Category: Equitablog

**Must-Read: Rich Gilbert**: [E-Books: A Tale of Digital Disruption](https://www.aeaweb.org/articles.php?doi=10.1257/jep.29.3.165): “E-book sales surged after Amazon introduced the Kindle e-reader at the end of 2007…

>…and accounted for about one quarter of all trade book sales by the end of 2013. Amazon’s aggressive (low) pricing of e-books led to allegations that e-books were bankrupting brick and mortar book booksellers. Amazon’s commanding position as a bookseller also raises concerns about monopoly power, and publishers are concerned about Amazon’s power to displace them in the book value chain. I find little evidence that e-books are primarily responsible for the decline of independent booksellers. I also conclude that entry barriers are not sufficient to allow Amazon to set monopoly prices. Publishers are at risk from Amazon’s monopsony (buyer) power and so sought ‘agency’ pricing in an effort to raise the price of ebooks, promote retail competition, and reduce Amazon’s influence as an e-retailer. (In the agency pricing model, the publisher specifies the retail price with a commission for the retailer. In a traditional, ‘wholesale’ pricing model, publishers sell a book to retailers at a wholesale price and retailers set the retail price.) Although agency pricing was challenged by the Department of Justice, it may yet prevail in some form as an equilibrium pricing model for e-book sales.

Must-Read: Jackson Hole 2015 Weblogging: As best as I can see, Robert Lucas is here saying that at the very same moment that Paul Volcker managed to push the U.S. unemployment rate up to 10% via monetary policy, he–Robert Lucas–was convinced by Ed Prescott’s “new style of comparing theory to evidence” that “monetary shocks were just not pulling their weight” in providing a potential explanation of short-run movements in production and employment.

No, Paul Romer, I will not let you blame this style of thought on the fact that Bob Solow was mean to Robert Lucas at Bald Peak. The reason that Bob Solow was mean to Robert Lucas at Bald Peak was that this episode was and is characteristic of how Bob Lucas does business:

Robert Lucas (2001): Bald Peak: “In October, 1978—leaf season—the Federal Reserve Bank of Boston sponsored a conference at the Bald Peak Colony Club in New Hampshire…

…Though I did not see it at the time, the Bald Peak conference also marked the beginning of the end for my attempts to account for the business cycle in terms of monetary shocks…. Ed Prescott presented a model… that was a kind of mixture of Brock and Mirman’s model of growth subject to stochastic technology shocks and my model of monetary shocks…. As they gained more experience through numerical simulations of their Bald Peak model, Kydland and Prescott found that the monetary shocks were just not pulling their weight: By removing all monetary aspects of the theory, they obtained a far simpler and more comprehensible structure that fit postwar U.S. time series data just as well as the original version.

Besides introducing an important substantive refocusing of business cycle research, Kydland and Prescott introduced a new style of comparing theory to evidence that has had an enormous, beneficial effect on empirical work in the field…

Note to Self: Several points to try to hit this week in Jackson Hole:

• The Federal Reserve was supposed to be a people’s central bank. The desire to make it a people’s central bank was behind the pre-World War I democratic progressive rejection of the Aldrich plan–written by John D. Rockefeller II’s father-in-law Sen. Nelson Aldrich (R-RI). Instead of being run by bankers for bankers, the Federal Reserve was to be run by wise technocrats–the Board in Washington, with presidentially-appointed members with very long terms–to be distributed around the country in 12 reserve banks only one of which would be in New York, and the directors the bank presidents served would have a solid majority representing their region’s public and the Board, not representing bankers.

• It hasn’t really worked–although at least some officials of the Federal Reserve will occasionally say that the Federal Reserve is the North Atlantic central bank that is least close to the banking sector it regulates, and might hint that that is one of the reasons why the Federal Reserve has done better than other North Atlantic central banks since 2007.

• Not only did Congress give the Federal Reserve a structure that is flawed, but Congress gave the Federal Reserve a mandate that is flawed: it places too high a weight on price-level stability rather than price-level predictability.

• Not only did Congress give the Federal Reserve a flawed structure and a flawed mandate, but the target the Federal Reserve has adopted is flawed: even with the weight given to price stability, a 2%/year average inflation rate is too low a target to aim for for economic health.

