Category: Equitablog

Must-Read: Paul Krugman: I do not think that word…<

Posted on by Brad DeLong

Must-Read: When did the default definition of “expansionary fiscal policy” become not (1) “the government hires people to build a bridge”, but rather (2) “the government borrows money from some people and writes checks to others, thus raising both current financial assets and expected future tax liabilities”? Or, rather, for what communities did it become (2) rather than (1), and why?

Or, perhaps, when did the deficit become the off-the-shelf measure of the fiscal-policy stance, rather than some other measure that incorporated some role for the balanced-budget multiplier?

This is something I really ought to know, but do not. It is bad that I do not know this:

Paul Krugman: I do not think that word…: “…means what Tyler Cowen and Megan McArdle think it means…

…The word in question is ‘spending.’ Tyler’s latest on temporary versus permanent government consumption clarifies… the confusion…. By ‘government spending’… I mean the government actually, you know, buying something–say, building a bridge. When Tyler says

The Keynesian boost to aggregate demand arises because people consider the resulting bonds to be ‘net wealth’ even when they are not,

the only way that makes sense is if he’s thinking of a rebate check. If the government builds a bridge, the boost to aggregate demand comes not because people are ‘tricked’ into feeling wealthier, but because the government is building a bridge. The question then is how much of that direct increase in government demand is offset by a fall in private consumption because people expect their future taxes to be higher; obviously that offset is smaller if they think the bridge is a one-time expense than if they think there will be a bridge built every year. That’s why temporary government spending has a bigger effect…. I guess there’s an alternative theory of what Tyler is talking about–maybe he doesn’t consider the wages of the bridge-builders count, that only what they do with those wages matters…

Or, rather, that all government expenditure is wasteful, and you might have well have simply handed out checks rather than forced people to engage in pointless useless make-work.

Must-Read: Zarek C. Brot-Goldberg et al.: What Does a Deductible Do?: The Impact of Cost-Sharing on Health Care Prices, Quantities, and Spending Dynamics

Posted on by Brad DeLong

Must-Read: Yes. When the stakes are large, the pricing structure is complex, transparency absent, and opportunities for social learning spotty, people are really lousy consumers. Why do you ask?

Zarek C. Brot-Goldberg et al.: What Does a Deductible Do?: The Impact of Cost-Sharing on Health Care Prices, Quantities, and Spending Dynamics: “Measuring consumer responsiveness to medical care prices is a central issue…

…in health economics and a key ingredient in the optimal design and regulation of health insurance markets. We study consumer responsiveness to medical care prices, leveraging a natural experiment that occurred at a large self-insured firm which forced all of its employees to switch from an insurance plan that provided free health care to a non-linear, high deductible plan. The switch caused a spending reduction between 11.79%-13.80% of total firm-wide health spending ($100 million lower spending per year)…. Spending reductions are entirely due to outright reductions in quantity. We find no evidence of consumers learning to price shop after two years in high-deductible coverage. Consumers reduce quantities across the spectrum of health care services, including potentially valuable care (e.g. preventive services) and potentially wasteful care (e.g. imaging services)…. Consumers respond heavily to spot prices at the time of care, and reduce their spending by 42% when under the deductible, conditional on their true expected end-of-year shadow price and their prior year end-of-year marginal price. In the first-year post plan change, 90% of all spending reductions occur in months that consumers began under the deductible, with 49% of all reductions coming for the ex ante sickest half of consumers under the deductible, despite the fact that these consumers have quite low shadow prices. There is no evidence of learning to respond to the true shadow price in the second year post-switch.

Accelerating wage growth has yet to show up

Posted on by Bridget Ansel

Another quarter has gone by, and accelerating wage growth has yet to show up.

The Employment Cost Index, a measure of wage growth updated every three months, shows that wages and salaries for U.S. private-sector workers grew at a 2.1 percent annual rate for the third quarter of 2015. If that rate sounds familiar, it’s because annual U.S. nominal wage growth has been stuck at around 2.0 percent to 2.2 percent for the past several years. Despite some signs earlier this year that wage growth had been accelerating, that optimism hasn’t been borne out yet. Wage growth is still trucking along with no sign of acceleration. (See Figure 1.)

Figure 1

It’s worth pointing out that the measures above are in nominal terms, as they don’t account for inflation. The reason why the graph looks at nominal growth rates instead of inflation-adjusted rates is so we don’t confuse trends in inflation for a strengthening labor market.

