The beginning of a long discussion from Gavyn Davies:
Has the rethinking of macroeconomic policy been successful?: The great financial crash of 2008 was expected to lead to a fundamental re-thinking of macro-economics, perhaps leading to a profound shift in the mainstream approach to fiscal, monetary and international policy. That is what happened after the 1929 crash and the Great Depression, though it was not until 1936 that the outline of the new orthodoxy appeared in the shape of Keynes’ General Theory. It was another decade or more before a simplified version of Keynes was routinely taught in American university economics classes. The wheels of intellectual change, though profound in retrospect, can grind fairly slowly.
Seven years after 2008 crash, there is relatively little sign of a major transformation in the mainstream macro-economic theory that is used, for example, by most central banks. The “DSGE” (mainly New Keynesian) framework remains the basic workhorse, even though it singularly failed to predict the crash. Economists have been busy adding a more realistic financial sector to the structure of the model , but labour and product markets, the heart of the productive economy, remain largely untouched.
What about macro-economic policy? Here major changes have already been implemented, notably in banking regulation, macro-prudential policy and most importantly the use of the central bank balance sheet as an independent instrument of monetary policy. In these areas, policy-makers have acted well in advance of macro-economic researchers, who have been struggling to catch up. ...
There has been more progress on the theoretical front than I expected, particularly in adding financial sector frictions to the NK-DSGE framework and in overcoming the restrictions imposed by the representative agent model. At the same time, there has been less progress than I expected in developing alternatives to the standard models. As far as I can tell, a serious challenge to the standard model has not yet appeared. My biggest disappointment is how much resistance there has been to the idea that we need to even try to find alternative modeling structures that might do better than those in use now, and the arrogance that asserts that we have little to learn about theory or policy from the economists who wrote during and after the Great Depression.
Last Exit Before Chaos: There’s an odd summer-of-1914 feel to the current state of the Greek crisis. While some of the main players are, rightly, desperate to find a way to head off Grexit and all it entails, others – on the creditor as well as the debtor side — seem not just resigned to collapse but almost as if they’re welcoming the prospect, the way, a century ago, far too many Europeans actually seemed to welcome the end of messy, frustrating diplomacy and the coming of open war.
Is there still a way out? There should be. As I and others have been saying for a while, the arithmetic is actually quite clear: Greece cannot run a primary deficit, it cannot be forced to run a large primary surplus, so a small primary surplus is the obvious solution and better for all concerned than euro exit.
There is, one must admit, a new problem caused by the current confrontation itself: uncertainty has pushed Greece back into recession, and the primary surplus achieved last year has vanished. But given a deal it should be possible to arrange some temporary financing while a modest recovery puts the primary balance back into the black.
The big problem is how to get a deal given lack of trust on all sides. ...
Yet from what I hear there is still room for at least a temporary deal. ...
There are just a few days left. Let’s hope that cool heads prevail.
I am an economist, and economics is often, with good reason, called the “dismal” science. But my message to you today is one of hope and optimism.
From 2006 to 2009, we saw a marked deterioration in labor market performance. As recently as a year ago, it seemed like this loss of human resources might prove to be permanent. But the rapid growth in employment that we saw in 2014 shattered this hypothesis. The lesson of 2014 is clear: We can do better. The FOMC is charged with promoting maximum employment. In the wake of 2014, I see no reason why the Committee should not aim to facilitate continued improvement in labor market conditions. Indeed, I see no reason why we should not aim for the kind of strong labor market conditions that prevailed at the end of 2006.
But we will only get there if we make the right choices. The FOMC can only achieve its congressionally mandated price and employment goals by being extraordinarily patient in reducing the level of monetary accommodation. Under my current outlook, I continue to believe that it would be a mistake to raise the target range for the fed funds rate in 2015.
I am not, or not only, talking about right-wing contempt for the poor, although the dominance of compassionless conservatism is a sight to behold. ... According to the Pew Research Center, more than three-quarters of conservatives believe that the poor “have it easy” thanks to government benefits; only 1 in 7 believe that the poor “have hard lives.” And this attitude translates into policy. ...
We learn, for example, that 3 in 10 nonelderly Americans said they had no retirement savings or pension, and that the same fraction reported going without some kind of medical care in the past year because they couldn’t afford it. Almost a quarter reported that they or a family member had experienced financial hardship in the past year.
And something that even startled me: 47 percent said that they would not have the resources to meet an unexpected expense of $400 — $400! They would have to sell something or borrow to meet that need, if they could meet it at all.
Of course, it could be much worse. Social Security is there, and we should be very glad that it is. Meanwhile, unemployment insurance and food stamps did a lot to cushion unlucky families from the worst during the Great Recession. And Obamacare, imperfect as it is, has immensely reduced insecurity, especially in states whose governments haven’t tried to sabotage the program.
But while things could be worse, they could also be better. There is no such thing as perfect security, but American families could easily have much more security than they have. All it would take is for politicians and pundits to stop talking blithely about the need to cut “entitlements” and start looking at the way their less-fortunate fellow citizens actually live.
... Among her most influential work is the research she did with Gourinchas when she was at Princeton on the role of the United States in a globalized financial system. Blanchard says it “changed the discussion on the current account deficit in the United States.”
Before the recent global financial crisis, when economists and politicians were concerned about the ballooning U.S. current account deficit, Gourinchas and Rey showed that the U.S. position was not as bad as it looked because of the country’s role as the center of the international financial system.
“Although the U.S. was running a big trade deficit, economists were not taking into account the large amounts the U.S. was earning on the financial side from capital gains and changes in the value of the dollar,” Gourinchas told F&D.
“For example, almost all U.S. foreign liabilities are in dollars, whereas approximately 70 percent of U.S. foreign assets are in other currencies. So a 10 percent depreciation of the dollar increases the value of foreign assets and represents a transfer of about 5.9 percent of U.S. GDP from the rest of the world to the United States. For comparison, the trade deficit on goods and services in 2004 was 5.3 percent of GDP. So these capital gains can be very large.”
