Category: Equitablog

Must-read: Jed Graham: “The Fed’s Historic Rate-Hike Goof–in One Chart”

Posted on by Brad DeLong

Must-Read: The very-sharp Jed Graham has… strong views… about the Federal Reserve’s rather counterintuitive decision to raise interest rates in a quarter at which nominal GDP grew at a rate of 1.5%/year, at the end of a year in which nominal GDP grew at 2.9%. The Fed is placing an awful lot of weight on the unemployment rate, and not on either non-labor market indicators or the employment-to-population ratio, in its decision to raise. I don’t think we even have to reach for the (very true and powerful) arguments about asymmetric risks to find the interest-rate increase technocratically incomprehensible, and the failure to roll it back last month technocratically incomprehensible as well:

The Fed s Historic Rate Hike Goof In One Chart Stock News Stock Market Analysis IBD

Jed Graham: The Fed’s Historic Rate-Hike Goof–in One Chart: “Janet Yellen’s Federal Reserve has done something that no other Fed has done since Paul Volcker…

…aimed to quash runaway inflation in the early 1980s, even if it meant a recession–and it did…. Nominal GDP grew at a 1.5% annualized rate in the fourth quarter…. (Inflation-adjusted GDP rose just 0.7% in Q4.) With the exception of Volcker’s interest-rate hike in early 1982 amid a recession, no other Fed has raised rates during a quarter in which nominal GDP grew less than 3%, dating back to the early 1970s. In fact, a rate hike when nominal GDP is growing less than 4%… from 1983 to 2014, it only happened twice, and one of those times (the second quarter of 1986), the Fed cut rates by a half-point before retracting 1/8th of a point of the reduction…. The first quarter of 1995, when nominal GDP grew 3.7%, [is] the only time since Volcker that the Fed had, on net, raised rates in a quarter when nominal growth was running below 4%. After that early 1995 hike, it should be noted, the Fed proceeded to cut rates three times before the next rate hike…. If one looks at the pace of GDP growth from the year-earlier quarter, the Yellen Fed stands alone as the only Fed to hike rates when nominal growth was below 3%.

Must-read: Branko Milanovic: “Global Inequality: A New Approach for the Age of Globalization”

Posted on by Brad DeLong

Must-Read: This moves to the very top of the “to-read” pile this morning:

Branko Milanovic (2016): Global Inequality: A New Approach for the Age of Globalization (Cambridge: Belknap Press: 067473713X) http://amzn.to/1PMGNIG: “Global Inequality takes us back hundreds of years…

…and as far around the world as data allow, to show that inequality moves in cycles, fueled by war and disease, technological disruption, access to education, and redistribution. The recent surge of inequality in the West has been driven by the revolution in technology, just as the Industrial Revolution drove inequality 150 years ago. But even as inequality has soared within nations, it has fallen dramatically among nations, as middle-class incomes in China and India have drawn closer to the stagnating incomes of the middle classes in the developed world. A more open migration policy would reduce global inequality even further. Both American and Chinese inequality seems well entrenched and self-reproducing…

Cash [demand] rules everything around us

Posted on by Bridget Ansel
People walk past in front of Bank of Japan on Friday, Jan. 29, 2016. The Bank of Japan last Friday introduced a negative interest policy for the first time, and has signaled that it’s prepared to push rates further negative.

On Friday morning, the Bank of Japan broke a barrier that economists once thought was impervious: The central bank set its interest rate at negative 0.1 percent, below the “zero lower bound.”

The Bank of Japan isn’t the first central bank to enter this undiscovered country, though. The central banks of Denmark, Sweden, and Switzerland have also moved their rates below zero, and the European Central Bank has a negative rate on bank deposits. But Japan is the largest economy to go fully below zero as it tries to boost its long-ailing economy.

What’s more, the Bank of Japan has signaled that it’s prepared to push rates further negative. So how far can they push? And how much would they want to?

First, it’s worthwhile to work through why economists thought zero was a lower bound for interest rates in the first place. The answer has to do with how much people would demand cash once interest rates went negative. The belief was that if a central bank tried to set nominal interest rates below zero, then the population would shift their savings all into cash—which wouldn’t have a negative return—and would continue to demand cash. In other words, the demand for cash would be infinite.

But looking at the past few years, the demand for cash doesn’t appear to be infinite in the places with sub-zero interest rates. Now the question has shifted to the appropriate use of negative interest rates. That’s exactly the focus of a recent paper by Matthew Rognlie of the Massachusetts Institute of Technology.

