Category: Equitablog

Must-Read: Paul Krugman: A Question For the Fed

Posted on by Brad DeLong

Must-Read: As I was just saying yesterday: Take the rate of profit–typically 6% to 7% per year–on the operating companies that make up the stock market. Subtract the risk premium–typically 4%. Add on the expected inflation rate–2.5% on the CPI basis. Get 4.5% to 5.5%. That is what the nominal interest rate on Treasury bills is likely to be in normal times toward the end of a healthy expansion. That provides a healthy amount of room for the Federal Reserve to cut interest rates to encourage spending and support the economy when a recession comes. But note that 5% of sea-room to cut interest rates when necessary was not nearly enough back in 2007-2010.

Now suppose that we are entering an age of secular stagnation. It will have a higher risk premium–say 5-6%. Slower growth will have an impact on the rate of profit for operating companies–knock, say, 1-2% off their typical value. Go through the math, and we get a likely nominal interest rate on Treasury in normal times toward the end of a healthy expansion of roughly 1-3%, not 5%.

The dot-plots tell us that the FOMC now thinks that it is headed for a 3% Treasury Bill rate–at the upper end of this range, but still very far from a 5% rate. And if we do live in a semi-permanent age of secular stagnation, this will not be a temporary inconvenience but, rather, a permanent structural fact.

That means that if the FOMC keeps its current inflation target then it will have only 3% of sea-room when the next big recession comes, whether next year, next decade, or a quarter century from now.

That means that if the FOMC keeps attempting to raise interest rates back to a 5% normal–or even, unless it is lucky, to a 3% normal–it will find itself continually undershooting its inflation target, and continually promising that rates will go up more real soon now as soon as the current idiosyncratic fit of sub-2% inflation passes.

I do not know anybody seriously thinking about all this who thinks that 3% of sea-room is sufficient in a world in which shocks as big as 2007-2010 are a thing. And I do not know anybody seriously thinking about all this who thinks that pressing for a premature “normalization” of interest rates is a good idea: It will deanchor inflationary expectations on the downside, and with rational market inflation expectations 1-2% below the “target” that means an equilibrium late-expansion Treasury Bill rate of not 1 to 3% but rather -1 to 2%.

Therefore either (a) the Federal Reserve really should raise its inflation target, or (b) the Federal Reserve should right now be screaming to high heaven about how it is the necessary and proper task of the rest of the government to do something, something big, something now to resolve our secular stagnation problem. And under no circumstances should the Fed be (c) pushing for probably premature “normalization” of interest rates.

Of course, the Fed could and should be doing both (a) and (b). But it seems to be doing neither–it seems to be doing (c).

Perhaps Janet’s thoughts on secular stagnation are part of process of trying to assemble an FOMC coalition to… do something… or at least beg others to do something…

But this intellect, at least, is pretty pessimistc.

A Question For the Fed The New York Times

Paul Krugman: A Question For the Fed: “There is a near-consensus at the FOMC that rates must eventually move up…

….But… exactly?… Which component of aggregate demand do we believe will continue to strengthen in a way that will require monetary tightening to avoid an overheating economy? Here’s a look at two obvious candidates… as shares of potential GDP… deviations from the 1990-2007…. Nonresidential investment has basically recovered from the recession-induced slump. Residential investment is still a bit low by historical standards, but not as much as you might think…. So I don’t see an obvious reason to believe that current rates are too low. Yes, they’re near zero–but that in itself doesn’t mean too low. Like others, notably Larry Summers, I think the Fed is trying to return to a normality that is no longer normal.

Must-Read: Nancy LeTourneau: What Happens When One Party Doesn’t Care About Governing?

Posted on by Brad DeLong

Must-Read: I want to play the bipartisan-technocrat policy game.

The old conventional wisdom was that playing that game was productive and fun. You see, members of the Senate and the House. Thus, and so the two houses–everybody in them–shared the goal of trying to arrange things so that they each looked good to their local constituents. And good technocratic policies were an effective move in that win-win–or mostly win-win–game.

