Must-Read: Paul Krugman: Notes on the Macroeconomic Situation

Must-Read: Let me disagree a bit with Paul: although evidence does suggest that we are near full employment, we are not at full employment–and the suggestion that we are near full employment is a very weak one. The unemployment rate is 4.6%–and six years ago I would have said that 5% unemployment is full employment. The prime-age employment-to-population ratio is 78.1%–and six years ago I would have said that an 80% prime-age employment-to-population ratio is full employment. It is possible to reconcile the two by saying that hysteresis has permanently knocked 2% of the prime-age population out of the labor force. But that claim is, itself, uncertain.

Paul rests his case for continued monetary policy at the zero lower bound and for fiscal expansion on the “precautionary motive”. That case is there, and is very strong. But IMHO there is still a very strong case for continued monetary policy at the zero lower bound and fiscal expansion resulting from recognition of our uncertainty about the current state of the economy.

The downsides of further expansionary policy to see if full employment is an 80% prime-age employment-to-population ratio are small. The upsides are large. We should follow Rikki-Tikki-Tavi, and run and find out.

Paul Krugman: Notes on the Macroeconomic Situation: “So the Fed has raised rates… a mistake, although not as severe… as it would have been a year ago….

Evidence does suggest that we’re close to full employment…. [So now] the case for easy monetary and fiscal policies… hinges mainly on the precautionary motive…. Because interest rates are still near zero, a bout of economic weakness can’t be met with strong monetary expansion; and discretionary fiscal stimulus is politically hard, especially given who’ll be running things…. So… I believe the Fed made a mistake, and would welcome a modest (1 or 2 point? maybe more?) rise in budget deficits, especially if it involved infrastructure spending.

But what if we are about to get significant fiscal stimulus from Trump? Well, it won’t be well-targeted…. That infrastructure build looks ever less likely, so we’re talking high-end tax cuts with low multipliers and little supply-side payoff…. Trump deficits won’t actually do much to boost [long-run] growth, because rates will rise and there will be lots of crowding out. Also a strong dollar and bigger trade deficit, like Reagan’s morning after Morning in America. So, the probable outlook is for not too great growth and deindustrialization. Not quite what people expect.