Month: August 2014

Free Exchange: Germany’s Hyperinflation-Phobia: “John Maynard Keynes, as early as 1919…

…recognised the threat inflation posed to modern capitalist societies:

Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency… [he] was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.

The German public, it seems, is particularly fearful of letting inflation getting out of control. This is, in part, due to the legacy of the German hyperinflation of 1922-3…. Present discomfort within Germany with policies designed to reflate the euro-zone economy has been stoked by the assertion of a linkage between hyperinflation and the rise to power of the Nazis…. Yet academics paint a very different picture… than the story… in the German press. The Nazi party did not become a popular political force until long after the hyperinflation period ended. The Nazis only won 32 Reichstag seats in the election of May 1924, and just 12 in 1928. As Paul Krugman has pointed out, ‘the 1923 hyperinflation didn’t bring Hitler to power; it was the Brüning deflation’ of the early-1930s….

The hyperinflation of 1923 created winners and losers among the middle classes…. Middle-class votes subsequently splintered between several different parties…. Yet virtually all classes lost out when Brüning’s government reacted to a projected fiscal deficit and gold outflows in 1930 with deflationary policies…. The experience of deflation made Hitler’s promises to conquer unemployment and stabilise prices by any means necessary attractive to a wide range of groups…. Deflation is now a greater risk than inflation in Europe…. A selective memory of the past may prove worse than no memory at all….

[See:] T. Balderston (2002): Economics and Politics in the Weimar Republic… A. Fergusson (1975): When Money Dies: The Nightmare of the Weimar Hyper-Inflation… J. M. Keynes (1919): The Economic Consequences of the Peace… A. Tooze (2006): *The Wages of Destruction: The Making and Breaking of the Nazi Economy… F. Taylor, (2013): The Downfall of Money: Germany’s Hyperinflation and the Destruction of the Middle Class“

Must- and Shall-Reads:

• **David H. Autor Structural Demand Shifts and Potential Labor Supply Responses in the New Century | Polanyi’s Paradox and the Shape of Employment Growth
• Greg Sargent: Scott Brown calls for replacing Obamacare with Romneycare
• Rakesh Vohra: Rethinking Intermediate (day 1)
• Matt O’Brien: Why are Venezuela’s supermarkets so empty?

 

1. Lawrence Mishel: Broadening Agreement That Job Polarization Wasn’t Present in the United States In 2000s: “The ‘job polarization hypotheses’… claim[s] that computerization leads to the ‘simultaneous growth of high-education, high-wage and low-education, low-wages jobs at the expense of middle-wage, middle education jobs’…. It is noteworthy, therefore, that MIT Professor David Autor, the leading intellectual architect of the job polarization hypothesis, has presented a paper at the Federal Reserve Bank of Kansas City’s economic policy symposium in Jackson Hole, Wyo., which finds that job polarization did not occur in the 2000s and that, in any case, job polarization is not necessarily connected to wage polarization. This confirms the findings of others, such as Beaudry, Green, and Sand and my own research with Heidi Shierholz and John Schmitt. One can only applaud Autor for updating his analysis of employment and wage trends, and acknowledging the lack of occupational job polarization in the 2000s and its failure to be able to explain wage trends…. In the new paper, Autor directly acknowledges the failure of occupational employment patterns to predict wage patterns, something he did not do in his earlier work, writing that ‘while computerization has strongly contributed to employment polarization, we would not generally expect these employment changes to culminate in wage polarization except in tight labor markets.’… In the end, changes in occupational employment patterns are a dim flashlight indeed for shining light on key wage patterns…”

2. Olivier Blanchard: Where Danger Lurks: “Until the 2008 global financial crisis, mainstream U.S. macroeconomics had taken an increasingly benign view of economic fluctuations in output and employment. The crisis has made it clear that this view was wrong…. The techniques we use affect our thinking in deep and not always conscious ways…. The techniques were best suited to a worldview in which economic fluctuations occurred but were regular, and essentially self-correcting. The problem is that we came to believe that this was indeed the way the world worked…”

3. Rob Weiner: Overruled: A (Third) Response To Professor Adler: “In the hopes of capping the increasingly tedious (not to mention snarky) contretemps with Professor Jonathan Adler, I think it worth reviewing a few of the instances where his responses to my blog posts on Halbig have ignored, elided, or misconstrued my points…. So, let’s return to substance…. None of Adler’s assertions, including his pointless quibble over the definition of ‘definition’, undermine the statutory arguments in my posts or in the judicial opinions rejecting his position. Adler’s theory requires reading the words, ‘established by the State’ in isolation, and saddling them with an interpretation that vitiates other pertinent provisions of the Act, sabotages the Exchanges that Congress took such pains to create, and denies low income families the subsidies needed to meet the objective proclaimed repeatedly in the statutory text, in the legislative debates, and, indeed, in the very name of the Act–extending affordable healthcare to all Americans…”