But now? The political-economy and political-structural questions are:

  1. Has this changed–is the game now to make the president of the other party look bad?
  2. Did the game change with the Democrats under Richard Nixon–who was genuinely bad–and have Republicans just been playing tit-for-tat since?
  3. Did the game change with the accession of Newt Gingrich–and his strange and false belief that he would have a better and longer career as a partisan bomb thrower than as a statesman?
  4. Did the game change with George W. Bush–and his decision that Democratic members of the House and Senate who supported him on policy would not be cut any campaign fund-allocation breaks at election time?
  5. Did the game change with the election of a Black man?

And how do we get back–if we can get back? And do we want to get back?

These are all the questions that I wish political scientists were trying to answer for me. Yet few are–save Tom Mann, Norm Ornstein, Rick Perlstein, and a very few others…

Nancy LeTourneau: What Happens When One Party Doesn’t Care About Governing?: “Over the course of the Obama presidency, we’ve watched as Republicans have thrown out many of the norms…

…[Not] just things like shouting ‘You lie!’ in a presidential address… not just a requirement that basically any vote (including presidential nominations) get a super majority… includes… overtly undermining the executive branch during complex negotiations with other countries… failing to give a Supreme Court nominee a hearing… threatening to not raise the debt limit…. These are the kinds of things a party does when it doesn’t care about governing…. I am reminded of something a blogger named mistermix wrote back in 2010 during the height of the budget negotiations.

As Tim F. posted earlier, Ezra Klein thinks that Obama’s a bad poker player…. The analogy isn’t helpful. Poker is a win/lose game. Negotiation is a win/win game…. Republicans aren’t playing poker or negotiating. They are playing another game, call it ‘You Must Lose’. They’re happy with win/lose, if they win, but they’ll tolerate lose/lose as long as Obama loses. The only analogy that springs to mind when I look at the Republicans’ recent behavior is a bad divorce…. Bob is so hell-bent on hurting Lisa that he doesn’t care about their kids or their bank account. Bob will deploy a hundred variations on the same tactic: put the Lisa in a bind where she has to choose between damaging the children and losing money. Lisa will lose money almost every time in order to save the children….

That caught my eye because, as a former family therapist I know the analogy well…. It actually becomes calcified and intractable when both parents buy in–which ensures that everyone always loses. Think about that next time you hear a liberal suggest that Democrats should employ the same tactics as the Republicans…. Here is how Mike Lofgren described it back in 2011:

A couple of years ago, a Republican committee staff director told me candidly (and proudly) what the method was to all this obstruction and disruption. Should Republicans succeed in obstructing the Senate from doing its job, it would further lower Congress’s generic favorability rating among the American people. By sabotaging the reputation of an institution of government, the party that is programmatically against government would come out the relative winner.

So what are the Democrats’ options in a situation like this? First of all, they shouldn’t take the bait and join in a guaranteed lose-lose game….At some point, voters have to decide if it is in their interest to elect politicians who are simply using them as their pawns in a power game. I know that as a family therapist, when I saw that a divorce wars situation was intractable, I would eventually go to the kids to begin the process of empowering them to make good choices (luckily in my practice they were adolescents)….

The old conservative vs liberal arguments aren’t much in play this election. That is obvious in the presidential contest. But it is also true in House/Senate races…

What’s behind the decline in male labor force participation in the United States?

Posted on by Nick Bunker

One of the most discussed problems in the U.S. labor market in recent years is the decline in the labor force participation rate, or the share of the population that’s employed or actively looking for a job. A big reason for this overall decline since 2000 is the aging of the U.S. population, but dig into the decline a bit more and there’s more to it than growing legions of retirees. The participation rate of prime-age workers, those 25-to-54 years old, also is falling. For women, this is a new trend in the 21st century, but for men the beginning of the decline dates back to the 1950s. Why are more and more men in their prime working years increasing not working? A new report from the President’s Council of Economic Advisers sheds some light on a potential answer, but first some context.