In short, the effectiveness of negative interest rates depends on the demand for cash, and how that demand changes as interest rates go lower. Extremely high demand for cash, and the resulting glut of cash, can have negative impacts on the economy. Very high levels of cash demand with negative rates would mean the central bank is constantly losing money and would eventually need to be bailed out by taxpayers. At the same time, if too much money is being held as cash instead of as a bank deposit, that money can’t be lent out to borrowers—it’s just sitting under a mattress.

But the increase in aggregate demand for the economy spurred by the sub-zero interest rates can outweigh the negative aspects. It’s just a matter of how cash demand reacts. If demand for cash increases at a small rate as interest rates go lower (the interest rate elasticity of cash demand is low), then rates can go quite negative. But if the elasticity is high, then rates might not get very negative. The effective lower bound is then the interest rate where cash demand becomes infinite.

Rognlie’s model has interesting ramifications for one idea for that deals with the zero lower bound: eliminating cash. Rognlie points out that this idea makes more sense in a world where cash demand is very high and elastic. But if demand is low and inelastic, then interest rates can go negative without having to abolish cash. He also points out that there might be more intermediate ways to reform cash to reduce demand for it—the elimination of high-denomination bills, for example. When interest rates get lower, the demand for $100 bills will increase relatively more than the demand for $1 bills. By getting rid of $100 bills, you’d reduce cash demand and allow interest rates to go lower.

Storage costs are another way that reduce demand for higher denomination bills. Many people have tried to determine the feasible lower bound by looking at the storage cost of cash. If storage costs are higher, then banks can charge depositors more and the interest rate can go lower. As you can see in the table at the top of this piece by David Keohane from FT Alphaville, the lower the highest denomination of a currency, the more space the currency takes up. If the only form of cash is, say, $1 bills, then you’ll need a whole lot more storage space to store the same amount of money. So that reduces the demand for cash and further decreases the lower bound.

Rognlie’s focus on cash demand is illuminating but can only get us so far. The problem is that we don’t yet have good estimates of cash demand at negative interest rates. It’s something for the economics profession to figure out, but at least we now have a better idea of what to focus on.

Skidelsky on “The Two Big Economic Policy Failures That John Maynard Keynes Would Be Disappointed by Today”

Posted on by Brad DeLong

I missed this six months ago:

Julie Verhage: The Two Big Economic Policy Failures That John Maynard Keynes Would Be Disappointed by Today: “The famous economist isn’t around for us to ask him…

…but here is probably the next best thing. Robert Skidelsky… said… Keynes would have found two things upsetting. First, he would be frustrated with the lack of  precautions taken to prevent a huge financial crash like the one we saw in 2008. Secondly, Lord Skidelsky believes Keynes… would have wanted a more ‘buoyant response,’ he said.  Specifically, he doesn’t think Keynes would have liked the Federal Reserve’s quantitative easing….

We’ve been for many years in a state of semi-stagnation, and the recovery is still very very weak in the European Union. The actual recovery measures we’ve taken, particularly quantitative easing, have actually skewed the recovery towards asset buying and real estate, thus threatening to recreate the circumstances that led to crash in the first place. I think he would have been disappointed by those policy failures…

Skidelsky is certainly correct in saying that Keynes would be driven raving mad by the failure of central banks and other regulatory agencies to take seriously the task of managing and bounding the illusion of collective liquidity, in order to curb the dangers created by systemic risk. And he is correct in believing that Keynes would be astonished at counterproductive fiscal austerity and incoherent worries about debt burdens at a time of extraordinarily low current and projected future interest rates.

But I am puzzled by Skidelsky’s third. He believes that Keynes would have seen not a second- but a first-order loss in responding to tighter-than-ideal fiscal policy with looser-than-ideal monetary policy in order to hold aggregate demand harmless. Good Belsky does not, and to my knowledge nobody has succeeded in, producing a coherent simple model of what they mean. I am going to have to put this down as yet another example of a case in which smart, sensible people claim to know more and know different then what is in the simple file-and-communications systems that are our standard economic models.

I can see that responding to inappropriately-austere fiscal policy with easier monetary policy and lower interest rates than in the first-best creates a world with too-little government capital, too-low a level of social insurance spending, an inappropriately low level of government-provided safe assets, and on inappropriately-high level of long-duration risky assets.

What I do not see is why all of this is a first-order loss, and why it is worth opening up a significant Okun Gap relative to full employment and potential output in order to prevent these Harburger Triangles.

So, I am once again pleading for an answer, or an explanation, preferably in the form of a simple model I can wrap my brain around.