4. Alicia Munnell: Dueling Data Muddies Social Security Debate: “The most recent missile is Andrew Biggs’ Wall Street Journal op-ed, ‘Liberals for Social Security Insolvency’. Biggs notes that 75-year Social Security deficit projections by the Congressional Budget Office (CBO) have nearly quadrupled between 2008 and 2014… to argue that it is foolish to put forth proposals to expand the program. The angle that I find the most disturbing is the suggestion that Social Security costs bounce around, that we don’t really know what’s going on, and that six years from now they could quadruple once again. Nothing could be further from the truth…”

5. Menzie Chinn: Wisconsin Forecasted to Lag Further Behind Minnesota, and Kansas travels its own path. Bruce Bartlett brings my attention to this article noting Minnesota’s economic performance. This reminded me to check on the Philadelphia Fed’s forecast…. The cumulative growth gap between Minnesota and Wisconsin (relative to 2011M01) is forecasted to grow–rather than shrink–over the past six months…. The cumulative growth gap between Kansas and the Nation is also forecasted to rise, from the current gap of 2.7%, to 3.2%, in just the next six months…”

6. Greg Robb: 5 things you won’t learn from reading Geithner’s book: “Key discussions redacted: After becoming president of the New York Fed from October 2003, Geithner assembled an all-star board of directors… [that] met every two weeks throughout the run-up to the crisis…. In his book, Geithner mentions the all-star board, but none of the specifics of their discussions. What did the New York Fed know about Bear Stearns and when did they know it?… Where in the world was Barack Obama?… Too big to jail?… The extent to which Treasury officials were warning the Justice Department not to be too aggressive and upset the recovery of the fragile banking system…. What went wrong? While Geithner portrays himself as a first responder to the crisis, experts said they were struck by the lack of discussion of what went wrong in the first place. ‘If you read the book and didn’t know anything about the crisis, you’d have no idea what caused it’, said Gerding of the University of Colorado…”

Should Be Aware of:

*Those Who Resist: Philip Zimbardo on The Two Types of Heroes
Jason Furman: Whatever Happened to the Great Moderation?
Scott Horton: Leo Strauss Gives His Cheer for Right-Wing Principles: Fascist, Authoritarian, Imperial
Lee Hutchinson: Tripping through IBM’s astonishingly insane 1937 corporate songbook
LOLGOP: MILESTONE: Republicans cannot take the presidency without winning states that have expanded Medicaid

 

1. Scott Lemieux: Lame Duck Governor [Tom Corbett] Decides To Stop Inflicting Needless Suffering on State’s Citizens: “Pennsylvania will be taking the Medicaid expansion. Not in an ideal form, although better than the Arkansas version (the administration was right to strike a harder bargain, with Corbett polling in the low 30s.) And, as Sargent says, the next government remains free to make the program more progressive, so it makes sense to let the state proceed now.”

2. Moshe Feiglin: My Outline for a Solution in Gaza: “Any place from which Israel or Israel’s forces were attacked will be immediately attacked with full force and no consideration for ‘human shields’ or ‘environmental damage’. Conquer – After the IDF completes the ‘softening’ of the targets with its fire-power, the IDF will conquer the entire Gaza, using all the means necessary to minimize any harm to our soldiers, with no other considerations. Elimination- The GSS and IDF will thoroughly eliminate all armed enemies from Gaza. The enemy population that is innocent of wrong-doing and separated itself from the armed terrorists will be treated in accordance with international law and will be allowed to leave. Israel will generously aid those who wish to leave…”

3. Jason Kuznicki: Leo Strauss, Meet John Stuart Mill | Ordinary Times “No existential, civilization-ending crisis of unbelief for [Mill]! Without it, no need for philosopher-kings to trick us into a belief in natural right. Also, no need for a war to revitalize our decadent, post-moral society in a rejuvenating bloodbath…”

Menzie Chinn: Wisconsin Forecasted to Lag Further Behind Minnesota, and Kansas travels its own path…

…Bruce Bartlett brings my attention to this article noting Minnesota’s economic performance. This reminded me to check on the Philadelphia Fed’s forecast…. The cumulative growth gap between Minnesota and Wisconsin (relative to 2011M01) is forecasted to grow–rather than shrink–over the past six months…. The cumulative growth gap between Kansas and the Nation is also forecasted to rise, from the current gap of 2.7%, to 3.2%, in just the next six months…

Alicia Munnell: Dueling Data Muddies Social Security Debate: “The most recent missile is Andrew Biggs’ Wall Street Journal op-ed…

…’Liberals for Social Security Insolvency’. Biggs notes that 75-year Social Security deficit projections by the Congressional Budget Office (CBO) have nearly quadrupled between 2008 and 2014… to argue that it is foolish to put forth proposals to expand the program. The angle that I find the most disturbing is the suggestion that Social Security costs bounce around, that we don’t really know what’s going on, and that six years from now they could quadruple once again. Nothing could be further from the truth…

Rob Weiner: Overruled: A (Third) Response To Professor Adler: “In the hopes of capping the increasingly tedious (not to mention snarky) contretemps with Professor Jonathan Adler…

