Our paper ... (joint with Suresh Naidu and Pascual Restrepo) is out, and as the title suggests “Democracy Does Cause Growth, it sharply disagrees with this consensus. ...

Our baseline estimates suggest that a country that democratizes increases its GDP per capita by about 20% in the next 20-30 years. Not a trivial effect at all. ...

In all, the evidence seems to be fairly clear that democracy is good for economic growth.

Why? This is a harder question to answer. Our evidence shows that democracies are better at implementing economic reforms, and also increase education. They also probably increase the provision of public goods (though the evidence here is a little less robust).

But none of this is conclusive evidence. ...

Wanted: A New Approach to Growth Policy

I have a new column:

Broadening the Discussion about Economic Growth, by Mark Thoma: Macroeconomic policy can be divided into two types, stabilization policy that attempts to keep the economy as close as possible to full employment, and growth policy that tries to make the economy expand as fast as possible over time. ...

Prior to the onset of our recent economic troubles, much of the research in economics and much of the political debate was about growth policy rather than stabilization policy. ...

That changed when the Great Recession hit. Suddenly, questions about stabilization policy came to the forefront. ...

Now that we are beginning to come out of the recession ... the focus is once again turning to economic growth. And it’s not just the political right that is thinking about the growth question. The left is thinking about growth too. ...

Increasingly, the idea that the ever-growing inequality can be harmful to economic growth has been taking hold. ...

Cutting taxes in the heyday of supply-side economics did not produce robust economic growth and ever lasting prosperity, and it did not solve the problem of rising inequality. If anything it made the problem worse. As we begin to focus on economic growth once again, it’s time for a new approach, one that recognizes the advantages of a more equitable distribution of income.

Links for 3-25-14

• When long-term unemployment becomes self-perpetuating - Catherine Rampell
• Long-Run Unemployment Arrives in the U.S. Economy - Tim Taylor
• I Really Do Not Think That We Were Doomed - Brad DeLong
• Is Surging Inequality Endemic to Capitalism? - John Cassidy
• Q&A: Minnesota Fed Chief Kocherlakota - Real Time Economics
• Congress Can Help the U.S. By Reforming The IMF - Christine Lagarde
• American Patrimony - Paul Krugman
• Mind the (Spending) Gap - House of Debt
• Layoffs in Maine - Paul Krugman
• Compared-to-what? - Mark Kleiman
• Tapering and the Emerging Markets - Angry Bear
• Stress Testing the Fed - FRBSF
• French Wages Are Not The Problem - Paul Krugman
• Has Janet Yellen Given Up On Her 2% Inflation Target? - EconoSpeak
• Empirical implications of Empirical Implications ... - Andrew Gelman
• Convexity Event Risks with Rising Interest Rates - Liberty Street
• The ECB should do QE via forex intervention - vox
• Helping Low-Income Children Succeed - Nancy Folbre

Fed Watch: Williams Acknowledges Forecast Change

Tim Duy:

Williams Acknowledges Forecast Change, by Tim Duy: Earlier today I said:

Fourth, the dots undeniably moved forward and steeper, which means individual outlooks on the definitions of "considerable period" or "accommodative" did in fact change in meaningful ways. I am surprised, however, that this was not anticipated by market participants given the rapid decline in the unemployment rate. Along any given Fed objective function, one would expect that a more rapid decrease in unemployment would move forward and steepen the interest rate trajectory, even if just by 25 or 50pb.

The Washington Post's Ylan Mui had a sitdown with Federal Reserve President John WIlliams:

Logically, given that the unemployment rate is a little bit lower, that suggests a little bit higher interest rate in 2016. Is that a big shift in the timing of the first rate increase? We’re talking about a relatively small change in terms of the forecast, and I wouldn’t see that as a significant shift.

When I look at the SEP projections for 2015, I just don’t see much of a change in the views on policy -- definitely not the kind of change in views on policy that represents some shift in our policy framework. The fact that unemployment has come down since December a little more than we thought, this is not news. Everybody knows that.

Also, regarding financial stability, I said Friday:

In short, if you believe that the Fed will not use monetary policy to address financial stability concerns, I think you might not be paying attention. They are already using monetary policy to address those concerns by not taking more aggressive action. Don't look to what they will do in the future for confirmation; look to what they are not doing right now.

I meant "aggressive action" as policy to speed the pace of the recovery, whereas current policy is geared toward ending asset purchases and paving the way for rate hikes. Williams on the topic:

I think our policies are doing about as well as we can without creating excessive risks down the road, either for the economy or financial stability. I think there is a little bit of a tradeoff between trying to push this economy now even harder and maybe having some unintended consequences down the road -- not today, not next year, probably not the year after -- and also the potential of making the exit out of our very accommodative policies a little more difficult to navigate.

Also, if you get a chance, read Gavin Davies at the Financial Times:

But in a wider sense there has been an unmistakable shift in the FOMC’s centre of gravity in the past few months. The key to this shift is that the mainstream doves who have dominated policy decisions in the past few years have now essentially stopped arguing against either the tapering of the balance sheet or the start of rate hikes within about a year from now. Only the isolated Narayana Kocherlakota remains in the aggressive dovish corner.

Bottom Line: Those who expected Federal Reserve Chair Janet Yellen to push for a more dovish policy path continue to be dissapointed.

Paul Krugman: Wealth Over Work

The drift toward oligarchy:

Wealth Over Work, by Paul Krugman, Commentary, NY Times: ...“Capital in the Twenty-First Century,” the magnum opus of the French economist Thomas Piketty,... does more than document the growing concentration of income in the hands of a small economic elite. He also makes a powerful case that we’re on the way back to “patrimonial capitalism,” in which the commanding heights of the economy are dominated not just by wealth, but also by inherited wealth, in which birth matters more than effort and talent.

To be sure, Mr. Piketty concedes that we aren’t there yet. ... But six of the 10 wealthiest Americans are already heirs rather than self-made entrepreneurs... As Mr. Piketty notes, “the risk of a drift toward oligarchy is real and gives little reason for optimism.”

Indeed. And if you want to feel even less optimistic,... America’s nascent oligarchy may not yet be fully formed — but one of our two main political parties already seems committed to defending the oligarchy’s interests.

Despite the frantic efforts of some Republicans to pretend otherwise, most people realize that today’s G.O.P. favors the interests of the rich over those of ordinary families. I suspect, however, that fewer people realize the extent to which the party favors returns on wealth over wages and salaries. And the dominance of income from capital, which can be inherited, over wages — the dominance of wealth over work — is what patrimonial capitalism is all about.

