Month: April 2015

Must-Read: Chris Meissner: Research Summary: “The first ‘Great Wave of Globalization,’ during the late 19th and early 20th centuries witnessed a historically unprecedented rise in spatial economic integration…

…Previous work in economic history has emphasized the rapid decline in transportation costs and the fall in tariffs. However, a number of other trade costs mattered over this period, and not all of them followed the same path as real transportation costs…. When two nations adopted the gold standard, trade was higher by 15 percent, on average, relative to non-adopters. Monetary unions, political alliances, language, and trade treaties also affected the direction of trade…. Our data for the U.S., U.K., and France and their major trading partners between 1870 and 1913 show that trade costs fell at a rate of about 0.3 percent per year, which is significantly slower than the decline in average maritime freight rates of 2 percent per year. Our explanation for this is, first, that our all-encompassing trade-cost measure captures many other frictions….

Globalization in the 19th century had a very important ‘extensive margin.’ While the existing literature on pre-1914 globalization has emphasized a ‘great specialization,’ this characterization fails to take into account that a significant fraction of the growth of trade was due to the export of new goods and the opening up of new markets. Significant amounts of the observed trade flows were also in fact already intra-industry. This observation leads us to believe that then, as now, firm-level heterogeneity and trade costs mattered…. As fixed costs fell and presumably as new firms found it profitable to enter export markets, many industries experienced relatively slow productivity growth as low-productivity entrants were now able to survive…. Overall productivity growth between 1870 and 1910 was much slower than we would expect in the midst of such an unprecedented trade boom, and it was much lower than productivity growth in the new-goods sectors….

Observe that, from the middle of the 19th century, many countries dramatically extended the franchise, thereby increasing the level of ostensible democracy. A similar trend coincided with the more-recent wave of globalization, as the number and share of democracies in the world rose dramatically from the 1960s…. We use an instrumental-variables strategy inspired by Jeffrey Frankel and David Romer to see whether, in the first wave of globalization in particular, exposure to trade flows might have had a causal impact on democracy. There is little evidence that it did…

Rethinking Macro Policy III: Progress or Confusion?

Things I Probably Will Have Time to Say

It could have turned out very differently.

It could have been that the money-center universal banks did understand their derivatives books. It could have been that, after the financial crisis, trust in financial intermediaries would rebuild itself quickly. It could have been that the North Atlantic’s central banks would have been able to nail market expectations to a rapid return to normalcy, thus providing cash holders with powerful incentives to spend. It could even have been the case that fiscal expansion would have proven ineffective. It was Karl Smith who pointed out to me that in the guts of even the IS-LM model, fiscal policy expands I+G by reducing the perceived average riskiness of and thus getting households to hold more. In the model it is guaranteed that a sovereign that issues more debt thereby necessarily reduces the perceived riskiness of average debt. In the world not.

But we all go to the blackboard with the economy we have, rather then the economy we used to think we had.

If you had asked me back in 2005 whether the world could possibly turn out to be as “Old Keynesian” as it has turned out to be over the past decade, I would have said: No.

Now there are two possible ways we can respond, given how the world has surprised us over the past decade:

We can turn our excellent brains to constructing increasingly implausible rationalizations for why what we thought in 2005 was right after all.

Or we can mark our beliefs to market.

I strongly recommend the second.

That is all I am going to say about fiscal policy in the short run–with the note that these days the “short run” is not the two or three years I used to teach my undergraduates, but rather a period of time that is uncertainly and terrifyingly long.

So let’s move, in our imagination at least, into the medium run in the North Atlantic: into a world in which short-term safe nominal interest rates rarely if ever hit the zero nominal bound, and the full employment and price stability stabilization-policy mission could be left to central banks and monetary policy.

First question: Can, in a political-economy sense, central banks be trusted with this mission? Are they not captured, to too great an extent, by the commercial-banking sector that, myopically, favors higher nominal interest rates to directly improve bank cash flows and indirectly dampen inflation and so redistribute wealth to nominal creditors–like banks? No, they cannot be trusted. Yes, they are so captured. This is a problem.

Second question: What is the proper size of the twenty-first century public sector? We all know the stringent requirements for market optimality: rivalry, excludibility, information symmetry, a distribution of wealth that accords with utility and desert, competition, neutralization of price stickiness, financial regulation to offset positive-feedback, along with other largely-fruitless attempts to deal with other behavioral-economics failures of human calculation: envy, spite, myopia, salience, and so forth.

