Must-Read: Marshall Steinbaum: The Unseen Threat of Capital Mobility

Must-Read: Marshall Steinbaum: The Unseen Threat of Capital Mobility: “The Hidden Wealth of Nations: The Scourge of Tax Havens

…by Gabriel Zucman, University of Chicago Press, $20 (cloth). Out of Sight: The Long and Disturbing Story of Corporations Outsourcing Catastrophe by Erik Loomis, The New Press, $25.95 (cloth). Two new books link rising inequality to unseen forces: tax havens in economist Gabriel Zucman’s case, and overseas labor and environmental exploitation in historian Erik Loomis’s. The adverse consequences of the free movement of capital suffuse both narratives…. Both authors propose tariffs, capital controls, and international regulatory standards that would either re-erect national boundaries or threaten to do so–proposals that will strike many readers as misguided, out of touch with political reality, or both….

When the Rana Plaza factory collapsed in 2013, Loomis engaged in a memorable online dispute with Matthew Yglesias, who published a piece on the disaster headlined ‘Different Places Have Different Safety Rules and That’s Okay’…. Loomis’s and Zucman’s calls for re-erecting national boundaries and re-empowering democratically accountable regulators are implications of a much more successful model for explaining why inequality has risen so much within developed and developing countries than in Yglesias’ just-so story: capital has gained the upper hand over labor by creating and accessing outside options while eliminating those of its opponents. Both books are the product of careful reconsideration and critique of received wisdom in the fields each covers, and more casual commentators would be wise to take heed of their implications instead of peddling discredited objections to any check on international capital mobility.

Must-Read: Antonio Fatas: The Missing Lowflation Revolution

Antonio Fatas: The Missing Lowflation Revolution: “It will soon be eight years since the US Federal Reserve decided to bring its interest rate down to 0%…

…In these eight years central banks have used all their available tools to increase inflation closer to their target and boost growth with limited success. GDP growth has been weak or anemic, and there is very little hope that economies will ever go back to their pre-crisis trends…. Very few would have anticipated… that central banks cannot lift inflation rates closer to their targets over such a long horizon… that a crisis can be so persistent and that cyclical conditions can have such large permanent effects on potential output… the slow (or inexistent) natural tendency of the economy to adjust by itself to a new equilibrium. To be fair… we had been warned about this by those who had studied the Japanese experience: both Krugman and Bernanke, among others…. But my guess is that even those who agreed with this reading of the Japanese economy would have never thought that we would see the same thing happening in other advanced economies….

It might be time to rethink our economic policy framework. Some obvious proposals include raising the inflation target and considering “helicopter money” as a tool for central banks. But neither of these proposals is getting a lot of traction. My own sense is that the view among academics and policy makers is not changing fast enough…. The comparison with the 70s when stagflation produced a large change in the way academic and policy makers thought about their models and about the framework for monetary policy is striking…. How many more years of zero interest rate will it take to witness a similar change in our economic analysis?

Secular Stagnation–That’s My Title, of the Longer Version at Least

J. Bradford DeLong: The Tragedy of Ben Bernanke: Project Syndicate:

Ben Bernanke has published his memoir, The Courage to Act.

I am finding it hard to read. And I am finding it hard to read as anything other than a tragedy. It is the story of a man who may have been the best-prepared person in the world for the job he was given, but who soon found himself outmatched by its challenges, quickly falling behind the curve and never quite managing to catch up.

It is to Bernanke’s great credit that the shock of 2007-2008 did not trigger another Great Depression. But the aftermath was unexpectedly disappointing… READ MOAR AT PROJECT SYNDICATE

Must-Read: Yael T. Abouhalkah: Paging Gov. Sam Brownback’s Sycophants

Must-Read: I must say: this amazes me. The old argument was that large Kansas-Missouri differences in AFDC payments back before 1995 did not lead single mothers to move across State Line Road into Kansas, so why should we expect even sharp state tax differentials to pull people across? The answer to that is: It was very, very clear that African-Americans in Kansas City were suppose to stay east of Troost. And non-African American AFDC recipients were much more geographically dispersed, hence it was not a short move.

Thus I thought business would be different.

