Category: Equitablog

Vitor Gaspar, Maurice Obstfeld, Ratna Sahay, et al.: Macroeconomic Management When Policy Space Is Constrained: A Comprehensive, Consistent, and Coordinated Approach to Economic Policy: “Global output remains below potential, unemployment above its natural rate, and inflation below target…

…Concern is widespread that countercyclical policies have run out of space or lack the power to raise growth or deal with the next negative shock. The common perceptions are that the effective lower bound on policy interest rates limits the room to loosen monetary conditions further and that high debt constrains fiscal policy, including automatic stabilizers….

This Staff Discussion Note argues that room exists for effective policies and that it should be used if appropriate… a comprehensive, consistent, and coordinated approach to policymaking….

Comprehensive policy… entails the mutually supportive use of the three policy prongs—monetary, fiscal, and structural—tailored to specific country circumstances…. Demand-management policies can support implementation of structural reforms that increase potential growth…. When monetary policy is constrained, fiscal policy provides support. Similarly, monetary policy accommodation prevents a crowding out of the expansionary fiscal response to a negative shock. Some countries have room for fiscal stimulus, especially in an environment of extremely low long-term interest rates. For others where room for fiscal maneuver is especially limited… better tailoring the pace of necessary fiscal adjustment and implementing growth-friendly fiscal rebalancing. Financial sector policies that strengthen banking systems and markets help improve the transmission of monetary policy and dampen shocks.

Consistent policy frameworks anchor long-term expectations while allowing decisive short- to medium-term accommodation whenever necessary. They do so by systematically linking instruments to policy objectives over time…. Monetary policy… allows effective stimulus, even when the policy interest rate is at its floor, in the form of a planned temporary overshoot of the inflation target. Fiscal policy must commit to managing public balance sheet risks…. Credible commitment and enduring practice of prudent management allow fiscal policy the flexibility to support economic activity when appropriate.

Finally, coordinated policies across major economies amplify the helpful effects of individual policy actions through positive cross-border spillovers…. Coordination of active monetary and fiscal policy adds particular value if the current policy approach falls short of reviving growth, or in the event of a further downward shock.

Must-Read: Stock and Watson look at growth rates and gaps between predicted and actual contributions to growth. I still think that my four-components graph conveys essentially the message more simply:

Stock: Half the GDP recovery slowdown is demographic trend-driven. But any argument that work though weak private investment and weak private consumption does not track. The explanations are, instead. The federal sequester. Weak state and local spending. Weak foreign demand.

I agree with the “demographic/trends” part, and the government purchases part. But rather than weak foreign demand I see the failure of residential construction to bounce back to normal, somewhat offset by strong exports.

No. I haven’t yet figured out why their more complex cut at the data has this different emphasis:

James Stock and Mark Watson: Why Has GDP Growth Been So Slow to Recover?:

Must-Read: Back in 2010 there were people saying:

• If you are not at the zero lower bound, fiscal policy is not necessary to stabilize the economy.
• If you are at the zero lower bound, the situation is so dire that using fiscal policy to stabilize the economy will require running the debt up to dangerously high levels.

The question is why six years of interest rates at rock bottom have not led more people to change their views of what “dangerously high” means in terms of debt. It remains a mystery to me.

Simon Wren-Lewis: Very Serious People and the Deficit: “George Osborne argued explicitly that the economic consensus was now that monetary policy should deal with stabilising output and inflation, while fiscal policy makers should look after their own deficit…

…I have called this the consensus assignment. If he, or his advisors, absorbed this piece of conventional wisdom, so may VSPs and mediamacro. So the headline academic scribbling was governments should control deficits, not the economy, and they are bad at it…. VSPs and the media more generally [would have] a clear role in providing a public service to help counteract the wickedness of politicians… to constantly advocate deficit reduction to counter deficit bias….

A little knowledge can be a dangerous thing…. [We] knew the conventional assignment broke down when interest rates hit their lower bound. We knew that a liquidity trap was absolutely not the time to worry about deficits, and if you did so you would cause tremendous damage. And we were right.