Crickets…

Must-reads: January 30, 2016

Posted on by Brad DeLong

Must-read: Andrew Gelman and Cosma Rohilla Shalizi: “Philosophy and the practice of Bayesian statistics”

Posted on by Brad DeLong

Andrew Gelman and Cosma Rohilla Shalizi (2011): Philosophy and the Practice of Bayesian Statistics: “A substantial school in the philosophy of science…

…identifies Bayesian inference with inductive inference and even rationality as such, and seems to be strengthened by the rise and practical success of Bayesian statistics. We argue that the most successful forms of Bayesian statistics do not actually support that particular philosophy but rather accord much better with sophisticated forms of hypothetico-deductivism. We examine the actual role played by prior distributions in Bayesian models, and the crucial aspects of model checking and model revision, which fall outside the scope of Bayesian confirmation theory. We draw on the literature on the consistency of Bayesian updating and also on our experience of applied work in social science.

Clarity about these matters should benefit not just philosophy of science, but also statistical practice. At best, the inductivist view has encouraged researchers to fit and compare models without checking them; at worst, theorists have actively discouraged practitioners from performing model checking because it does not fit into their framework.

Weekend reading: The “still shoveling out” edition

Posted on by Nick Bunker

This is a weekly post we publish on Fridays with links to articles that touch on economic inequality and growth. The first section is a round-up of what Equitable Growth has published this week and the second is work we’re highlighting from elsewhere. We won’t be the first to share these articles, but we hope by taking a look back at the whole week, we can put them in context.

Equitable Growth round-up

U.S. corporations are increasingly holding onto cash—a phenomenon often called the “corporate savings glut.” This is a rapid turnaround from when the corporate sector borrowed from the financial sector. And it may be a worrying sign for the future of economic growth.

Heather Boushey notes the growing influence of feminist economics on policymaking in her inaugural post for the International Association for Feminist Economics blog.

With U.S. wage growth seeming to accelerate, it seems like a good time to return to the question of the Phillips curve. The relationship between inflation and unemployment seems to have shifted in recent decades, mainly because wage growth doesn’t turn into inflation like it used to.

The fall and rise of income and wealth inequality in the United States over the course of the 20th century is well-known by now. New research shows that housing inequality has followed a very similar trend and seems strongly linked to increasing segregation by income.

Links from around the web

“There are times when jumping off a high cliff into the sea below might make sense, but there’s no sense rushing into it when you don’t have to: you run out of options pretty quickly once you’re in the air.” That’s Ryan Avent on the tricky situation the Federal Reserve has put itself in. [free exchange]

One of the Federal Reserve’s concerns at the moment is that expectations of future inflation seem to be on the decline. As Carola Binder points out, the decline in expectations (at least in one survey) is strongest among those with higher incomes. And they’re the ones whose expectations drive inflation the most. [quantitative ease]

The U.S. dollar continues to strengthen as the U.S. economy (relatively) outperforms many of the economies across the world. What does this mean for the U.S. economy and the global economy writ large? Eduardo Porter looks at the positive and negative aspects of the stronger dollar. [nyt]

The phrase “tax haven” usually conjures up images of Swiss bank accounts or shell corporations in the Cayman Islands. But maybe your mental image should now include Reno, Nevada. Jesse Drucker looks at how the United States might be turning into a tax haven. [bloomberg businessweek]

Some economists and analysts have argued that the Federal Reserve could have done more to lessen the blow of the Great Recession. But a recent New York Times op-ed argues that the Fed actually caused the recession by not loosening monetary policy early enough. Mike Konczal finds the argument unpersuasive. [rortybomb]

Friday figure

Figure from “Context may be everything when it comes to the Phillips curve” by Nick Bunker

Obsessing yet again about the Federal Reserve’s unnecessary current dilemma

Posted on by Brad DeLong

I really am obsessing about this to excess, am I not?

But it’s overwhelmingly weird: conclusions that seem to me obvious and inescapable, nailed-down and air-tight, ironclad and titanium do not seem to have any force with the deciding members of the FOMC:

Paul Krugman: Fed Fumble: “US growth seems to have slowed sharply…

…Given the combination of slowing growth and a big deterioration of financial conditions, there’s growing talk that the Fed made an error in hiking rates. Oh, and market compensation for future inflation, which may not be a good indicator of expectations but surely contains some information, has plunged. It might still turn out OK. But it might not, and surely everyone would be feeling more comfortable if the Fed had waited, and probably decided not to hike for a while. Still, who could have seen this coming? Um, Larry Summers; me; Brad DeLong; basically everyone who thought about the asymmetry of risks. We didn’t know that the data would come in weaker than expected, but we knew that they might, and that it would be much harder to respond to a downside shock than positive news.