To see what I’m talking about, start with ... Representative Paul Ryan’s “road map” — calling for the elimination of taxes on interest, dividends, capital gains and estates. Under this plan, someone living solely off inherited wealth would have owed no federal taxes at all. ...

Why is this happening? Well, bear in mind that both Koch brothers are numbered among the 10 wealthiest Americans, and so are four Walmart heirs. Great wealth buys great political influence — and not just through campaign contributions. Many conservatives live inside an intellectual bubble of think tanks and captive media that is ultimately financed by a handful of megadonors. Not surprisingly, those inside the bubble tend to assume, instinctively, that what is good for oligarchs is good for America.

As I’ve already suggested, the results can sometimes seem comical. The important point to remember, however, is that the people inside the bubble have a lot of power, which they wield on behalf of their patrons. And the drift toward oligarchy continues.

Fed Watch: Post-FOMC Fedspeak

Tim Duy:

Post-FOMC Fedspeak, by Tim Duy: Some thoughts on post-FOMC activity as we head into Monday.

First, I did not cover Federal Reserve Chair Janet Yellen's definition of a "considerable period" as six months in my review of the FOMC statement. I did not highlight the issue because when I went back to the tape, it looked clear to me that the bulk of the bond market response came at the release of the statement and projections. To be sure, the equity market stumbled, but here I completely agree with Felix Salmon:

But here’s the thing: the market didn’t freak out....last Thursday, for instance, the yield fell by a good 10bp when John Kerry made noises about imposing sanctions on Russia. And overall, the yield has stayed comfortably in a range between 2.6% and 2.8%.

What’s more, the big FOMC-related move in the 10-year bond yield happened immediately at 2pm, when the statement was released. Yellen’s “gaffe” caused barely a wobble.

So why does everybody think that Yellen blundered? The answer is simple: they were looking at the stock market (which doesn’t matter), rather than the bond market (which does). Stocks fell, briefly; not a lot, and not for long, but enough that people noticed.

It is the bond market response that is important, and that response was pre-Yellen. It is not entirely clear that the six months timeline was new information. Or, at least, it wasn't to St. Louis Federal Reserve President James Bullard:

“That wasn’t very different from what we had heard from financial markets, so I think she’s just repeating that at that time period,” Bullard said at a roundtable at the Brookings Institution. Bullard doesn’t vote on policy this year.

Second, the more important issue appears to be the interest rate projections, the now infamous dot chart. In her press conference, Yellen attempted to deny the projections contained much useful information in her testimony:

But more generally, I think that one should not look to the dot-plot, so to speak, as the primary way in which the committee wants to or is speaking about policies to the public at large. The FOMC statement is the device that the committee as a policy-making group uses to express its – its opinions. And we have expressed a number of opinions about the likely path of rates.

Dallas Federal Reserve President Richard Fisher went further. Via Bloomberg:

Fisher suggested investors were placing too much emphasis on the change in forecasts, which the Fed illustrates as dots plotted on a chart.

There is a “fixation if not a fetish on the dots,” he said at the London School of Economics. The change in forecasts by Fed officials came before this week’s meeting, he said.

“Somehow, this was read as a massive shift,” Fisher said. “These are our best guesses.”

The Fed wants markets to focus on the distance between the bulk of the dots and participants view of normal. Back to Yellen:

Looking further out, let's say if you look at toward the end of 2016, when most participants are projecting that the employment situation, that the unemployment rate will be close to their notions of mandate-consistent or longer-run normal levels. What you see -- I think if you look, this time if you gaze at the picture from December or September, which is the first year that we showed those dot-plots for the end of 2016, is the massive points that are notably below what the participants believed is the normal longer-run level for nominal short‐term rates. And the committee today for the first time endorsed that as a committee view.

That said, it is clear the dots moved:

So I think that's significant. I think that's what we should be paying attention to. And I would simply warn you that these dots -- these dots are going to move up and down over time, a little bit this way or that. The dots moved down a little bit in December relative to September. And they moved up ever so slightly. I really don't think it's appropriate to read very much into it.

What should we take away from all of this? Well, first of all, I think it is absolutely ludicrous that the Fed is trying to claim the dots have no value. Seriously, can they work any harder to raise the act of bungling their communications strategy to an art form? If the dots have no value, then why force feed this information to market participants in the first place?

Second, yes, the dots do not represent the FOMC consensus. The statement represents the consensus. But the consensus is vague about what defines a "considerable period" or "accommodative" policy. Each individual participant has their own definition of these terms, and the dots thus provide value by quantifying the vagueness of the consensus. That is the real problem here - as a group, the Fed wants qualitative discretionary policy, and the dots provide quantifiable guidance. If they want qualitative discretionary policy, they need to pull all the numbers from their communications.

Third, Yellen needs to accept responsibility for mangling communications. She has been pushing her optimal control story for a long, long time. In the process, she has convinced market participants on the importance of the forward projections of economic variables. Yet now forward projections are meaningless?

Fourth, the dots undeniably moved forward and steeper, which means individual outlooks on the definitions of "considerable period" or "accommodative" did in fact change in meaningful ways. I am surprised, however, that this was not anticipated by market participants given the rapid decline in the unemployment rate. Along any given given Fed objective function, one would expect that a more rapid decrease in unemployment would move forward and steepen the interest rate trajectory, even if just by 25 or 50pb.

Why, why, why should Federal Reserve participants be permitted to change their outlooks but the Fed believes financial market participants are not allowed to follow suit?

Perhaps it is that while - and I believe this - the Fed's reaction function did not change, I suspect there is a very good chance that market participants expected it to change in a more dovish direction. This follows directly again from Yellen's optimal control story. How many analysts were expecting a September lift-off on the basis of her charts? How many expected Yellen push for a more dovish reaction function? I think you need to throw any analysis that explicitly allowed for above target inflation out the window - and that includes the optimal control framework.

In my opinion, some financial market participants are resisting abandoning their dovish interpretation of Fed policy. For instance, Jan Hatzius of Goldman Sachs continues to hold to its 2016 rate hike call. Via the Wall Street Journal:

“Rate hikes are far off,” wrote Jan Hatzius, Goldman’s chief Fed watcher, in a note to clients late Thursday. “Our central forecast for the first hike remains early 2016, although the risks now tilt in the direction of a slightly earlier move.”

Recall, however, Goldman's view from November:

According to an analysis from Jan Hatzius, chief economist at Goldman Sachs, the two Fed papers actually would imply an earlier reduction of QE than planned—perhaps as soon as December—while the zero-bound interest rates could remain in place until 2017 and kept below normal into "the early 2020s."