As we move into the twenty-first century, the commodities we want to produce are becoming less “Smithian”. More education–and I do not think anyone in the U.S. is happy with the decisions twenty-year olds are currently making about how much education they should get and how to finance the debt incurred. Deciding to fund education via long-term loan-finance and to leave societal cost-benefit investment calculations in the hands of adolescents: not a good idea.

Pensions: The privatization of pensions via 401k(s) has been, I think, a disaster. The rise in finance from 15% to 40% of profits has come from somewhere, and one big somewhere has been the ability of Wall Street to tempt investors to churn their 401(k)s–the 0.01% exploiting the 5% that are the investing class. Health-care spending as a share of total income will cross 25% if not 33%. In the U.S., we are making one last effort to preserve a private insurance market for those rich enough for insurance companies to value their willingness to pay and young enough for insurance companies to be willing to bear the risks. But information asymmetries are large and mounting as expenses riss. Enough said.

The twenty-first century will see information goods a much larger part of the total pie than the twentieth. And if we know one thing, it makes no microeconomic sense at all for services like those provided by Google to be funded and incentivized by how much money can be raised not off of the value of the services provided, but off of the fumes rising from Google’s ability to sell the eyeballs of the users to advertisers as an intermediate good. Infrastructure? R&D?

Now we know that as bad as market failures can be, government failures can be worse. We badly need new effective institutional forms. But the decreasing salience of “Smithian” commodities in the twenty-first century means that rational governance would expect the private-market sphere to shrink relative to the public.

This is very elementary micro and behavioral economics. We need to think about what its implications for public finance are.

Third, the proper size of the government debt. Back in the Clinton administration–back when the U.S. government’s debt really did look like it was an an unsustainable course–we noted that the correlation between shocks to U.S. interest rates and the value of the dollar appeared to be shifting from positive to zero, and we were scared that the U.S. was alarmingly close to its debt capacity and needed major, radical policy changes to reduce the deficit. Whether we were starting at shadows then, or whether we were right then and the world has changed since, or whether the current world is in an unstable configuration and we will return to normal within a decade is unclear to me.

But right now financial markets are telling us very strange things about the debt capacity of reserve currency-issuing sovereigns.

Since 2005, the interest rate on U.S. ten-year Treasury bonds has fallen from roughly the growth rate of nominal GDP–5%/year–to 300 basis points below the growth rate of nominal GDP. Because the duration of the debt is short, the average interest rate on Treasury securities has gone from 100 basis points below the economy’s trend growth rate to nearly 400 basis points below. And maybe you can convince yourself that the market expects the ten-year rate over the next generation to average 50 basis points higher than it is now. Maybe.

Taking a longer run view, Richard Kogan of the CBPP has been cleaning the data from OMB. Over the past 200 years, for the U.S., the government’s borrowing rate has averaged 100 basis points lower than the economy’s growth rate. Over the past 100 years, 170 basis points lower. Over the past 50 years, 30 basis points lower. Over the past twenty years Treasury’s borrowing rate has been on average greater than g by 20 basis points. And over the past ten years, 70 basis points lower.

Now nobody sees the United States or the North Atlantic economies as dynamically inefficient from a Golden Rule growth-theory standpoint as far as our investments in private physical, knowledge, and organizational capital are concerned. r > g by a very comfortable margin. Investments in wealth in the form of private capital are, comfortably, a cash-flow source for savers.

But there is this outsized risk premium, outsized equity and low-quality debt premium, outsized wedge. And that means that while investments in wealth in the form of private capital are a dynamically-efficient cash-flow source for savers, investments by taxpayers in the form of paying down debt are a cash-flow sink. Over the past 100 years, in the United States, at the margin, each extra stock 10% of annual GDP’s worth of debt has provided a flow of 0.1% of GDP of services in taxpayers in increased primary expenditures or reduced taxpayers.

What is the elementary macroeconomics of dynamic inefficiency? If a class of investment–in this case, investment by taxpayers in the form of wealth held by the government via amortizing the debt–is dynamically inefficient, do less of it. Do less of it until you get to the Golden Rule, and do even less if you are impatient. How do taxpayers move away from dynamic inefficiency toward the Golden Rule? By not amortizing the debt, but rather by borrowing more.