For example, inflation in the United States has been quite low throughout the recovery from the Great Recession. By looking at nominal wage growth, we can see if employers are actually starting to bid up wages, a sign that the labor market is getting tighter. We would adjust nominal wages for inflation if were interested in determining whether living standards are on the rise. But to understand the health of the labor market, we need to focus on nominal growth. While a lack of nominal wage growth certainly sounds like a bad thing, though, there is a positive aspect to this trend. The current slow, steady nominal wage growth is a sign of insufficient aggregate demand and a remaining slack in the labor market. There are many U.S. workers who currently want more work but can’t get a job or extra hours. In other words, these workers can conceivably join the ranks of the full-time employed again. Wage growth is tepid because they are still a significant amount of working sitting on the sideline. Employment can go higher, and the unemployment rate can go much lower. Short-term policy can bring these workers into the mix. The issue, of course, is that policymakers would have to actually take those steps—or at least not step on the brakes of currently supporting policy.

John Maynard Keynes in His High Wicksellian Mode in 1937: Today’s History of Economic Thought

Posted on by Brad DeLong

Today’s History of Economic Thought: Here we have John Maynard Keynes in his High Wicksellian mode:

  • The natural rate of interest depends on unstable and flutuating opinions about the future yield of capital-assets.
  • The market rate of interest depends on the supply of money and the unstable and fluctuating propensity to hoard–liquidity preference.
  • Thus we have large-scale fluctuations in investment (unless a central bank can neutralize fluctuations in liquidity preference and also make the market rate dance in time with the fluctuating natural rate)
  • Add in the multiplier, and we have unemployment business cycles.

This was, I think, the article that made the Swedes whimper: “Why are the citations to Knut Wicksell missing?”

John Maynard Keynes (1937): The General Theory of Employment: “Money, it is well known, serves two principal purposes…

…By acting as a money of account it facilitates exchanges without its being necessary that it should ever itself come into the picture as a substantive object. In this respect it is a convenience which is devoid of significance or real influence. In the second place,it is a store of wealth.

So we are told, without a smile on the face. But in the world of the classical economy, what an insane use to which to put it! For it is a recognized characteristic of money as a store of wealth that it is barren; whereas practically every other form of storing wealth yields some interest or profit.

Why should anyone outside a lunatic asylum wish to use money as a store of wealth? Because, partly on reasonable and partly on instinctive grounds, our desire to hold Money as a store of wealth is a barometer of the degree of our distrust of our own calculations and conventions concerning the future. Even though this feeling about Money is itself conventional or instinctive, it operates, so to speak, at a deeper level of our motivation. It takes charge at the moments when the higher, more precarious conventions have weakened. The possession of actual money lulls our disquietude; and the premium which we require to make us part with money is the measure of the degree of our disquietude.

The significance of this characteristic of money has usually been overlooked; and in so far as it has been noticed, the essential nature of the phenomenon has been misdescribed. For what has attracted attention has been the quantity of money which has been hoarded; and importance has been attached to this because it has been supposed to have a direct proportionate effect on the price-level through affecting the velocity of circulation. But the quantity of hoards can only be altered either if the total quantity of money is changed or if the quantity of current money-income (I speak broadly) is changed; whereas fluctuations in the degree of confidence are capable of having quite a different effect, namely, in modifying not the amount that is actually hoarded, but the amount of the premium which has to be offered to induce people not to hoard. And changes in the propensity to hoard, or in the state of liquidity-preference as I have called it, primarily affect, not prices, but the rate of interest; any effect on prices being produced by repercussion as an ultimate consequence of a change in the rate of interest.

This, expressed in a very general way, is my theory of the rate of interest. The rate of interest obviously measures–just as the books on arithmetic say it does–the premium which has to be offered to induce people to hold their wealth in some form other than hoarded money. The quantity of money and the amount of it required in the active circulation for the transaction of current business (mainly depending on the level of money-income) determine how much is available for inactive balances, i.e. for hoards. The rate of interest is the factor which adjusts at the margin the demand for hoards to the supply of hoards.

Now let us proceed to the next stage of the argument. The owner of wealth, who has been induced not to hold his wealth in the shape of hoarded money, still has two alternatives between which to choose. He can lend his money at the current rate of money-interest, or he can purchase some kind of capital-asset. Clearly in equilibrium these two alternatives must offer an equal advantage to the marginal investor in each of them. This is brought about by shifts in the money-prices of capital-assets relative to the prices of money-loans. The prices of capital-assets move until, having regard to their prospective yields and account being taken of all those elements of doubt and uncertainty, interested and disinterested advice, fashion, convention and what else you will which affect the mind of the investor, they offer an equal apparent advantage to the marginal investor who is wavering between one kind of investment and another.