So why didn’t the Fed see it that way? I have never gotten a clear answer…

Krugman’s conclusion:

It really seems as if management somehow got set on the notion that it was time to raise rates–I think because, consciously or not, they wanted to throw Wall Street and the GOP a bone–and got into a loop of incestuous amplification in which the clear precautionary case against a hike got excluded from the room.

Not just a clear precautionary case: an overwhelming precautionary case given uncertainty about the location and slope of the Phillips Curve in addition to uncertainty about the trajectory of global and U.S. demand.

Cf: Nick Bunker:

Nick Bunker: Context may be everything when it comes to the Phillips curve: “The slope of the Phillips curve has declined…

..inflation will increase less for a given decrease in the unemployment rate. At the same time, inflation expectations have become, in economics-speak, incredibly ‘well-anchored.’ Investors believe quite strongly that U.S. inflation will stay around 2 percent…. Wage growth actually doesn’t pass through that much to inflation anymore…. Given the declining share of income going to labor and the high share of income going to profits, perhaps we shouldn’t be surprised that wage increases aren’t filtering on to accelerating inflation. The economic situation has changed quite a bit. Stronger wage growth today may do more to increase the labor share of income than spark inflation.

Context may be everything when it comes to the Phillips curve Equitable Growth

Cf: Robin Wigglesworth:

Robin Wigglesworth: Talk of Fed ‘Policy Error’ Grows: “Even fund managers who were sanguine about December rate rise are now more unnerved…

…‘It is reasonable for investors to wonder whether Fed’s December rate hike was a policy error,’ admits Bob Michele, chief investment officer of JPMorgan Asset Management. ‘Historically the Fed has raised rates because either growth or inflation was uncomfortably high. This time is different — growth is slow; wage growth is limited; deflation is being imported.’… Most economists maintain the risk of a US recession this year are slim, but markets are now pricing roughly even odds of one, and that in itself has consequences. As Larry Fink, the head of BlackRock, said last week, the ferocity of the stock market rout ‘puts a negativity across the economy, a negativity to every CEO looking at his or her stock price, a negativity about business’. Should financial turbulence infect the real economy, the US central bank’s plan to raise rates another four times this year becomes extremely challenging. Investors have long doubted this rate path, but now they are virtually laughing at it…

But what happens next?

Tim Duy has views:

Tim Duy: The Five Scenarios Now Facing the Federal Reserve: “I see five likely scenarios…

…(1) The economy slips into recession, and the December rate hike is yet another in a long line of central banks’ failed efforts to pull up from the zero-bound. (2) Financial market conditions stabilize… limit(ing) the Fed to just one or two more rate hikes later in the year…. (3) The Fed’s baseline scenario in which it hikes rates in four 25-basis-point increments this year…. (4) Inflation begins to accelerate. This would push the Fed toward more than 100 basis points in rate hikes this year. (5) Financial markets remain choppy in the first half of the year, pushing the Fed into ‘risk management’ mode…. Officials’ delayed response calms markets and prevents a slowdown in activity, but they feel behind the curve and try to catch up with a steeper pace of hikes late in the year.

Financial market participants at the moment are likely caught somewhere between the first two scenarios. Scenario five, however, requires serious consideration (and would currently be difficult to differentiate from the first two)…

The asymmetry of risks inescapably leads to the conclusion that you only want to start raising interest rates when you are pretty sure that you will see the whites of inflation’s eyes in two years. The flatness of the slope of the Phillips Curve in recent Phillips Curve data, the low pass-through of past inflation to current expectations in recent Phillips Curve data, and the large residual variance that has always been found in estimated Phillips Curves together make it impossible to conclude that we are pretty sure that we will see the whites of inflation’s eyes in two years.

Very sharp observers report that their conversations with current FOMC staff go along the lines of: “Well, you need a forecast to make policy, and you need a model to make a forecast, and this is the model we have got.” And I concur that that is what they are thinking: that is what I hear too. But you don’t need to use a model with expectational and employment-pressure gearing that is two decades out of date when you know that those coefficient have stochastic drift over time. You don’t need to use a model that puts a weight of one on the unemployment rate and zero on the employment-to-population ratio when there is no evidence-based way to separate out the two to assess the proper weighted average. And you don’t need to make policy using only the expected model path paying no attention to the asymmetric risks, the asymmetric loss, and the wide fan of possible future states of the world. “This is the model we have got” is simply not an answer at any appropriate level…

Glosses on Jo Walton’s Plato Fanfic and Robots: A Brief Pickup Platonic Dialogue: Today’s Economic History

Posted on by Brad DeLong

Jo Walton (2015): The Just City (New York: Tor Books: 9780765332660) http://amzn.to/1WQi0cn

John Holbo: Walton’s Republic: What is Athene’s motive in dragging all those robots from the future to help build this thing?…

Brad DeLong: Re: ‘What is Athene’s motive in dragging all those robots from the future to help build this thing?’ Aristoteles son of Nikomakhos of Stagira:

Aristoteles: Let us first speak of master and slave, looking to the needs of practical life…. [Some] affirm that the rule of a master over slaves is contrary to nature…. Property is a part of the household… no man can live well, or indeed live at all, unless he be provided with necessaries…. [T]he workers must have their own proper instruments… of various sorts; some are living, others lifeless; in the rudder, the pilot of a ship has a lifeless, in the look-out man, a living instrument….