As Gourinchas and Rey (2005) pointed out, a depreciation of the U.S. dollar has two beneficial effects on the external position of the United States. It helps boost net exports and increases the dollar value of U.S. assets.
Gourinchas and Rey said that the U.S. position at the center of the system gave it what they called an “exorbitant privilege”... The exorbitant privilege, Rey and Gourinchas explained, came about because the United States could borrow at a discount on world financial markets and get high yields on its external assets. They tracked how the United States had gradually taken on riskier overseas investments.
“Then we pushed these ideas further, by pointing out that the key role of the United States makes it also look very much like an insurer for the rest of the world,” Rey explains. ...
Gourinchas said Washington has become more like the world’s venture capitalist since the 1990s. “During the whole period, U.S. assets have shifted more and more out of long-term bank loans toward foreign direct investment (FDI) and, since the 1990s, toward FDI and equity. At the same time, its liabilities have remained dominated by bank loans, trade credit, and debt—that is, low-yield safe assets.
“Hence, the U.S. balance sheet resembled increasingly one of a venture capitalist with high-return risky investments on the asset side. Furthermore, its leverage ratio has increased sizably over time.”
Rey says they expanded on this research during the global financial crisis, finding that the United States had reversed its role by channeling resources to the rest of the world through its external portfolio—on a large scale. “Our estimate is 13 to 14 percent of U.S. GDP in 2008 alone. So that was very significant.”
The United States was providing “some sort of global insurance to the world economy and the rest of the world—earning the equivalent of an insurance premium in good times and paying out in bad times. And that’s exactly what we see in the data.”
“While the United States enjoys an exorbitant privilege on one side,” says Rey, “it also, as global insurer, has an exorbitant duty in time of crisis on the other.”
Melissa S. Kearney and Phillip B. Levine at Vox EU:
Income inequality, social mobility, and the decision to drop out of high school: Compared to other developed countries, the US ranks high on income inequality and low on social mobility. This could be particularly concerning if such a trend is self-perpetuating. In this column, the authors argue that there is a causal relationship between income inequality and high school dropout rates among disadvantaged youth. In particular, moving from a low-inequality to a high-inequality state increases the likelihood that a male student from a low socioeconomic status drops out of high school by 4.1 percentage points. The lack of opportunity for disadvantaged students, therefore, may be self-perpetuating.
The banks had engaged in the biggest price-fixing conspiracy in modern history. Their self-described “cartel” used an exclusive electronic chat room and coded language to manipulate the $5.3 trillion-a-day currency exchange market. It was a “brazen display of collusion” that went on for years, said Attorney General Loretta Lynch.
But there will be no trial, no executive will go to jail, the banks can continue to gamble in the same currency markets, and the fines – although large – are a fraction of the banks’ potential gains and will be treated by the banks as costs of doing business.
America used to have antitrust laws that permanently stopped corporations from monopolizing markets, and often broke up the biggest culprits.
No longer. Now, giant corporations are taking over the economy – and they’re busily weakening antitrust enforcement.
The result has been higher prices for the many, and higher profits for the few. It’s a hidden upward redistribution from the majority of Americans to corporate executives and wealthy shareholders. ...
Antitrust has been ambushed by the giant companies it was designed to contain.
Congress has squeezed the budgets of the antitrust division of the Justice Department and the bureau of competition of the Federal Trade Commission. Politically-powerful interests have squelched major investigations and lawsuits. Right-wing judges have stopped or shrunk the few cases that get through.
We’re now in a new gilded age of wealth and power similar to the first gilded age when the nation’s antitrust laws were enacted. But unlike then, today’s biggest corporations have enough political clout to neuter antitrust.
Conservatives rhapsodize about the “free market” and condemn government intrusion. Yet the market is rigged. And unless government unrigs it through bold antitrust action to restore competition, the upward distributions hidden inside the “free market” will become even larger.
The start of a longer post from Cecchetti & Schoenholtz
Do central banks need capital?: If you ask monetary economists whether we should care if a central bank’s capital level falls below zero (even for an extended period of time), most will say no. Pose the same question to central bank governors, and the answer in nearly every case will be yes.
What accounts for this stark difference? How can something that seems not to matter in theory be so important in practice?
The economists correctly argue that central banks are fundamentally different from commercial banks, so they can go about their business even if they have negative net worth. However, central bankers know instinctively that the effectiveness of policy depends critically on their credibility. They worry that a shortfall of capital would threaten their independence, which is the foundation of that credibility.
The recent experience of the Swiss National Bank (SNB) can help us to explain what we mean. ...
John Cochrane points to this from the Richmond Fed (he has a few additional comments):
Bailout Barometer: How Large is the Financial Safety Net?: ...The Bailout Barometer is our estimate of the share of financial system liabilities for which the federal government provides protection from losses. In addition to protection from explicit government guarantee programs, our estimate includes implicit protection that people are likely to infer from past government actions and statements. Despite efforts to end ad hoc bailouts, the financial safety net that protects certain firms remains large under current government policies.
How large is it?
Our latest estimate shows that the financial safety net covers 60 percent of the financial sector. This estimate also includes a breakdown by sector. These measures, compiled in March 2015, use data as of December 31, 2013. Our Bailout Barometer has grown considerably since our first estimate in 1999.
Why does it matter?
When creditors expect to be protected from losses, they will overfund risky activities, making financial crises and bailouts like those that occurred in 2007-08 more likely. An extensive safety net also creates a need for robust supervision of firms benefitting from perceived protection. Over time, shrinking the financial safety net is essential to restore market discipline and achieve financial stability. Doing so requires credible limits on ad hoc bailouts. Read more on our perspective.
From today's links, Lane Kenworthy asks Tim Smeeding about reducing inequality:
How to reduce income inequality: Tim Smeeding knows more than virtually anyone else about inequality and poverty in the United States and other rich nations. I asked him what he recommends to reduce income inequality. His response:
Tax appreciated assets when inherited or transferred inter-vivos.