Why? Because of extensions of the optimal control framework.

"The studies suggest that some of the most senior Fed staffers see strong arguments for a significantly greater amount of monetary stimulus than implied by either a Taylor rule or the current 6.5 percent/2.5 percent threshold guidance," Hatzius wrote. "Given the structure of the Federal Reserve Board, we believe it is likely that the most senior officials—in particular, Ben Bernanke and (Chair-elect) Janet Yellen—agree with the basic thrust of the analysis."

And more from Hatzius from Bill McBride at Calculated Risk:

It is hard to overstate the importance of two new Fed staff studies that will be presented at the IMF's annual research conference on November 7-8. The lead author for the first study is William English, who is the director of the Monetary Affairs division and the Secretary and Economist of the FOMC. The lead author for the second study is David Wilcox, who is the director of the Research and Statistics division and the Economist of the FOMC. The fact that the two most senior Board staffers in the areas of monetary policy analysis and domestic macroeconomics have simultaneously published detailed research papers on central issues of the economic and monetary policy outlook is highly unusual and noteworthy in its own right. But the content and implications of these papers are even more striking.

...[O]ur initial assessment is that they considerably increase the probability that the FOMC will reduce its 6.5% unemployment threshold for the first hike in the federal funds rate, either coincident with the first tapering of its QE program or before.
...
[O]ur central case is now that the FOMC will reduce the threshold from 6.5% to 6% at the March 2014 FOMC meeting, alongside the first tapering of QE; however, a move as early as the December 2013 meeting is possible, and if so, this might also increase the probability of an earlier tapering of QE.

In comparison to these expectations, the Fed is downright hawkish despite no change to their reaction function. The point is that, in my opinion, reality is starting to set in and financial market participants are walking back on their caricaturization of Yellen and the most dovish of all doves.

Bottom Line: The Fed is pushing back on the dots because they don't want quantitative guidance, and they forgot they were giving it. Expectations that Yellen will push for a more dovish reaction function are being disappointed. Note that the interest rates forecasts are just that - forecasts. They will evolve in one direction or the other in response to incoming data. But incoming data on unemployment undeniably pushes in the direction of an earlier liftoff and, subsequently, a steeper trajectory for rates. If they want to lean against those expectations, the Fed does need to change its reaction function, but to a more dovish one. That, I think, is not the direction of policy at this point.

Links for 3-24-14

• Did Yellen intend to tighten policy last week? - Gavyn Davies
• All Economics Is Local - NYTimes.com
• I Didn't Build That - Paul Krugman
• Bank says money multiplier is wrong - ... shocked? - mainly macro
• Trickle-up economics - David Cay Johnston
• The Undercover Economist Strikes Back - Book TV
• The Crime of 2010 - Paul Krugman
• Tarnished Silver - Paul Krugman
• Ideology & behavioural economics - Chris Dillow
• The Spring Snaps Back - Economic Principals
• Causal necessity? - Understanding Society
• You Can’t Connect the [Fed’s] Dots Looking Forward - John Taylor
• GAS and DCS Models - No Hesitations

'Secular Stagnation and Wealth Inequality'

Atif Mian and Amir Sufi:

Secular Stagnation and Wealth Inequality, by Atif Mian and Amir Sufi: Alvin Hansen introduced the notion of “secular stagnation” in the 1930s. Hansen’s hypothesis has been brought back to life by Larry Summers...

A brief summary of the hypothesis goes something like this: A normally functioning economy would lower interest rates in the face of low current demand for goods and services... A lower interest rate helps boost demand.

But what if ... real interest rates need to be very negative to boost demand, but prevailing interest rates are around zero, then we will have too much savings in risk-free assets — what Paul Krugman has called the liquidity trap. In such a situation, the economy becomes demand-constrained.

The liquidity trap helps explain why recessions can be so severe. But the Summers argument goes further. He is arguing that we may be stuck in a long-run equilibrium where real interest rates need to be negative to generate adequate demand. Without negative real interest rates, we are doomed to economic stagnation. ...

In our view, what is missing from the secular stagnation story is the crucial role of the highly unequal wealth distribution. Who exactly is saving too much? It certainly isn’t the bottom 80% of the wealth distribution! We have already shown that the bottom 80% of the wealth distribution holds almost no financial assets.

Further, when the wealthy save in the financial system, some of that saving ends up in the hands of lower wealth households when they get a mortgage or auto loan. But when lower wealth households get financing, it is almost always done through debt contracts. This introduces some potential problems. Debt fuels asset booms when the economy is expanding, and debt contracts force the borrower to bear the losses of a decline in economic activity.

Both of these features of debt have important implications for the secular stagnation hypothesis. We will continue on this theme in future posts.

On Greg Mankiw's 'Do No Harm'

A rebuttal to Greg Mankiw's claim that the government should not interfere in voluntary exchanges. This is from Rakesh Vohra at Theory of the Leisure Class:

Do No Harm & Minimum Wage: In the March 23rd edition of the NY Times Mankiw proposes a 'do no harm' test for policy makers:

…when people have voluntarily agreed upon an economic arrangement to their mutual benefit, that arrangement should be respected.

There is a qualifier for negative externalities, and he goes on to say:

As a result, when a policy is complex , hard to evaluate and disruptive of private transactions, there is good reason to be skeptical of it.

Minimum wage legislation is offered as an example of a policy that fails the do no harm test. ...

There is an immediate 'heart strings' argument against the test, because indentured servitude passes the 'do no harm' test. ... I want to focus instead on two other aspects of the 'do no harm' principle contained in the words 'voluntarily'and 'benefit'. What is voluntary and benefit compared to what? ...

When parties negotiate to their mutual benefit, it is to their benefit relative to the status quo. When the status quo presents one agent an outside option that is untenable, say starvation, is bargaining voluntary, even if the other agent is not directly threatening starvation? The difficulty with the `do no harm’ principle in policy matters is the assumption that the status quo does less harm than a change in it would. This is not clear to me at all. Let me illustrate this...

Assuming a perfectly competitive market, imposing a minimum wage constraint above the equilibrium wage would reduce total welfare. What if the labor market were not perfectly competitive? In particular, suppose it was a monopsony employer constrained to offer the same wage to everyone employed. Then, imposing a minimum wage above the monopsonist’s optimal wage would increase total welfare.

[There is also an example based upon differences in patience that I left out.]