• Not only did Congress give the Fed a flawed structure and a flawed mandate, and not only is the Fed’s 2%/year inflation target (rather than, say, a 4%/year inflation target or a 6%/year NGDP growth target) flawed, but the Federal Reserve’s decisions are not a successful implementation of that target. Right now Wall Street is betting that the Federal Reserve will undershoot its target by a cumulative total of 5% over the next decade.

https://www.icloud.com/keynote/AwBUCAESEAAUD2PCz4iTr9JO8k4Tn08aKQE_mZALGX2aq0JZdX8fvKiMcHTJblc9m6acPd4yOsW9Cqzp4LPaPE2iMCUCAQEEIO7aG-oyXDuP0R2LjtdS2a5Y5-8UqD1BSieFGo_alXpD#2015-08-25_DeLong_Possible_Jackson_Hole_Slides.key

Kevin Cirillo shows up in my inbox:

Kevin Cirilli: Activists Confront Fed Leaders to Warn Against Rate Hike

And my first reaction: Is he talking about former Treasury Secretary and Harvard President Lawrence H. Summers? Is he one of the “activists” in question?

Lawrence Summers: The Fed Looks Set to Make a Dangerous Mistake: “the Fed has put its price stability objective into practice by adopting…

…a 2 per cent inflation target. The biggest risk is that inflation will be lower than this–a risk that would be exacerbated by tightening policy…. Tightening policy will adversely affect employment levels… increase the value of the dollar, making US producers less competitive…. This is especially troubling at a time of rising inequality…. There may have been a financial stability case for raising rates six or nine months ago…. That debate is now moot…. At this moment of fragility, raising rates risks tipping some part of the financial system into crisis, with unpredictable and dangerous results.

Why, then, do so many believe that a rate increase is necessary? I doubt that, if rates were now 4 per cent, there would be much pressure to raise them. That pressure comes from a sense that the economy has substantially normalised… and so the extraordinary stimulus of zero interest rates should be withdrawn…. Whatever merit this view had a few years ago, it is much less plausible as we approach the seventh anniversary of the collapse of Lehman Brothers. It is no longer easy to think of economic conditions that can plausibly be seen as temporary headwinds…

No, I do not believe that LHS is on a plane to Jackson Hole tomorrow. But I am going. This is perhaps the first time I have been described as a “liberal activist”:

Liberal activists are descending upon a global economic conference in Jackson Hole, Wyo., to criticize Federal Reserve officials… The liberal Center for Popular Democracy has launched a ‘Fed Up’ campaign to urge the central bank’s chairwoman, Janet Yellen, and her team of policymakers against raising interest rates…. ‘The economy remains far too weak to slow it down. We shouldn’t mince words — when the Fed raises interest rates, it’s doing that to slow the economy down,’ said Ady Barkan, Fed Up campaign director, on a conference call with reporters. He called the prospect of the Fed raising interest rates ‘an insane perspective to take and an insane policy to take at the moment.’

The group is sending about 50 activists to the annual Economic Policy Symposium, which includes members of the Federal Reserve, global bankers and top economists. The activists will hold ‘Teach Ins’ that coincide with the annual summit. Among the planned events is one titled, ‘Do Black Lives Matter to the Fed?’ — a nod to the national movement to highlight policies that disproportionately hurt the African-American community….

And:

AP: Fed Up Group Plans Counter Jackson Hole Conference: “Federal Reserve Chair Janet Yellen may be skipping this year’s annual gathering of central bank policymakers in Wyoming…

…but a group of demonstrators will be making their second appearance at the elite gathering. And this year they will be conducting their own teach-in…. The Fed Up coalition, made up of community activist groups, has rented a conference room in the same hotel where the Kansas City Federal Reserve Bank will be holding its annual Jackson Hole conference starting Thursday… will bring in low-wage workers from around the country who are struggling to make ends meet to emphasize the need for the Fed to do more to attack income inequality….