This, then, is the first repercussion of the rate of interest, as fixed by the quantity of money and the propensity to hoard, namely, on the prices of capital-assets. This does not mean, of course,that the rate of interest is the only fluctuating influence on these prices. Opinions as to their prospective yield are themselves subject to sharp fluctuations, precisely for the reason already given, namely, the flimsiness of the basis of knowledge on which they depend. It is these opinions taken in conjunction with the rate of interest which fix their price.

Now for stage three. Capital-assets are capable, in general, of being newly produced. The scale on which they are produced depends, of course, on the relation between their costs of production and the prices which they are expected to realize in the market. Thus if the level of the rate of interest taken in conjunction with opinions about their prospective yield raise the prices of capital-assets, the volume of current investment (meaning by this the value of the output of newly produced capital-assets) will be increased; while if, on the other hand, these influences reduce the prices of capital-assets, the volume of current investment will be diminished.

It is not surprising that the volume of investment, thus determined, should fluctuate widely from time to time. For it depends on two sets of judgments about the future, neither of which rests on an adequate or secure foundation–on the propensity to hoard, and on opinions of the future yield of capital-assets. Nor is there any reason to suppose that the fluctuations in one of these factors will tend to offset the fluctuations in the other. When a more pessimistic view is taken about future yields, that is no reason why there should be a diminished propensity to hoard. Indeed, the conditions which aggravate the one factor tend, as a rule, to aggravate the other. For the same circumstances which lead to pessimistic views about future yields are apt to increase the propensity to hoard.

The only element of self-righting in the system arises at a much later stage and in an uncertain degree. If a decline in investment leads to a decline in output as a whole, this may result (for more reasons than one) in a reduction of the amount of money required for the active circulation, which will release a larger quantity of money for the inactive circulation, which will satisfy the propensity to hoard at a lower level of the rate of interest, which will raise the prices of capital-assets, which will increase the scale of investment, which will restore in some measure the level of output as a whole.

This completes the first chapter of the argument, namely, the liability of the scale of investment to fluctuate for reasons quite distinct (a) from those which determine the propensity of the individual to save out of a given income and (b) from those physical conditions of technical capacity to aid production which have usually been supposed hitherto to be the chief influence governing the marginal efficiency of capital.

If, on the other hand, our knowledge of the future was calculable and not subject to sudden changes, it might be justifiable to assume that the liquidity-preference curve was both stable and very inelastic. In this case a small decline in money-income would lead to a large fall in the rate of interest, probably sufficient to raise output and employment to the full. In these conditions we might reasonably suppose that the whole of the available resources would normally be employed;and the conditions required by the orthodox theory wouldbe satisfied.

My next difference from the traditional theory concerns its apparent conviction that there is no necessity to work out a theory of the demand and supply of output as a whole. Will a fluctuation in investment, arising for the reasons just described,have any effect on the demand for output as a whole, and consequently on the scale of output and employment? What answer can the traditional theory make to this question? I believe that it makes no answer at all, never having given the matter a single thought; the theory of effective demand,that is the demand for output as a whole, having been entirely neglected for more than a hundred years.

My own answer to this question involves fresh considerations. I say that effective demand is made up of two items–investment-expenditure determined in the manner just explained, and consumption-expenditure. Now what governs the amount of consumption-expenditure? It depends mainly on the level of income. People’s propensity to spend (as I call it) is influenced by many factors, such as the distribution of income, their normal attitude to the future and-though probably in a minor degree–by the rate of interest. But in the main the prevailing psychological law seems to be that when aggregate income increases, consumption-expenditure will also increase, but to a somewhat lesser extent. This is a very obvious conclusion…

John Maynard Keynes (1937), “The General Theory of Employment”, Quarterly Journal of Economics 51:2 (February), pp. 209-223 http://www.jstor.org/stable/1882087

Must-Read: Olivier Blanchard et al.: ion”>

Posted on by Brad DeLong

Must-Read: Olivier Blanchard et al., eds.: Progress and Confusion: The State of Macroeconomic Policy: “What will economic policy look like…

…once the global financial crisis is finally over? Will it resume the pre-crisis consensus, or will it be forced to contend with a post-crisis ‘new normal’? Have we made progress in addressing these issues, or does confusion remain?… Prominent figures—including Ben Bernanke, Lawrence Summers, and Paul Volcker—offer… essays that address topics that range from the measurement of systemic risk to foreign exchange intervention. The chapters address whether we have entered a ‘new normal’ of low growth, negative real rates, and deflationary pressures, with contributors taking opposing views; whether new financial regulation has stemmed systemic risk; the effectiveness of macro prudential tools; monetary policy, the choice of inflation targets, and the responsibilities of central banks; fiscal policy, stimulus, and debt stabilization; the volatility of capital flows; and the international monetary and financial system, including the role of international policy coordination…. Is there progress or confusion?… Both. Many lessons have been learned; but, as the chapters of the book reveal, there is no clear agreement on several key issues.