Links for 3-23-14

• What place do applied middlebrow models have? - mainly macro
• A grand unified theory of behavioral economics? - Noahpinion
• India, Pakistan, and Growth – Part I - House of Debt
• Favoring Wealth Over Work - Paul Krugman
• The Truth About ObamaCare - Robert Reich
• When the Scientist Is Also a Philosopher - Greg Mankiw
• EU antitrust fines and economic distortions - vox
• Working for the Owners - Paul Krugman
• How Technology Creates Jobs - James Bessen
• Abenomics a Short-Run Success - Brad DeLong

Fed Watch: Kocherlakota's Dissent

Tim Duy:

Kocherlakota's Dissent, by Tim Duy: Minneapolis Federal Reserve President Narayana Kocherlakota defended his dissent at the March FOMC meeting. I thought it was quite remarkable. The reason of the dissent itself is not particularly unexpected:

I dissented from the new guidance for two reasons. The first reason is that the new guidance weakens the credibility of the Committee’s commitment to target 2 percent inflation. The second reason is that the new guidance fosters policy uncertainty and thereby suppresses economic activity.

I have already discussed the implications of dropping the Evans rule in regards to inflation. It implies an intention to approach the inflation target from below as well as a lack of tolerance for above target inflation. As far as the second point, Kocherlakota is arguing that the lack of quantitative guideposts increases uncertainty about the path of policy and that uncertainty tends to make economic agents risk adverse. Market participants, for example, might rationally believe they should react to that risk by moving up their expectations of the first rate hike, which by itself induces somewhat less accommodative policy.

More interesting, in my opinion, was Kocherlakota's alternative language. Consider for a moment the Evans rule as it was in January:

The Committee also reaffirmed its expectation that the current exceptionally low target range for the federal funds rate of 0 to 1/4 percent will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

Now consider Kocherlakota's version of the Evans rule:

For example, the Committee could have adopted language of the following form: “the Committee anticipates keeping the fed funds rate in its current range at least until the unemployment rate has fallen below 5.5 percent, as long as the one-to-two-year-ahead outlook for PCE inflation remains below 2 1/4 percent, longer-term inflation expectations remain well-anchored, and possible risks to financial stability remain well-contained.”

Kocherlakota has to come up with something he can sell to the rest of the FOMC. It says something about the rest of the FOMC that the most he thinks he can sell is a meager 25bp bump above the Federal Reserve inflation target. It says even more if that's the most he could sell to himself. If the most dovish member of the FOMC can tolerate no more than a 25bp upside miss on inflation, what does it say about the other FOMC members? Regardless of whether this is Kocherlakota's max or the best he thinks he can get, it tells you that 2% is really a ceiling, not a target. Now, generously, it maybe that the FOMC believes that they cannot exceed 2% politically given the amount of extraordinary stimulus already in place. But that still leaves 2% as a ceiling.

Moreover, look at the addition of the "possible risks to financial stability remain well-contained" language. It is no longer just about the length of accomodative policy, but about the first rate hike itself. It suggests that a rate hike to snuff out financial stability is clearly on the table. Moreover, if Kocherlakota thinks the only way he can sell his new version of the Evans rule is address financial stability, it means that such concerns are already an impediment to even more supportive monetary policy. This is something I noted yesterday with respect to Yellen's comments about the tapering debate last spring.

In short, if you believe that the Fed will not use monetary policy to address financial stability concerns, I think you might not be paying attention. They are already using monetary policy to address those concerns by not taking more aggressive action. Don't look to what they will do in the future for confirmation; look to what they are not doing right now.

Bottom Line: Kocherlakota's dissent paints the rest of the FOMC as surprisingly hawkish.

Links for 3-22-14

• Price level targeting intuition - mainly macro
• Janet Yellen didn’t gaffe - Felix Salmon
• Timid Analysis (Wonkish) - Paul Krugman
• Why Are Physicists Drawn to Economics? - Orderstatistic
• The Government Is No Drunken Sailor - NYTimes.com
• Strong versus Weak Net Neutrality - Digitopoly
• Why We Love Cars - House of Debt
• The limited economic impact of the US shale gas boom - vox
• Inflation expectations and real treasury yields - MacroMania
• Tea Party and Wall Street Are Getting Along Just Fine - Mike Konczal
• Federal Reserve dissenter Kocherlakota attacks new guidance - FT.com
• Will the U.S. Dollar Remain the World's Reserve Currency? - Tim Taylor
• Why the Dollar Endures - Eswar Prasad
• Skew - Baseline Scenario
• Wearables and Real Estate - Digitopoly

'Labor Markets Don't Clear: Let's Stop Pretending They Do'

Roger farmer:

Labor Markets Don't Clear: Let's Stop Pretending They Do: Beginning with the work of Robert Lucas and Leonard Rapping in 1969, macroeconomists have modeled the labor market as if the wage always adjusts to equate the demand and supply of labor.

I don't think that's a very good approach. It's time to drop the assumption that the demand equals the supply of labor.

Why would you want to delete the labor market clearing equation from an otherwise standard model? Because setting the demand equal to the supply of labor is a terrible way of understanding business cycles. ...

Why is this a big deal? Because 90% of the macro seminars I attend, at conferences and universities around the world, still assume that the labor market is an auction where anyone can work as many hours as they want at the going wage. Why do we let our students keep doing this?

'The Counter-Factual & the Fed’s QE'

I tried to make this point in a recent column (it was about fiscal rather than monetary policy, but the same point applies), but I think Barry Ritholtz makes the point better and more succinctly:

Understanding Why You Think QE Didn't Work, by Barry Ritholtz: Maybe you have heard a line that goes something like this: The weak recovery is proof that the Federal Reserve’s program of asset purchases, otherwise known as quantitative easement, doesn't work.

If you were the one saying those words, you don't understand the counterfactual. ...

This flawed analytical paradigm has many manifestations, and not just in the investing world. They all rely on the same equation: If you do X, and there is no measurable change, X is therefore ineffective.

The problem with this “non-result result” is what would have occurred otherwise. Might “no change” be an improvement from what otherwise would have happened? No change, last time I checked, is better than a free-fall.

If you are testing a new medication to reduce tumors, you want to see what happened to the group that didn't get the test therapy. Maybe this control group experienced rapid tumor growth. Hence, a result where there is no increase in tumor mass in the group receiving the therapy would be considered a very positive outcome.

We run into the same issue with QE. ... Without that control group, we simply don't know. ...