Must-Read: The argument for a Brexit recession always seemed to me to be that:

1. The pound would need to drop a lot to generate enough exports to offset the fall in investment in the City that the prospect of downsizing London finance would generate.
2. Perhaps the Bank of England would be unwilling to let the pound drop that far for fear of what it would do to inflation.
3. Perhaps the drop in the pound would destabilize the pound’s role as a safe store of value and thus further erode the City’s comparative advantage, already under threat by the uncertain institutional consequences of Brexit.

Whether the pound and the domestic interest rate drop far enough to avoid a short-term Brexit recession thus always seemed to me to be a matter of policy choice and animal spirits…

Paul Krugman: Notes on Brexit and the Pound: “The much-hyped severe Brexit recession does not, so far, seem to be materializing…

…But we are seeing a large drop in the pound, which has steepened as it becomes likely that this will indeed be a very hard Brexit. How should we think about this?… I’m coming at it from the trade side–especially trade in financial services…. Financial services… are subject to both internal and external economies of scale, which tends to concentrate them in a handful of huge financial centers… one of which is, of course, the City of London. But now… those services [will move] away from the smaller economy (Britain) and into the larger (Europe). Britain therefore needs a weaker currency to offset this adverse impact. Does this make Britain poorer? Yes… the efficiency effect of barriers to trade… [and] a terms-of-trade effect…. A weaker pound shouldn’t be viewed as an additional cost from Brexit, it’s just part of the adjustment. And it would be a big mistake to prop up the pound: old notions of an equilibrium exchange rate no longer apply.

Must-Read: Loren Brandt, Debin Ma, and Thomas G. Rawski (2012): From Divergence to Convergence: Re-evaluating the History Behind China’s Economic Boom: “The Qing Empire (1644-1911), the world’s largest national economy prior to the 19th century, experienced a tripling of population during the 17th and 18th centuries with no signs of diminishing per capita income…

…In some regions, the standard of living may have matched levels recorded in advanced regions of Western Europe. However, with the Industrial Revolution a vast gap emerged between newly rich industrial nations and China’s lagging economy. Only with an unprecedented growth spurt beginning in the late 1970s has the gap separating China from the global leaders been substantially diminished, and China regained its former standing among the world’s largest economies.

This essay develops an integrated framework… to explain how deeply embedded political and economic institutions that had contributed to a long process of extensive growth subsequently prevented China from capturing the benefits associated with new technologies and information arising from the Industrial Revolution. During the 20th century, the gradual erosion of these historic constraints and of new obstacles created by socialist planning eventually opened the door to China’s current boom. Our analysis links China’s recent economic development to important elements of its past, while using the success of the last three decades to provide fresh perspectives on the critical obstacles undermining earlier modernization efforts, and their removal over the last century and a half….

What circumstances enabled the hesitant reforms of the late 1970s which restored no more than a small fraction of the market arrangements stifled by socialist policies during the previous three decades, to launch the economy on a steep and durable growth path? How could several hundred million Chinese villagers escape from “absolute poverty” within 10-15 years following the onset of economic reform during the late 1970s with, if anything, declining external support as former collective institutions withered away? How did the number of so-called “township-village” (TVE) enterprises jump from 1.5 million to nearly 20 million, including many with substantial overseas sales, between 1978 and 1990 without encountering a shortage of capable managers and accountants? How did millions of firms conduct business, often on a large scale, without well-developed systems of commercial law or property rights?…

This essay is written in the conviction thathistorical legacies rooted in the decades and centuries prior to the establishment of the People’s Republic in 1949 continue to exert powerful influence upon the evolution of China’s economy. Prior to the industrial revolution, China led the world in both economic size and in many dimensions of technology…

Must-Read: Nick Bunker: How Much Bigger Can the U.S. Labor Force Get?: “The White House’s Council of Economic Advisers puts about half of the decline in [labor force] participation from 2007 to 2014 into the “aging” category…

…But several structural factors can be addressed through policy actions…. Alan Krueger… tries to understand what is depressing participation for men and women who are in prime working ages of 25 to 54…. [For] prime-age men, health problems seem to be a huge barrier…. For prime-age women… the importance of family-friendly policies, or rather the lack thereof…. There is still the possibility that cyclical forces are pushing down the labor force participation rate…. Wage growth hasn’t been particularly strong during this recovery, which points to continued weaknesses in the demand…