Category: Equitablog

Ben Bernanke: The Fed’s Shifting Perspective:

Over the past couple of years, FOMC participants have often signaled…

…that they expected repeated increases in the federal funds rate as the economic recovery continued. In fact, the policy rate has been increased only once, in December 2015, and market participants now appear to expect few if any additional rate rises in coming quarters…. Market commentary on FOMC decisions typically focuses on short-run factors… [but] they can’t account for extended deviations of policy from its expected path. The more fundamental reason for the shift in policy trajectory is the ongoing change in how most FOMC participants view the key parameters of the economy.

The two changes in participants’ views that have been most important in pushing the FOMC in a dovish direction are the downward revisions in the estimates of r* (the terminal funds rate) and u* (the natural unemployment rate). As mentioned, a lower value of r* implies that current policy is not as expansionary as thought…. Likewise, the decline in estimated u* implies that bringing inflation up to the Fed’s target may well take a longer period of policy ease than previously believed. The downward revisions in estimated u* likely have also encouraged FOMC participants who see scope for further sustainable improvement in labor market conditions. The downward revisions to estimates of y* have mixed implications….

FOMC participants’ views of how the economy is likely to evolve have not changed much:  They still see monetary policy as stimulative (the current policy rate is below r*), which should lead over time to output growing faster than potential, declining unemployment, and (as reduced economic slack puts upward pressure on wages and prices) a gradual return of inflation to the Committee’s 2 percent target. However, the revisions in FOMC participants’ estimates of key parameters suggest that they now see this process playing out over a longer timeframe than they previously thought…. Relative to earlier estimates, they see current policy as less accommodative, the labor market as less tight, and inflationary pressures as more limited.  Moreover, there may be a greater possibility that running the economy a bit “hot” will lead to better productivity performance over time. The implications of these changes for policy are generally dovish, helping to explain the downward shifts in recent years in the Fed’s anticipated trajectory of rates….

It has not been lost on Fed policymakers that the world looks significantly different… than they thought… and that the degree of uncertainty about how the economy and policy will evolve may now be unusually high. Fed communications have therefore taken on a more agnostic tone recently…. With policymakers sounding more agnostic and increasingly disinclined to provide clear guidance, Fed-watchers will see less benefit in parsing statements and speeches and more from paying close attention to the incoming data…

Must-Read: Barry Ritholtz: Let’s Put the Lehman Bailout Debate to Rest:

Could the Fed have rescued Lehman? Was Lehman solvent? Was it capable of raising capital?…

The issue I’m skipping for now (assuming the Fed could have rescued Lehman) is whether it should have done so. That’s a separate question. Let’s dispose of the first issue…. As subsequent events have shown, most especially with the Fed-led bailout of insurance giant American International Group, if there was a will, there most certainly was a way…. The second issue is two-fold: Was Lehman technically solvent and could this be determined in the weekend before the collapse with any degree of confidence? The answer to the former is probably not; the answer to the latter is definitely not. As researchers William R. Cline and Joseph E. Gagnon at the Peterson Institute  wrote, Lehman Brothers was “deeply insolvent… true net worth at the time it filed for bankruptcy is somewhere between –$100 billion and –$200 billion”…. Questions of Lehman’s true liquidity were evident even in early 2008….

But the proof of Lehman’s insolvency is found in its notorious accounting deception, Repo 105. Each quarter, Chief Executive Officer Dick Fuld and his team of accountants at Lehman managed to move about $50 billion in liabilities off of Lehman’s books just in time for the quarterly earnings report. As the Wall Street Journal reported, “Because no U.S. law firm would bless the transaction, Lehman got an opinion letter from London-based law firm Linklaters.” Hiding $50 billion dollars or more of liabilities each quarter is prima facie evidence of insolvency…. Lehman’s accounting was especially opaque, even relative to other investment banks (and that’s saying something!), making it difficult for any suitor to throw Lehman a lifeline, especially on such short notice.

There was one white knight who could have saved Lehman: Warren Buffett…. Berkshire Hathaway offered to buy preferred shares that would pay a dividend of 9 percent and could be converted to common at the then-market price of $40.30. Buffett’s money was costlier than other potential investors, but it came with the imprimatur of the world’s best-loved investor. That alone probably would have guaranteed Lehman’s survival. Part of Buffett’s offer was that Lehman Brothers senior managers invest on the same terms alongside him with their own cash. Fuld spurned that proposal. When Buffett offers you a few billion dollars–and you foolishly reject it–you can no longer make the claim that attempts to raise capital were unsuccessful….

Lehman was the first trailer in the park to be destroyed by the tornado. Whether it lived or died was not going to stop the financial forces that had been decades in the making and unleashed when the credit bubble popped. I agree with Ann Rutledge, a principal with New York-based R&R Consulting, and co-author of two books on structured finance. She noted “It wasn’t a mistake to let Lehman fail, it was a mistake to let it live so long.

Must-Read: Once more: the importance of the zero lower bound in generating asymmetric risks, and the importance of asymmetric risks in generating a policy bias toward substantial easing. The reason is the same as the reason that you stand well out to sea when sailing from Point Arena to San Francisco…

Paul Krugman:: Prudential Macro Policy: Monetary:

It was easy to say what U.S. monetary and fiscal policy should be doing…

the indicated demand policy was pedal to the metal all the way–no need to worry about inflation, no reason to believe that deficit spending would cause any crowding out (in fact it would almost surely crowd in private investment, because such investment depends on demand.)… The right kept warning about a debased dollar, while the Very Serious People were obsessed with debt and deficits, so that in practice we didn’t do the obvious. But it was obvious.

Now, however, we’re arguably not too far from full employment…. Has the macro case for strongly stimulative policy gone away?… [On] monetary policy… uncertainty plays the central role…. Risks are asymmetric. Waiting too long [to raise interest rates] risks embarrassment and some cost of wringing out the extra inflation, but moving too soon risks long-term stagnation. Wait until you see the whites of inflation’s eyes!…

Must-Read: Back before 2008, too much conventional wisdom held that the state of the business cycle did not matter much for the standard of living of those who did not own much capital. If inflation was to remain constant over time, a high-pressure economy that pushed inflation up had to be offset by an equal and opposite low-pressure economy that pushed inflation down, and so there was no permanent first-order gain for the working class from working hard to try to improve stabilization policy performance.

This was, I think, always false. But now it is obviously false. It now seems very unlikely we will get any rapid growth of potential output without a high pressure economy. And, as Larry says: “Tight labour markets are the best social program.”

Lawrence Summers: The Progressive Case for Pro-Growth Policies:

Tight labour markets are the best social programme, as they force employers to hire the inexperienced…

In the late 1970s, I was taught… that the shares of US total income going to profits and to wages, and to the rich and to the poor, was constant. All of this has changed. It is totally appropriate that widening inequality and the associated stalling of middle-class living standards should become an urgent political issue…. [But] the single most important determinant of almost every aspect of economic performance [is] the rate of growth of total income…. More growth means more employment. And with the college-graduate unemployment rate only 2.5 per cent, the newly employed are disproportionately less educated and disadvantaged. It can hardly be an accident that the decades of maximum growth, the 1960s and 1990s, also saw the most rapid job growth and most rapid increase in middle-class living standards….

How, then, can growth be accelerated? In an economy like that of the US, the vast majority of job creation and income growth comes from the private sector. If the next president is lucky enough to preside over the creation of 10m jobs from 2017-20, more than 8m of them will surely come from businesses hiring in response to profit opportunities. The question is not whether business success is desirable. The question is how it can best be achieved. At a moment when capital costs are close to zero, the stock market is at a record high and businesses are earning record profit margins, we do not need to bribe businesses to make investments that now do not seem worthwhile to them. There is no case for reducing already low corporate taxes or removing regulations unless it can be shown that these have costs in excess of benefits. What is needed is more demand…. This is the core of the case for policy approaches to raising public investment, increasing workers’ purchasing power and promoting competitiveness. That such policies also contribute to fairness is not a reason to lose sight of the central objective of promoting growth. Often in economics there are trade-offs. But not always. We can and must promote both fairness and growth.

Must-Read: An acerbic take on the economics profession and Brexit, but based, I think, on a false premise. I believe that when the economists’ negative assessments of Brexit “will eventually be tested against reality”, it will turn out that the negative forecasts were not “meant as a scare story only” and will come true. That–if anyone remembers–will not “reduce the profession’s reputation among non-economists further”:

Eurointelligence: Economics Profession Doubling Down:

What [should] the response… be to the rise in economic populism[?]…

Tony Yates… encapsulates the problem almost perfectly, in an unintended way: it is hard to find a better example of the profession’s arrogance. Yates’ discourse presumes the presence of a right and rational choice–and that those who disagree with the position are illiterate. In particular, Yates talks about “perceived grievances”, and notes that Brexit was “voted for by the older, less educated, less skilled”…. He confuses politics and policies… assumes that people care about aggregates and averages, rather than about their own position. When your real income falls, as it has done for almost 40% of the UK population in the last ten years, then this is not a perceived grievance but a real one…. These people… are not necessarily irrational…. Yates castigates policies to address these grievances as a “sop response”. That may be so to the extent that some of these policies may be symbolic and superficial. But for sure we need to address the problems. 

We have before discussed the surprise expressed by some economists that no one is listening to them any more. There is a reason for this. The profession, which is very inward-looking, has failed to address its shortcomings after the financial crisis. And if this article is any way representative of the post-Brexit response of the economics establishment, it is doubling down. The profession is shocked by the Brexit vote partly because the forecasts about the long-term impact of Brexit will eventually be tested against reality. It was meant as a scare story only. And it will reduce the profession’s reputation among non-economists further.

Must-Read: Note that it is not so much inequality that backlash is a backlash to. It is, rather, disappointment with what were previously-thought to be reasonable expectations–the breaking of the social contract that you believe the market economy has made with you:

Kevin O’Rourke: Brexit Backlash Has Been a Long Time Coming:

Globalisation in general, and European integration in particular, can leave people behind… ignoring this… can have severe political consequences…

The historical record demonstrates plainly and repeatedly [that] too much market and too little state invites a backlash. Markets and states are political complements, not substitutes… [that was] the main point of my 1999 book with Jeff Williamson… based on late-19th century evidence. Then the main losers… were European landowners… competing with an elastic supply of cheap New World land…. Meanwhile, across the Atlantic, immigration restrictions were gradually tightened as workers found themselves competing with European migrants coming from ever-poorer source countries. While Jeff and I were firmly focused on economic history, we were writing with an eye on the ‘trade and wages’ debate that was raging during the 1990s….

In our concluding chapter, we noted that economists who base their views of globalisation, convergence, inequality, and policy solely on the years since 1970 are making a great mistake. The globalisation experience of the Atlantic economy prior to the Great War speaks directly and eloquently to globalisation debates today….

Politicians, journalists, and market analysts have a tendency to extrapolate the immediate past into the indefinite future, and such thinking suggests that the world is irreversibly headed toward ever greater levels of economic integration. The historical record suggests the contrary. Unless politicians worry about who gains and who loses,î we continued, ìthey may be forced by the electorate to stop efforts to strengthen global economy links, and perhaps even to dismantle them…. We hope that this book will help them to avoid that mistake–or remedy it.

This time it is not different….

For a long time, conventional wisdom ignored these rather large straws in the wind–after all, the Irish could always be asked to vote again, while the French could always be told that they couldn’t vote again. And so the show could go on. But now Brexit is happening, and the obvious cannot be ignored any longer…. What can be done?… This is where Dani Rodrik’s finding that more open states had bigger governments in the late 20th century comes in (Rodrik 1998)…. Huberman and Meissner 2009… showed that this correlation between states and markets was present before 1914 as well….

If the Tories had really wanted to maintain support for the EU, investment in public services and public housing would have been the way to do it. If these had been elastically supplied, that would have muted the impression that there was a zero-sum competition between natives and immigrants. It wouldn’t have satisfied the xenophobes, but not all anti-immigrant voters are xenophobes. But of course the Tories were never going to do that, at least not with George Osborne at the helm…. We will have to wait and see what the English decide. But there are also lessons for the 27 remaining EU states (28 if, as I hope, Scotland remains a member). Too much market and too little state invites a backlash. Take the politics into account…