The Fool on the Icy Hill

As a follow-up to Krugman's article, this is something I wrote in January of 2009:

...I think the stimulus package is like driving up an icy hill. If you don't have enough momentum from the start and fail to provide enough "stimulus" to get the car over the crest of the hill, you can slide all the way back to the bottom, crashing into things along the way and ending up worse off than when you started. Maybe you can give it more gas along the way if needed without spinning out, and perhaps you can hold your position if you don't make it to the top, and then start again from the higher level, but that's not a chance I want to take when I'm sitting at the bottom wondering if I can make it to the top without wrecking my car -- the possibility of falling all the way back to the bottom and ending up worse off would make me want to start with sufficient momentum and then some. Essentially, I am arguing that there are crucial economic and psychological "tipping points" that must be reached in order for the economic recovery package to be effective (or at least, there's enough of a chance that they exist that they cannot be ignored when formulating robust policy). ...

Paul Krugman added:

I’d add that there may also be a political tipping point: if the stimulus package is too weak, conservatives will pile on after it fails to deliver, claiming that the whole concept has been discredited.

Paul Krugman: The Timidity Trap

When policymakers are overly cautious, it can backfire:

The Timidity Trap, by Paul Krugman, Commentary, NY Times: There don’t seem to be any major economic crises underway right this moment, and policy makers in many places are patting themselves on the back. ...

Unfortunately, that ... just goes to show how accustomed we’ve grown to terrible economic conditions. We’re doing worse than anyone could have imagined a few years ago, yet people seem increasingly to be accepting this miserable situation as the new normal.

How did this happen? ... I’d argue that an important source of failure was what I’ve taken to calling the timidity trap — the consistent tendency of policy makers who have the right ideas in principle to go for half-measures in practice, and the way this timidity ends up backfiring, politically and even economically.

In other words, Yeats had it right: the best lack all conviction, while the worst are full of passionate intensity.

About the worst: If you’ve been following economic debates these past few years, you know that both America and Europe have powerful pain caucuses — influential groups fiercely opposed to any policy that might put the unemployed back to work. There are some important differences between the U.S. and European pain caucuses, but both now have truly impressive track records of being always wrong, never in doubt. ...

So what has been the response of the good guys?

For there are good guys out there... But these good guys never seem willing to go all-in on their beliefs.

The classic example is the Obama stimulus, which was obviously underpowered... Some of us warned right from the beginning that the plan would be inadequate — and that because it was being oversold, the persistence of high unemployment would end up discrediting the whole idea of stimulus in the public mind. And so it proved.

What’s not as well known is that the Fed has, in its own way, done the same thing. From the start, monetary officials ruled out the kinds of monetary policies most likely to work — in particular, anything that might signal a willingness to tolerate somewhat higher inflation, at least temporarily. As a result, the policies ... have fallen short of hopes, and ended up leaving the impression that nothing much can be done. ...

You might ask why the good guys have been so timid, the bad guys so self-confident. I suspect that the answer has a lot to do with class interests. But that will have to be a subject for another column.

Links for 3-21-14

• Abenomics—Time for a Push from Higher Wages - IMF Blog
• Unemployed? You Might Never Work Again - NYTimes.com
• The Case for Not Worrying About Financial Instability - WSJ
• Job lock: Theory - Incidental Economist
• See no evil - mainly macro
• Weekly Initial Unemployment Claims at 320,000 - Calculated Risk
• MCMC for Econometrics Students - III - Dave Giles
• Real Wages below Peak for 41st Straight Year - Ken Thomas

A Break

Yahoo! The quarter is over. No more teaching for 18 months (except for a summer class at UT Austin).

'Capital Ownership and Inequality'

Atif Mian and Amir Sufi follow up on something noted here a few days ago:

Capital Ownership and Inequality, by Atif Mian and Amir Sufi: Lots of interesting and thought-provoking reactions to our post yesterday on how the gains in U.S. productivity are shared.

One aspect of the debate that is often over-looked is the concentration of financial asset holdings in the U.S. economy. Who owns financial assets such as stocks and bonds in corporations tells us who has a direct claim to the income generated by capital. Here is the distribution of financial asset holdings across the wealth distribution. This is from the 2010 Survey of Consumer Finances:

The top 20% of the wealth distribution holds over 85% of the financial assets in the economy. So it is clear that the direct income from capital goes to the wealthiest American households. ...

There is ... the question of incorporating housing wealth in the graph above. How should we think about housing which is more broadly held? But it’s important to have the basic facts established to begin the debate. If you think the above chart is misleading or incorrect in some way, we are happy to hear why. ...

Turning Their Backs on the Unemployed

The Fed:

Fiscal policy is restraining economic growth

Congress, implicitly:

We don't care

Maximizing the fortunes of the wealthy backers of political campaigns -- e.g. cutting their taxes so they don't have to pay for programs that help "those people" after the financial wizards on Wall Street cause the economy to crash -- is not the same as maximizing economic growth and employment. The wealthy think it's the same -- in their minds they are the job creators, what's good for the wealthy is good for America! -- but it's not.

Fed Watch: Unintentionally Hawkish

Tim Duy:

Unintentionally Hawkish, by Tim Duy: The outcome of the FOMC meeting was pretty much as I anticipated. Asset purchases were cut by $10 billion. The Evans rule was dumped. And forward guidance was enhanced to emphasize that rates would be low for a long, long time. All seems pretty much in-line with the general consensus.

Yet financial market participants took a hawkish view of the news. Bonds were trounced - the 5 year Treasury yield lept almost 15bp. Market participants clearly saw something they didn't like. This despite what was a reasonably dovish inaugural press conference by Federal Reserve Chair Janet Yellen. Indeed, she strongly emphasized the new forward guidance language:

When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.

This makes clear that low rates may persist after the unemployment rate hovers closer to 5.5%. In other words, in the absence of clearly higher inflation or a reasonable forecast of higher inflation, the Fed is in no rush to push rates to a more normalish 4%.

Low rates, however, are not the same as near zero interest rates. And the interest rate forecasts seems to imply tighter policy in 2015 and 2016 than implied by the December projections. But during the press conference, Yellen denied the little dots contained any meaningful forecast information. Again, she pointed to the statement as the relevant guidance. And the statement clearly says to expect a period of low interest rates and takes no firm position on the exact timing of the first rate hike. Sounds pretty dovish.

Moreover, it is not clear that the patterns of the dots represent a meaningful change in policy even if taken at face value. Consider the dots in the context of this line from the statement:

The change in the Committee's guidance does not indicate any change in the Committee's policy intentions as set forth in its recent statements.

The dots always made clear that rates would remain low even as unemployment fell. Arguably, the Fed did nothing more in the statement than turn unofficial policy into official policy. And the slight move forward in the rate forecast was completely reasonable given the optimistic forecast of the unemployment rate. Assuming the Fed is following some Taylor-type rule, a lower unemployment rate would be sufficient to nudge forward the timing of the first rate hike. That seems perfectly consistent with the Fed's reaction function as detailed in recent statements.