The U.S. labor force participation rate for prime-age men peaked in 1954 at just under 98 percent. The rate declined for the next decade before the decline accelerated around 1965. Over the next 50 years, the participation rate for these men declined by 8.3 percentage points as of last month. In May 2016, only 88.4 percent of prime-age men had a job or were actively looking for one.

What’s behind this decline? Economists divide the reasons into supply-side explanations (prime-age men are less willing to work) and demand-side explanations (employers are less willing to hire prime-age men). But the report by the Council of Economic Advisers finds relatively little evidence for the supply-side explanations. They find that increased reliance on programs such as Social Security Disability Insurance can explain, at the most, 0.5 percentage points of the 7.5 percentage point decline since 1967. And the share of men who are neither working nor seeking work and who also are married to a working spouse is low—less than 25 percent) and declining—meaning these men aren’t opting-out because they can rely on the earnings of their spouses.

Instead, the Council of Economic Advisers finds much more evidence for demand-side explanations. The decline in labor force participation is strongest among men with a high school degree or less (14 percentage points), which is also the group that experienced the most significant decline in their wages relative to other workers in the economy. Declining employment and declining wages indicates that demand-side issues are mostly to blame. Indeed, the report also shows that in states where the absolute return on work (wages at the low end) and the relative return on work (less low-end wage inequality) are higher, prime-age men are more likely to be in the labor force.

A decline in the demand for less-educated men in the United States seems to be part of longer-term trends such as technological change, globalization, or changing labor market institutions. What’s more, these same trends also have decreased demand for middle-skill workers, which in turn may have caused declining employment for low-skilled men. As these middle-skilled workers lost their jobs and moved into lower-paying occupations, they pushed less-educated men out of the labor force all together.

This “cruel game of musical chairs” can be seen in the wake of economic recoveries over the past five decades. The employment-to-population ratio for prime-age men has declined after every recession (except for one) since 1965 and never reached its previous high before the next recession. And the employment losses for prime-age men during a recession don’t bounce back as much amid each recovery. (See Figure 1.)

Figure 1

 

As the Council of Economic Advisers notes, the decline in male labor force participation is a sign of a longer-term decline in fluidity in the U.S economy. Less job creation by firms and less job movement by workers mean that the labor market is less able to bounce back from negative shocks. If the long-term trends mean less demand for middle and low-skill workers, then those at the bottom of the ladder have a hard time getting back on it. To help counteract some of the long-term trends then, policymakers should focus on strengthening the recoveries from recessions.

Must-Reads: June 22, 2016

Posted on by Brad DeLong

Should Reads:

Must-Read: Paul Taylor: “We Skipped Elasticity Completely…”

Posted on by Brad DeLong

Must-Read: Very flattering…

I must say: I don’t know how one would teach Econ 1 other than organizing it around the principles of (a) market success and (b) types of market failure…

Paul F Taylor: On Twitter:

Must-Read: Richard Scheffler and Sherry Glied: States Can Contain Health Care Costs. Here’s How

Posted on by Brad DeLong

Must-Read: Perhaps even very large health-insurance entities can be made to behave competitively if their regulator is clever enough…

Richard Scheffler and Sherry Glied: States Can Contain Health Care Costs. Here’s How: “THE architects of the Affordable Care Act counted on competition in the health insurance market to keep costs down and quality high…

…[But] its vision of a more competitive insurance market seems to be fading. The nation’s second-largest health insurer, Anthem, is poised to acquire Cigna, the fourth-largest. Aetna, the third-largest insurer, is seeking to acquire Humana, the fifth-largest. If approved by the Justice Department, these mergers would produce companies controlling about 35 percent of the health insurance market. These mergers would likely leave that market with far fewer competitors….