I really did think that Brownback’s tax cuts would pull enough income across State Line Road to allow him to declare him non-defeat, and indeed to avoid utter defeat, when the rubber of his ideology met the road of reality and he had to make a Kansas state budget. Yet it is not so:

Yael T. Abouhalkah: Paging Gov. Sam Brownback’s Sycophants: “Kansas tax cuts still aren’t killing Missouri jobs in KC area…

…Jobs continue to grow more quickly on the Missouri side of the state line than on the Kansas side of the Kansas City metropolitan area. The Bureau of Labor Statistics reported that the Missouri portion of the region gained 2 percent in employment from September 2014 to September 2015. Meanwhile, the Kansas portion gained .9 percent…. This new report continues a recent trend in year-over-year superiority for the Missouri side…. This is not supposed to be happening, at least according to Brownback and his followers. He has stated that the income tax cuts he put in place in 2013 would generate more jobs especially in the Kansas City area, because it’s supposedly so easy just to hop the state line to reap tax benefits. Yet, month after month, that’s not happening…

Must-Read: Lawrence Summers: Global Economy: The Case for Expansion

Must-Read: Uncertainty about what the correct model of the economy is and a strongly asymmetric loss function do not simply apply to the question of whether the Federal Reserve should start a tightening cycle now or delay for a year and reevaluate then. It also applies to the question of whether fiscal policy–with its substance-free love of austerity–is fundamentally, tragically, and potentially catastrophically misguided:

Lawrence Summers: Global Economy: The Case for Expansion: “The inability of the industrial world to grow at satisfactory rates even with very loose monetary policies…

…problems in most big emerging markets, starting with China… the spectre of a vicious global cycle…. The risk of deflation is higher than that of inflation… we cannot rely on the self-restoring features of market economies… hysteresis–where recessions are not just costly but stunt the growth of future output–appear far stronger…. Bond markets… are [saying:] risks tilt heavily towards inflation… below… targets… [despite expected] monetary policy… looser than the Federal Reserve expects… [plus] extraordinarily low real interest rates….

If I am wrong about [the need for] expansionary fiscal policy, the risks are that inflation will accelerate too rapidly, economies will overheat and too much capital will flow to developing countries. These outcomes seem remote. But even if they materialise, standard approaches can be used to combat them. If I am right and policy proceeds along the current path, the risk is that the global economy will fall into a trap not unlike the one Japan has been in for 25 years…. What is conventionally regarded as imprudent offers the only prudent way forward.

If the world undertook a large, coordinated fiscal expansion, five years from now we might regret it: we might be trying to reduce an uncomfortably-high inflation rate via tight monetary policy and relatively-high interest rates, and worrying about the long-term sustainability of government debt given that, finally, r>g. But those are problems we can handle, and those are problems of a world near full employment with ample incentives to invest in physical capital, organizational business models, and new technology.

If the world does not undertake a large, coordinated fiscal expansion, five years from now we might regret it: having failed to do anything to claw the global economy off the lee shore of the zero lower bound in 2015-6, the next adverse shock would leave the world mired in a depression as deep as 2008-9 with no available monetary policy tools to fight it.

In a world of uncertainty about the right model, the correct policy choice is obvious.

Yet the center of the Fed–both FOMC participants and staff alike–say things like: “You cannot make policy without a forecast.” And they go on to say that they will take the next policy step as if the forecast is accurate, and reevaluate only as outcomes differ from expectations. This seems to me to be an elementary mistake: in finance, after all, those who neglect optionality get taken to the cleaners by those who see it and use it.

And it is not as if the Federal Reserve’s current forecast–for rising PCE inflation crossing 2%/year in less than two years–even looks to me like the right forecast: is this a pattern that you think will generate wage growth high enough to sustain 2%/year-plus PCE inflation in two years?

A kink in the Phillips curve Equitable Growth

Must-Read: Henry Aaron: Can Taxing the Rich Reduce Inequality? You Bet It Can!