Noted for the Evening of November 1, 2015

Posted on by Brad DeLong

Must- and Should-Reads:

Might Like to Be Aware of:

Must-Read: Alan Greenspan (1994): Testimony before the Subcommittee on Economic Growth and Credit Formation of the Committee on Banking, Finance and Urban Affairs, U S House of Representatives, July 20

Posted on by Brad DeLong

Must-Read: July 20, 1994: Alan Greenspan reintroduces Knut Wicksell’s 1898 Geldzins und Güterpreise, and so shifts America’s macroeconomic discussion from the quantity of money to the natural (or equilibrium, or neutral) rate of interest.

As I remember it, I then spent my lunchtime seated at my computer in my office on the third floor of the U.S. Treasury, frantically writing up just what Alan Greenspan was talking about. For over in the Capitol, Greenspan had just said:

  1. Pay no attention to Federal Reserve policy forecasts of M2.
  2. Instead, pay attention to our assessments of the relationship of interest rates to an equilibrium interest rate.

In Greenspan’s view:

[the] equilibrium interest rate [is]… the real rate… if maintained, [that] would keep the economy at its production potential…. Rates persisting above that level, history tells us, tend to be associated with slack, disinflation, and economic stagnation–below that level with eventual resource bottlenecks and rising inflation…

And I said: this is Wicksell. Greenspan is announcing that the Fed is no longer asking in a Friedmanite mode “do we have the right quantity of money?”, but rather asking in a Wicksellian mode “do we have the right configuration of interest rates”:

Alan Greenspan (1994): Testimony before the Subcommittee on Economic Growth and Credit Formation of the Committee on Banking, Finance and Urban Affairs, U S House of Representatives, July 20: “In addition to focusing on the outlook for the economy at its July meeting…

…the FOMC, as required by the Humphrey-Hawkins Act, set ranges for the growth of money and debt for this year and, on a preliminary basis, for 1994…. The FOMC lowered the 1993 ranges for M2 and M3–to 1 to 5 percent and 0 to 4 percent, respectively…. The lowering of the ranges is purely a technical matter, it does not indicate, nor should it be perceived as, a shift of monetary policy in the direction of restraint It is indicative merely of the state of our knowledge about the factors depressing the growth of the aggregates relative to spending….

In reading the longer-run intentions of the FOMC, the specific ranges need to be interpreted cautiously The historical relationships between money and income, and between money and the price level have largely broken down, depriving the aggregates of much of their usefulness as guides to policy. At least for the time being, M2 has been downgraded as a reliable indicator of financial conditions in the economy, and no single variable has yet been identified to take its place. At one time, M2 was useful both to guide Federal Reserve policy and to communicate the thrust of monetary policy to others. Even then, however, a wide range of data was routinely evaluated to assure ourselves that M2 was capturing the important elements in the financial system that would affect the economy…. The so-called “P-star” model, developed in the late 1980s, embodied a long-run relationship between M2 and prices that could anchor policy over extended periods of time But that long-run relationship also seems to have broken down with the persistent rise an M2 velocity.

M2 and P-star may reemerge as reliable indicators of income and prices…. In the meantime, the process of probing a variety of data to ascertain underlying economic and financial conditions has become even more essential to formulating sound monetary policy….

In assessing real rates, the central issue is their relationship to an equilibrium interest rate, specifically the real rate level that, if maintained, would keep the economy at its production potential over time. Rates persisting above that level, history tells us, tend to be associated with slack, disinflation, and economic stagnation–below that level with eventual resource bottlenecks and rising inflation, which ultimately engenders economic contraction. Maintaining the real rate around its equilibrium level should have a stabilizing effect on the economy, directing production toward its long-term potential.

The level of the equilibrium real rate–or more appropriately the equilibrium term structure of real rates–cannot be estimated with a great deal of confidence, though with enough to be useful for monetary policy. Real rates, of course, are not directly observable, but must be inferred from nominal interest rates and estimates of inflation expectations. The most important real rates for private spending decisions almost surely are the longer maturities. Moreover, the equilibrium rate structure responds to the ebb and flow of underlying forces affecting spending. So, for example, in recent years the appropriate real rate structure doubtless has been depressed by the head winds of balance sheet restructuring and fiscal
retrenchment.