…I think it worth reviewing a few of the instances where his responses to my blog posts on Halbig have ignored, elided, or misconstrued my points…. I observed that a threat… must be communicated and understood…. Among the evidence I cited that Section 36B was not perceived as a threat were the initial characterizations of the disputed language by Adler and others as a ‘glitch’ and the consequences, as ‘perhaps unintended’.  Adler’s response re-imagines the word ‘glitch’…. But in Volokh on September 9, 2011, Adler recounted the theory of some observers that ‘Congress meant to provide tax credits for any exchange-purchased insurance, because Congress wanted lower-income individuals to be able to purchase health insurance (and comply with the mandate)’…. Adler conceded that, ‘it is certainly plausible–perhaps even likely–that many in Congress wanted tax credits for the purchase of health insurance to be broadly available.’ ‘Congress may have wanted to make tax credits more widely available’, Adler also wrote, ‘but that is not what Congress did’. It is highly unlikely that Congress’s intent to coerce states was clear in 2010 when the ACA was enacted, but became retroactively cloudy over the next 18 months….

No legislator offered Professor Adler’s interpretation of the provision in Section 36B during the debates…. Adler responds that no legislator specifically said tax credits were available in states with federally-facilitated exchanges.  And in fact, they did not specifically say that.  Instead, they repeatedly used the word ‘all’ in describing who… would receive assistance…. ‘All’ is a fairly inclusive word. But those statements don’t count, Adler claims, because ‘PPACA supporters believed all fifty states would create their own exchanges, the legislators assumed that every state would establish its own exchange, as many repeatedly said’. Are those ‘many’ the same ones who used the word ‘all’?  And when legislators made statements about the broad availability of tax credits and subsidies, did they say it was because all fifty states would establish exchanges?…

Adler relied extensively on a 1987 opinion by Judge Edwards espousing a very limited compass for en banc review. I pointed out in my last post that this decision, as well as others cited by the Halbig plaintiffs, predated the amendment of Federal Rule of Appellate Procedure 35 highlighting inter-circuit conflict as an express basis for en banc review…. Rather than addressing his and the Halbig plaintiffs’ reliance on precedents superseded (essentially overruled) by changes in the relevant rule, Professor Adler repeatedly returns to the peripheral question whether the DC Circuit regularly issues orders staying its mandate until the time for rehearing expires…. The key point… is that this is not the point. It does not affect at all the conclusion that the Halbig decision was aberrant and that the full Court of Appeals is unlikely to let it linger….

So, let’s return to substance…. None of Adler’s assertions, including his pointless quibble over the definition of ‘definition’, undermine the statutory arguments in my posts or in the judicial opinions rejecting his position. Adler’s theory requires reading the words, ‘established by the State’ in isolation, and saddling them with an interpretation that vitiates other pertinent provisions of the Act, sabotages the Exchanges that Congress took such pains to create, and denies low income families the subsidies needed to meet the objective proclaimed repeatedly in the statutory text, in the legislative debates, and, indeed, in the very name of the Act–extending affordable healthcare to all Americans. 
And that, I hope, is my final word on why I believe the D.C. Circuit will grant en banc review and overturn the panel decision adopting Adler’s theory.

Olivier Blanchard: Where Danger Lurks: “Until the 2008 global financial crisis…

…mainstream U.S. macroeconomics had taken an increasingly benign view of economic fluctuations in output and employment. The crisis has made it clear that this view was wrong…. The techniques we use affect our thinking in deep and not always conscious ways…. The techniques were best suited to a worldview in which economic fluctuations occurred but were regular, and essentially self-correcting. The problem is that we came to believe that this was indeed the way the world worked…

Lawrence Mishel: Broadening Agreement That Job Polarization Wasn’t Present in the United States In 2000s: “The ‘job polarization hypotheses’…

claim[s] that computerization leads to the ‘simultaneous growth of high-education, high-wage and low-education, low-wages jobs at the expense of middle-wage, middle education jobs’…. It is noteworthy, therefore, that MIT Professor David Autor, the leading intellectual architect of the job polarization hypothesis, has presented a paper at the Federal Reserve Bank of Kansas City’s economic policy symposium in Jackson Hole, Wyo., which finds that job polarization did not occur in the 2000s and that, in any case, job polarization is not necessarily connected to wage polarization. This confirms the findings of others, such as Beaudry, Green, and Sand and my own research with Heidi Shierholz and John Schmitt. One can only applaud Autor for updating his analysis of employment and wage trends, and acknowledging the lack of occupational job polarization in the 2000s and its failure to be able to explain wage trends…. In the new paper, Autor directly acknowledges the failure of occupational employment patterns to predict wage patterns, something he did not do in his earlier work, writing that ‘while computerization has strongly contributed to employment polarization, we would not generally expect these employment changes to culminate in wage polarization except in tight labor markets.’… In the end, changes in occupational employment patterns are a dim flashlight indeed for shining light on key wage patterns…

READ at Project Syndicate When Do We Start Calling This “The Greater Depression”?