Must-Read: Henry Aaron: Can Taxing the Rich Reduce Inequality? You Bet It Can!: “Two recently posted papers by Brookings colleagues purport to show that…

…‘even a large increase in the top marginal rate would barely reduce inequality.’  This conclusion, based on one commonly used measure of inequality, is an incomplete and misleading answer to the question posed: would a stand-alone increase in the top income tax bracket materially reduce inequality?  More importantly, it is the wrong question to pose, as a stand-alone increase in the top bracket rate would be bad tax policy that would exacerbate tax avoidance incentives.  Sensible tax policy would package that change with at least one other tax modification, and such a package would have an even more striking effect on income inequality.  In brief:

  • A stand-alone increase in the top tax bracket would be bad tax policy, but it would meaningfully increase the degree to which the tax system reduces economic inequality.  It would have this effect even though it would fall on just ½ of 1 percent of all taxpayers and barely half of their income.
  • Tax policy significantly reduces inequality.  But transfer payments and other spending reduce it far more.  In combination, taxes and public spending materially offset the inequality generated by market income.
  • The revenue from a well-crafted increase in taxes on upper-income Americans, dedicated to a prudent expansions of public spending, would go far to counter the powerful forces that have made income inequality more extreme in the United States than in any other major developed economy.”

Must-Read: Paul Krugman: Rethinking Japan

Must-Read: Paul Krugman is musing about and rethinking his 1998 analysis of Japan and its macroeconomic problems:

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Paul Krugman: Rethinking Japan: “[How] would change what I said in my 1998 paper…

…on the liquidity trap[?]… Japan and the world look different…. First, the immediate economic problem is… weaning the economy off fiscal support. Second… demand weakness looks… permanent…. Back in 1998 Japan… [was] operating far below potential…. This is, however, no longer the case…. Output per working-age adult has grown faster than in the United States since around 2000…. [But] Japan’s relatively healthy output and employment levels depend on continuing fiscal support… ever-rising debt/GDP…. So far this hasn’t caused any problems…. But even those of us who believe that the risks of deficits have been wildly exaggerated would like to see the debt ratio stabilized and brought down at some point…..

With policy rates stuck at zero, Japan has no ability to offset the effects of fiscal retrenchment with monetary expansion. The big reason to raise inflation… is to… allow… monetary policy to take over from fiscal policy…. But what would it take to raise inflation?… Back in 1998… [I assumed] the Wicksellian natural rate of interest… would return to a normal, positive level at some future date… [thus] the liquidity trap became an expectations problem…. But what is this future… normality[?]… [If] a negative Wicksellian rate is… permanent… [even] a credible promise to be irresponsible might do nothing: if nobody believes that inflation will rise, it won’t….

The only way to be at all sure… is… a changed monetary regime with a burst of fiscal stimulus…. While the goal… is… to make space for fiscal consolidation, the first part of that strategy needs to involve fiscal expansion… really aggressive policy, using fiscal and monetary policy to boost inflation… setting the target high enough… escape velocity. And while Abenomics has been a favorable surprise, it’s far from clear that it’s aggressive enough to get there.

In many ways, things are even worse than Paul says. Paul Krugman’s original argument assuming that the economy would eventually head towards a long-run equilibrium in which flexible wages and prices what make Say’s Law hold true, in which there would be a positive natural nominal rate of interest, and thus in which the price level would be proportional to the money stock. That now looks up for grabs. It is the fact that that is up for grabs that currently disturbs Paul. Without a full-employment Say’s Law equilibrium out there in the transversality condition to which the present day is anchored by intertemporal financial-market and intertemporal consumer-utility arbitrage, all the neat little mathematical tricks that Paul and Olivier Blanchard built up at the end of the 1970s to solve for *the* current equilibrium break in their hands. And we enter Roger Farmer-world–a scary and frightening place.

But there is even more. Paul Krugman’s original argument also assumed back-propagation into the present via financial-market intertemporal arbitrage and consumer-satisfaction intertemporal utility arbitrage of the effects of that future well-behaved full-employment equilibrium. The equilibrium has to be there. And the intertemporal arbitrage mechanisms have to work. Both have to do their thing.