All in all, it seems relatively easy to make a case that this was a dovish policy decision and a dovish press conference. Others will make the case, and offer more details, I expect, about things such as Yellen's emphasize on a wide array of labor market indicators as evidence of slack. What about a hawkish version?

If I am making a hawkish interpretation, it starts with the end of the Evans rule. Everyone seems focused on the unemployment part of the Evans rule, while my attention is on the inflation part. The Evans rule allowed for the Fed to reach their inflation target from above. It provided wiggle room on the target as long as unemployment was above 6.5%. With the end of the Evans rule, the Fed sends a signal that they no longer find it acceptable to reach the target from above. They intend to reach it from below. 2% is officially once again a ceiling. Indeed this is pretty much made explicit in the statement:

The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.

Low rates are only guaranteed if inflation remains below 2%. Above 2%, you had better expect a fast and furious reaction. Moreover, Minneapolis Federal Reserve President Narayana Kocherlakota's dissent makes clear the topic on the table is a below-target approach for inflation:

Voting against the action was Narayana Kocherlakota, who supported the sixth paragraph, but believed the fifth paragraph weakens the credibility of the Committee's commitment to return inflation to the 2 percent target from below and fosters policy uncertainty that hinders economic activity.

Responding to a question about the dissent, Yellen did emphasize that she did not want to undershoot inflation, but she made no mention of a willingness to overshoot inflation. Ceiling.

Moreover, the new-found 2% ceiling puts a cloud over the importance of Yellen's optimal control theory. The whole point of that exercise was that the cost of allowing inflation to rise above 2% was less than the cost of high unemployment. Seems like this idea is abandoned when you explicitly rule out the ability to reach the target from above.

The whole tenor of the policy discussion has a hawkish tone as well. As the Washington Post's Ylan Mui notes, the policy focus has shifted entirely to the timing of the first rate hike:

The nation’s central bank said Wednesday it will look at a broad swath of indicators – including job market data, inflation expectations and financial developments – as it determines when to raise rates for the first time since the recession hit. The deliberately vague wording is a retreat from the Fed’s concrete promise to leave rates untouched. Though they disagree on when to act – targets range from this year to 2016 – the statement signals the moment has finally come within striking distance.

There is no longer any reasonable expectation that the Fed has any interest in accelerating the pace of the recovery to more quickly alleviate poor labor market conditions. Barring a sharp change in economic conditions, the Fed is headed in only one direction.

Finally - and I don't think that many caught this - toward the end of the press conference, Yellen explicitly states that the higher term-premiums triggered by the tapering discussion hurt economic activity by slowing the housing recovery. But then she credited the move with reducing financial instabilities. In other words, she willingly traded growth for financial stability. Something to think about as equities plow higher.

Bottom Line: If you focus on the "low rates for a long time" language, you walk away with dovish interpretation. If you focus on the implications of the end of the Evans rule on the Fed's inflation target, I think you can walk away with a hawkish interpretation. Moreover, if you believe that 2% is now a ceiling, you probably should think the risk of inflation triggering a Fed response is higher than under the Evans rule, and adjust your forecast accordingly.

Links for 3-20-14

• Capital Ownership and Inequality - House of Debt
• The Chartbook of Economic Inequality - INET
• Paleontologists announce discovery of Anzu wyliei - EurekAlert
• Nobody Could Have Predicted, Monetary Edition - Paul Krugman
• The Red Faces of the Solar Skeptics - Environmental Economics
• I got to the third sentence of Osborne’s speech - mainly macro
• The Economics of Limiting Russia’s Expansion - NYTimes.com
• Whatever Happened To Regional Science? - EconoSpeak
• Job lock: Introduction - The Incidental Economist
• On the impact of economic ideas - Alex Marsh
• How Academics Learn to Write Badly - Tim Taylor
• Which is better, data or theory? - Noahpinion
• On Yellen’s First FOMC Presser And Efficient Markets… - Jodi Beggs
• Overheat to Raise Potential Growth? - Gloomy European Economist

'The Voluntarism Fantasy'

In case you missed this in the daily links, a topic that comes up here often, the need for government sponsored social insurance:

The Voluntarism Fantasy, by Mike Konczal: Ideology is as much about understanding the past as shaping the future. And conservatives tell themselves a story, a fairy tale really, about the past, about the way the world was and can be again under Republican policies. This story is about the way people were able to insure themselves against the risks inherent in modern life. Back before the Great Society, before the New Deal, and even before the Progressive Era, things were better. Before government took on the role of providing social insurance, individuals and private charity did everything needed to insure people against the hardships of life; given the chance, they could do it again.

This vision has always been implicit in the conservative ascendancy. It existed in the 1980s, when President Reagan announced, “The size of the federal budget is not an appropriate barometer of social conscience or charitable concern,” and called for voluntarism to fill in the yawning gaps in the social safety net. It was made explicit in the 1990s, notably through Marvin Olasky’s The Tragedy of American Compassion, a treatise hailed by the likes of Newt Gingrich and William Bennett, which argued that a purely private nineteenth-century system of charitable and voluntary organizations did a better job providing for the common good than the twentieth-century welfare state. This idea is also the basis of Paul Ryan’s budget, which seeks to devolve and shrink the federal government at a rapid pace, lest the safety net turn “into a hammock that lulls able-bodied people into lives of dependency and complacency, that drains them of their will and their incentive to make the most of their lives.” It’s what Utah Senator Mike Lee references when he says that the “alternative to big government is not small government” but instead “a voluntary civil society.” As conservatives face the possibility of a permanent Democratic majority fueled by changing demographics, they understand that time is running out on their cherished project to dismantle the federal welfare state.

But this conservative vision of social insurance is wrong. It’s incorrect as a matter of history; it ignores the complex interaction between public and private social insurance that has always existed in the United States. It completely misses why the old system collapsed and why a new one was put in its place. It fails to understand how the Great Recession displayed the welfare state at its most necessary and that a voluntary system would have failed under the same circumstances. Most importantly, it points us in the wrong direction. The last 30 years have seen effort after effort to try and push the policy agenda away from the state’s capabilities and toward private mechanisms for mitigating the risks we face in the world. This effort is exhausted, and future endeavors will require a greater, not lesser, role for the public. ...[continue]...

Fed Watch: That Train Left the Station

Tim Duy:

That Train Left the Station, by Tim Duy: I was re-reading some of the recent overshooting debate and it occurred to me that it is comical that we are even having this discussion. The Fed is not going to deliberately overshoot inflation, period. That train left the station long ago. So long ago that you can't even here the rumble on the tracks.