Raise income tax rates on capital income — capital gains and dividends — to levels just below labor, e.g. maximum rate at true current marginal tax rate or 30%. And curtail practices of defining earnings as capital income, e.g. “carried interest” provisions.
Reduce political rents: close tax loopholes that benefit mainly the wealthy (e.g. cap on deductions for employer-provided health insurance); turn deductions that benefit the richest into credits, many refundable, to benefit lower- and middle-income families; allow drug purchases at “best price” rates, not market rates, for Medicare; get rid of oil and gas exploration tax subsidies; limit and phase out agricultural subsidies.
Use tax revenue to improve public infrastructure (including internet).
Improve college prep classes and college counseling for students.
More and better apprenticeships (get employers involved).
Raise the minimum wage to $10 per hour, index it, and enforce labor laws (e.g. on scheduling).
Universal child allowance at $2,500 per child, refundable if this is more than income taxes owed, and separate from the EITC.
Profit sharing among all long-term (full year or more) employees.
I would add: Do more to eliminate monopoly and monopsony power (they distort the flow of income).
The geek heretic: My first job abroad was helping to roll out rural Internet in India, by radio. It was 2001, the peak of the dot com boom, but before the ubiquity of mobile phones. Connecting remote villages in India to the Internet via radio waves was the great frontier, and I was hired to help roll it out and evaluate it.
Fifteen years later the idea of radio-based Internet seems quaint, but I recall Paul Samuelson telling one of the professors I worked for that he thought it was the most exciting idea he’d heard in years. Like I said, dot com boom. Unless you lived through it it’s hard to explain, but everybody was a little crazy when it came to the web those days.
The project was a debacle for more reasons I can recount in a blog post. A big one: relieving an information and communication constraint was not going to cause markets to surge or governments to become accountable. Even if that information mattered, any surge would come to a screeching halt with the dozen other greater constraints holding change back.
You could say I became a geek heretic. No longer would I believe that technology is the solution. It didn’t hurt that the stock market bubble was popping at the same time. ...
Many years later, I met Kentaro Toyama, a kindred spirit, but one who had gone to much further lengths and depths in his fervor for and against technology in development. ...
If you find yourself even remotely optimistic about technology and development, you should read this book.
You might think that the higher prices in the 15 states with markets would encourage investment, creating an abundance of new power plants. That, at any rate, is what right-wing Chicago School economic theories on which the electricity markets were created say should happen. The validity of these theories, and flaws in how they were implemented, matter right now because Congress is considering a raft of energy supply bills that include some expansion of the market pricing of wholesale electricity. ...
Yet just 2.4 percent of new electric generating capacity in 2013 “was built for sale into a market,” electricity-market analyst Elise Caplan showed in a study last fall... The rest were built in states with traditional regulation or under long-term supply contracts that essentially guaranteed repayment of loans to build the plants.
Here’s another measure of failure: Areas covered by electricity markets have 60 percent of America's generating capacity, but enjoyed just 6 percent of new generation built in 2013.
If unregulated markets are invariably better, as the Chicago School holds, why was 94 percent of new generating capacity built in traditionally regulated jurisdictions? ...
Why hasn't the digital technological revolution had a bigger impact on productivity?:
The Big Meh, by Paul Krugman, Commentary, NY Times: ...Everyone knows that we live in an era of incredibly rapid technological change, which is changing everything. But what if what everyone knows is wrong? .... A growing number of economists ... are wondering if the technological revolution has been greatly overhyped... New technologies have yielded great headlines, but modest economic results. Why?
One possibility is that the numbers are missing the reality, especially the benefits of new products and services. I get a lot of pleasure from technology that lets me watch streamed performances by my favorite musicians, but that doesn’t get counted in G.D.P. Still, new technology is supposed to serve businesses as well as consumers, and should be boosting the production of traditional as well as new goods. The big productivity gains of ... 1995 to 2005 came largely in things like inventory control, and showed up as much or more in nontechnology businesses like retail as in high-technology industries themselves. Nothing like that is happening now.
Another possibility is that new technologies are more fun than fundamental. ...
So what do I think is going on...? The answer is that I don’t know — but neither does anyone else. Maybe my friends at Google are right, and Big Data will soon transform everything. Maybe 3-D printing will bring the information revolution into the material world. Or maybe we’re on track for another big meh.
What I’m pretty sure about, however, is that we ought to scale back the hype.
You see, writing and talking breathlessly about how technology changes everything might seem harmless, but, in practice, it acts as a distraction from more mundane issues — and an excuse for handling those issues badly. If you go back to the 1930s, you find many influential people saying the same kinds of things such people say nowadays: This isn’t really about the business cycle, never mind debates about macroeconomic policy; it’s about radical technological change and a work force that lacks the skills to deal with the new era.
And then, thanks to World War II, we finally got the demand boost we needed, and all those supposedly unqualified workers — not to mention Rosie the Riveter — turned out to be quite useful in the modern economy, if given a chance.
Of course, there I go, invoking history. Don’t I understand that everything is different now? Well, I understand why people like to say that. But that doesn’t make it true.
I started out saying: I find my peers, as they age, become increasingly unwilling to mark their beliefs to market. .... So let me ... spend my time this lunchtime detailing four points in economics at which the world has surprised me over the past decade, and in which as a result reality has led me to shift my beliefs.
The world has turned out to be more Keynesian than I would have imagined a decade ago.
Low-tax, low-service U.S. state level political economy has proved to be ineffective as an economic development model. I was always pretty sure that it was a lousy bet from the standpoint of societal welfare. But a decade ago I thought it at least boosted state-level GDP. Now I do not.
The success of the implementation of Obamacare has raised my estimation of the administrative competence of the government.
And the aggregate economic costs to America of local NIMBYism now appear to me to be much larger than I would have thought reasonable decade ago: we are no longer a country in which people can afford to move to places where they will be more productive and more highly paid because high-productivity places refuse to upgrade their residential density.