But, as Paul wrote in another context:

Paul Krugman**: Multipliers and Reality: “Rigorous intertemporal thinking…

…even if empirically ungrounded, can be useful to focus one’s thoughts. But as a way to think about the reality of spending decisions, no…. Consider… what the public knows about the biggest new government program of recent years[, ObamaCare]…. If people are that uninformed about something that big, imagining that they do anything like the calculations assumed in DSGE models is ludicrous. Surely they rely on rules of thumb that don’t make use of the kind of information that plays such a large role in our models…

Suppose the full employment equilibrium is really out there. People still have to anticipate that it is out there, and then take account of the fact that it is out there and the way that a rational-expectations utility-maximizing agent would.

Now sometimes we get lucky.

Sometimes the fact that one can transact on financial markets on a large scale means that even if only a few are willing to bet on fundamentals, the fact that they can make huge fortunes betting on fundamentals on a large scale drives current asset prices to fundamental values, and those asset prices then drive the current behavior even those who do not know anything about the future equilibrium that is driving the present via this process of expectational back-propagation inductive-unraveling.

But when we are talking about inducing people to spend more now because they fear their money will be worth less then in the future when the debt will have been monetized–well, if that were an important and active channel, we would not now have our current sub-2%/year inflation in Japan and the United States, would we?

Time to drop a link to my New Economic Thinking, Hicks-Hansen-Wicksell Macro, and Blocking the Back Propagation Induction-Unraveling from the Long Run Omega Point: The Honest Broker for the Week of May 31, 2015.

In fact, let me just repeat the whole thing below the fold…


Over at Equitable Growth: In the long run… when the storm is long past, the ocean is flat again.

At that time–or, rather, in that logical state to which the economy will converge if values of future shocks are set to zero–expected inflation will be constant at about the 2% per year that the Federal Reserve has announced as its target. At that time the short-term safe nominal rate of interest will be equal to that 2% per year of expected inflation, plus the real profits on marginal investments, minus a rate-of-return discount because short-term government bonds are safe and liquid. At that time the money multiplier will be a reasonable and a reasonably stable value. At that time the velocity of money will be a reasonable and a reasonably stable value. Why? Because of the powerful incentive to economize on cash holdings provided by the the sacrifice of several percent per year incurred by keeping cash in your wallet rather than in bonds. And at that time the price level will be proportional to the monetary base. READ MOAR

That was and is the logic behind so many economists’ beliefs. Their beliefs before 2008 that economies could not get stuck in liquidity traps (because central banks could always create inflation by boosting the monetary base); beliefs in 2008 and 2009 that economies’ stays in liquidity traps would be very short (because central banks were then boosting the monetary base); and beliefs since then that (because central banks had boosted the monetary base) those who believe will not taste death before, but will live to see exit from the liquidity trap and an outburst of inflation as the Federal Reserve tries and fails at the impossible task of shrinking its balance sheet to normal without inflation–all of these beliefs hinged and hinge on a firm and faithful expectation that this long run is at hand, or is near, or will soon draw near (translations from the original koine texts differ). Because the long run will come, increases now in the monetary base of sufficient magnitude that are believed to be permanent will–maybe not now, but soon, and for the rest of our lives, in this long run–produce equal proportional increases in the price level, and thus substantial jumps in the inflation rate as the price level transits from its current to its long-run level.

Moreover, there is more to the argument: The long run is not here. The long run may not be coming soon. But the long run will come. And so there will will a time when the long run is near. At that time, those who are short long-term bonds will be about to make fortunes as interest rates normalize and long bond prices revert to normal valuation ratios. At that time, those who are leveraged and short nominal debt will be about to make fortunes as the real value of their debt is heavily eroded by the forthcoming jump in the price level .

And there is still another step in the argument: When the long run is near but not yet here–call it the late medium run–investors and speculators will smell the coffee. This late medium run will see investors and speculators frantically dumping their long bonds so as not to be caught out as interest rates spike and bond prices collapse. It will see investors and speculators frantically borrowing in nominal terms to buy real assets and currently-produced goods and services so as not to be caught out when the price level jumps. Thus even before the long run is here–even in the late medium run–their will already be very powerful supply-and-demand forces at work. Those forces will be pushing interest-rates up, pushing real spending levels, and pushing price levels and inflation rates up.

The next step in the argument continues the induction unraveling: When it is not yet the late medium run but only the medium run proper, rational investors and speculators must still factor the future coming of the long run into their decisions. The long run may not be near. But it may be that soon markets will conclude the long run is near. Thus in the medium run none will want their portfolios to be so imbalanced that when the late medium run does come and with it the time to end your exposure to long-term bonds and to nominal assets and leverage up, you are on the wrong foot and so last person trying to get through the door in the stampede. There may be some short run logic that keeps real spending low, prices low, inflation quiescent, and interest rates at zero. But that logic’s effects will be severely attenuated when the medium run comes, for then investors and speculators will be planning not yet for the long run or even the at-handness of the long run, but for the approach of the approach of the long run.

And so we get to the final step of the induction-unraveling: Whatever may be going on in the short run must thus be transitory in duration, moderate in their effects, and limited in the distance it can can push the economy away from its proper long run equilibrium. And it certainly cannot keep it there. Not for long.

This is the real critique of Paul Krugman’s “depression economics”. Paul can draw his Hicksian IS-LM diagrams of an economy stuck in a liquidity trap:

The Inflationista Puzzle NYTimes com

He can draw his Wicksellian I=S diagrams of how the zero lower bound forces the market interest rate above the natural interest rate at which planned investment balances savings that would be expected were the economy at full employment:

Lifestream vpdoc 2015 06 02 Tu Krugman Feldstein

Paul can show, graphically, that conventional monetary policy is then completely ineffective–swapping two assets that are perfect substitutes for each other. Paul can show, graphically, that expansionary fiscal policy is then immensely powerful and has no downside: it does not generate higher interest rates; it does not crowd out productive private investment; and, because interest rates are zero, it entails no financing burden and thus no required increase in future tax wedges. But all this is constrained and limited by the inescapable and powerful logic of the induction-unraveling propagating itself back through the game tree from the Omega Point that is the long run equilibrium. In the IS-LM diagram, the fact that the long run is out there means that even the contemplation of permanent expansion of the monetary base is rapidly moving the IS curve up and to the right, and thus leading the economy to quickly exist the liquidity trap. In the Wicksellian I=S diagram, the fact that the long run is out there means that even the contemplation of permanent expansion of the monetary base is rapidly moving the I=S curve up so that the zero lower bound will soon no longer constrain the economy away from its full-employment equilibrium.

The “depression economics” equilibrium Paul plots on his graph is a matter for today–a month or two, or a quarter or two, or at most a year or two.

But it will soon be seven years since the U.S. Treasury Bill rate was more than whispering distance away from zero. And it is now more than two decades since Japan’s short-term bonds sold at less than par.

Paul has a critique of the extremely sharp Marty Feldstein’s latest over at Project Syndicate (parenthetically, I must say it is rather cruel for Project Syndicate to highlight Feldstein’s August 2012 “Is Inflation Returning” in site-searches for “Feldstein”):

Paul Krugman: The Inflationista Puzzle: “Martin Feldstein has a new column on what he calls the ‘inflation puzzle’…

…the failure of inflation to soar despite the Fed’s large asset purchases, which led to a very large rise in the monetary base. As Tony Yates points out, however, there’s nothing puzzling at all about what happened; it’s exactly what you should expect when interest rates are near zero…. This isn’t an ex-post rationale, it’s what many of us were saying from the beginning. Traditional IS-LM analysis said [it]… so did the translation of that analysis into a stripped-down New Keynesian framework that I did back in 1998, starting the modern liquidity-trap literature. We even had solid recent empirical evidence: Japan’s attempt at quantitative easing in the naughties, which looked like this:

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I’m still not sure why relatively moderate conservatives like Feldstein didn’t find all this convincing back in 2009. I get, I think, why politics might predispose them to see inflation risks everywhere, but this was as crystal-clear a proposition as I’ve ever seen.

Still, even if you managed to convince yourself that the liquidity-trap analysis was wrong six years ago, by now you should surely have realized that Bernanke, Woodford, Eggertsson, and, yes, me got it right…. Maybe it’s because those tricksy Fed officials started paying all of 25 basis points on reserves[?] ([But] Japan never paid such interest[.]).

Anyway, inflation is just around the corner, the same way it has been all these years.

Unlike Paul, I get why moderate conservatives like Feldstein didn’t find “all this convincing” back in 2009. I get it because I only reluctantly and hesitantly found it convincing. Feldstein got the Hicksian IS-LM and the Wicksellian S=I diagrams: he just did not believe that they were anything but the shortest of short run equilibria. He could feel in his bones and smell in the air the up-and-to-the-right movement of the IS curve and the upward movement of the S=I curve as investors, speculators, and businesses took look at the size of the monetary base and incorporated into their thinking about the near future the backward induction-unraveling from the long run Omega Point. My difference with Marty in 2009 is that he thought then that the liquidity trap was a 3 month-1 year phenomenon–that that was the duration of the short run–while I was much more pessimistic about the equilibrium-restoring forces of the market: I thought it was a 3 year-5 year phenomenon.

And it was not just me. Consider Ben Bernanke. I have no memory any more of who was writing [Free Exchange] back in 2009. But whoever it was was very sharp, and wrote:

????: Person of the next five to ten years: “There are those who blame [Bernanke] for missing all the warning signs…

…those who blame him for managing the crisis in the most Wall Street-friendly way… those who blame him for laying the groundwork for a future asset bubble or inflation crisis…. I think his defining decision… has been to conclude that 10% unemployment is acceptable–that having averted a Depression-style 25% unemployment scenario, his countercyclical work is complete… that the risk of sustained high unemployment is outweighed by the risk of… efforts to boost the economy… by asking for more fiscal stimulus… targeting nominal GDP or… committing… to some [higher] level of inflation….

Bernanke believes most of the increase in unemployment… to be cyclical… does not think that pushing… unemployment… down to… 7% would overextend the economy…. He simply seems to think that leaving his primary job half done is acceptable. That’s a pretty momentous choice, affecting millions of people directly and billions indirectly. It will shape American politics and economics for the next decade, at least…. He deserves… person of the year…. But reappointment? That’s another story entirely.

What this leaves out is that Bernanke was willing to take his foot off the gas in late 2009 with an unemployment rate of 10% because, like Marty, he could smell the back-propagation of the induction-unraveling of the short run equilibrium. He us expected that, with his foot off the gas, unemployment would be 8.5% by the end of 2010, 7% by the end of 2011, 6% by the end of 2013–and thus that further expansionary policies in 2010-2011 would run some risk of overheating the economy in 2013-2014 that was not worth the potential game. He didn’t see the liquidity trap short run as as brief as Marty did. But he also didn’t see the short run as as long as I did–and I have greatly underestimated its duration.

(Someday I want Christina Romer to write up her memoir of late 2009-late 2010, as she wandered the halls of the White House, the Federal Reserve, the IMF, and the OECD, trying to convince a bunch of economists certain that the short run was a year or two that all the historical evidence we had–the Great Depression and Japan’s Lost Decades, plus what we dimly think we know about 1873-9, and so forth–suggested, rather, that it the short run would, this time, be a five to ten-year phenomenon. Yet even with backing by Rinehart and Rogoff on the short run equilibrium duration (albeit not the proper fiscal policy) front, she made little impression and had next to no influence.)

Ahem. I have gotten off track…

My point:

Back in late 2009 I thought that the liquidity-trap short run was likely to be a three-to-five-year phenomenon. It has now been six. And the Federal Reserve’s proposed interest-rate liftoff now scheduled for the end of 2015 appears to me profoundly unwise as a matter of technocratic optimal control, prudent policy, and recognition of the situation. The duration of the short run thus looks to me to be, this time, not three to five years but more like ten. Or more. The backward-propagation of the induction-unraveling of the short run under pressure of the healing rays of the long run Omega Point is not just not as strong as Marty Feldstein thought, is not just not as strong as I thought, it is nearly non-existent.