Despite the uncertainties about the levels of equilibrium and actual real interest rates, rough judgments about these variables can be made and used in conjunction with other indicators in the monetary policy process. Currently, short-term real rates, most directly affected by the Federal Reserve, are not far from zero; long-term rates, set primarily by the market, are appreciably higher, judging from the steep slope of the yield curve and reasonable suppositions about inflation expectations. This configuration indicates that market participants anticipate that short-term real rates will have to rise as the head winds diminish, if substantial inflationary imbalances are to be avoided

While the guides we have for policy may have changed recently, our goals have not. As I have indicated many times to this Committee, the Federal Reserve seeks to foster maximum sustainable economic growth and rising standards of living. And in that endeavor, the most productive function the central bank can perform is to achieve and maintain price stability…

Cracking the Hard Shell of the Macroeconomic Knut: “Keynesian”, “Friedmanite”, and “Wicksellian” Epistemes in Macroeconomics

Posted on by Brad DeLong

The very-sharp Tyler Cowen gets one, I think, more wrong than right. He writes:

Tyler Cowen: What’s the Natural Rate of Interest?: “I… find all this talk of natural rates of interest…

…historically strange. A few points: (1) David Davidson and Knut Wicksell debated the… concept very early in the twentieth century, in Swedish…. Most people believe Davidson won…. (2) Keynes devoted a great deal of effort to knocking down the natural rate of interest…. There could be multiple natural rates… [or] no rate of interest whatsoever…. (3) In postwar economics, the Keynesians worked to keep natural rates of interest concepts out….

(4) The older natural rate of interest used to truly be about price stability… [not] “two percent inflation a year.”… (5) Milton Friedman warned (pdf) not to assign too much importance to interest rates…. (6) When Sraffa debated Hayek and argued the natural rate of interest was not such a meaningful concept, it seems Sraffa won…. (7) I sometimes read these days that the “natural [real] rate of interest” consistent with full employment is negative. To me that makes no sense in a world with positive economic growth and a positive marginal productivity of capital….

Of course economic theory can change, and if the idea of a natural rate of interest makes a deserved comeback we should not oppose that development per se. But I don’t see that these earlier conceptual objections have been rebutted, rather there is simply now a Kalman filter procedure for coming up with a number…. In any case, this is an interesting case study of how weak or previously rebutted ideas can work their way back into economics. I don’t object to what most of the people working on this right now actually are trying to say. Yet I see the use of the term acquiring a life of its own, and as it is morphing into common usage some appropriately modest claims are taking on an awful lot of baggage from the historical connotations of the term…

In my view, all (7) of these are more than debatable. For example, (7): “[That] the ‘natural [real] rate of interest’ consistent with full employment is negative… makes no sense in a world with positive economic growth and a positive marginal productivity of capital…” misses the wedge–the wedge between the (positive) expected real rate of return from risky investments in capital and the (positive) temporal slope to the expected inverse marginal utility of consumption, on the one hand; and the (negative) equilibrium real low-risk interest rate, on the other hand.

In a world that is all of a global savings-glut world with large actors seeking portfolios that provide them with various kinds of political risk insurance, risk-tolerance gravely impaired by the financial crisis and the resulting deleveraging debt supercycle, moral hazard that makes the remobilization of societal risk-bearing capacity difficult and lengthly, and reduced demographic and technological supports for economic growth, it seems to me highly plausible that this wedge can be large enough to make the low-risk ‘natural [real] rate of interest’ consistent with full employment negative alongside positive economic growth and a positive marginal productivity of capital.

And the bond market agrees with me in email:

Graph Long Term Government Bond Yields 10 year Main Including Benchmark for Germany© FRED St Louis Fed Graph 10 Year Treasury Inflation Indexed Security Constant Maturity FRED St Louis Fed

And (2): “Keynes devoted a great deal of effort to knocking down the natural rate of interest…” Indeed he did Keynes saw the natural rate of interest as part of a wrong loanable-funds theory of interest rates: that, given the level of spending Y, supply-and-demand for bonds determined the interest rate. Keynes thought that people must reject that wrong theory before they could adopt what he saw as the right, liquidity-preference, theory of interest rates: that, given the level of spending Y and the speculative demand for money S, supply-and-demand for money determined the interest rate.

I think Keynes was wrong. I think Keynes made an analytical mistake.

Hicks (1937) established that Keynes was wrong when he believed that you had to choose. You don’t. Because spending Y is not given but is rather jointly determined with the interest rate, you can do both. Indeed, you have to do both. Liquidity-preference without loanable-funds is just one blade of the scissors: it cannot tell you what the interest rate is. And loanable-funds without liquidity-preference is just the other blade of the scissors: it, too, cannot tell you what the interest rate is. You need both.

More important, however, in thinking about our present concern with the natural (“neutral”) (“equilibrium”) real rate of interest is knowledge of the historical path by which we arrived at our current intellectual situation. Alan Greenspan did it. On July 20, 1994, Alan Greenspan announced that the Federal Reserve was not a “Keynesian” institution, focused on getting the volume of the categories of aggregate demand–C, I, G, NX–right. He announced that the Federal Reserve was not a “Friedmanite” institution, focused on getting the quantity of money right. He announced that the Federal Reserve was now a “Wicksellian” institution, focused on getting the configuration of asset prices right:

Alan Greenspan (1994): Testimony before the Subcommittee on Economic Growth and Credit Formation of the Committee on Banking, Finance and Urban Affairs, U S House of Representatives, July 20: “The FOMC, as required by the Humphrey-Hawkins Act…

…set[s] ranges for the growth of money and debt…. M2 has been downgraded as a reliable indicator…. [The] relationship between M2 and prices that could anchor policy over extended periods of time… [has] broken down…. M2 and P-star may reemerge as reliable indicators of income and prices….

In the meantime… in assessing real rates [of interest], the central issue is their relationship to an equilibrium interest rate, specifically the real rate level that, if maintained, would keep the economy at its production potential over time. Rates persisting above that level, history tells us, tend to be associated with slack, disinflation, and economic stagnation–below that level with eventual resource bottlenecks and rising inflation, which ultimately engenders economic contraction. Maintaining the real rate around its equilibrium level should have a stabilizing effect…. The level of the equilibrium real rate… [can] be estimated… [well] enough to be useful for monetary policy…. While the guides we have for policy may have changed recently, our goals have not…

Greenspan thus shifted the focus of America’s macroeconomic discussion away from the level of spending and the quantity of money to the configuration of asset prices. In some ways this is no big deal: “Keynesian”, “Friedmanite”, and “Wicksellian” frameworks are all perfectly-fine ways to think about macroeconomic policy. They are different–some ideas and some factors are much easier to express and focus on and are much more intuitive in one of the frameworks than in the others. But they are not untranslateable–I have not found any point that you can express in one framework that cannot be more-or-less adequately translated into the others.

The point, after all, is to find a macroeconomic policy that will make Say’s Law, false in theory, true enough in practice for government work. You can start this task by focusing your analysis first on either spending, or liquidity, or the slope of the intertemporal price structure. You will almost surely have to dig deeper into the guts of the economy in order to understand why the current emergent macro properties of the system are what they are. But any one of the languages will do as a place to start. Greenspan in the mid-1990s judged that the Wicksellian language provided the best way to communicate. And, looking back over the past 25 years, I cannot really disagree.

But at the time, back in 1994, the shift to a Wicksellian episteme led to substantial confusion. As I remember it, I spent my lunchtime on July 20, 1994, seated at my computer in my office on the third floor of the U.S. Treasury, frantically writing up just what Alan Greenspan was talking about when he said (1) pay no attention to Federal Reserve policy forecasts of M2; instead, (2) pay attention to our assessments of the relationship of interest rates to an equilibrium interest rate. Greenspan announced that the Fed was no longer asking in a Friedmanite mode “do we have the right quantity of money?”, but rather was asking in a Wicksellian mode “do we have the right configuration of interest rates”. And that still does not seem to me to be a bad place to be.

Must-Read: Mark Thoma: Truth-Defying Feats

Posted on by Brad DeLong

Must-Read: Mark Thoma: Truth-Defying Feats: “By Rick Perlstein:…

…Step right up! Be amazed, be enchanted, by the magic GOP unicorn-and-rainbow-producing tax cut machine! It takes a lot of energy to sustain a lie. When enough people do it together, over a sustained period of time, it wears on them. It also produces a certain kind of culture: one cut loose from the norms of fair conduct and trust that any organization requires in order to survive as something more than a daily, no-holds-barred war of all against all. A battle royale. A circus, if you prefer. And the act in the center ring? The Amazing Death Spiral. One performer does something so outrageous that anyone else who wishes to further hold the audience’s attention has to match or top it––even if they know it’s insane…. That’s what poor old John Kasich did. Hear him cry about his:

great concern that we are on the verge, perhaps, of picking someone who cannot do this job. I’ve watched people say that we should dismantle Medicare and Medicaid…. I’ve heard them talking about deporting 10 or 11 [million] people from this country…. I’ve heard about tax schemes that don’t add up.’

And what happened to him? Read the snap poll from Gravis research. Only 3 percent of Republicans thought he won the debate….

David Brooks says not to worry if candidates are lying about their economic plans, they are just exaggerating to make themselves more attractive to conservative voters…. Paul Krugman is, shall we say, unconvinced….

‘What matters is how a candidate signals priorities.’ Yes, and the priority seems to be lying is okay to get what you want. That’s a great trait to have in a president who might fact the decision to send our kids to die in a war he or she wants. Oh wait.”

What Kind of New Economic Thinking Is Needed Now?: A Twitter Dialogue, with References

Posted on by Brad DeLong

A Twitter Dialogue: IS-LM and the Neoclassical Synthesis in the Short-Run and the Medium-Run: Andy Harless asks a question, and I try to explain what I think Paul Krugman is thinking…

And let me put the relevant Paul Krugman pieces down here below the fold… or, rather, below the second fold:

Paul Krugman (October 30, 2015): An Unteachable Moment: “It is, as Antonio Fatas notes, almost seven years since the Fed cut rates to zero…

…The era of lowflation-plus-liquidity-trap now rivals in length the 70s era of stagflation, and has been associated with much worse real economic performance. So where, asks Fatas, is the rethinking of economic theory and policy? I asked the same question a couple of years ago…. Some of us anticipated much though not all of what has gone wrong. [But as] Fatas says…

even those who agreed with this reading of the Japanese economy would have never thought that we would see the same thing happening in other advanced economies. Most thought that this was just a unique example of incompetence among Japanese policy makers….

I did write a 1999 book titled The Return of Depression Economics, basically warning that Japan might be a harbinger…. [But even] I never expected policy to be so bad that Japan ends up looking like a role model…. We should have expected… as major a rethink as… in the 70s… [but] we’ve seen almost no rethinking. Economists who wrote that ‘inflation is looming’ in 2009 continued to warn about looming inflation five years later. And that’s the professional economists. As Josh Barro notes, conservatives who imagine themselves intellectuals have increasingly turned to Austrian economics, which explicitly denies that empirical data need to be taken into account….

Back to Fatas: how long will it take before the long stagnation has the kind of intellectual impact that stagflation did… before people stop holding up the 1970s as the ultimate cautionary tale, even… in the midst of a continuing disaster that makes the 70s look mild? I don’t know…. It’s clear that we have to understand this phenomenon in terms of politics and sociology, not logic.

Paul Krugman (October 20, 2015): Rethinking Japan: “The IMF held a small roundtable discussion on Japan yesterday…

…and in preparation for the event I thought it was a good idea to update my discussion of Japan…. I find it useful to approach this subject by asking how I would change what I said in my 1998 paper on the liquidity trap… one of my best papers; and it has held up pretty well…. But… there are two crucial differences between then and now. First, the immediate economic problem is no longer one of boosting a depressed economy, but instead one of weaning the economy off fiscal support. Second, the problem confronting monetary policy is harder than it seemed, because demand weakness looks like an essentially permanent condition.

Back in 1998 Japan was in the midst of its lost decade… good reason to believe that it was operating far below potential output. This is… no longer the case…. Output per working-age adult has grown faster than in the United States since around 2000, and at this point the 25-year growth rates look similar (and Japan has done better than Europe)…. Japan [may be] closer to potential output than we are.

So if Japan isn’t deeply depressed at this point, why is low inflation/deflation a problem?The answer… is largely fiscal. Japan’s relatively healthy output and employment levels depend on continuing fiscal support… large budget deficits, which in a slow-growth economy means an ever-rising debt/GDP ratio. So far this hasn’t caused any problems…. But even those of us who believe that the risks of deficits have been wildly exaggerated would like to see the debt ratio stabilized and brought down at some point. And here’s the thing: under current conditions, with policy rates stuck at zero, Japan has no ability to offset the effects of fiscal retrenchment with monetary expansion.

The big reason to raise inflation, then, is to make it possible to cut real interest rates… allowing monetary policy to take over from fiscal policy…. The fact that real interest rates are in effect being kept too high by insufficient inflation at the zero lower bound also means that debt dynamics for any given budget deficit are worse than they should be…. Raising inflation would both make it possible to do fiscal adjustment and reduce the size of the adjustment needed.

But what would it take to raise inflation? Back in 1998… I envisaged an economy in which the current level of the Wicksellian natural rate of interest was negative, but that rate would return to a normal, positive level…. It was easy to show that this proposition applied only if the money increase was perceived as permanent, so that the liquidity trap became an expectations problem. The approach also suggested that monetary policy would be effective if… the central bank could ‘credibly promise to be irresponsible’…. But what is this future period of Wicksellian normality of which we speak?…

Japan looks like a country in which a negative Wicksellian rate is a more or less permanent condition. If that’s the reality, even a credible promise to be irresponsible might do nothing: if nobody believes that inflation will rise, it won’t. The only way to be at all sure of raising inflation is to accompany a changed monetary regime with a burst of fiscal stimulus…. While the goal of raising inflation is, in large part, to make space for fiscal consolidation, the first part of that strategy needs to involve fiscal expansion. This… is unconventional enough that one despairs of turning the argument into policy (a despair reinforced by yesterday’s meeting…)

How high should Japan set its inflation target?… High enough so that when it does engage in fiscal consolidation it can cut real interest rates far enough to maintain full utilization…. It’s really, really hard to believe that 2 percent inflation would be high enough…. Japan may face a version of the timidity trap. Suppose it convinces the public that it will really achieve 2 percent inflation… engages in fiscal consolidation, the economy slumps, and inflation falls well below 2 percent… the whole project unravels–and the damage to credibility makes it much harder to try again. What Japan needs (and the rest of us may well be following the same path) is really aggressive policy, using fiscal and monetary policy to boost inflation, and setting the target high enough that it’s sustainable. It needs to hit escape velocity. And while Abenomics has been a favorable surprise, it’s far from clear that it’s aggressive enough to get there.

Paul Krugman (March 21, 2014): Timid Analysis: IAn issue I’ve worried about for a long time…

…which I think I’ve been able to formulate a bit better. Here goes: If you look at the extensive theoretical literature on the zero lower bound since my 1998 paper, you find that just about all of it treats liquidity-trap conditions as the result of a temporary shock… [that] leads to a period of very low demand, so low that even zero interest rates aren’t enough to restore full employment. Eventually, however, the shock will end. So the way out is to convince the public that there has been a regime change, that the central bank will maintain expansionary monetary policy even after the economy recovers, so as to generate high demand and some inflation.

But if we’re talking about Japan, when exactly do we imagine that this period of high demand… is going to happen?… What does it take to credibly promise inflation? Well, it has to involve a strong element of self-fulfilling prophecy: people have to believe in higher inflation, which produces an economic boom, which yields the promised inflation. But a necessary (not sufficient) condition for this to work is that the promised inflation be high enough that it will indeed produce an economic boom if people believe the promise will be kept. If it isn’t, then the actual rate of inflation will fall short of the promise even if people believe in the promise–which means that they will stop believing after a while, and the whole effort will fail….

Suppose that the economy really needs a 4 percent inflation target, but the central bank says, ‘That seems kind of radical, so let’s be more cautious and only do 2 percent.’ This sounds prudent–but may actually guarantee failure.

Paul Krugman (March 20, 2014): The Timidity Trap: “In Europe… they’re crowing about Spain’s recovery…

…growth of 1 percent, versus 0.5 percent, in a deeply depressed economy with 55 percent youth unemployment. The fact that this can be considered good news just goes to show how accustomed we’ve grown to terrible economic conditions…. People seem increasingly to be accepting this miserable situation as the new normal…. How did this happen?… I’d argue that an important source of failure was what I’ve taken to calling the timidity trap–the consistent tendency of policy makers who have the right ideas in principle to go for half-measures in practice, and the way this timidity ends up backfiring, politically and even economically….

There are some important differences between the U.S. and European pain caucuses, but both now have truly impressive track records of being always wrong, never in doubt…. In America… a faction both on Wall Street and in Congress… has spent five years and more issuing lurid warnings about runaway inflation and soaring interest rates. You might think that the failure of any of these dire predictions to come true would inspire some second thoughts, but, after all these years, the same people are still being invited to testify, and are still saying the same things…. In Europe, four years have passed since the Continent turned to harsh austerity programs. The architects of these programs told us not to worry about adverse impacts on jobs and growth–the economic effects would be positive, because austerity would inspire confidence. Needless to say, the confidence fairy never appeared….

So what has been the response of the good guys?… The Obama administration’s heart–or, at any rate, its economic model–is in the right place. The Federal Reserve has pushed back against the springtime-for-Weimar, inflation-is-coming crowd. The International Monetary Fund has put out research debunking claims that austerity is painless. But these good guys never seem willing to go all-in…. The classic example is the Obama stimulus… obviously underpowered given the economy’s dire straits. That’s not 20/20 hindsight….

The Fed has, in its own way, done the same thing. From the start, monetary officials ruled out the kinds of monetary policies most likely to work–in particular, anything that might signal a willingness to tolerate somewhat higher inflation, at least temporarily. As a result, the policies they have followed have fallen short of hopes, and ended up leaving the impression that nothing much can be done.

And the same may be true even in Japan… finally adopting the kind of aggressive monetary stimulus Western economists have been urging for 15 years and more. Yet there’s still a diffidence… a tendency to set things like inflation targets lower than the situation really demands… [that] increases the risk that Japan will fail to achieve ‘liftoff’–that the boost it gets from the new policies won’t be enough to really break free from deflation.

You might ask why the good guys have been so timid, the bad guys so self-confident. I suspect that the answer has a lot to do with class interests. But that will have to be a subject for another column.