Ady Barkan with the Center for Popular Democracy and campaign director for Fed Up said that before Fed officials ‘can have a real discussion of raising interest rates and slowing the economy, they should understand firsthand who it would effect.’… In addition to arguing that raising rates now would be premature, the group will hold discussions on ways to reform the Fed’s current selection process for the presidents of the Fed’s 12 regional banks….

While the Fed announced in May that Yellen would not be attending this year’s conference, Fed Vice Chairman Stanley Fischer is scheduled to deliver comments on inflation during a panel discussion at Jackson Hole on Saturday. Financial markets will be closely examining those comments for any hints about whether the Fed is still likely to boost interest rates at its Sept. 16-17 meeting despite a huge sell-off in recent days in stocks that saw the Dow Jones industrial average fall another 588.47 points or 3.6 percent on Monday.

Back when the Federal Reserve was founded, it was subject to harsh criticism from the banking lobby for giving non-bankers too much influence over the new organization–that it was not enough under the thumb of the bankers:

Roger T. Johnson: Historical Beginnings: The Federal Reserve: “On June 23, 1913, President Wilson appeared before a joint session of Congress and presented his program…

…pleaded for a banking system that would provide for an elastic currency and that would vest control in the government:

so that the banks may be the instruments, not the masters, of business and of individual enterprise and initiative.

Most bankers did not like what they heard. Particularly vigorous—and often very bitter—in their opposition were the big-city bankers, especially from New York. Conservatives also lambasted the bill as a radical break in… laissez-faire…. The bankers… favored… a central bank under banker control, disliked the framework of government regulation, dominated by political appointees… disliked the fact that the new Federal Reserve banks would be the sole holders of reserves… disliked compulsory membership… criticized the bill’s assault on “private rights”… termed the bill a Democratic party measure… dominated by [the Democratic Party’s] southern, western, and “anti-business” elements. The New York Times referred derisively to the “Oklahoma idea, the Nebraska idea,” clearly pointing to Senator Owen and Secretary of State Bryan who, as we have seen, played a major role in writing the bill and adding the government control through the Federal Reserve Board….

The Times said [that the plan]:

reflects the rooted dislike and distrust of banks and bankers that has been for many years a great moving force in the Democratic party, notably in the Western and Far Western States… goes to the very extreme in establishing absolute political control over the business of banking.

The New York Sun… the spokesman for Wall Street at that time, called the bill:

this preposterous offspring of ignorance and unreason… covered all over with the slime of [soft-money] Bryanism….

The vast majority of the nation’s bankers—country and city—still strongly opposed the bill, often with the bitterest hostility; a San Antonio banker, for example, called the bill a “communistic idea.”… Meeting in Chicago in late August with a commission of the American Bankers Association, the presidents of 47 state banking associations and 191 clearinghouse associations raised many objections to the Administration’s banking reform. They made it clear that they wanted the Aldrich plan, with one central bank generally controlled by bankers and generally independent of government regulation.

According to Wilson’s major biographer, Professor Arthur S. Link, the Chicago conference decisively altered the controversy over the banking issue, making the Administration more
hostile to the bankers publicly opposing the Federal Reserve bill. Until this time Wilson and his major advisers had believed that the bankers, despite their rhetoric, would in the final analysis work responsibly for the Administration plan. The Chicago manifesto appeared to kill that hope and sharply etched the broad differences between the majority of the banking community and the Wilson Administration. From then until final passage of the Federal Reserve bill in December, the Wilson Administration tended to regard banker opposition as essentially irreversible…

The bankers’ fear was that the new Federal Reserve system would be a hostile regulator, tightly constraining their businesses and curbing their profits. And the bankers’ fear was that the new Federal Reserve would be excessively attached to inflationary soft-money monetary policies–after all, the leader of the soft-money wing of the Democratic Party, then Secretary-of-State William Jennings Bryan, endorsed it. Political appointees making up the Board of Governors, regional banks directors dominated by public and Board-appointed members, the banker “representatives” on regional bank boards a solid minority–how could this regulatory agency do its job of providing a comfortable life for the banking industry it was set to regulate?

Good questions all. Yet–with the singular notable exception of the 1965-1979 later Martin-Burns-Miller period–nobody who is not a wingnut goldbug argues that the Federal Reserve has been unduly attached to inflation. And the perennial problem has been that the Federal Reserve–even with an entire Board appointed by the president and confirmed by the senate, even with regional bank boards dominated by the public Class B and the Board-appointed Class C directors–has been too attached to the interests of the financial system when those are at odds with the interest of the public.

Paul Krugman has taken the latest whack at why this has turned out to be so:

Paul Krugman: Rate Hike Fever: “Larry Summers argues that a Fed rate hike would be a big mistake…

…I completely agree. Yet he also suggests that the Fed ‘seems set’ to do this foolish thing. Why?… [This] is not like debating monetary policy with the seventeen stooges conservatives whose doctrine tells them that fiat money will turn us into Zimbabwe any day now, and are impervious to evidence. The Fed chair is Janet Yellen; the vice chair is Stan Fischer… salt-water economists whose underlying macro worldview is surely very much like Larry’s, or mine, not least because we studied under Stan himself. So why the difference on policy?… Something about being on the inside is making the Fedsters more rate-hike prone…. Pressure from the usual suspects–the constant sniping against easy money–may play a role. But I also suspect that a lot has to do with the urge to resume a conventional central-banker role. The whole culture of central banks involves saying no to stuff people want, taking away the punch bowl as the party gets going, having the courage to do unpopular things; everyone wants to be Paul Volcker. The Fed is really, really eager to return to that position–and is, I fear, engaging in wishful thinking, believing much too readily that a return to normalcy is appropriate. It’s not.

And:

Paul Krugman: Insiders, Outsiders, and U.S. Monetary Policy: “I ran into Olivier Blanchard… [another] of the people who either make monetary policy or comment on it…

…from fairly influential perches [and] are members of what you might call the 1970s Cambridge mafia. Olivier, Ben Bernanke, Ken Rogoff, Mario Draghi, and yours truly all overlapped at MIT… Larry Summers was at Harvard at the same time… just about everyone was Stan Fischer’s student…. Unusually, Olivier and I do have a significant disagreement right now, over US monetary policy…. I’m very worried that the Fed may be gearing up to raise rates too soon; he’s sanguine…. Our disagreement over coffee is part of a wider split. Among the Cambridge mafia… there’s a surprisingly sharp divide… [that] seems to depend on one thing: whether the economist in question is currently in a policy position…. We don’t have access to different facts; we don’t… have different economic models. It’s an uncertain world, but why do those in office come down on one side of that uncertainty, while those outside come down on the other? Well, even smart, flexible people can fall prey to incestuous amplification. And I worry that this is what is happening to the insiders. On the whole, it seems less likely for the outsiders, although it’s true that the Keynesian econoblogs form what amounts to a tight ongoing discussion group that could be doing some amplification of its own…. But if you ask me, there’s a worrying complacency among the insiders right now, and I would urge them to consider the potential consequences if they’re wrong.

I am not at all confident he has it right. But this is a serious problem. And we are showing up in Jackson Hole to remind the people in the conference rooms upstair from us that they need to worry about whether their view of the world is a little bit too accommodating to the interests–or I would argue the irrational prejudices–of those whom they are supposed to be regulating in the public interest.

Manu Saadia, the author of the forthcoming book, Trekonomics, discusses the economic theories behind the creation of the Star Trek with J. Bradford DeLong, professor of Economics at UC Berkeley and former Deputy Assistant Secretary at the US Treasury. Inkshares’ Adam Gomolin is the moderator:

The Vulcans are not coming…:

• https://www.inkshares.com/projects/trekonomics
• https://readfold.com/read/delong/unfinished-notes-on-trekonomics-tKdx6Njn

Must-Read: David Blanchflower, Mariana Mazzucato, et al.: Jeremy Corbyn’s Opposition to Austerity Is Actually Mainstream Economics: “The accusation is widely made that Jeremy Corbyn and his supporters have moved to the extreme left…

…[But his opposition to austerity is actually mainstream economics, even backed by the conservative IMF. He aims to boost growth and prosperity. He voted against the shameful £12bn in cuts in the welfare bill…. It is the current government’s policy and its objectives which are extreme…. Increasing child poverty and cutting support for the most vulnerable is unjustifiable. Cutting government investment in the name of prudence is wrong because it prevents growth, innovation and productivity increases…. We the undersigned are not all supporters of Jeremy Corbyn. But we hope to clarify just where the ‘extremism’ lies in the current economic debate.

David Atkins: Sam Brownback’s Kansas Disaster is Getting Even Worse#annotations:7676499): “Reasonable people can come to different moral value judgments…

…But it’s important to remember that it’s not just about empathy and ethics. It’s about what works and what doesn’t. And every day in every way, we are learning that conservative approaches simply don’t work…. Exhibit A in the utter failure of conservative dogma is Sam Brownback’s trainwreck in Kansas… Yael Abouhalkah….

This has been a bad week for Gov. Sam Brownback and others who believe his massive income tax cuts are going to dramatically boost employment in the state. A new report Friday showed that Kansas had lost a whopping 4,300 jobs in July from a month earlier…. Kansas has added a puny 5,600 total jobs in the last year — from July 2014 to July 2015. The new information shows that the tax cuts that have drained the Kansas treasury of hundreds of millions of dollars the past two years are not working to attract employers and jobs…

Kansas’ atrocious performance has nothing to do with the state of the midwest or the manufacturing sector generally, because both manufacturing and Kansas’ neighbors are actually doing pretty well comparatively…. All this as Brownback’s tax cuts are destroying what remains of the state’s educational system and social services. Brownback and his allies suffer under the delusion that supply-side economics really works, and that if they cut taxes enough on rich people and businesses that there will be an explosion of jobs and economic growth. That’s not just immoral because it increases inequality and hurts the poor. It’s as wrong as 2+2=5. In all but the most extreme cases, cutting taxes on the rich does nothing to create jobs, but slashing the salaries of teachers and cutting welfare benefits means less consumer demand, which in turns drives the economy into recession. The immorality would at least be somewhat tolerable if the ideology functioned at a broad utilitarian level, but it doesn’t.

Must-Read: I think that Paul Krugman’s jump from the first to the second paragraph I quote below is wrong–or at least much too hasty: Reason is not that Cunning. Robert Lucas is no more of a right-wing nut than Milton Friedman and George Stigler–indeed, Lucas probably never was, as Gene Smolensky characterized Milton and George, “in love with Barry Goldwater”. But for Uncle Milton, maintenance of a stable, predictable path for nominal GDP by means of a “neutral” monetary policy was not just Job Number One but Job Number Only–and for Uncle Milton, whatever policy maintains a stable, predictable path for nominal GDP was by definition a “neutral” monetary policy.

But more on this anon, after I return from Jackson Hole..

Paul Krugman: Fairy Tales: “Mike Konczal, channeling Kalecki, pointed out…

…arguments rejecting Keynes and declaring that only business confidence can achieve full employment serve [the] very useful political purpose… [of] empower[ing] plutocrats and big business….

And this speaks to the wider point of the politicization of macroeconomics. Why did freshwater macroeconomists refuse to learn from the lessons of the Volcker recession and recovery, which clearly refuted their approach and supported some kind of Keynesian view on monetary policy? Why has the overwhelming recent evidence for a Keynesian view of fiscal policy been ignored? You might think that business, at least, would welcome policies that boost sales; but the ideology of confidence must be defended.

Must-Read: Stephen Roach: China’s Complexity Problem: “There are many moving parts in China’s daunting transition…

..to what its leaders call a moderately well-off society…. Is China’s leadership up to the task?… The far bigger story is its economy’s solid progress on the road to rebalancing…. Services activity grew 8.4% year on year in the first half of 2015, far outstripping the 6.1% growth in manufacturing and construction…. China’s employment trends have held up much better than might be expected in the face of an economic slowdown…. Services are also the ingredient that makes China’s urbanization strategy so effective. Today, approximately 55% of China’s population lives in cities, compared to less than 20% in 1978….

While progress on economic rebalancing is encouraging, China has put far more on its plate: simultaneous plans to modernize the financial system, reform the currency, and address excesses in equity, debt, and property markets… [plus] an aggressive anti-corruption campaign, a more muscular foreign policy, and a nationalistic revival couched in terms of the “China Dream.”… China could inadvertently find itself mired in something comparable to what Minxin Pei has long called a “trapped transition,” in which the economic-reform strategy is stymied by the lack of political will in a one-party state…. As warnings about the “middle-income trap” underscore, history is littered with more failures than successes in pushing beyond the per capita income threshold that China has attained. The last thing China needs is to try to balance too much on the head of a pin. Its leaders need to simplify and clarify an agenda that risks becoming too complex to manage.

Must-Re-Read: Yes, you do need to reread this. And I do still find myself disturbed by a division in the ranks of those of us economists who I think have some idea of what the elephant in the room us. Some of us–Rogoff, Krugman, Blanchard, me–think our deep macro economic problems could be largely solved by the adoption and successful maintenance of a 4%/year inflation target in the North Atlantic. Others–Summers, Bernanke–do not. They appear to think that a strongly negative natural real safe rate of interest (there’s at mouthful!) will cause sigificant problems even if 4%/year inflation allows a demand-stabilizing central to successfully do its job without hitting the zero lower bound.

My failure to comprehend why they think this disturbs me, for I would have said that my mental model of Bernanke thought is very good. And I would have said that the sub-Turing evocation of Summers that I am currently running on my wetware is world-class:

Paul Krugman (2013): Secular Stagnation, Coalmines, Bubbles, and Larry Summers: “I’m pretty annoyed with Larry Summers right now…

…His presentation at the IMF Research Conference is, justifiably, getting a lot of attention. And here’s the thing…. Larry’s formulation is much clearer and more forceful, and altogether better, than anything I’ve done. Curse you, Red Baron Larry Summers! OK, with professional jealousy out of the way, let me try to enlarge on Larry’s theme….

Larry’s formulation… is the same as my own… works from the understanding that… monetary policy is de facto constrained by the zero lower bound… [and] in this situation the normal rules of economic policy don’t apply…. This is the kind of environment in which Keynes’s hypothetical policy of burying currency in coalmines and letting the private sector dig it up… becomes a good thing…. Larry also indirectly states an important corollary: this isn’t just true of public spending. Private spending that is wholly or partially wasteful is also a good thing…. This is… standard, although a lot of people hate, just hate, this kind of logic–they want economics to be a morality play, and they don’t care how many people have to suffer in the process. But now comes the radical part of Larry’s presentation: his suggestion that this may not be a temporary state of affairs…. The point is that it’s not hard to think of reasons why the liquidity trap could be a lot more persistent than anyone currently wants to admit….

The underlying problem in all of this is simply that real interest rates are too high…. The market wants a strongly negative real interest rate, [and so] we’ll have persistent problems until we find a way to deliver such a rate. One way to get there would be to reconstruct our whole monetary system–say, eliminate paper money and pay negative interest rates on deposits. Another way would be to take advantage of the next boom–whether it’s a bubble or driven by expansionary fiscal policy–to push inflation substantially higher, and keep it there. Or maybe, possibly, we could go the Krugman 1998/Abe 2013 route of pushing up inflation through the sheer power of self-fulfilling expectations….

Oh, and one last point. If we’re going to have persistently negative real interest rates along with at least somewhat positive overall economic growth, the panic over public debt looks even more foolish than people like me have been saying: servicing the debt in the sense of stabilizing the ratio of debt to GDP has no cost, in fact negative cost…. What Larry did at the IMF wasn’t just give an interesting speech. He laid down what amounts to a very radical manifesto. And I very much fear that he may be right.

Gavyn Davies (2013): The implications of secular stagnation: “The alleged consequence of the fact that the actual real rate is above the equilibrium…

…is that there has been a prolonged period of under-investment in the developed economies, with GDP falling further and further behind its underlying long run potential. In a largely unsuccessful effort to close the gap, the central banks have created asset price bubbles (technology stocks in the late 1990s, housing in the mid 2000s and possibly credit today), since this has been the only means available to boost demand…. If they are right, is that the problem of under-performance of GDP will last for a very long time, and will not solve itself through flexibility in prices and interest rates…. The normal route through which monetary policy works, by bringing forward consumption from the future into the present, is unlikely to be successful…. There will still be a shortage of demand when the future comes around…. Calls for fiscal action are bound to intensify…. The conclusion about public investment now seems to be supported by most shades of professional economic opinion, including Ken Rogoff at the IMF conference. Yet there is little sign of it happening on any significant scale.

Paul Krugman (2013): Bubbles, Regulation, and Secular Stagnation: “Looking at current macroeconomic policy…

…the obvious question is, stupid or evil? And the obvious answer is, why do we have to choose? But it is… at any rate soothing… to think about the longer-term future…. I recently talked about some of these issues with Adair Turner… (just to be clear, Adair bears no responsibility for any errors or confusion in what follows). In brief, there is a case for believing that the problem of maintaining adequate aggregate demand is going to be very persistent–that we may face something like the “secular stagnation” many economists feared after World War II….

When the Minsky moment came, there was a rush to deleverage; this drove down overall demand for any given interest rate, and made the Wicksellian natural rate substantially negative, pushing us into a liquidity trap…. How should pre-2008 policy have been different? And what should policy look like looking forward? There are many economic commentators who take rising leverage, asset bubbles and all that as prima facie evidence that monetary policy was too loose…. The trouble with this line of argument is that if monetary policy is assigned the task of discouraging people from excessive borrowing, it can’t pursue full employment and price stability, which are also worthy goals (as well as being the Fed’s legally binding mandate)…. Since the US economy shows no signs of having been overheated on average from 1985 to 2007, the argument that the Fed should nonetheless have set higher rates is an argument that the Fed should have kept the real economy persistently depressed, and unemployment persistently high…. That’s quite a demand. Many of us would therefore argue that the right answer isn’t tighter money but tighter regulation….

Our current episode of deleveraging will eventually end, which will shift the IS curve back to the right. But if we have effective financial regulation, as we should, it won’t shift all the way back to where it was before the crisis…. And here’s the worrisome thing: what if it turns out that we need ever-growing debt to stay out of a liquidity trap?… Bear in mind that interest rates were actually pretty low even during the era of rising leverage, and got worryingly close to zero after the 2001 recession and even, you might say, after the 90-91 recession (there was talk of a liquidity trap even then)….

One answer could be a higher inflation target, so that the real interest rate can go more negative. I’m for it! But you do have to wonder how effective that low real interest rate can be if we’re simultaneously limiting leverage. Another answer could be sustained, deficit-financed fiscal stimulus. But, you say, this would lead to exploding public debt! Actually, no–not if the real interest rate is persistently below the economy’s growth rate….

OK, I’m shooting from the hip here. The main point is simply that the weirdness of our current situation may well go on much longer than anyone currently imagines.

Jared Bernstein (2013): Paul, Larry, Secular Stagnation, and the Impact of Negative Real Rates: “Paul K was as impressed with the recent words of Larry S as I was…

…I’d like to further elaborate and pose a question to Paul and Larry (really, Larries—Summers and Ball) and, of course, anyone else who’d like to weigh in…. Larry’s analysis is… compelling… [because] it’s framed quite cozily in neoclassical thinking… and simple empirics…. Many years post-panic, we still have large output gaps and no evidence of price pressures.  The zero-bound is constraining Fed policy, and thus we must do more with economic policy, not less…. [This] suggests a level of secular stagnation that I and others have been worrying about for a very long time… [is] behind my conviction… my life’s work… that left to its own devices, the market can’t be counted on to generate full employment….

In the spirit of recognizing limits of interest rate policy, how certain are those of us who advocate this position—which given today’s ZLB means higher inflation to achieve lower real rates—that it would help much? At first blush, this is simple IS-LM stuff—history is very clear that the IS curve slopes down…. But there’s something about “secular stagnation” that has a way of messing with old rules…. Many observers of the US economy have worried about the impact of financialization… the bubble machine… the devotion of considerable resources to non-productive activities…. Who out there thinks financial markets are playing their necessary role of allocating excess savings to their most productive uses?…

So, I’m totally with the program re getting the real interest rate down… But I’m nervous that it might not be as effective as historical correlations would suggest. I’d be interested in Paul and Larries responses.