Thus I find myself getting somewhat annoyed at Paul Krugman when he writes that:

Paul Krugman: Choose Your Heterodoxy: “A lot of what I use is 1930s economic theory…

…via Hicks. And I should be deeply ashamed…. [But] plenty of physicists who still use Newtonian dynamics, which means that they’re seeing the world through the lens of 17th-century theory. Fools!… Farmer is trying to explain an empirical regularity he thinks he sees, but nobody else does–a complete absence of any tendency of the unemployment rate to come down when it’s historically high. I’m with John Cochrane here: you must be kidding…

Or that:

Paul Krugman: Nonlinearity, Multiple Equilibria, and the Problem of Too Much Fun: “Was the crisis something that requires novel multiple-equilibrium models to understand?…

…That’s far from obvious. The run-up to crisis looks to me more like Shiller-type irrational exuberance. The events of 2008 do have a multiple-equilibrium feel to them, but not in a novel way… pull Diamond-Dybvig…. And since the crisis struck, as I’ve argued many times, simple Hicksian macro–little equilibrium models with some real-world adjustments–has been stunningly successful…

Or:

Paul Krugman: Learned Helplessness: “We knew all about liquidity traps, and had at least thought about balance-sheet crises…

…a decade ago…. The Return of Depression Economics in 1999. The world we’re now in isn’t that different from the world I suspected, back then, we’d find ourselves in. Oh, and about Roger Farmer and Santa Fe and complexity and all that: I was one of the people who got all excited about the possibility of getting somewhere with very detailed agent-based models–but that was 20 years ago. And after all this time, it’s all still manifestos and promises of great things one of these days…

The problem is that the macroeconomics that Paul Krugman learned at Jim Tobin’s knee wasn’t just 1930s-style Hicks-Hansen Keynesianism. It was the 1970s adaptive-expectations Phillips Curve neoclassical synthesis–nearly the same stuff that I first learned at Marty Feldstein and Olivier Blanchard’s knees in the spring of 1980. That is the framework that Marty is using know, and that generates his puzzlement. That framework had a short run of 1-2 years, a medium-run transition-dynamics phase of 2-5 years, and a long run of 5 years or more baked into it. You cannot–or at least I cannot–just throw away the medium run transition dynamics* and the declaration that the long run Omega Point is five years out, and say that mainstream economics does well. You need to explain why the back-propagation induction-unraveling worked at its proper time scale in the 1970s and the 1980s, but is nowhere to be found now.

And so I am much less confident that I have solid theoretical ground under my feet than Paul Krugman does.

A Reader’s Guide to the Secular Stagnation Debate: The Honest Broker for the Week of October 12, 2015

The very sharp and energetic Peter Passell, who runs the Milken Institute Review these days, commissioned me to write a reader’s guide to the secular stagnation debate. I set it up as a four-corner cage match–Bernanke, Rogoff, Krugman, and Summers–and I am proud of it. (But I have to offer apologies to those–Koo, Blanchard, Feldstein come most immediately to mind, but there are others–who have their own serious positions that are not completely and satisfactorily understood as linear combinations of the four I chose to be my basis vectors.) It is out:

J. Bradford DeLong (2015): The Scary Debate Over Secular Stagnation, Milken Institute Review 2015:IV (October) pp. 34-51:

Bernanke… says we have entered an age of a “global savings glut.”… Rogoff… points to the emergence of global “debt supercycles.”… Krugman warns of the return of “Depression economics.” And… Summers calls for broad structural shifts in government policy to deal with “secular stagnation.” All… are expecting a future that will be very different than the second half of the 20th century, or even the so-far, not-so-good third millennium. But they… [differ on] optimism or pessimism… [and on whether] cautious repairs or an abrupt break with policy as usual [are needed. This] is, I believe, the most important policy-relevant debate in economics since John Maynard Keynes’s debate with himself… which transformed him from a monetarist to the apostle of active fiscal policy.

I think Summers is largely right, but then, I would, since I have been losing arguments with him since I was 20. What’s needed here, though, is not a referee’s decision, but a guide to the fight…


Briefly:

  • Bernanke sees anomalies in portfolio decisions by emerging-market central banks and plutocrats that have generated a global savings glut in the relatively short-run.
  • Rogoff sees overleverage as having created a medium-run period of stagnation that requires active debt-liquidation policies to shorten it.
  • Krugman sees the end of the era of moderate inflation as bringing about a return to “Keynesian” economic structures that require activist fiscal policy.
  • Summers sees deeper problems that call for more in the way of government’s acting as investment-spender, risk-bearer, safe asset-supplier, and bubble-preventer of last resort, and thus extend its proper role beyond that of Keynesian demand-management policies toward what Keynes called a “comprehensive socialization of investment”.