The train left the station on January 25, 2012, with this statement by the Federal Reserve:

The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve's statutory mandate.

On that day, the Federal Reserve locked in the definition of price stability. They locked it in specifically to prevent even the appearance they might deliberately overshoot as a result of extraordinary monetary policy. They locked it in as a commitment device to tie the hands of future policymakers as they would need to justify changing the definition of price stability, presumably a very high bar for any central banker to cross.

On that day, the Federal Reserve took higher inflation expectations off the table. They pulled it from the toolkit. They made clear there is one and only one inflation target for all time. The only tolerable deviations from that target are essentially forecast errors. That's it.

Moreover, I would argue that their behavior has been entirely consistent with maintaining that expectation. Inflation expectations - as measured by TIPS - have been more volatile than prior to the recession, but have cylced around pre-recession levels, or, arguably, a little below:

There is no reason to believe that the Fed has acted to try to sustain inflation expectations beyond those in place prior to the recession. Perhaps thay came close in late-2012, as measured by the five year, five year forward breakevens:

But that was soon met by official pushback. Via Bloomberg:

“Distant inflation expectations from the TIPS market seem to suggest that investors do not completely trust the Fed to deliver on its 2 percent inflation target,” Bullard said today in a speech in Memphis, Tennessee, referring to Treasury Inflation-Protected Securities...

...The five-year, five-year forward break-even rate, which projects the pace of price increases starting in 2017, rose to 2.88 percent on Sept. 14, the day after the FOMC announced a third round of quantitative easing. That was up half a percentage point from July 26. It dropped to 2.77 percent on Oct. 2.

Soon thereafter began the tapering chatter that ultimately culminated in then-Chairman Ben Bernanke's press conference in which he introduced the 7% trigger for asset purchases. The result was a sharp snap-back in real yields:

If the Fed has already proved they can't stomach inflation expectations hovering just below 3% (remember that this is on a CPI basis by which TIPS are calculated, not on a PCE basis that is the Fed's target) for even a few months, they really can't wrap their minds around inflation actually reaching 3% as suggested by Karl Smith:

The Evans Rule was nice, but addressing the overshoot directly would be better. For example, a statement like: “In the committee’s view the appropriate path for the federal funds rate would, in the medium term, allow inflation to rise above 2 per cent, but not above 3 per cent, for a period no less than three months but no greater than one year. Within those parameters the committee will continue to adjust the target for the federal funds rate so as to achieve maximum employment and keep long term inflation expectation well anchored.”

And note that I am being generous by trusting that the Fed's inflation target is actually 2%. David Beckworth suggests it is actually the range of 1% to 2%.

Ultimately, I think Robin Harding correctly identifies the mood at the Fed:

Even Janet Yellen, in her “optimal control” speeches in 2011 and 2012, never argued that the Fed should promise extra inflation in the future. There has never been much support for it on the FOMC and the Fed’s statement of long-run goals would have to be modified to allow for it. At this stage in the game, when the Fed is slowing down its stimulus via asset purchases, it makes little sense to add more stimulus in another way.

What remains the case is that Fed doves think there is slack in the labour market and are willing to risk some above target inflation – while targeting 2 per cent – in order to bring joblessness down more rapidly. I think the centre of the committee under Janet Yellen agrees (and their fairly aggressive forward rate path reflects that). In an ideal world, though, the Fed would gracefully stabilize inflation at 2 per cent with no overshoot or undershoot, creating a soft landing as the economy regains full employment.

The Evans rule was never about higher inflation expectations. It only clarified the acceptable range of forecast errors around the 2% target for a given unemployment rate. And note that it is clear that a forecast error in the other direction is also acceptable with below target outcomes in the labor market. That acceptability is evident in the eagerness to end asset purchases and telegraph the first rate hike. Does anyone believe that the Fed would find a 2.5% inflation rate acceptable if unemployment is at 6%? Or would it be cause of worry and hand-wringing among policymakers? The latter, I think. Yes, they are willing to risk some above target inflation, but should it actually emerge, they would act quickly to snuff it out.

Bottom Line: Expect the Fed to manage policy to contain disinflation and deflationary expectations. But overshooting in the sense of raising inflation expectations to lower the real interest rate further? It very much seems like they made clear long ago that wasn't an option.

Links for 3-19-14

• There’s No Substitute for the Government - Baseline Scenario
• Uncertainty and the Great Trade Collapse: New evidence - vox
• Q&A: A Development Expert on Narrowing Inequality - NYTimes.com
• Sergeant Friday Was Not A Fox - Paul Krugman
• Further Thoughts on Hedgehogs and Foxes - Paul Krugman
• MCMC for Econometrics Students - II - Dave Giles
• Wage growth, spare capacity and rate hikes - Jérémie Cohen-Setton
• High Fallutin' Nazis - Paul Krugman
• The Dismal Art - James Surowiecki
• Two LM curves - Nick Rowe
• The U.S. Productivity Challenge - Tim Taylor
• The Voluntarism Fantasy - Mike Konczal
• Poverty and the Tax Code - Jason Furman
• Time for Some Traffic - Econbrowser
• Low Inflation in February - Calculated Risk

Fed Watch: FOMC Meeting Begins

Tim Duy:

FOMC Meeting Begins, by Tim Duy: The FOMC meeting begins today and ends tomorrow, followed by the traditional statement and Chair Janet Yellen's first press conference. The Fed will also update its forecasts - important because ultimately the forecast drives the policy decisions. I don't anticipate large changes to the growth or inflation forecasts. We should see modest downward revisions to the unemployment rate forecast. What will be more interesting is the impact those changes will have on the interest rate forecast. The bulk of the FOMC expects the first rate hike will be in the range of mid- to late-2015, with a handful earlier or later. A lower unemployment rate forecast may prompt some to move up their forecast. That said, I do not expect large changes in either direction.

As far as policy itself is concerned, it is widely anticipated that the Fed will continue to taper asset purchases and slice another $10 billion from the monthly total. There is no reason to think that the economy has shifted dramatically in either direction to alter the Fed's current strategy for ending asset purchases. We know also that forward guidance will be on the table. Sometime soon - and I think the odds are better than even that "soon" is tomorrow - the Fed will need to address the Evans rule. My expectation is that they ditch numerical guidance for qualitative, discretionary guidance. The new guidance, however, should make it clear that rates will remain low for a long time.