We started by calling it the financial crisis of 2007. Then it became the financial crisis of 2008. Next it was the downturn of 2009-2009. By the middle of 2009 it was clearly the biggest thing since the 1930s, and acquired the name of “The Great Recession”. By the end of 2009 the business cycle trough had been passed, and people breathed a sigh of relief: “The Great Recession” would be its stable name–we would not have to change its name again, and move on to labels containing the D-word.

But we breathed our sigh of relief too soon. Although politicians and their senior aides went on speaking tours playing up “recovery summer”, the United States did not experience a rapid V-shaped recovery carrying it back to the previous growth trend of potential output. In this the post-2009 recovery was lightyears different from the post-1982 recovery. Between the start of 2005 and the end of 2007 U.S. real GDP grew at 3.1%/year. The recession trough in 2009 saw the U.S. real GDP level 11% lower than the 2005-2007 trend. Today it stands 16% below.

Things have been even worse in Europe. The Eurozone experienced not recovery but renewed recession with a second-wave downturn starting in 2010–an event that shifted the consensus name of the current episode to “The Great Recession”. Eurozone real GDP stood 8% below its 1995-2007 trend at the recession trough. It now stands 15% below.

Cumulative output losses relative to the 1995-2007 trends now stand at 78% of a year’s GDP for the United States, and at 60% of a year’s GDP for the Eurozone. These are extraordinary magnitudes of foregone prosperity–prosperity that we were all confident was in our grasp back in 2007: nobody back in 2007 was forecasting anything like what the decade starting in 2008 will turn out to have been like; nobody back in 2007 was forecasting any extraordinary decline in the rate of growth of potential output that statistical and policymaking agencies are now baking into their estimates. These magnitudes made me conclude at the start of 2011 that “The Great Recession” was no longer adequate: it was time to start calling this episode “The Lesser Depression”.

Now, however, we face two additional downward shocks to the North Atlantic economy. Consider the page that Lorcan Roche Kelly of Agenda Research noted Mario Draghi ad-libbing in his late-August Jackson Hole speech:

Inflation has been on a downward path from around 2.5% in the summer of 2012 to 0.4% most recently.

I comment on these movements about once a month in the press conference, and I have given several reasons for this downward path in inflation, saying it is because of food and energy price declines; because after mid-2012 it is mostly exchange rate appreciation that has impacted on price movements; more recently we have had the Russia-Ukraine geopolitical risks, which will also exert a negative impact on the euro area economy; and of course we had the relative price adjustment that had to happen in the stressed countries as well as high unemployment. I have said in principle most of these effects should in the end wash out because most of them are temporary in nature–though not all of them.

But I also said if this period of low inflation were to last for a prolonged period of time, the risk to price stability would increase. Inflation expectations exhibited significant declines at all horizons. The 5-year/5-year swap rate declined by 15 basis points to just below 2%–this is the metric that we usually use for defining medium term inflation. But if we go to shorter- and medium-term horizons, the revisions have been even more significant. The real rates on the short and medium term have gone up, on the long term they haven’t gone up because we are witnessing a decline in long-term nominal rates, not only in the euro area but everywhere really.

The Governing Council will acknowledge these developments and within its mandate will use all the available unconventional instruments needed to ensure price stability safeguard the firm anchoring of inflation expectations over the medium to long term.

In the Eurozone, the pretense that recovery was in train is now gone, and there is no way to read the financial markets other than as anticipating a Eurozone triple dip recession. In the United States, the Federal Reserve under Janet Yellen has moved from wondering whether it will ever be appropriate to cease asset purchases and raise interest rates without a significant upturn in the employment share to ceasing asset purchases and wondering when it will raise interest rates–even without either a significant upturn in the employment share or a significant upward breakout in inflation.

A year and a half ago, when some of us were expecting a return to whatever the path of potential output was by 2017, our guess was that the Great Recession would wind up costing the North Atlantic in lost production about 80% of one year’s output–call it $13 trillion. Today a five-year return to whatever the new normal might be looks optimistic–and even that scenario carries us to $20 trillion. And a pessimistic scenario of five years that have been like 2012-2014 plus then five years of recovery would get us to a total lost-wealth cost of $35 trillion.

At some point we will have to stop calling this thing “The Great Recession” and start calling it “The Greater Depression”. When?

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Appendix: Data and Calculations: http://delong.typepad.com/20140825-financial-crisis-to-great-recession-to-lesser-depression-to-greater-depression.rmd | http://delong.typepad.com/20140825_financial_crisis_to_great_recession_to_lesser_depression_to_greater_depression.html

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A Note on the Core PCE Inflation Phillips Curve

The Honest Broker for the Week of August 30, 2014

David Beckworth notes that in the Bernanke-Yellen era the FOMC gets uncomfortable and decides that it has to loosen policy and steps up its interventions when PCE inflation falls below 1.5%/year and gets uneasy and decides that it has to tighten policy when PCE inflation rises above 2%/year:

[This] reduced-form relationship… is highly suggestive and consistent with my claim… that… there is a 2% ceiling to an inflation target corridor…

Now the FOMC’s preferred inflation measure–the core PCE deflator–is giving signs of crawling up toward above 2%/year again. Thus the FOMC Is no longer discussing whether to stop its programs of asset purchases and start raising interest rates, but rather when to do so.