All this, I said, has powerful political consequences. And the politics of the last decade has also been very surprising to me. But I did not have time to get into that in any depth…
The biggest surprise for me, and perhaps it shouldn't have been, is the degree to which politicians are willing to put political interests ahead of helping people in need. Watching the political/policy reaction to the Great Recession was both disappointing and eye opening.
This is the first part of an interview of Claudia Goldin by the Richmond Fed (later she also talks about her work on education and inequality, among other things):
Econ Focus: Much of your work has focused on the history of women's employment in the United States. You've described the past few decades of that history as a "quiet revolution." What do you mean by that?
Goldin: The quiet revolution is a change in how young women perceive the courses their lives are going to take. One of the places we see this is the National Longitudinal Survey, which began in 1968 with women who were between 14 and 24 years old. One of the questions the survey asked was, "What do you think you're going be doing when you're 35 years old?" In 1968, young women essentially answered this question as if they were their mothers. They would say, "Well, I'm going to be a homemaker, I'm going to be at home with my kids." Some did say they would be working in the labor market, but the fraction that said they would be out of the home was much smaller than the fraction that actually did end up working outside the home.
But as these women matured and as successive cohorts were interviewed, their perceptions of their futures, their own aspirations, began to change. And so their expectations when young about being in the labor force began to match their actual participation rates once they were older. That meant these young women could engage in different forms of investment in themselves; they attended college to prepare for a career, not to meet a suitable spouse. College women began to major in subjects that were more investment oriented, like business and biology, rather than consumption oriented, like literature and languages, and they greatly increased their attendance at professional and graduate schools.
EF: What changed in society that allowed this revolution to occur?
Goldin: One of the most important changes was the appearance of reliable, female-controlled birth control. The pill lowered the cost to women of making long-term career investments. Before reliable birth control, a woman faced a nontrivial probability of having her career derailed by an unplanned pregnancy — or she had to pay the penalty of abstinence. The lack of highly reliable birth control also meant a set of institutions developed around dating and sex to create commitment: Couples would "go steady," then they would get "pinned," then they would get engaged. If you're pinned or engaged when you're 19 or 20 years old, you're not going to wait until you're 28 to get married. So a lot of women got married within a year or two of graduating college. That meant women who pursued a career also paid a penalty in the marriage market. But the pill made it possible for women who were "on the pill" to delay marriage, and that, in turn, created a "thicker" marriage market for all women to marry later and further lowered the cost to women of investing in a career.
EF: What happened during previous periods of change in women's labor force participation?
Goldin: A large fraction of employment in the early 20th century, outside of agriculture, was in manufacturing. And manufacturing jobs were not particularly nice jobs. White-collar jobs in offices greatly expanded in the 1910s and 1920s, but they required one to be literate and possibly numerate, and women who were older at the time would not have had the education to move into those jobs. And so there developed a social norm against married women working. It was OK if you were single, it was often OK if you were an immigrant or African American, but it wasn't OK if you were an American-born white woman from a reasonable family, especially if you had kids.
New technologies further increased the demand for white-collar workers, and the high school movement produced a huge increase in women's education during the early decades of the 20th century. More positions were created that were considered "good" jobs, those that young women could start after high school and keep after marriage with far less social stigma.
The income effect and the substitution effect come from a set of preferences. If individual families have more income in a period when there are various constraints on women's work, they're going to purchase the leisure and consumption time of the women in the family, and the income effect will be higher. But if well-paying jobs with lower hours and better working conditions open up, then the income effect will decrease and the substitution effect will increase and both will serve to move women into the labor force. ...
The Obama administration is risking its credibility over the trade deal:
Trade and Trust, by Pau Krugman, Commentary, NY Times: One of the Obama administration’s underrated virtues is its intellectual honesty. Yes, Republicans see deception and sinister ulterior motives everywhere, but they’re just projecting. The truth is that, in the policy areas I follow, this White House has been remarkably clear and straightforward about what it’s doing and why.
Every area, that is, except one: international trade and investment.
I don’t know why the president has chosen to make the proposed Trans-Pacific Partnership such a policy priority. Still, there is an argument to be made for such a deal, and some reasonable, well-intentioned people are supporting the initiative.
But other reasonable, well-intentioned people have serious questions about what’s going on. ...
The administration’s main analytical defense of the trade deal came earlier this month, in a report from the Council of Economic Advisers. Strangely, however, the report didn’t actually analyze the Pacific trade pact. Instead, it was a paean to the virtues of free trade, which was irrelevant to the question at hand.
First of all, whatever you may say about the benefits of free trade, most of those benefits have already been realized. ...
In any case, the Pacific trade deal isn’t really about trade. Some already low tariffs would come down, but the main thrust of the proposed deal involves strengthening intellectual property rights — things like drug patents and movie copyrights — and changing the way companies and countries settle disputes. And it’s by no means clear that either of those changes is good for America. ...
As I see it, the big problem here is one of trust.
International economic agreements are, inevitably, complex, and you don’t want to find out at the last minute ... that a lot of bad stuff has been incorporated into the text. So you want reassurance that the people negotiating the deal are listening to valid concerns, that they are serving the national interest rather than the interests of well-connected corporations.
Instead of addressing real concerns, however, the Obama administration has been dismissive, trying to portray skeptics as uninformed hacks who don’t understand the virtues of trade. But they’re not...
It’s really disappointing and disheartening to see this kind of thing from a White House that has, as I said, been quite forthright on other issues. And the fact that the administration evidently doesn’t feel that it can make an honest case for the Trans-Pacific Partnership suggests that this isn’t a deal we should support.
Conservatives and Keynes: ...the debate over business-cycle economics has always been a left-right thing. Specifically, the right has always been deeply hostile to the notion that expansionary fiscal policy can ever be helpful or austerity harmful; most of the time it has been hostile to expansionary monetary policy too... So the politicization of the macro debate isn’t some happenstance, it evidently has deep roots.