Our research suggests that this apparent failure obscures a potential path to success, one that lies between competition and a fully regulated market…. States could, for instance, either accept all insurers who seek to participate or select a limited number to sell coverage. New York chose the first course, permitting all willing insurers to join; California chose the second, selecting 12 of the 32 insurers that initially showed interest. This choice was critical because Covered California, the state’s marketplace, used its leverage in selecting plans to keep initial premiums low…. New York, by contrast, permitted insurers to offer not just standard plans, but also alternative plans with different cost-sharing and benefit designs.

When we examined the two states, we found that the effect of insurer competition differed greatly. In both states, areas with more hospitals had lower premiums compared with areas with fewer hospitals. But in New York, areas with fewer insurers had higher premiums, suggesting that insurers kept the benefits of greater bargaining power for themselves. In California, by contrast, areas with fewer insurers also had lower premiums. Why? With initial premiums set at modest but adequate levels, and a vibrant marketplace, there was no need to further threaten insurers who might consider large premium increases. If an insurer tried to raise its premiums too far, consumers could easily shop….

Over time, we will learn more about how these alternative designs work. But one point is already clear: The choice between regulation and competition is a false one. To best manage our health care system, we will need both.

International capital flows and secular stagnation

Posted on by Bridget Ansel
Photo of former U.S. Treasury Secretary Larry Summers.

One of the reasons why so many people are interested in determining the natural rate of interest is due to its implications for the secular-stagnation hypothesis. That hypothesis, originally laid out by the late Alvin Hansen at Harvard University in the 1930s and resuscitated by former U.S. Treasury Secretary Larry Summers, argues that economies can get stuck in a state where the natural rate of interest is negative, which then requires central banks to keep interest at or very close to zero percent. There are many aspects to this hypothesis, but one factor that we should keep in mind as the Federal Reserve considers its next interest rate hike is the international aspect—specifically, the role of capital flows potentially aggravating the problems of secular stagnation.

The major effect of a negative natural rate of interest is that the economy ends up vacillating between slow growth characterized by a lack of aggregate demand or an economy growing steadily but propped up by a speculative bubble. International capital flows can have a major role in inflating asset bubbles. Consider the recent outflow of capital from China. At Bloomberg View, Noah Smith details the role of Chinese capital in a potential housing bubble in Canada. Foreign capital flowing into the Canadian real estate market could possibly be convincing other investors that higher housing prices are here to stay. By exporting some of the savings of wealthy Chinese individuals to Canada, the free movement of capital seems to exacerbate one of the problems of secular stagnation.

At the same time, increased capital flows into a country pushes down interest rates. For a given demand for loanable funds, an increase in the supply of savings will push down interest rates. The potential for secular stagnation to be transmitted via capital flows is a concern discussed in a working paper by economists Gauti B. Eggertsson and Neil R. Mehrotra of Brown University and Larry Summers. The paper emphasizes how today’s integrated international capital markets can cause problems for central banks. When the Federal Reserve, for example, looks to raise interest rates it needs to consider whether other economies are experiencing slowdowns or are experiencing political instability, which the three co-authors caution could result in increased capital flows to the United States. They note that such capital inflows could put further downward pressure on the natural rate of interest in the United States, making it hard for the Federal Reserve to continue to raise rates as the rate consistent with a stable growing economy declines.

In the model examining these capital flows, Eggertsoon, Mehrotra, and Summers show that increased capital controls, or restrictions on capital flows, could help alleviate the problems of secular stagnation. This is part of a reconsideration of capital controls that were once thought to be a bad move on the part of policymakers. But even if policymakers aren’t willing to go that far, the role of capital flows is a good reason to consider the health of global economy when considering macroeconomic policy at home. The Federal Reserve might have to fight off a cold if the rest of the world sneezes.

Must-Reads: June 20, 2016

Posted on by Brad DeLong

Should Reads:

Determining the natural rate of interest

Posted on by Bridget Ansel
The headquarters of the Federal Reserve Bank is seen at sunrise in Washington.

