Category: Equitablog

Jared Bernstein: Optimal Fiscal Policy: “I testified in the House Budget Committee this AM…

…[with Ryan Silvey from Missouri, John B. Taylor from Stanford, and Chris Edwards from Cato], and have many excellent war stories to share. But no time to do so now.

Well! Jared, where are the war stories? We demand them.

Jared continues:

Roughly speaking, the position of the majority R’s is that you should always balance the budget for… I just sat with these folks for two long hours and I can’t really finish that sentence.

Partly for moral reasons. One witness blamed ‘Keynesianism for the decline in beneficial “Victorian fiscal morality”.’ Another had a macro-model that maintained, contrary to the CBO’s analysis of the R[epublican]’s budget resolution, that the deep near term cuts would boost, not hurt, growth, because forward-looking households would realize that R[epublican] spending cuts would eventually lead to greater investment, more tax cuts, and higher incomes in the future, so they’d spend more today to offset the cuts. One member, touting the folk’ism that since families have to balance their budgets, the Feds should too, took issue with my point that in fact, families borrow long-term all the time for things like college and homes. He asked me if I make more than I spend. I told him I certainly went into debt to pay for college, and he said he did too!

Another R[epublican] member went on about how much he hated government debt and I had the chance to ask him, ‘so, why did you guys pass $570 billion in non-offset tax cuts?!’ I think he answered, not unreasonably, something like, ‘well, maybe that’s something we can put on the table.’

The longer this continues, the more clear it becomes to me that Alan Greenspan’s setting the Federal Reserve’s inflation target at 2%/year and Ben Bernanke’s formalization of that–and perhaps more so making it an effective upper bound on the inflation the Federal Reserve will tolerate even for the short run without taking action–were disasters. If the past seven years have taught us anything, it is that central banks do not have the will and may not have the power to aim for full employment even in the medium run at the zero lower bound without the assistance of fiscal policy. And if the past seven years have taught us anything, it is that in today’s political-economic environment the expansionary fiscal policy phantom is just as phantasmal as the confidence fairy.

Failing the sudden appearance of said phantom, restructuring the procedures of monetary policy in order to summon the inflation-expectations imp may be, like Obi-Wan Kenobi, our only hope.[1]

Sooner or later we are going to have an economy stuck in a depressed state in or near the liquidity trap and then another big negative shock will hit from somewhere. Maybe that shock is coming from China right now. And should that happen, we will look back to the happy days of 2009.

Back in the late 1990s the Federal Reserve Bank of Boston ran a conference about what to do should we find ourselves at the zero lower bound.

I found myself thinking over and over again of something my great uncle Phil from Marblehead Massachusetts used to say. He once took a sailing safety examination. One question was: “What should you do if you are caught on a lee shore in a hurricane?” His answer was: “You never get caught on a lee shore in a hurricane!” He was correct. If you want to minimize financial, monetary, and economic instability, you work very very hard indeed to make sure that you are never in a position where short-term safe nominal interest rates are constrained by the zero lower bound.

And the consequences of such constraint are such that back in 1992 although Larry Summers and I were very enthusiastic about reducing inflation from 10%/year to 5%/year, we were very wary of reducing it from 5%/year to 0:

Lawrence Summers and J. Bradford DeLong (1992): Macroeconomic Policy and Long-Run Growth: “Even leaving dramatic instances of policy failure like the Depression aside,

we suspect it would be a mistake to extrapolate the results on the benefits…. On almost any theory of why inflation is costly, reducing inflation from 10 percent to 5 percent is likely to be much more beneficial than reducing it from 5 percent to zero…. And there are potentially important benefits of a policy of low positive inflation…. A large easing of monetary policy, as measured by interest rates, moderated but did not fully counteract the forces generating the recession that began in 1990. The relaxation of monetary policy seen over the past three years in the United States would have been arithmetically impossible had inflation and nominal interest rates both been three percentage points lower in 1989. Thus a more vigorous policy of reducing inflation to zero in the mid-1980s might have led to a recent recession much more severe than we have in fact seen…

What are the drawbacks of a 4%/year inflation target, really? Commercial banks are very happy–in such an environment they can invest their customers’ deposits in liquid Treasury securities and well-collateralized loans and be confident of a profit if they focus their attention on efficient customer service. Few people will face a situation in which their bosses will go bankrupt unless they either diss them by cutting their nominal wages or fire them.