Oh, and some of us have been discussing those roots in articles and blog posts for years now. We’ve noted that after World War II there was a concerted, disgraceful effort by conservatives and business interests to prevent the teaching of Keynesian economics in the universities, an effort that succeeded in killing the first real Keynesian textbook. Samuelson, luckily, managed to get past that barrier — and many were the complaints. ...
What’s it all about, then? The best stories seem to involve ulterior political motives. Keynesian economics, if true, would mean that governments don’t have to be deeply concerned about business confidence, and don’t have to respond to recessions by slashing social programs. Therefore it must not be true, and must be opposed. ...
If you think I’m being too flip, too conspiracy-minded, or both, OK — but what’s your explanation? For conservative hostility to Keynes is not an intellectual fad of the moment. It has absolutely consistent for generations, and is clearly very deep-seated.
1776: The Revolt Against Austerity: Was the Declaration of Independence a powerful indictment of British austerity policies? Does America’s founding document need to be seen as part of an economic debate about the British Empire? ... Just as political debates in Britain and the United States today turn in large part on the response to the great recession of 2008, so the events that made the United States were shaped by the British imperial government’s reaction to the debt crisis of the 1760s. What made the Declaration so offensive to British politicians then ... is that America’s founders offered a blueprint for a different kind of state response to fiscal crisis. ... [explains how debt crisis led to austerity policies for the colonies] ...
What alternative strategy did the authors of the Declaration propose? Today, we tend to regard the practice of using government spending to stimulate economic growth as an invention of John Maynard Keynes in the 1930s. But already in the eighteenth century, self-styled Patriots, followers of Pitt on both sides of the Atlantic, argued that what the British Empire needed if it was to recover from the fiscal crisis was not austerity but an economic stimulus. ...
Twenty-first century American politicians routinely draw our attention to our founding moment and founding document... But they fail to understand the economic arguments that in large measure shaped what Thomas Jefferson and his colleagues wrote. When Governor Scott Walker of Wisconsin proudly proclaims that “we celebrate the fourth of July and not April 15, because in America we celebrate our independence from the government, not our dependence on them [sic],” he fails to see that our founders blamed George III and his government not for taxing too much but for doing too little to stimulate consumer demand. ...
America’s founding document called for an American state that would promote economic growth just as the British state had done before the shift toward balancing the books. ... Had George III and his ministers not adopted austerity measures in the 1760s and 1770s, had they chosen to follow Pitt’s policies of economic stimulus, America’s founders might not have needed to declare their independence at all.
[That's only a small part of the essay -- there's a lot more in the full post, e.g. an argument the Adam Smith supported expansionary policy for the colonies.]
Before heading to one of my least favorite places, the dentist, here's one from the Liberty Street Economics Blog at the NY Fed:
Why Are Interest Rates So Low?, by Marco Del Negro, Marc Giannoni, Matthew Cocci, Sara Shahanaghi, and Micah Smith: Second post in the series: In a recent series of blog posts, the former Chairman of the Federal Reserve System, Ben Bernanke, has asked the question: “Why are interest rates so low?” (See part 1, part 2, and part 3.) He refers, of course, to the fact that the U.S. government is able to borrow at an annualized rate of around 2 percent for ten years, or around 3 percent for thirty years. If you expect that inflation is going to be on average 2 percent over the next ten or thirty years, this implies that the U.S. government can borrow at real rates of interest between 0 and 1 percent at the ten- and thirty-year maturities. This phenomenon is by no means limited to the United States. Governments in Japan and Germany are able to borrow for ten years at nominal rates below 1 percent, and the ten-year yield on Swiss government debt is slightly negative. Why is that?
To answer this question, it is useful to consider the concept of the “natural rate of interest,” introduced by Knut Wicksell in 1898 and fully integrated in modern macroeconomic models by Michael Woodford. This natural rate refers to the real interest rate consistent with full employment of labor and capital resources. More specifically, it can be viewed as the rate of interest that would obtain if all prices and wages had adjusted so as to bring the level of economic activity to its full-employment level. The natural rate of interest can vary substantially over time, as it is driven by numerous factors such as the long-run potential growth rate of the economy, demographic composition of the population, desirability of saving on the part of households, perceived profitability of investment opportunities, government spending, and taxes. Importantly, by construction, the natural rate of interest does not depend on the stance of monetary policy: when prices and wages are assumed to adjust instantaneously, economic activity fully employs all available resources, and there is little monetary policy can do to affect economic activity.
According to Wicksell, the natural rate of interest is the right benchmark for determining the extent to which monetary policy is accommodative. He argues that, “it is not a high or low rate of interest in the absolute sense which must be regarded as influencing the demand for raw materials, labour, and land or other productive resources, and so indirectly as determining the movement of prices. The causality factor is the current rate of interest on loans as compared to [the natural rate].” An implication is that monetary policy is not by itself expansionary if interest rates are low and restrictive if interest rates are high. Instead, monetary policy turns out to be expansionary if rates are below the natural rate and restrictive if rates are above the natural rate.
One key difficulty, however, is that the natural rate is not directly observable, as it is a counterfactual rate that would obtain only if all the economy’s resources were fully employed. To get a sense of where the natural rate is, economists have employed various techniques. In a recent paper, Jim Hamilton, Ethan Harris, Jan Hatzius, and Kenneth West use moving averages of the actual real rate of interest over a relatively long period of time as a proxy for the natural rate of interest. The idea is that we can estimate the natural rate of interest by averaging the actual interest rate in periods when the actual rate is below the natural rate and periods when the actual rate is above the natural rate. They assess that recent estimates of the real rate are low as a result of temporary headwinds on investment, deleveraging, and so on, but that the long-run equilibrium U.S. real interest rate remains significantly positive. While the measure provided by these authors is very useful to understand low frequency changes in the actual real rate of interest, it arguably does not correspond to the Wicksellian notion of the natural rate. As Paul Krugman points out in a recent blog post, when monetary policy is constrained (by, for example, the zero lower bound) the actual and natural rates may not coincide, and if the constraint binds for a long time, the difference between the two can be quite persistent. The practical implication is that this long-run measure of the effective real rate cannot be used to assess the stance of monetary policy in those instances.
Another approach, proposed by Thomas Laubach and John C. Williams, involves estimating a statistical model linking real GDP, inflation, and a short-term interest rate, and assuming that the gap between real GDP and its long-run trend depends on the past gaps between the actual interest rate and the natural rate. This model allows one to disentangle movements in the natural rate driven by long-run growth considerations from those driven by cyclical considerations. However, the estimated measure is best suited for a longer-run measure of the natural rate of interest, as discussed more recently in an article by San Francisco Fed President Williams.
DSGE models, such as the New York Fed’s DSGE model, provide an alternative approach for estimating the natural rate of interest by imposing on the relationships among economic variables a structure informed by modern economic theory. This model, which builds on the model with financial frictions used in Del Negro, Giannoni, and Schorfheide (2015), is estimated using data on real GDP, consumption, investment, hours worked, real wages, two distinct measures of inflation (the GDP deflator and core PCE inflation), the federal funds rate, and the ten-year Treasury yield. We also use survey-based long-run inflation expectations to capture information about the public’s perception of the Fed’s inflation objective, and market data on expectations of future federal funds rates to incorporate the effects of forward guidance on the policy rate. Finally, the model allows for persistent shocks to both the level and the growth rate of productivity, in an attempt to allow for the possibility of secular stagnation, and uses data on the growth rate of productivity. We discuss the model’s forecasts in the first post of the series.
Having a model makes it possible to define, and compute, the Wicksellian notions of “full employment” output and interest rates, precisely because we can construct a counterfactual economy. Specifically, we construct the natural rate as the equilibrium interest rate that would obtain if prices and wages were perfectly flexible (so that output and employment would be at their “potential”), if there were no shocks to the markup on goods and labor markets, and no financial frictions. Robert Barsky, Alejandro Justiniano, and Leonardo Melosi have used a similar model to estimate the natural rate of interest.
The red line in the chart below shows the model’s estimate of the nominal natural rate of interest (that is, the sum of the real natural rate of interest and expected inflation) along with its forecast. For comparison, the chart also shows the recent evolution of the nominal federal funds rate (solid blue line).
The chart shows that the estimated quarterly natural rate of interest is quite volatile in the short run, mostly because of fluctuations in quarterly consumption. As these short-term fluctuations are averaged out (right-hand panel), the estimated natural rate paints a fairly consistent picture: The natural rate fell sharply during the crisis, from above 6 percent in early 2007 to about -2 percent in mid-2009. The natural rate was slightly above the actual rate for the period preceding the Great Recession, and well below it for the entire post-Recession period, indicating that the zero lower bound imposed a constraint on interest rate policy. The natural rate is currently close to, but still below, the actual rate, suggesting that policy is not particularly accommodative. Finally, the natural rate is projected to increase in the near future, since the factors that brought down the natural rate during the crisis are dissipating, as discussed in our first post.
What are the factors that have led to such a precipitous drop in the natural rate and that have kept the rate at such a low level? The DSGE model allows us to trace the evolution of the natural rate back to the original shocks perturbing the economy. The next chart shows the real natural rate of interest, in deviations from its long-run mean. The colored bars show the contribution of various shocks to the evolution of the natural rate.
The dark blue bars refer to household “discount factor” shocks, that is, to disturbances to the household’s willingness to consume or save. The chart shows that while in 2007, households appeared more willing than normal to consume, they have since reversed this tendency by saving more than usual. This factor boosted the real natural rate above its long-run average by 2 percentage points in early 2007 and depressed the rate by about 1 ½ percentage points in 2012-13. The light blue bars refer to shocks in firms’ willingness to invest in physical capital. The chart reveals that in 2007 and 2008, firms were very willing to invest. However, since 2009, they have been much more prudent, which contributed to lowering the natural rate by more than one percentage point. These effects are projected to abate slowly as consumers are able and willing to consume more again and firms are projected to invest more. Changes in total factor productivity are also responsible for large drops in the natural rate, from 2008 to late 2014, as the orange bars show. Finally, other aggregate demand factors, such as government expenditures, have pushed up the natural rate in late 2008 but have exerted a downward pressure on rates since then.
Several factors are missing from the analysis. For instance, a potentially important omission relates to the assumption of a closed economy. Properly accounting for international factors would likely result in a different estimate of the natural rate. Explanations pertaining to the “global saving glut” advanced by Ben Bernanke suggest that foreign saving might push the natural rate of interest to even lower levels than estimated here.
In conclusion, the low level of interest rates experienced since 2008 is largely attributable to a reduction in the natural rate of interest, which reflects cautious behavior on the part of households and firms. Monetary policy has largely accommodated the decline in the natural rate of interest, in order to mitigate the adverse effects of the crisis, but the zero lower bound on interest rates has imposed a constraint on the ability of interest rate policy to stabilize the economy. Looking ahead, we expect these headwinds to continue to abate, and the natural rate of interest to return closer to historical levels.
Disclaimer The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.
From the blog Three-Toed Sloth by Cosma Shalizi (this also appeared in yesterday's links):
Any P-Value Distinguishable from Zero is Insufficiently Informative: After ten years of teaching statistics, I feel pretty confident in saying that one of the hardest points to get through to undergrads is what "statistically significant" actually means. (The word doesn't help; "statistically detectable" or "statistically discernible" might've been better.) They have a persistent tendency to think that parameters which are significantly different from 0 matter, that ones which are insignificantly different from 0 don't matter, and that the smaller the p-value, the more important the parameter. Similarly, if one parameter is "significantly" larger than another, then they'll say the difference between them matters, but if not, not. If this was just about undergrads, I'd grumble over a beer with my colleagues and otherwise suck it up, but reading and refereeing for non-statistics journals shows me that many scientists in many fields are subject to exactly the same confusions as The Kids, and talking with friends in industry makes it plain that the same thing happens outside academia, even to "data scientists". ... To be fair, one meets some statisticians who succumb to these confusions.