All are serious and live possibilities…

Must-Read: Paul Krugman: Did The Fed Save The World?

Must-Read: Looking back at my archives, I find that my own ratio of “Paul Krugman is right” to “Paul Krugman is wrong” posts is not in the rational range between 10-1 and 5-1, but is 15-1. So I am looking for an opportunity to rebalance. And I find one this morning: Here I think Paul Krugman is wrong. Why? Because of this:

2015 10 06 for 2015 10 07 DeLong ULI key

Housing crashes. And does not bounce back quickly by the end of 2010–or, indeed, at all. And Paul Krugman is correct to write that “Even a total collapse of home lending couldn’t have subtracted more than a point or two more off aggregate demand”:

2015 10 06 for 2015 10 07 DeLong ULI key

But exports collapse as the financial crisis hits, and then bounce back very rapidly as the financial crisis passes:

2015 10 06 for 2015 10 07 DeLong ULI key

And roughly one-third of the financial-crisis associated collapse in business investment is quickly reversed after the financial crisis passes:

2015 10 06 for 2015 10 07 DeLong ULI key

Together these two factors plausibly associated with the reuniting of the web of financial intermediation look to me to be five times as large as the fiscal stimulus measured by government purchases. Now fiscal stimulus worked through channels other than government purchases. And without the Recovery Act we would have seen states and localities not holding their purchases constant over 2008-2011 but cutting them by 1% of GDP or so. And not all of the export and business investment bounce-back in the two years after the 2009 trough can be attributed to lender-of-last-resort and easy-money policies.

But it looks to me like the balance is that–even with housing left to rot on the stalk–monetary and banking policy did more than fiscal policy to stem the downturn and promote recovery up to 2011. And it looks to me that, since 2011, it is the reknitting of the financial system and easy money that has kept the extraordinary austerity that the states and the Republicans imposed and that Obama has bought into from sending the U.S., at least, into a renewed and deeper downturn.

Paul Krugman: Did The Fed Save The World?: “Bernanke’s basic theme is that the shocks of 2008 were bad enough that we could have had a full replay of the Great Depression…

…the reason we didn’t was that in the 30s central banks just sat immobilized while the financial system crashed, but this time they went all out to keep markets working. Should we believe this?… I very much agree with BB that pulling out all the stops was the right thing to do…. But I’m not persuaded that the real difference between 2008 and 1930-31 (which is when the Depression turned Great) lies in central bank action, or related bailouts. It’s true that the 30s were marked by a big financial disruption…. Shadow banking rapidly shriveled up, with repo and other alternatives to bank financing shrinking very fast; liquidity for everything but the safest of assets disappeared even though the big financial firms remained in being. And if we’re looking for effects of the tightening in credit conditions, remember that credit policy usually exerts its biggest effects through housing — and housing investment fell more than 60 percent as a share of GDP….

So really, was putting a limit on the financial crisis the reason we didn’t do a full 1930s? Or was it something else? And there is one other big difference between the world in 2008 and the world in 1930: big government…. Again, Bernanke and company were right to step in forcefully. But I’d argue that the fiscal environment was probably more important than monetary actions in limiting the damage. Oh, and since 2010 officials everywhere, but especially in Europe, have been doing all they can to undo the favorable effects…. And the result is that in Europe economic performance is at this point considerably worse than it was at this point in the 1930s.

Must-Read: Marshall Steinbaum: How Much Would Increasing Top Income Tax Rates Reduce Inequality?

Must-Read: Marshall Steinbaum: How Much Would Increasing Top Income Tax Rates Reduce Inequality?: “William Gale, Melissa Kearney, and Peter Orszag… increasing top-bracket ordinary income tax rates…

would have little impact on inequality…. There are two key reasons why [their] tax scenarios do not affect [their measure of] inequality very much. First of all, the rich earn a great deal of their income in categories other than “ordinary income,” to which these tax rates apply…. The other reason… is that GKO measure inequality by the Gini Coefficient. But the scenarios only affect individuals comfortably within the top 1% of the income distribution…. The Gini Coefficient is insensitive to measuring inequality in that group….. [But] the reduction in the top 1% income share as a result of the GKO scenario is just under 20% of the total increase in inequality over the whole period the CBO analyzes…