Now we resist this logic. I resist this logic. I tend to say that we have a huge underlying market failure here that we see in the form of the equity return premium–a failure of financial markets to mobilize society’s risk-bearing capacity, and that pushes down the value of risky investments and pushes up the value of assets perceived as safe, in this case the debt of sovereigns possessing exorbitant privilege.

But how do we fix this risk-bearing capacity mobilization market failure? And isn’t the point of the market economy to make things that are valuable? And isn’t the debt of reserve-currency issuing sovereigns an extraordinarily valuable thing that is very cheap to make? So shouldn’t we be making more of it?

Looking out the yield curve, such government debt looks to be incredibly valuable for the next half-century, at least.

And this gets us to the last question: isn’t high government debt–even for a reserve currency-issuing sovereign–risky?

What if there is a sudden downward shock to the willingness of investors to hold this debt? What if the next generation born and coming to the market is much more impatient than the current one? Governments might then have to roll over their debt on terms that require high debt-amortization taxes. If the debt is high enough, those taxes could push economies up the Laffer curve. Could that render the debt unsustainable, or the decision to tolerate a high government debt unwise?

Two considerations make me think that this is a relatively small danger. First, when I look back in history I cannot see any such strong fundamental news-free negative preference shock to the willingness to hold the government debt of the North Atlantic’s major powers s. The North Atlantic fiscal crises we see both after and before the advent of parliamentary goverment–of the Weimar Republic, Louis XIV Bourbon, Charles II Stuart, Felipe IV Habsburg, and so forth–appear driven by fundamental news: a government that loses its power to tax or its willingness to repay its debt. Second, as Rinehart and Rogoff point out at great length, 20th and 19th Century North Atlantic governments have proven able to tax their financial sectors via financial repression with great ease. And the amount of real wealth for debt amortization that can be raised by financial repression scales roughly with the value of outstanding government debt.

It is large-scale borrowing in harder currencies–or writing unhedged puts on your currency–that is the source of real trouble.

Rethinking Macro Policy III: Progress or Confusion?

Things I am almost surely not going to have time to say III:

Can, in a political-economy sense, central banks be trusted with the full-employment-and-price-stability stabilization-policy mission? Are they not captured, to too great an extent, by the commercial-banking sector that, myopically, favors higher nominal interest rates to directly improve bank cash flows and indirectly dampen inflation and so redistribute wealth to nominal creditors–like banks?

No, they cannot be trusted. Yes, they are captured to too great an extent by the commercial-banking sector. Yes, the commercial banking sector is very myopic in its conventional wisdom.

Rethinking Macro Policy III: Progress or Confusion?

Things I am almost surely not going to have time to say II:

Take the mechanics of demand stabilization and management off the table. Move, in our imagination at least, into a world in which short-term safe nominal interest rates rarely if ever hit the zero nominal bound. In that world, as a result, the full employment and price stability stabilization-policy mission could be left to central banks and monetary policy. Furthermore, confine our thinking to the North Atlantic, possibly plus Japan.

It seems to me then that there are four big remaining questions:

1. Can, in a political-economy sense, central banks be trusted with this mission? Are they not captured, to too great an extent, by the commercial-banking sector that, myopically, favors higher nominal interest rates to directly improve bank cash flows and indirectly dampen inflation and so redistribute wealth to nominal creditors–like banks?

2. What is the proper size of the twenty-first century public sector?

3. What is the proper size of the public debt for (a) countries that do possess exorbitant privilege because they do issue reserve currencies, and (b) countries that do not?

4. What are the real risks associated with the public debt in the context of historically-low present and anticipated future interest rates?

Rethinking Macro Policy III: Progress or Confusion?

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Things I am almost surely not going to have time to say I:

It could have turned out very differently.

It could have been–as those of us who more-or-less hooted Raghu Rajan down at Jackson Hole in August 2005 wrongly thought—-that the money-center universal banks did understand their derivatives books; that asset-price innovation variances did drift up or down with time relatively slowly; that the weak point in the global economy in the mid 2000s was the global imbalance of the US trade deficit, and the possibility that some large bad actor had been selling unhedged dollar puts on a very large scale–not the subprime mortgages on houses built in the desert between Los Angeles and Albuquerque, and the use of securities based on those subprime mortgages as core banking reserves.

It could have been that, after the financial crisis, trust in financial intermediaries would rebuild itself quickly. It was not certain ex ante that trust would remain nonexistent, giving rise to our extraordinary, ludicrous, bizarre, and apparently permanent upward spike in liquidity preference.

It could have been that the North Atlantic’s central banks, even stuck at the zero lower bound on short-term safe nominal interest rates, would have been able to nail market expectations. Markets could have been confident of a rapid return to normalcy in the path of nominal demand. That would have provided cash holders with powerful incentives to spend on real assets. That would have created not the L but rather the U or even the V-shaped recovery that we all wish we had and had had.

It could have been the case that fiscal expansion–even at the zero short-term safe interest-rate nominal bound, even for reserve-currency printing sovereigns–would have proven ineffective, or even counterproductive. It was Karl Smith pointed out to me that in the guts of even the IS-LM model, a principal channel through which fiscal policy expands I+G is via reducing the perceived average riskiness of debt, and thus getting households to hold more debt. It is not guaranteed that a sovereign that issues more debt thereby necessarily reduces the perceived riskiness of the average piece of debt.

But we all go to the blackboard with the economy behalf, rather then the economy we used to think we had.

If Paul Krugman were here, he would say that if he has had an analytical edge since 1995, it was because he stopped taking macro after his class with Jim Tobin, and since 1995 we have been living in Jim Tobin’s world. I will say that if I have had an analytical edge, it would be because my Econ 2410 teacher, Olivier Blanchard, made us spend weeks–it seemed then like months–decoding Lloyd Metzler’s paper, “Wealth, Saving, and the Rate of Interest”, from the early 1950s.

If you had asked me back in 2005 whether the world could possibly turn out to be as “Old Keynesian” as it has turned out to be over the past decade, I would have said: No.

Suppose you had told me back in 2005 that the Federal Reserve was going to take the size of its balance sheet north of $4 trillion in the forthcoming decade. I would have immediately leveraged up as far as I possibly could on nominal debt. I would then have sat back and waited for the inflation to make me rich.

Now there are two possible ways we can respond given how the world has surprised us over the past decade.

We can turn our excellent brains to constructing increasingly implausible rationalizations for why what we thought in 2005 was right after all.

Or we can mark our beliefs to market.

I strongly recommend the second.

That is all I am going to say about fiscal policy in the short run–with the note that these days the “short run” is not the two or three years I used to teach my undergraduates, but rather a period of time that is uncertainly and terrifyingly long.

Sent from my iPhone

Must-Read: Adam Ozimek: The New Liberal Consensus Is a Force to Be Reckoned with: “Paul Krugman… provides what I think amounts to the basic case…

Low wages… are not the product of inscrutable market forces, but rather choices… connecting rising income inequality with the decline in workers’ bargaining power.

It’s not just Paul Krugman and liberal politicians like Barack Obama and labor secretary Tom Perez embracing this ‘new consensus’ either. Even some centrist economists like Larry Summers and Robert Rubin have been making similar arguments…. This is… a conclusion that is drawn from recent trends in empirical research… Arin Dube and coathors… Justin Wolfers, Adam Posen, Jacob Funk Kirkegaard and others…. An increasing number of pundits and economists who look at the literature on minimum wages and other research on labor markets and conclude that the stronger unions, higher wages, and more labor market regulations are a good idea…. Those who don’t buy the ‘new consensus’, again including myself, have a lot to worry about…. Rebuttals are piecemeal, attacking the minimum wage or unions alone, while the new consensus provides a whole story.  Just as importantly, those voicing dissent are outnumbered…. Nobody else has a very easy-to-tell story right now, or at least those that do have good stories aren’t addressing the recent trends in empirical evidence…. Right now, new liberal consensus proponents have the upper hand in this argument, at the very least rhetorically and certainly in terms of sheer quantity of output and controlling the conversation. Libertarians, conservatives, old fashioned neoliberals, and other liberals who disagree need to do a better job. I suspect there are actually a lot of liberal economists who don’t embrace this new consensus, but we aren’t hearing much from them. This consensus appears to be a big part of Hillary Clinton’s economic agenda, so if there are going to be alternatives now is the time to speak up.

Must- and Should-Reads:

• Tim Worstall: Increased Globalisation Explains Some Of The Increase In The US Profit Share
• Nathaniel Hendren: “I show adjusting for increased income inequality lowers the rate of U.S. economic growth since 1980 by roughly 15-20%, implying a social cost of increased income inequality in the U.S. of roughly $400 billion. Adjusting for differences in income inequality across countries, the U.S. is poorer than countries like Austria and the Netherlands, despite having higher national income per capita…”
• Zeynep Tufkeci: Facebook, Network Externalities, Regulation
• Susan Boynton: A Tenured Professor On Why Hiring Adjuncts Is Wrong
• Must-Read: Wolfgang Münchau: Macroeconomists Need New Tools to Challenge Consensus
• Today’s Must-Must-Read: Matthew Yglesias: A Chart Obamacare’s Critics Have a Hard Time Explaining
• Must-Read: Simon Wren-Lewis: Macro Teaching and the Financial Crisis
• Must-Read: Josh Zumbrun: Is Your Job ‘Routine’? If So, It’s Probably Disappearing

Might Like to Be Aware of:

• Kane Baccigalupi: The Code Is Just the Symptom
• Tim Worstall: [Increased Globalisation Explains Some Of The Increase In The US Profit Share http://www.forbes.com/sites/timworstall/2015/04/14/increased-globalisation-explains-some-of-the-increase-in-the-us-profit-share

Must-Read: Josh Zumbrun: Is Your Job ‘Routine’? If So, It’s Probably Disappearing: “The American labor market and middle class was once built on the routine job…

…workers showed up at factories and offices, took their places on the assembly line or the paper-pushing chain, did the same task over and over, and then went home. New research from Henry Siu at the University of British Columbia and Nir Jaimovich from Duke University shows just how much the world of routine work has collapsed…. Over the course of the last two recessions and recoveries, a period beginning in 2001, the economy’s job growth has come entirely from nonroutine work…. Examples of routine manual jobs in their classification system include rules-based and physical tasks, such as factory workers who operate welding or metal-press machines, forklift operators or home appliance repairers. Routine cognitive jobs include tasks done by secretaries, bookkeepers, filing clerks or bank tellers…. Nonroutine manual jobs include occupations like janitors or home-health aides. Finally, nonroutine cognitive jobs include tasks like public relations, financial analysis or computer programming….

In the most recent recession, routine jobs collapsed and simply have not recovered, with employment in both cognitive and manual jobs down by more than 5% if the tasks are mostly routine. “Historically these occupations rebounded,” Mr. Siu said. “It suggests a startling fundamental shift in the way the labor market is behaving.”… In the late 1980s, routine cognitive jobs were held by about 17% of the population and routine manual jobs by about 16%. Today, that’s declined to about 13.5% and 12%…. Mr. Siu and Mr. Jaimovich see no reason the trend would abate…

Note that these jobs are “routine” only in the sense that they involve using the human brain as a cybernetic control processor in a manner that was outside the capability of automatic physical machinery or software until a generation ago. In the words of Adam Smith (who probably garbled the story):

In the first fire-engines, a boy was constantly employed to open and shut alternately the communication between the boiler and the cylinder, according as the piston either ascended or descended. One of those boys, who loved to play with his companions, observed that, by tying a string from the handle of the valve which opened this communication to another part of the machine, the valve would open and shut without his assistance, and leave him at liberty to divert himself with his playfellows. One of the greatest improvements that has been made upon this machine, since it was first invented, was in this manner the discovery of a boy who wanted to save his own labour…

And Siu and Jaimovich seem to have gotten the classification wrong: A home-appliance repair technician is not doing a routine job–those jobs are disappearing precisely because they are not routine, require considerable expertise, are hence expensive, and so swirly swapping out the defective appliance for a new one is becoming more and more attractive.

Wolfgang Münchau: Macroeconomists Need New Tools to Challenge Consensus: Secular stagnation–a sharp fall in growth rates lasting a very long time…

…is not something that you can easily square with the current generation of macroeconomic theories and models…. The advent of chronic instability…. The present tools used by mainstream macroeconomists cannot deal with this adequately. New ones are needed. They exist in other disciplines, but to macroeconomists they look as weird today as the abstract stuff looked to mathematicians of the 19th century. For the moment, the traditionalists still rule. They managed to go beyond the ideological turf wars of the 20th century, by taking a leap towards a new generation of economic models that were technically complex–in the sense of 19th century mathematics…. The so-called dynamic stochastic general equilibrium (DSGE) models were…just not able to deal with the shocks we eventually got…. The modern models have at least three questionable features… a single macroeconomic equilibrium… linearity….. Few of these criticisms left a lasting impression on the profession. The mainstream invested a life’s work in developing their DSGE models. They will not let go easily…. My hunch is that, unlike in mathematics, the successful challenge will come from outside the discipline, and that it will be brutal.