Thus it is time to remind ourselves of just what the U.S. macroeconomic time series on the core PCE deflator has to tell us about the risks and resulting costs of an inflationary spiral should the FOMC retain or even increase its current degree of monetary accomodation for another two or three years or so. And when I look at the time series, I find myself once again driven to the conclusion that what the time series of inflation in th U.S. over the past half century is that the risks and resulting costs of such an inflaitionary spiral are quite low. I cannot see how to get any other conclusion out of the data.

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Begin with the core PCE deflator inflation rate: Annual:

And monthly at an annual rate:

The first obvious lesson is that monthly numbers are very noisy estimates of what the underlying PCE core price trend is. The monthly PCE core inflation rates make up a negatively-autocorrelated band 2.5%-points wide around the underlying inflation state of the economy. The second is that, in spite of a great deal of angst about how the Federal Reserve is about to lose its inflation-fighting credibility and risks the imminent-deanchoring of inflation expectations, the time series shows only four run-ups of inflation:

1. The late 1960s Vietnam War period.
2. The 1973-5 Yom Kippur War oil-shock period.
3. The 1979 Iranian Revolution oil-shock period.
4. The post-1987 crash Greenspan inflation.

Of these, the fourth was deliberate: Alan Greenspan did not know how much of a negative shock to the real economy would follow in the wake of the October 1987 stock market crash, and he did not want to find out. The first was semi-deliberate: William McChesney Martin understood tht there were risks in acceding to Johnson-administration pressure and while Lyndon Johnson may not have know there were risks his economic advisors certainly did. The second and third saw Arthur Burns and G. William Miller unable to master but rather mastered by events. What, quantitatively, can these four episodes of inflationary breakout–and the symmetric Volcker deflation of the early 1980s and Greenspan opportunistic disinflation of the 1990s tell us about how far the unemployment rate would have to get below the NAIRU for how long to produce how large an inflationary breakout?

Start with the accelerationist Phillips Curve model: future inflation will be equal to “expected inflation” plus disturbance terms, one of which is the level of unemployment relative to the NAIRU–the non-inflation accelerating rate of unemployment–and what the rate of inflation has been over the past year Will in many cases be a reasonable proxy for “expected inflation”. Thus we plot the difference between the next month’s inflation and what inflation has been over the past year, and between the next year’s inflation and what inflation has been over the past year:

The time series shows significant negative autocorrelation at the monthly level, which is not surprising: it is what noise in the observed price level would produce in the inflation rate. The time series at the annual frequency crosses the y-axis enough to make it clear that there is little serial correlation at the annual inflation frequency.

The next step is to consider the simplest possible accelerationist Phillips curves: regressions of the one-year and one-month forward change in annual inflation on the unemployment rate:

First, the standard errors that R spits out are, of course, wrong. For the monthly left-hand-side variable, each monthly inflation residual is negatively autocorrelated with its temporal neighbors. Thus the standard errors that R reports are too large. For the annual left-hand-side variable, the residuals in the regression are a twelve-observation moving average of those negatively-autocorrelated monthly inflation residuals. Multiply the reported standard errors of the estimates by at least two when using these estimates. The annual-frequency left-hand-side variable shows more of a relationship, so henceforth focus on that case.

Second, what R spits out are:

• A slope coefficient for the annual left-hand-side variable of -0.232: an unemployment rate 1%-point below the NAIRU will raise annual inflation next year by 0.232%-points.
• A NAIRU estimate of 6.06%: if the unemployment rate is below that, inflation will tend to drift up; if the unemployment rate is above that, inflation will tend to drift down.

The natural next question to ask is: why is the slope coefficient so small? between 1966 and 1969 core PCE inflation rose from 1.2%/year to 4.6%/year–and with a slope coefficient of -0.232 the unemployment rate would have had to average 4.8%-points below the NAIRU for 1966 through 1968 in order to generate such an acceleration. Between 1973 and 1975 core PCE inflation jumped by 7%-points–requiring a 15%-point gap between the actual unemployment rate and the NAIRU to generate such a large move so fast. And 1979-19890 saw a 2.5%-point runup in a single year: a 10.8%-point one-year unemployment-rate impetus. Even the 1986-1989 jump from 3.3% to 4.6% in 2.5 years would require a 2.2%-point gap between the actual unemployment rate and the NAIRU in a period in which the unemployment rate averaged 6.2%. We did not see such large shifts in unemployment as would be needed to drive such runups (although we did see a prolonged period of high super-NAIRU unemployment in the 1980s of sufficient magnitude to drive the Volcker disinflation).

Perhaps the problem is omitted variables? Perhaps when the unemployment rate is low other factors omitted from the simplest regression that tend to retard inflation are present, and that the true coefficient on unemployment is much larger. This is certainly a possibility. The obvious variables to add to the regression are (a) measures of supply shocks, (b) some way to account for the fact that the NAIRU is not constant, and (c) richer inflation dynamics. For our purposes we want to leave (a) to one side: the low unemployment of the early 1970s and the high inflation of the first oil-shock period are a significant source of what coefficient the unemployment rate had. Indeed, Milton Friedman used to argue that the OPEC oil-price increases were not a cause of future inflation but a consequence of past easy money and inflation and should be omitted from the determinants of inflation precisely because their inclusion had the effect of reducing the coefficient on unemployment.

As far as (b), all we can say about the NAIRU is that it presumably evolves slowly over time. A polynomial in time thus suggests itself. For (c), the natural variables to add are lags of inflation. And th obvious strategy is to conduct a specification search: add a time trend and powers thereof and add lags of inflation and see what specifications produce a substantially increased unemployment coefficient without obvious overfitting of the time series. Proceeding in steps until we have a fourth-degree polynomial time trend and three annual lags of annual inflation produces an extraordinarily overfitted equation:

But none of the regressions up to and including the massively-overfitted one generate a coefficient on the unemployment rate even 1/3 greater than the simple one-independent-variable unemployment rate specification.

The weak dependence in econometic estimates of inflation on the unemployment rate means that inflation hawks rarely rely on econometric estimates of the price pressure produced by sub-NAIRU unemployment rates to support their fears of runaway inflationary spirals. The time series tells us that a central bank that pushes the unemployment rate a full percentage point below the NAIRU and keeps it there sees inflation higher by 0.23%-points after one year, by 0.46%-points after two years, and by 0.92%-points after four years. That is not a catastrophe.

Instead, the argument is made that allowing the unemployment rate to decline below the NAIRU by even a small amount is likely, unless immediate and strong steps are taken to cool the economy and raise unemployment, to cause a sudden loss of confidence in the central bank’s commitment to price stability and an immediate and substantial rise in inflation expectations that have suddenly become “de-anchored”. For example, consider Philadelphia Federal Reserve Bank President Charles Plosser speaking in the FOMC in April 2008:

I remain concerned, however, about inflation and our calibration of the appropriate level of the fed funds rate consistent with our goals. Inflation readings have abated marginally since our last meeting; but as the Greenbook suggests, there is reason to believe that this is a temporary reprieve… year-over-year CPI inflation was 4 percent in March, and year-over-year PCE inflation was 3.4 percent—well above their 2007 levels…. Markets question our willingness to take actions consistent with sustained and credible price stability. Now, we have often alluded to the idea that near-term weakness will help mitigate some of the inflation pressures. However, I would just like to remind us that this critically depends on inflation expectations remaining well anchored…. I believe that the FOMC’s commitment to price stability remains credible at this time, but just barely…

However, identifying the upward breakouts of inflation not with oil or other supply shocks but with a sudden loss of credibility generating an expectational shift to a different equilibrium runs into a problem–at least if the goal is to caution against policies that might temporarily produce a too-low unemployment rate. The upside breakouts took place in a few isolated time periods when the unemployment rate was 6% or 5%. Most of the time when the unemployment rate was 6% or 5% or even 4% there was little if any upward acceleration in inflation. The most that can be said of this hawkish point of view, even viewing it through the most rose-colored glasses imaginable and reading it in the most favorable light, is that a super-NAIRU unemployment rate insulates against a breakdown of confidence in the central bank’s commitment to fighting inflation. But a sub-NAIRU unemployment rate does not reliably trigger a breakdown of such confidence, does not even make such a breakdown more likely than not, and–given the small effect of low-NAIRU unemployment price pressure on inflation–would not seem to be the natural place to look for risks to the central bank’s credibility.

In some ways, the basic message here is one that I first learned back in the mid-1990s from Douglas O. Staiger et al. They asked: “http://www.nber.org/books/rome97-1)”>How Precise Are Estimates of the Natural Rate of Unemployment?” They answered: not at all. Why not? Because the only way to possibly pin down the value of the NAIRU with any precision is through the effects of unemployment on inflation. Since the econometric time series tells us that the effects of unemployment on inflation are small, there is no way to precisely pin down the NAIRU. By the same coin, the costs in terms of a damaging suboptimal inflation rate of policies that produce deviations of unemployment from the NAIRU must also be small, because the effects of unemployment on the NAIRU are weak.

Inflation hawks thus face a benefit-cost question that they need to answer. The benefits for societal welfare of the Federal Reserve’s successfully fulfilling its dual mandate are very large. To successfully fulfill the employment part requires tiptoeing unemployment down to the NAIRU. The costs of making a mistake–of overdoing it–are, the computer tells us, small in terms of the amount of undesired and costly inflation produced. Does this not imply a Rikki-Tikki-Tavi “run and find out!” attitude toward monetary policy–that learning more about where the NAIRU is by engaging in policies that allow for information-revealing deviations of unemployment from the NAIRU and inflation from its target is also an important monetary policy goal?