If every instrument could accomplish its own work, obeying or anticipating the will of others, like the [automated] statues of Daedalus, or the [self-propelled catering carts] of Hephaestus, which, says the poet, ‘of their own accord entered the assembly of the Gods’; if, in like manner, the shuttle would weave and the plectrum touch the lyre without a hand to guide them, chief workmen would not want servants, nor masters slaves…

But is there any one thus intended by nature to be a slave, and for whom such a condition is expedient and right?… There is no difficulty in answering this question… that some should rule and others be ruled is a thing not only necessary, but expedient; from the hour of their birth, some are marked out for subjection, others for rule…

Neville Morley: @Brad De Long #1: yes, I was wondering about that passage, via Marx’s sarcastic gloss on it (someone else will surely remember the precise quote, but it’s words to the effect of:

Who’d have imagined that we’d get self-acting spindles not to shorten the working day but to lengthen it so that a few people can become most eminent shoe-black manufacturers’

but didn’t feel that it got developed in the novel as much as it might have been–and then by the second book most of the robots have simply gone.

Brad DeLong: Karl Marx (1867): Capital vol. I, ch 15, §3B ‘The Prolongation of the Working Day’ https://www.marxists.org/archive/marx/works/1867-c1/ch15.htm:

Karl Marx: ’If,’ dreamed Aristotle, the greatest thinker of antiquity:

If every tool, when summoned, or even of its own accord, could do the work that befits it, just as the creations of Daedalus moved of themselves, or the tripods of Hephaestos went of their own accord to their sacred work, if the weavers’ shuttles were to weave of themselves, then there would be no need either of apprentices for the master workers, or of slaves for the lords.

And Antipatros, a Greek poet of the time of Cicero, hailed the invention of the water-wheel for grinding corn, an invention that is the elementary form of all machinery, as the giver of freedom to female slaves, and the bringer back of the golden age.

Oh! those heathens! They understood, as the learned Bastiat, and before him the still wiser MacCulloch have discovered, nothing of Political Economy and Christianity. They did not, for example, comprehend that machinery is the surest means of lengthening the working-day. They perhaps excused the slavery of one on the ground that it was a means to the full development of another. But to preach slavery of the masses, in order that a few crude and half-educated parvenus, might become ‘eminent spinners,’ ‘extensive sausage-makers,’ and ‘influential shoe-black dealers,’ to do this, they lacked the bump of Christianity.

Must-read: Tim Duy: “FOMC Recap”

Posted on by Brad DeLong

Must-Read: Once again: if the economy comes in weak, then the FOMC will wish that it had not raised interest rates in December and will find it impossible to induce an offsetting deviation from the ex post interest rate path it will wish it had followed in order to balance things out. If the economy comes in strong, then the FOMC will wish that it had raised interest rates even earlier than December, but it will then find it easy to induce an offsetting deviation from the ex post interest rate path it will wish it had followed in order to balance things out. This ain’t rocket science. This is the simple logic of optionality near the zero lower bound and the liquidity trap.

So why does this logic evade the FOMC? What are they thinking?

Tim Duy: FOMC Recap: “Now they have slow GDP growth and fast employment growth…

…That will make brains explode on Constitution Ave. They don’t know what to do with that when unemployment is at 5%…. If the recessionistas are correct, then they already made a mistake in December. If the optimitistas are correct, they will fall behind the curve if they hold in March. And that is without the uncertainty of the financial markets. Did the Fed release a little steam by shifting into a tightening cycle, the avalanche control of Mark Dow?  Or did they set in motion the next financial crisis? And recognize that this is within the context of a no-win political situation….

So, considering all this, you can’t really blame the Fed for taking a pass on quantifying the balance of risks…. Bottom Line: The Fed got lucky this month. They weren’t expected to do anything, which takes the pressure off. But in March they might have a real decision to make. We have only six weeks of data to digest. Even assuming that labor markets hold solid, will that be enough? Doubtful. They will need more.