Knut Wicksell is not a name you’d expect to pop up in a Wall Street Journal article, even if it’s about a Federal Reserve meeting. But the name of the late 19th and early 20th century Swedish economist appears in a recent article by Harriet Torry published after the U.S. central bank declined to move short-term interest rates up from its current target. He’s there for good reason. The Fed is currently grappling with a concept that Wicksell pioneered: the natural rate of interest.

The natural rate is the rate of interest that’s “consistent with the economy operating at its full potential, expanding without overheating,” as Torry puts it. And it’s also the rate of interest that balances desired savings with desired investment. As you might expect from institutions that try to affect interest rates, the Fed and other central banks have a strong interest in figuring out the natural rate.

The most immediate concern for the Federal Reserve, however, is determining the short-term federal funds rate of interest. One way to think about the natural rate is that it is the short-term rate the Fed sets that is consistent with full employment and stable inflation. This is the level where the Fed can stop hiking interest rates. The lower the natural rate, the fewer hikes the Federal Reserve will have to make during its tightening cycle.

Estimates of this short-term  rate can be found by looking at the “Longer Term” dots on the Fed’s quarterly dot plot. These estimates have declined over time and, as Federal Reserve chair Janet Yellen said during her press conference last week, the forecast and path for these rates is quite uncertain.

But how do these short-term rates relate to more longer-term interest rates? The Federal Reserve has far less control over interest rates 10 years out and further. But long-term rates are vitally important for policymakers because they determine the rates at which the federal government borrows money and partially determine how much debt servicing the government can afford. Since 1980, the global long-term natural rate has fallen by about 4.5 percentage points.

Economists Lukasz Rachel and Thomas D. Smith of the Bank of England took a look at what has caused this decline—with an eye to seeing how the natural rate might move in the future. According to their analysis, weaker economic growth has contributed to lower rates, but only by 1 percentage point of the total 4.5 points. Another three points of the decline can be attributed to shifts in demand for savings and investment. (The co-authors say they cannot identify the cause of final 0.5 percentage point change.)

On the savings side of those 3 percentage points, there are three important driving trends. A full percentage point of the decline is attributed to demographic trends of an aging society increasing desired savings, a half point coming from increased inequality, and only a quarter of a point is due to the “global savings glut,” the last of which is often cited by many economists as a major culprit for low long-term interest rates. On the investment side, the co-authors say three smaller factors are responsible for the decline of the long-term natural rate: the gap between the risk-free rate and the return on capital (0.7 points); a decline in the price of capital goods (0.5 points); and less public-sector investment (0.2 points).

Looking at these underlying factors, Rachel and Smith don’t expect a major increase in the long-term natural rate of interest anytime soon. Inequality doesn’t seem ready to decline quickly and they do not see more retirees boosting the savings rate significantly. If they are right then it means lower rates will make financing fiscal stimulus programs much easier, though it also will pose problems for conventional monetary policy. Fiscal and monetary policymakers should prepare for dealing with this reality for quite some time to come.

Must-Read: Daniel Davies: “The Absolute Height of Irresponsibility…

Posted on by Brad DeLong

Must-Read: I confess that I haven’t been following Brexit, because it has seemed to me that–whatever you think of the European Union–Britain’s strategy is obvious. It is large enough and important enough either to get an explicit carve out from European Union institutions it does not like (i.e., the Euro) or, if necessary, to nullify them. As long as it is in, it has a powerful voice to shape what happens in Brussels. Thus the right strategy is: Use your voice to pressure Brussels in positive directions, nullify the application inside Britain of European Union policies that are intolerable, and let the “leave” decision by theirs–make them throw you out if they don’t like your attitude.

“Leave” has always seemed to me to be a destructive attempt to summon the demons of nationalism, and “leave”‘s advocates have seemed to me to have careerist rather than public-spirited motivations…

Dan Davies: The absolute height of irresponsibility…: