Category: Equitablog

Must-Read: John Maynard Keynes (1937): The General Theory of Employment: Today’s Economic History

Posted on by Brad DeLong

Must-Read: Today’s Economic History: John Maynard Keynes (1937): The General Theory of Employment: “There are passages which suggest that Professor Viner is thinking too much…

…in the more familiar terms of the quantity of money actually hoarded, and that he overlooks the emphasis I seek to place on the rate of interest as being the inducement not to hoard. It is precisely because the facilities for hoarding are strictly limited that liquidity preference mainly operates by increasing the rate of interest. I cannot agree that:

in modern monetary theory the propensity to hoard is generally dealt with, with results which in kind are substantially identical with Keynes’, as a factor operating to reduce the ‘velocity’ of money.

On the contrary, I am convinced that the monetary theorists who try to deal with it in this way are altogether on the wrong track.

Again, when Professor Viner points out that most people invest their savings at the best rate of interest they can get and asks for statistics to justify the importance I attach to liquidity-preference, he is over-looking the point that it is the marginal potential hoarder who has to be satisfied by the rate of interest, so as to bring the desire for actual hoards within the narrow limits of the cash available for hoarding. When, as happens in a crisis, liquidity-preferences are sharply raised, this shows itself not so much in increased hoards–for there is little, if any, more cash which is hoardable than there was before–as in a sharp rise in the rate of interest, i.e. securities fall in price until those, who would now like to get liquid if they could do so at the previous price, are persuaded to give up the idea as being no longer practicable on reasonable terms. A rise in the rate of interest is a means alternative to an increase of hoards for satisfying an increased liquidity-preference.

Nor is my argument affected by the admitted fact that different types of assets satisfy the desire for liquidity in different degrees. The mischief is done when the rate of interest corresponding to the degree of liquidity of a given asset leads to a market-capitalization of that asset which is less than its cost of production…

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: Lawrence Summers: Global Economy: The Case for Expansion

Posted on by Brad DeLong

Must-Read: Uncertainty about what the correct model of the economy is and a strongly asymmetric loss function do not simply apply to the question of whether the Federal Reserve should start a tightening cycle now or delay for a year and reevaluate then. It also applies to the question of whether fiscal policy–with its substance-free love of austerity–is fundamentally, tragically, and potentially catastrophically misguided:

Lawrence Summers: Global Economy: The Case for Expansion: “The inability of the industrial world to grow at satisfactory rates even with very loose monetary policies…

…problems in most big emerging markets, starting with China… the spectre of a vicious global cycle…. The risk of deflation is higher than that of inflation… we cannot rely on the self-restoring features of market economies… hysteresis–where recessions are not just costly but stunt the growth of future output–appear far stronger…. Bond markets… are [saying:] risks tilt heavily towards inflation… below… targets… [despite expected] monetary policy… looser than the Federal Reserve expects… [plus] extraordinarily low real interest rates….

If I am wrong about [the need for] expansionary fiscal policy, the risks are that inflation will accelerate too rapidly, economies will overheat and too much capital will flow to developing countries. These outcomes seem remote. But even if they materialise, standard approaches can be used to combat them. If I am right and policy proceeds along the current path, the risk is that the global economy will fall into a trap not unlike the one Japan has been in for 25 years…. What is conventionally regarded as imprudent offers the only prudent way forward.

If the world undertook a large, coordinated fiscal expansion, five years from now we might regret it: we might be trying to reduce an uncomfortably-high inflation rate via tight monetary policy and relatively-high interest rates, and worrying about the long-term sustainability of government debt given that, finally, r>g. But those are problems we can handle, and those are problems of a world near full employment with ample incentives to invest in physical capital, organizational business models, and new technology.

If the world does not undertake a large, coordinated fiscal expansion, five years from now we might regret it: having failed to do anything to claw the global economy off the lee shore of the zero lower bound in 2015-6, the next adverse shock would leave the world mired in a depression as deep as 2008-9 with no available monetary policy tools to fight it.

In a world of uncertainty about the right model, the correct policy choice is obvious.

Yet the center of the Fed–both FOMC participants and staff alike–say things like: “You cannot make policy without a forecast.” And they go on to say that they will take the next policy step as if the forecast is accurate, and reevaluate only as outcomes differ from expectations. This seems to me to be an elementary mistake: in finance, after all, those who neglect optionality get taken to the cleaners by those who see it and use it.

And it is not as if the Federal Reserve’s current forecast–for rising PCE inflation crossing 2%/year in less than two years–even looks to me like the right forecast: is this a pattern that you think will generate wage growth high enough to sustain 2%/year-plus PCE inflation in two years?

A kink in the Phillips curve Equitable Growth

Checking in on the herd of unicorns

Posted on by Bridget Ansel
Magical Unicorn Forest by Catmando, veer.com

Talk about unicorns, up until a few years ago, was usually reserved for discussions about the plot of Harry Potter novels or the latest Lisa Frank product. But due to some clever marketing, “unicorns” are now the talk of Silicon Valley.

The term refers to privately held companies worth more than $1 billion a piece—and they’re some of the U.S. economy’s most hyped companies. Think Uber, Airbnb, and Dropbox. But with the proliferating number of these private companies, investors and commentators have started to wonder whether the whole endeavor is a repeat of the tech bubble of the late 1990s and early 2000s. Whatever the case, the rise of the unicorns does point to something interesting about the state of U.S. businesses overall.

During the dotcom frenzy, the exit strategy for young tech firms was an initial public offering. After an IPO, the firm would be listed on a stock market and the company could raise funds from public investors. But unicorns and their ilk seem happy to stay private for much longer. This trend isn’t restricted to high-growth tech firms, however—the number of public firms in the United States actually peaked in 1998. Companies are far less likely to go public than they were in the past, but the exact reason for this hesitance isn’t well understood.

The Economist would have you believe that the shift to private ownership is because companies have just realized that private ownership is superior in most cases to public ownership. In the case of public companies, according to the magazine, the lines of ownership are no longer clear. On paper, shares of the company are owned by public investors, often workers through retirement accounts. But these shares are really held by asset management companies in the form of mutual funds. This opacity doesn’t happen in private companies, as owners and managers are often the very same people.

While it’s true that private companies can specifically dole out ownership shares to workers, public firms can do that as well via stock options. In fact, the increasing use of stock options for compensating executives at public firms seems to mirror The Economist’s belief in such a tight integration between owners and executives. Of course, some research has argued that increasing concentration of ownership among mutual funds has resulted in anti-competitive behavior among firms.

It’s also worth noting the incentives of one set of key investors in unicorns. Venture capital firms eventually have to show a return to their own investors, and have specific funds that need to be closed, usually over a 10-year period, so that their invested dollars are returned with, well, a return. An eventual exit of these high-growth unicorns onto public markets or their sale via acquisitions by public or private companies seems likely given the needs of their venture investors.

If these unicorns do go fully public, some may reserve a special class of shares that actually maintains the control of the founders, as Facebook did. Businesses in other sectors of the economy might continue to stay private or take another form for a variety of reasons, but the unicorns seem to be outliers in this regard.

But while these unicorns remain private, there’s fear that they are just the latest bubble to arise in the U.S. economy. Given the track record of predicting bubbles, it’s hard to say for sure what will happen. But if the valuations of these companies do crash, it seems unlikely that the fallout will be anywhere near the damage done by the bursting of the housing bubble.

For starters, the potential unicorn bubble would affect an incredibly small share of the population that has the ability to invest in these companies. A dent in the net worth of those rich individuals who have the wherewithal to invest in venture funds or directly in high-tech startups would have a small impact on consumption across the entire U.S. economy. The reason: An equity bubble is nowhere near as bad as a debt bubble—as the dotcom implosion proved—for either long-term share valuations or the severity of the ensuing recession. But who knows. Maybe the valuation of unicorns will stay high and nonbelievers in these new firms will be shunned.

While it’s tempting to believe in unicorns as the future of the U.S. firm, they are outliers in important ways. Yes, U.S. businesses are increasingly likely to be privately held, and there has been a movement toward non-corporate business types. But these companies are high-growth start-ups in an economy with a declining start-up rate. Holding them up as a new model for the U.S. economy doesn’t add up. They are, it seems, just horses of a different color.

Noted for the Evening of October 27, 2015

Posted on by Brad DeLong

Things to Read for Your Nighttime Procrastination##

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Must- and Should-Reads:

Might Like to Be Aware of:

Must-Read: Jong-Wha Lee: Containing China’s Slowdown

Posted on by Brad DeLong

Must-Read: Jong-Wha Lee: Containing China’s Slowdown: “China has been breaking the mold on economic growth for the last three decades…

…So, are China’s economic prospects as bad as prevailing wisdom seems to indicate? And, if they are, how can they be improved?… Former US Treasury Secretary Lawrence Summers and his Harvard colleague Lant Pritchett to argue that China’s growth could slow to 2-4% over the next two decades, as the country succumbs to the historically prevalent growth pattern implied by “regression to the mean.” But, given that China’s growth pattern has, so far, been exceptional, the notion that it will suddenly start following a common trajectory seems unlikely….

China’s leaders [must] move the economy onto a more balanced and sustainable growth path… must implement reforms… in factor markets…. China’s leaders must improve labor-market flexibility and labor mobility; make land use, acquisition, and compensation more efficient; and build a more market-based financial system…. Similarly, policies to promote continuous technological innovation and industrial upgrading can increase productivity. And measures that increase domestic research capacity–for example, by strengthening protection of intellectual property rights–can nurture innovation.
Reform of China’s massive state-owned-enterprise (SOE) sector would also boost productivity…. The final piece of the puzzle for China is realism…

Must-Read: Henry Aaron: Can Taxing the Rich Reduce Inequality? You Bet It Can!

Posted on by Brad DeLong

Must-Read: Henry Aaron: Can Taxing the Rich Reduce Inequality? You Bet It Can!: “Two recently posted papers by Brookings colleagues purport to show that…

…‘even a large increase in the top marginal rate would barely reduce inequality.’  This conclusion, based on one commonly used measure of inequality, is an incomplete and misleading answer to the question posed: would a stand-alone increase in the top income tax bracket materially reduce inequality?  More importantly, it is the wrong question to pose, as a stand-alone increase in the top bracket rate would be bad tax policy that would exacerbate tax avoidance incentives.  Sensible tax policy would package that change with at least one other tax modification, and such a package would have an even more striking effect on income inequality.  In brief:

  • A stand-alone increase in the top tax bracket would be bad tax policy, but it would meaningfully increase the degree to which the tax system reduces economic inequality.  It would have this effect even though it would fall on just ½ of 1 percent of all taxpayers and barely half of their income.
  • Tax policy significantly reduces inequality.  But transfer payments and other spending reduce it far more.  In combination, taxes and public spending materially offset the inequality generated by market income.
  • The revenue from a well-crafted increase in taxes on upper-income Americans, dedicated to a prudent expansions of public spending, would go far to counter the powerful forces that have made income inequality more extreme in the United States than in any other major developed economy.”

Department of “Huh!?!?”: QE Has Retarded Business Investment!?

Posted on by Brad DeLong

Kevin Warsh and Michael Spence attack Ben Bernanke and his policy of quantitative easing, which they claim “has hurt business investment.”

2015 10 06 for 2015 10 07 DeLong ULI key

I score this for Bernanke: 6-0, 6-0, 6-0.

In fact, I do not even think that Spence and Warsh understand that one is supposed to have a racket in hand when one tries to play tennis. As I see it, the Fed’s open-market operations have produced more spending–hence higher capacity utilization–and lower interest rates–has more advantageous costs of finance–and we are supposed to believe that its policies “have hurt business investment”?!?!

Michael Spence and Kevin Warsh: The Fed Has Hurt Business Investment: “Bernanke[‘s view]… may well be true according to economic textbooks…

…But textbooks presume the normal conduct of policy and that the prices of financial assets like stocks and bonds are broadly consistent with expectations for the real economy. Nothing could be further from the truth in the current recovery…. Earnings of the S&P 500 have grown about 6.9% annually… pales in comparison to prior economic expansions… half of the profit improvement… from… share buybacks. So the quality of earnings is as deficient as its quantity…. Extremely accommodative monetary policy… $3 trillion in… QE pushed down long-term yields and boosted the value of risk-assets…. Business investment in the real economy is weak. While U.S. gross domestic product rose 8.7% from late 2007 through 2014, gross private investment was a mere 4.3% higher. Growth in nonresidential fixed investment remains substantially lower than the last six postrecession expansions….

As I have said before and say again, weakness in overall investment is 100% due to weakness in housing investment. Is there an argument here that QE has reduced housing investment? No. Is nonresidential fixed investment below where one would expect it to be given that the overall recovery has been disappointing and capacity utilization is not high? No. The U.S. looks to have an elevated level of exports, and depressed levels of government purchases and residential investment. Given that background, one would not be surprised that business investment is merely normal–and one would not go looking for causes of a weak economy in structural factors retarding business investment. One would say, in fact, that business investment is a relatively bright spot.

Yes, businesses have been buying back shares. How would the higher interest rates and higher risk spreads in the absence of QE retard that? They wouldn’t. Yes, earnings growth from business operations over the past five years has been slower than in earlier expansions. How has QE dragged on earnings growth. It hasn’t.

Efforts by the Fed to fill near-term shortfalls in demand… have shown limited and diminishing signs of success. And policy makers refuse to tackle structural, supply-side impediments to investment growth, including fundamental tax reform.

And the Federal Reserve’s undertaking of QE has hampered efforts to engage in “fundamental tax reform” how, exactly? Is an argument given here? No, it is not.

We believe that QE has redirected capital from the real domestic economy to financial assets…. How has monetary policy created such a divergence between real and financial assets?

OK: Now there is a promise that there will be some meat in the argument.

How do Spence and Warsh say QE has reduced corporate investment? Let’s look:

First, corporate decision-makers can’t be certain about the consequences of QE’s unwinding on the real economy… [that] translates into a corporate preference for shorter-term commitments–that is, for financial assets….

Let’s see: when QE is unwound, asset prices are likely to fall. The period of QE may have boosted the economy and created a virtuous circle–in which case unwinding QE will still leave asset prices higher than they would have been in its absence. Unwinding QE may return asset supplies and demands to where they would have been if it had never been undertaken–in which asset prices will be what they would have been in its absence. Is there a story by which first winding and then unwinding QE leaves asset prices afterwards lower than in QE’s absence? Is there? Anyone? Anyone? Bueller?

Without an argument that the round-trip will leave lower asset prices than the absence of QE, this “uncertainty” argument is incoherent. No such argument is offered.

And I cannot envision what such an argument would be.

The financial crisis taught an important lesson…. Illiquidity can be fatal….

So in the absence of QE people would have forgotten about the financial crisis and would be eager to get illiquid–no, wait a minute! This is not an argument that QE has depressed business investment.

QE reduces volatility in the financial markets, not the real economy…. Much like 2007, actual macroeconomic risk may be highest when market measures of volatility are lowest…

QE reduces volatility in financial markets by making some of the risk tolerance that was otherwise soaked up bearing duration risk free to bear other kinds of risk. That is what it is supposed to do. With more risk tolerance available, more risky real activities will be undertaken–and so microeconomic risk will grow. A higher level of activity with more risky enterprises being undertaken is the point of QE. To say that it pushes up macroeconomic risk is to say that it is doing its job, isn’t it? If that isn’t its job, then there needs to be an argument to that effect, doesn’t there? I do not see one.

QE’s efficacy in bolstering asset prices may arise less from the policy’s actual operations than its signaling effect…

The originator of the idea of signaling equilibrium thinks that such a thing is bad? If QE has effects because it is an informative signal, then it is a good thing as long as its dissipative costs are not large. Is an argument offered that its dissipative costs are large? No. Is there reason to think that its dissipative costs are large? No.

We recommend a change in course. Increased investment in real assets is essential to make the economic expansion durable.

And unwinding QE more rapidly accomplishes this how, exactly? In the absence of QE increased investment in real assets would be higher why, exactly?

If you set out to take Vienna, take Vienna. If you are going to argue that QE has reduced real business investment, argue that QE has reduced real business investment. I see no such argument anywhere in the column.

So Warsh and Spence should not be surprised at my reaction: “Huh!?!?!” and “WTF!?!?!?!?”

Mr. Phillips and His Curve: “What Should the Fed Do?” Weblogging

Posted on by Brad DeLong

Nick Bunker says:

Nick Bunker says: A Kink in the Phillips Curve: “Look at the relationship between wage growth and another measure of labor market slack, however, [and] the [Phillips-Curve] relationship might hold up. Take a look at Figure 1:

A kink in the Phillips curve Equitable Growth

This is entirely consistent with inflation-expectations anchored near 2%/year–or inflation so low that shifts in inflation expectations are not a thing–and a Phillips Curve that gradually loses its slope as wage growth approaches the zero-change sticky point:

A kink in the Phillips curve Equitable Growth

This is entirely consistent with inflation-expectations anchored near 2%/year–or inflation so low that shifts in inflation expectations are not a thing–and a Phillips Curve in which the right labor slack variable is some average of prime-age employment-to-population and the (now normalized) unemployment rate:

A kink in the Phillips curve Equitable Growth

It is really not consistent with any naive view that holds that the Phillips Curve has the unemployment rate and the unemployment rate alone on its right-hand side, and that inflation is about to pick up substantially with little increase in the employment-to-population ratio.

Thus not only does the right wing of the Federal Reserve expecting an imminent upswing of inflation because of MONEY PRINTING! have it wrong, it strongly looks as though the center of the Federal Reserve has it wrong too…

A kink in the Phillips curve

Posted on by Bridget Ansel
Janet Yellen by Jessica Hill, apimages.com

At the beginning of your first course on economics, the entire field can seem like an exercise in drawing curves on a board and explaining why they slope up or down. Economics is far more complex than that, of course, but the many important curves in the literature give that initial impression some glint of truth. Consider the fact that policymakers at the Federal Reserve are currently having a debate about the future of monetary policy that hinges on the interpretation of one of these lines: the Phillips curve. The debate, insomuch that it’ll affect policy, could determine when the central bank raises interest rates, and signals what the Fed thinks about the future of the labor market.

At The New York Times’s The Upshot, Neil Irwin clearly lays out the context for the current debate about the Phillips curve. First noted in British data by economist William Phillips of New Zealand, the curve depicts the relationship between the unemployment rate and the rate of inflation. It’s been replicated using different data sets over the years, but the number of variations has been astounding.

The issue, however, seems to be that the curve has broken in recent years—there’s not a strong relationship between inflation and the unemployment rate. While the unemployment rate is hitting levels close to the Federal Reserve’s estimate of its long-run level, inflation isn’t close to the Federal Reserve’s target of 2 percent over time. In fact, inflation almost looks like it’s trending down.

Yet this isn’t the first time we’ve had reason to question the curve. Members of the Federal Reserve strongly relied on the Phillips curve back in the 1970s—in fact, they may have been too reliant upon it. The seemingly static relationship between inflation and the unemployment rate led policymakers to think that they could push down unemployment without concerns about inflation jumping up. But inflation did jump up. What the Fed didn’t account for was the possibility that people in the economy would come to change their expectations about inflation. As policymakers did more to reduce unemployment, people kept shifting up their expectations of what would happen to inflation. The result was accelerating inflation, and an understanding within economics that policymakers need to account for inflation expectations.

That’s why Fed Chair Janet Yellen cited the expectations-augmented Phillips curve in her speech about inflation last month. Looking at the curve, Yellen expects inflation to soon hit the Federal Reserve’s 2 percent target. But that’s the debate at the Fed right now: whether the Phillips curve currently makes sense for policymaking. Lael Brainard and Daniel Tarullo, both members of the Board of Governors of the Federal Reserve, disagree with Yellen on the usefulness of the curve. In their view, inflation has far from tracked the fall in the unemployment rate.

To understand the changes in the overall inflation Phillips curve, it might be useful to look at another version of the curve: the relationship between unemployment and “wage inflation,” better known as wage growth. Now, that curve doesn’t look that great either, but that might be because the unemployment rate is currently overstating the health of the labor market. If we take a look at the relationship between wage growth and another measure of labor market slack, however, the relationship might hold up. Take a look at Figure 1:

The graph shows the relationship between wage growth for production and non-supervisory workers, and the employment rate for prime-age workers six months prior. It clearly shows that when the labor market is tighter (when the employment rate is higher), wage growth is stronger.

In other words, the underlying idea of the wage Phillips curve still stands. It’s just a matter of using measures that fit the time.

As Matt Phillips (no relation to William presumably) points out in his Quartz piece on the curve, the labor market has changed quite a bit since the mid-1970s. He points specifically to the decline in the unionization rate, which is a sign of the decreasing bargaining power of labor in the economy. A 5 percent unemployment rate when labor is relatively much stronger, for example, is very different from a 5 percent unemployment rate when labor is on the back of its heels. Changes in the labor market might be a reason why increases in wages and salaries don’t pass through to overall inflation as much as we might have thought. Back when labor had more bargaining power, wage hikes would bite more into profits and therefore spur companies to raise prices. Now companies have more of a cushion, so a similar wage increase won’t necessarily lead to as strong of a price increase.

Context appears to very much matter. Policymakers will always need to create rules of thumb to help them make sense of an incredibly complex economy. But those rules need to be updated as the world changes.

Must-Read: Kathleen Maclay: Climate Change Will Reshape Global Economy

Posted on by Brad DeLong
How climate change will affect world economies

Must-Read: Kathleen Maclay: Climate Change Will Reshape Global Economy: “Unmitigated climate change is likely to reduce the income of an average person on Earth by roughly 23 percent in 2100…

…according to [Solomon Hsiang, Marshall Burke, and Edward Miguel]… in the journal Nature…. Climate change will widen global inequality, perhaps dramatically, because warming is good for cold countries, which tend to be richer, and more harmful for hot countries, which tend to be poorer. In the researchers’ benchmark estimate, climate change will reduce average income in the poorest 40 percent of countries by 75 percent in 2100, while the richest 20 percent may experience slight gains…. The Nature paper focuses on effects of climate change via temperature, and does not include impacts via other consequences of climate change such as hurricanes or sea level rise….

They find climate change is likely to have global costs generally 2.5-100 times larger than predicted by current leading models…. In less optimistic scenarios, the authors estimate that 43 percent of countries are likely to be poorer in 2100 than today due to climate change, despite incorporating standard projections of technological progress and other advances. ‘Differences in the projected impact of warming are mainly a function of countries’ baseline temperatures, since warming raises productivity in cool countries,’ the researchers write in Nature. ‘In particular, Europe could benefit from increased average temperatures.’… ‘Introducing climate change to the global economy is like encountering a headwind when flying across the country,’ said Hsiang. ‘You might never feel it, but it can slow you down dramatically.’…

Humans exhibit optimal productivity in a specific band of temperatures… approximately 13 degrees Celsius or 55 Fahrenheit…. ‘Everybody knows that when they’re hot, it’s really challenging to focus, work and be productive,’ said Miguel. ‘When a few hundred million people are feeling that way, it’s the exact same thing, times a few hundred million. The whole economy is likely to slow down.’… The authors find that the global economy’s sensitivity to temperature has not changed appreciably in more than 50 years, in rich as well as poor countries… [suggesteing] adaptation to hot temperatures appears much harder than many had previously thought…

Jason Kottke: How Climate Change Will Affect World Economies: “Countries in the Northern Hemisphere with cooler climates stand to benefit…

…while the rest of the world will not. Here are some of the projected big winners (the Nordic countries) and losers (the Middle East): Mongolia +1413%, Finland +516%, Iceland +513%, Russia +419%, Estonia +259%; Saudi Arabia -96%, Kuwait -96%, Oman -94%, United Arab Emirates -94%, Iraq -93%. Canada (+247%) is another one of the potential big winners while the US (-36%) stands to lose out… along with all of Africa, South America, India, and China. This quote by one of the study’s lead authors, really grabbed me by the throat:

What climate change is doing is basically devaluing all the real estate south of the United States and making the whole planet less productive. Climate change is essentially a massive transfer of value from the hot parts of the world to the cooler parts of the world. This is like taking from the poor and giving to the rich….

Rich, predominantly white countries caused the problem and can do the most to limit the damage, but climate change will disproportionately affect poor countries, poor people (even in rich countries), women, and people of color. The rich need to do something about it so that the poor will not suffer. The problem is, the world’s wealthy have a long history of not being incentivized to help anyone but themselves. I hope this will turn out differently…or, as sometimes happens, the desires of the wealthy and the needs of the poor dovetail into action of joint benefit.