Regarding low rates, I think it is worth reiterating a theme that the Wall Street Journal's Jon Hilsenrath has been pushing this week: At this point, the Federal Reserve expects a long period of low interest rates even after they initiate the first hike. From Monday's Grand Central Station:

...The central banks are projecting an economy that looks on its face like it is returning to normal in the next couple of years...Yet most Fed officials are projecting the target for short-term interest rates will be below 2%, much less than the 4% level that officials think is appropriate in normal times.

How can the Fed expect to maintain short-term rates so far below normal when its main metrics of economic vitality look like they’re back to normal?...

The economy is not getting back to normal, officials like Mr. Dudley are essentially arguing. It’s just getting to something a little less vulnerable. Watch out for the persistent headwinds argument in the Fed’s policy statement Wednesday or in Fed Chairwoman Janet Yellen’s press conference. It is the linchpin to the Fed’s assurance that rates won’t rise much in the next couple of years, even after they start inching up from zero. It is also one of the next battlegrounds in the Fed’s policy debates.

I am not entirely sure I like this characterization. The economy could have shifted into a new normal, and that new normal is characterize by a different constellation of prices, exchanges rates, and interest rates than the old normal. The new normal for interest rates may simply be lower than the old normal. Remember that we are still in the midst of a long-term secular decline in the level of interest rates:

Peak cycle interest rates - both short and long rates - have been on a steady decline since the 1980's. And notice that the well-telegraphed Fed tightening in the last cycle had very little impact on long-rates. This raises the possibility that the big move in long-rates (after the tapering talk began) is already behind us. Thus, long-rate might not rise much if at all even as the Fed raise short rates. We will know the answer to that if buyers keep coming out of the woodwork whenever rates approach 3%.

This also implies that although the Fed may think they are running a looser policy than normal because short-rates are historically low, the reality is that the policy is equally tight in relative terms. Thus even though they will argue that rates are low even after they begin raising rates, they will still be reinforcing the continuation of the new normal.

Bottom Line: The Fed will continue with tapering by cutting another $10 billion from asset purchases. They will most likely alter the guidance but continue to signal an extended period of low interest rates. Low rates might simply be part of the "new normal" the economy is settling into, a new normal that the Fed may be unintentionally reinforcing.

'The Most Important Economic Chart'

Atif Mian and Amir Sufi at House of Debt on a subject that has come up here many, many times:

The Most Important Economic Chart, by Atif Mian and Amir Sufi: If you must know only one fact about the U.S. economy, it should be this chart:

The chart shows that productivity, or output per hour of work, has quadrupled since 1947... This is a spectacular achievement...

The gains in productivity were quite widely shared from 1947 to 1980. ... However, what we want to focus on today is the remarkable separation in productivity and median real income since 1980. While the United States is producing twice as much per hour of work today compared to 1980, a small part of the gain in real income has gone to the bottom half of the income distribution. The gap between productivity and median real income is at an historic all-time high today.

So where are all of the gains in productivity going? Two places: First,... the share of profits has risen faster than wages. Second, the highest paid workers are getting a bigger share of the wages that go to labor. ...

It is not just about inequality... The widening gap between productivity and median income has serious implications for macroeconomic stability and financial crises. Our forthcoming book takes up these issues in more detail.

We will also discuss some of these issues in coming posts.

Links for 3-18-14

• Fed Meetings and Asset Prices - House of Debt
• Who will Save Us from Inequality? - Carola Binder
• Paul Ryan isn't the wonk of Washington – Dean Baker
• Instrumental Variables: An Econometrician's Perspective - NBER - Imbens
• The Effects of Monetary Policy on Stock Market Bubbles - Gali and Gambetti
• MCMC for Econometrics Students - I - Dave Giles
• Yellen and the Fed, a WSJ Briefing - WSJ
• Evidence from Keynes the trader - vox
• You Don’t Say - The Baseline Scenario
• Financial Literacy - Tim Taylor
• During Crisis the €500 Note, Beloved by Criminals, Saved the Day - WSJ
• Financing new economic activities and bankrolling speculation… - Angry Bear
• Euro Zone Inflation in Surprise Fall to 0.7% - NYTimes.com
• Memories, & mechanisms - Stumbling and Mumbling
• Insurance Companies and Systemic Risk - The Baseline Scenario
• Do economists control our ideas? - Noahpinion
• Russia’s Unconventional Weapon: Natural Gas - James Surowiecki

Moving Day

I am moving today, so blogging is unlikely until much later (sold my house and am moving to an apartment temporarily until I figure out what I want to do).

Paul Krugman: That Old-Time Whistle

Conservatives "can’t bring themselves to acknowledge the reality of what’s happening to opportunity in America":

That Old-Time Whistle, by Paul Krugman, Commentary, NY Times: ...Paul Ryan, chairman of the House Budget Committee and the G.O.P.’s de facto intellectual leader ... attributed persistent poverty to a “culture, in our inner cities in particular, of men not working and just generations of men not even thinking about working.” He was, he says, simply being “inarticulate.” How could anyone suggest that it was a racial dog-whistle? Why, he even cited the work of serious scholars — people like Charles Murray, most famous for arguing that blacks are genetically inferior to whites. Oh, wait.

Just to be clear, there’s no evidence that Mr. Ryan is personally a racist, and his dog-whistle may not even have been deliberate. But it doesn’t matter. He said what he said because that’s the kind of thing conservatives say to each other all the time. And why do they say such things? Because American conservatism is still, after all these years, largely driven by claims that liberals are taking away your hard-earned money and giving it to Those People.

Indeed, race is the Rosetta Stone that makes sense of many otherwise incomprehensible aspects of U.S. politics. ...

One odd consequence of our still-racialized politics is that conservatives are still, in effect, mobilizing against the bums on welfare even though both the bums and the welfare are long gone or never existed. Mr. Santelli’s fury was directed against mortgage relief that never actually happened. Right-wingers rage against tales of food stamp abuse that almost always turn out to be false or at least greatly exaggerated. And Mr. Ryan’s black-men-don’t-want-to-work theory of poverty is decades out of date. ...

The ... sociologist William Julius Wilson has documented, the flight of industry from urban centers meant that minority workers literally couldn’t get to those good jobs, and the supposed cultural causes of poverty were actually effects of that lack of opportunity. Still, you could understand why many observers failed to see this.

But over the past 40 years good jobs for ordinary workers have disappeared, not just from inner cities but everywhere: adjusted for inflation, wages have fallen for 60 percent of working American men. ...

These awkward facts have not, however, penetrated the world of conservative ideology. ... And since conservatives can’t bring themselves to acknowledge the reality of what’s happening to opportunity in America, they’re left with nothing but that old-time dog whistle. Mr. Ryan wasn’t being inarticulate — he said what he said because it’s all that he’s got.