I have asked this question a number of times. I haven’t gotten an answer…

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Source: http://delong.typepad.com/20140827-core-inflation-phillips-curve.rmd

References

2 William T. Dickens (2007): A New Method for Estimating Time Variation in the NAIRU

1 Douglas O. Staiger et al. (1996): How Precise Are Estimates of the Natural Rate of Unemployment? in Christina D. Romer and David H. Romer, eds. (1996): Reducing Inflation: Motivation and Strategy (Chicago: University of Chicago Press: 0-226-72484-0 http://www.nber.org/books/rome97-1)

3 Mark Watson (2014): Inflation Persistence, the NAIRU, and the Great Recession, American Economic Review Papers and Proceedings

4 David Beckworth: About the Fed Not Trying Hard Enough To Hit Its Inflation Target)

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Must- and Shall-Reads:

• Matthew Yglesias: 38 maps that explain the global economy
• Amitabh Chandra et al.: Who Ordered That?: The Economics of Treatment Choices in Medical Care
• Erwin Chemerinsky: How the Supreme Court Protects Bad Cops
• Chang-Tai Hsieh and Enrico Moretti: Growth in Cities and Countries
• Martin Wolf: Opportunist shareholders must embrace commitment

 

1. Greg Sargent: GOP’s Obamacare repeal follies continue: “One of the most amusing subplots of the 2014 elections has been the endless and frequently comic struggles of GOP Senate candidates to articulate their position on Medicaid…. Iowa Senate candidate Joni Ernst… says people on Medicaid should should be allowed to keep it…. And yet she proudly touted her vote against Iowa’s Medicaid expansion and continues to be a gung-ho advocate for repealing Obamacare, which would roll back funding for the expansion…. Ernst’s repeal stance would mean all those people lose their coverage. Does she no longer think that should happen?…. Tom Cotton in Arkansas once again refused to say this week whether his repeal stance means he would roll back his state’s version of the Medicaid expansion…. Terri Lynn Land in Michigan has also refused to clarify her position on this…. Commentators are not telling the full story of how the politics of Obamacare are really playing out…. At this point [candidates] are largely attacking the word ‘Obamacare’ while reassuring swing voters they support its general goals, without saying how they would accomplish those goals…”

2. David Kotok: Deflation Fears: “1. United States 10-Year Treasury Yield, 2.4% 2. Germany 10-Yield Bund Yield, under 1%. 3. Japanese 10-Year JGB Yield, under 0.5%. 4. France 10-Year Government Bond Yield, 1.3%. 5. Canada 10-Year Government Bond Yield, 2%. 6. United Kingdom 10-Year Government Bond Yield, 2.5%. 7. Mexico 10-Year Government Bond Yield, 3.2%. 8. Italy 10-Year Government Bond Yield, 2.4%…”

3. Jonathan Chait: Dreamers Have Destroyed GOP Immigration Strategy: “After the 2012 election, Marco Rubio tried to craft himself as the leader of a pro-immigration-reform Republican Party. That effort has capsized, pulling Rubio’s standing with conservatives down along with it. Now Rubio is refashioning himself as the leader of a restrictionist Republican Party…. The newest iteration of Rubio is the opposite of the figure he and party leaders envisioned last year. The transformation ought to terrify them…. Of course, the 2016 campaign has hardly begun…. The trouble for Republicans is that the political theater created by the Dreamers is not going to stop. They can try their best to control officially sanctioned media debates, but the Dreamers are staging debates without permission, endlessly highlighting the cruelty of the Republican stance. It is a strategy for which the Republicans so far have no answer. The symbolic denouement of Rubio’s immigration debacle may well be an angry old man brandishing his cane at young Dreamers.

4. Matthew Klein: This time is different, long-term unemployment edition: “Jae Song and Till von Wachter… the impact of the most recent recession on long-term unemployment was not actually that unusual given the number of jobs lost at the outset. The paper also presents some encouraging evidence that many of those who appear to have given up hope of finding a job could rejoin the labour force if the economy keeps expanding, as well as sobering demonstrations of the permanent costs of being laid off…. Long-term non-employment in the immediate aftermath of the Great Recession was not much worse than it was in the early 1980s for most cohorts, with the notable exception of young men…. As the paper puts it: ‘There is no evidence that the rate of exit from long term nonemployment has slowed during the Great Recession compared to the patterns in all episodes since the 1990s.’ But this is not all good news… ‘five to ten years after the Great Recession the employment population ratio would be predicted to be 1 to 2 percentage points lower than it was before the recession.’…”

5. Jay Rosen: Features and details of the personal franchise model in digital journalism, with 11 ex. Grantland, Bill Simmons, ESPN. Five thirty eight, Nate Silver, ESPN. xoJane, Jane Pratt, Say Media. GigaOm, Om Malik, independent. Talking Points Memo, Josh Marshall, independent. Daily Dish, Andrew Sullivan, independent. Recode.net, Walt Mossberg and Kara Swisher, independent. Tech Dirt, Mike Masnick, independent. Project X, Ezra Klein, Vox Media. The Information, Jessica Lessin, independent”

6. Daniel Kuehn: Yes, Acemoglu and Robinson’s review of Piketty is very strange: “I just happened to get to one of the parts in Piketty that Acemoglu and Robinson quote to show that Piketty doesn’t think institutions matter (from page 365): ‘The fundamental inequality r > g can explain the very high level of capital inequality observed in the nineteenth century, and thus in a sense the failure of the French revolution…. The formal nature of the regime was of little moment compared with the inequality r > g.’ So what is in that ellipses? [Piketty] explains that the revolution didn’t change the course of inequality (relative to monarchical Britain) because the new institutions that were established were much closer to Britain than popular perception in France at the time suggested! It was NOT a big change in institutions, which was why the French revolution did not shift the parameters…. Immediately after this he goes on to discuss changes in institutions in the 20th century that WERE substantial enough to impact inequality…. In other words, the real point of this section is that institutions matter a lot…. And not only did A&R get that wrong–they deliberately removed the portion of the quote where he made the point…. All of the explanations for the empirical changes in the distribution over time are either (1) institutions, or (2) shocks…. Apparently it’s not just Acemoglu and Robinson that missed this memo…. Piketty without institutions in the capital share of income section could probably survive. Piketty without institutions in the inequality section of the book simply wouldn’t exist any more…. This is like saying Milton Friedman wasn’t all that concerned with money!”

7. John Cole: Bitter Irony: “Here’s the facebook page of Charles Vacca, the range instructor who was killed by a 9 year old with an UZI that we mentioned earlier. Here are some of the pictures he posted to Facebook…”

Should Be Aware of:

• Michael Hiltzik: Another GOP state may be signing up for Medicaid, and the reason is obvious
• Robert Skidelsky: Endgame for Putin in Ukraine?
• David Glasner: The Trouble with IS-LM (and its Successors)
• Erle Elis et al.: Dating the Anthropocene: Towards an empirical global history of human transformation of the terrestrial biosphere

 

1. Jonathan Chait: Paul Ryan’s 6 Favorite Books List Has Huge Omission “Paul Ryan has tried… to downplay his love of Ayn Rand and… Atlas Shrugged… the volume that Ryan once handed out to all his staffers, listed as one of his three most frequently reread books of any kind and cited as the entire reason he got into public service, no longer makes the top six list of books on politics and economics…. More interesting… are the final two books Ryan does name…. Wealth and Poverty is a weird, rambly, mostly unoriginal recitation of free-market homilies…. The Way the World Works is a novel argument that the entire history of the world can be explained by changes of tax rates… a work of genuine derangement on the same intellectual level as the sorts of unpublishable hand-scrawled diatribes that I used to scan through when I sorted the mail as a magazine intern…. Eventually Wanniski started defending the likes of Louis Farrakhan and Slobodan Milosevic, denying Saddam Hussein had gassed the Kurds, and so on, which made his oddity more obvious to the lay audience. Gilder is actually even less hinged than Wanniski, and has held forth on various views from a belief that ESP is real to insisting ‘there is no such thing a reasonably intelligent feminist’…”

2. Christopher Cotton et al.: Affirmative Action and Human Capital Investment: Evidence from a Randomized Field Experiment “The empirical literature on Affirmative Action (AA) in college admissions tends to ignore the effects admissions policies have on incentives of students to invest developing pre-college human capital. We explore the incentive effects of AA using a field experiment that creates a microcosm of the college admissions market. Our experimental design is based on the asymmetric, multi-object, all-pay auction framework in Bodoh-Creed and Hickman (2014). We pay 5th through 8th grade students based on their performance on a national mathematics exam relative to other competitor students, and observe the use of a study website as students prepare for the exam. An AA treatment favors “disadvantaged” students by reserving prizes for lower grade students who on average have less mathematics training and practice. We find that the AA policy significantly increases both average time investment and subsequent math achievement scores for disadvantaged students. At the same time, we find no evidence that it weakens average human capital investment incentives for advantaged students. We also find strong evidence that AA can narrow achievement gaps while promoting greater equality of market outcomes.”

3. Daniel S. Hamermesh et al.: Does Labor Legislation Benefit Workers? Well-Being after an Hours Reduction: “Are workers in modern economies working “too hard”—would they be better off if an equilibrium with fewer work hours were achieved? We examine changes in life satisfaction of Japanese and Koreans over a period when hours of work were cut exogenously because employers suddenly faced an overtime penalty that had become effective with fewer weekly hours per worker. Using repeated cross sections we show that life satisfaction in both countries may have increased relatively among those workers most likely to have been affected by the legislation. The same finding is produced using Korean longitudinal data. In a household model estimated over the Korean cross-section data we find some weak evidence that a reduction in the husband’s work hours increased his wife’s well-being. Overall these results are consistent with the claim that legislated reductions in work hours can increase workers’ happiness.”