One reason for this, I think, is that we fail to teach well how, with enough data, any non-zero parameter or difference becomes statistically significant at arbitrarily small levels. The proverbial expression of this, due I believe to Andy Gelman, is that "the p-value is a measure of sample size". More exactly, a p-value generally runs together the size of the parameter, how well we can estimate the parameter, and the sample size. The p-value reflects how much information the data has about the parameter, and we can think of "information" as the product of sample size and precision (in the sense of inverse variance) of estimation, say n/σ2. In some cases, this heuristic is actually exactly right, and what I just called "information" really is the Fisher information.
Rather than working on grant proposals Egged on by a friend As a public service, I've written up some notes on this... [The mathematics comes next.]
Quite often, the facts are consistent with either theory. For example, the well-attested momentum anomaly - the tendency for assets that have risen in price recently to continue rising - is "consistent with" both a cognitive bias (under-reaction) and with rational behaviour; fund managers' desire to avoid benchmark risk.
My point here should be well-known. The Duhem-Quine thesis warns us that facts under-determine theory: they are "consistent with" multiple theories. ...
So, how can we guard against the "consistent with" error? One thing we need is history: this helps tell us how things actually happened. And - horrific as it might seem to some economists - we also need sociology: we need to know how people actually behave and not merely that their behaviour is "consistent with" some theory. Economics, then, cannot be a stand-alone discipline but part of the social sciences and humanities...
Alan Krueger kicks off a debate on the relationship between inequality and mobility:
The great utility of the Great Gatsby Curve: Every so often an academic finding gets into the political bloodstream. A leading example is "The Great Gatsby Curve," describing an inverse relationship between income inequality and intergenerational mobility. Born in 2011, the Curve has attracted plaudits and opprobrium in almost equal measure. Over the next couple of weeks, Social Mobility Memos is airing opinions from both sides of the argument, starting today with Prof Alan Krueger, the man who made the Curve famous.
Building on the work of Miles Corak, Anders Björklund, Markus Jantti, and others, I proposed the “Great Gatsby Curve” in a speech in January 2012. The idea is straightforward: greater income inequality in one generation amplifies the consequences of having rich or poor parents for the economic status of the next generation.
The curve is predicted by economic theory…
There are strong theoretical underpinnings for the Great Gatsby Curve. Gary Solon has shown, for example, that the relationship is predicted by a standard intergenerational model if the payoff to education increases over time. This causes inequality to rise in one generation, but also increases the significance of this inequality for children’s economic success, since well-off parents have more resources and more incentive to invest in their children’s education.
Other mechanisms could also underlie the Great Gatsby Curve. For example, if social connections are important for success in the economy (e.g., getting the right summer internship), and wealthy parents have access to job networks, then a spreading out of the income distribution would leave children from the bottom of the distribution in a more disadvantaged position in terms of gaining access to networks that will ultimately lead to a higher paid job.
Consistent with the Great Gatsby Curve, several studies also point to a growing gap in the resources devoted to education between high- and low-income American families. As predicted by the Great Gatsby Curve, it appears that the dramatic rise in income inequality has created a more tilted playing field for the next generation. ...
The two key remaining questions now are:
What are the main mechanisms underlying the Great Gatsby Curve?
What policy actions can be taken to improve economic opportunities for children born in disadvantaged circumstances?
Learning more about the former can help us to achieve the latter — which is, in the end, the most important goal of all.
The situation where there is no way to make some people better off without making anyone worse off is often referred to as “Pareto optimal” after the Italian economist and political theorist Vilfredo Pareto, who developed the underlying concept. “Pareto optimal” is arguably, the most misleading term in economics (and there are plenty of contenders). ...
Describing a situation as “optimal” implies that it is the unique best outcome. As we shall see this is not the case. Pareto, and followers like Hazlitt, seek to claim unique social desirability for market outcomes by definition rather than demonstration. ...
If that were true, then only the market outcome associated with the existing distribution of property rights would be Pareto optimal. Hazlitt, like many subsequent free market advocates, implicitly assumes that this is the case. In reality, though there are infinitely many possible allocations of property rights, and infinitely many allocations of goods and services that meet the definition of “Pareto optimality”. A highly egalitarian allocation can be Pareto optimal. So can any allocation where one person has all the wealth and everyone else is reduced to a bare subsistence. ...
Restoring the Public’s Trust in Economists: The belief that economics has become politicized is a big reason the general public has lost faith in the ability of economists to give advice on important policy questions. For most issues, like raising the minimum wage, the effects of government spending, international trade, whether CEOs deserve their high compensation, etc., etc., it seems as though economists who also happen to be Republicans will mostly line up on one side of the issue, while economists who are Democrats mostly take the other. Members of the general public, not knowing who to believe and unable to rely upon the press to sort it out, either throw up their hands in frustration or follow the side that agrees with their preconceived notions and ideological beliefs.
But why is it so hard to sort out? Why can’t the press do a better job of avoiding “he said – she said” reporting and give the public direct and specific answers to these important policy questions? One reason is the “mathiness” that has infected our economic models, something economist Paul Romer recently identified as a big problem with economic theory. ...
Errors and Lies, by Paul Krugman, Commentary, NY Times: Surprise! It turns out that there’s something to be said for having the brother of a failed president make his own run for the White House. Thanks to Jeb Bush, we may finally have the frank discussion of the Iraq invasion we should have had a decade ago...
The Iraq war wasn’t an innocent mistake, a venture undertaken on the basis of intelligence that turned out to be wrong. America invaded Iraq because the Bush administration wanted a war. The public justifications for the invasion were nothing but pretexts, and falsified pretexts at that. We were, in a fundamental sense, lied into war. ...
This was, in short, a war the White House wanted, and all of the supposed mistakes that, as Jeb puts it, “were made” by someone unnamed actually flowed from this underlying desire. ...
Now, you can understand why many political and media figures would prefer not to talk about any of this. Some of them ... may have fallen for the obvious lies, which doesn’t say much about their judgment. More, I suspect, were complicit: they realized that the official case for war was a pretext, but had their own reasons for wanting a war, or, alternatively, allowed themselves to be intimidated into going along. ...
On top of these personal motives, our news media in general have a hard time coping with policy dishonesty. Reporters are reluctant to call politicians on their lies, even when these involve mundane issues like budget numbers, for fear of seeming partisan. In fact, the bigger the lie, the clearer it is that major political figures are engaged in outright fraud, the more hesitant the reporting. And it doesn’t get much bigger — indeed, more or less criminal — than lying America into war.
But truth matters, and not just because those who refuse to learn from history are doomed in some general sense to repeat it. The campaign of lies that took us into Iraq was recent enough that it’s still important to hold the guilty individuals accountable. Never mind Jeb Bush’s verbal stumbles. Think, instead, about his foreign-policy team, led by people who were directly involved in concocting a false case for war.
So let’s get the Iraq story right. Yes, from a national point of view the invasion was a mistake. But (with apologies to Talleyrand) it was worse than a mistake, it was a crime.
Efficiency matters! It can make the economy better off. Understanding efficiency in manufacturing and retail markets can help guide policy, according to prize-winning research by Daniel Muller and Fabian Herweg in The Economic Journal. See the summary here: http://www.res.org.uk/details/mediabr...
The interview was recorded at the Royal Economic Society annual conference at The University of Manchester in Spring 2015 and produced by Econ Films.
Blaming Keynes: A few people have asked me to respond to this FT piece from Niall Ferguson. I was reluctant to, because it is really just a bit of triumphalist Tory tosh. That such things get published in the Financial Times is unfortunate but I’m afraid not surprising in this case. However I want to write later about something else that made reference to it, so saying a few things here first might be useful.
The most important point concerns style. This is not the kind of thing an academic should want to write. It makes no attempt to be true to evidence, and just cherry picks numbers to support its argument. I know a small number of academics think they can drop their normal standards when it comes to writing political propaganda, but I think they are wrong to do so. ...
Ed Prescott is No Robert Solow, No Gary Becker: In his comment on my Mathiness paper, Noah Smith asks for more evidence that the theory in the McGrattan-Prescott paper that I cite is any worse than the theory I compare it to by Robert Solow and Gary Becker. I agree with Brad DeLong’s defense of the Solow model. I’ll elaborate, by using the familiar analogy that theory is to the world as a map is to terrain.
There is no such thing as the perfect map. This does not mean that the incoherent scribbling of McGrattan and Prescott are on a par with the coherent, low-resolution Solow map that is so simple that all economists have memorized it. Nor with the Becker map that has become part of the everyday mental model of people inside and outside of economics.
Noah also notes that I go into more detail about the problems in the Lucas and Moll (2014) paper. Just to be clear, this is not because it is worse than the papers by McGrattan and Prescott or Boldrin and Levine. Honestly, I’d be hard pressed to say which is the worst. They all display the sloppy mixture of words and symbols that I’m calling mathiness. Each is awful in its own special way.
What should worry economists is the pattern, not any one of these papers. And our response. Why do we seem resigned to tolerating papers like this? What cumulative harm are they doing?
The resignation is why I conjectured that we are stuck in a lemons equilibrium in the market for mathematical theory. Noah’s jaded question–Is the theory of McGrattan-Prescott really any worse than the theory of Solow and Becker?–may be indicative of what many economists feel after years of being bullied by bad theory. And as I note in the paper, this resignation may be why empirically minded economists like Piketty and Zucman stay as far away from theory as possible. ...
[He goes on to give more details using examples from the papers.]
Factoryless Goods Producing Firms: Andrew B. Bernard and Teresa C. Fort sketch what is known about the "Factoryless Goods Producing Firm" in the May 2015 issue of the American Economic Review: Papers and Proceedings (vol. 105:5, pp. 518-523). The AER is not freely available on-line, but many readers will have access through a library subscription. Succumbing to acronyms, Bernard and Fort write: "We define a FGPF as a firm that has no manufacturing establishments in the United States, but performs pre-production activities such as design and engineering itself and is involved in production activities, either directly or through purchases of contract manufacturing services (CMS)."
The best-known example of a factoryless goods producer is Apple Inc. Apple designs, engineers, develops, and sells consumer electronics, software, and computers. For the vast majority of its products, including iPhones, iPads, and MacBooks, Apple does none of the production and the actual manufacturing is performed by other firms in China and elsewhere. While Apple is known for its goods and services and closely controls all aspects of a product, almost none of Apple’s US establishments would be in the manufacturing sector. ...
How prominent are factoryless goods producing firms in the US economy, and how much have they expanded over time? By definition, you don't find these firms in the manufacturing sector of the economy. Bernard and Fort look at statistics on the wholesale trade sector of the economy. As background, wholesale trade is about 6% of the US GDP when measured in value-added terms. which is about half the size of the manufacturing sector, or half the size of the professional and business services sector. Here are a few facts from Barnard and Fort about factoryless goods producing firms:
In 2007, the total number of factoryless good producing firms was 13,500, and these firms employed 672,000 workers. "
Industries where factoryless goods producing firms tend to focus include electrical machinery and equipment, machine and mechanical appliances and computers, pharmaceuticals, and apparel.
Compared to other firms in the wholesale industry, the factoryless goods producing firms tend to be larger and to pay higher wages.
If you go back to 1992, and look at the factoryless goods producing firms of that time, you find that many of them begin manufacturing in the US at some point. Indeed, "it is likely that the current set of FGPFs are a mix of different types of firms including former manufacturing firms, new firms created as FGPFs from their inception, and other firms that have made the transition to the design and manufacture of products. More work is needed to understand the evolution of FGPFs over time."
The imports of factoryless goods producing firms are equal to about 38% of their total sales. Thus, a majority of money spent at such firms ends up flowing to non-manufacturing inputs from the US economy.
The growth of factoryless goods producing firms may have effects on wages, employment, and productivity. It's a phenomenon worth understanding. ...