In the past century, the United States has had three-month Treasury Bill rates below 1/2%/year for fully one-quarter of the time. Used to be able to say that the Great Depression and World War II were special. Today it is much much harder to say that…

[1] Now can somebody remind me why Lars Svennson is confident that a crawling-peg exchange-rate target would summon the inflation-expectations imp, and Paul Krugman is not?

**Must-Read: A set of model runs backing up the judgment of the very sharp–and, alas!, late–Federal Reserve Governor Ned Gramlich: increases in interest rates large enough to discourage a housing bubble would me much too large for there to be even a faint prayer that the economy could escape a damaging recession. Much better, Ned Gramlich thought, to use macroprudential regulation to keep leverage capable of causing systemic risk from emerging. Much better, Alan Greenspan thought, do stand ready to intervene to clean up the mess after the crash and so build a firewall between financial distress and the real economy of spending, production, and employment.

History has, I think, already judged. It is good to have Jorda and company here to report history’s verdict:

Òscar Jordà, Moritz Schularick, and Alan M. Taylor: Interest Rates and House Prices: Pill or Poison?: “Wild swings in asset prices over the past 20 years and the associated boom-bust cycles…

…have sparked considerable debate about how monetary policy might play a stabilizing role…. Jeremy Stein (2014), argued for using interest rate policy to reduce financial market vulnerability and as a complement to regulation and supervision. Such an approach entails a tradeoff: Raising interest rates to curb financial risk could mean deviating from the dual mandate, therefore entertaining higher unemployment and lower inflation. A recent paper by Ajello et al. (2015) is among the first to explore this tradeoff quantitatively…. We… ask how much interest rates would have had to rise to keep housing prices under control. Our rough figures suggest interest rates would have needed to rise around 8 percentage points to completely avoid the boom-bust cycle. However, such a boost also could have caused significant damage to the Fed’s main objectives of full employment and price stability…

Must-Read: Rudi Dornbusch (2001): Remarks Prompted by Rogoff’s Mundell-Fleming Lecture https://www.imf.org/EXTERNAL/PUBS/FT/STAFFP/2001/00-00/pdf/rd.pdf:

This is not part of the program, but it’s an unavoidable remark.

Ken, of course, was generous far beyond reason. For a man on a new job to put his credibility on the line that much. I appreciate it. I have a slight contest with him whether not labeling your axes or closing off the light on the overhead–which of the two is a better educational strategy. We’ll all see what future generations learn from that.

I want to use the presence of so many friends and students to make an acknowledgement beyond Ken. I was very fortunate, as an undergraduate, to have a teacher who said, “go to America”. He sits in this room. [Editor’s Note: Prof Alexandre Swoboda, Graduate Institute of International Studies, Geneva].

I was immensely lucky to go to Chicago at its very best time, when people were fighting about what was the right model, there was an assumption that no one knew what it was. Our teachers were fighting about it. I was immensely lucky to have Mike Mussa as a colleague/teacher both in Chicago and Rochester, and much of what I learned comes from him. He knows it.

So there are the debts.

And then there was the great luck to stand around while all the ingredients were thrown around. There was sticky prices that we had in our first graduate year. They had become flexible under the impact of inflation by the time we graduated. Expectations had suddenly emerged from Phelps, Friedman,and Lucas. Rational expectations were just thrown at us. We had all these ingredients to make our omelets. Mike and I did that in looking, really, for the same effects.

So the message is: stand around while guys lay out the ingredients while there isn’t a settled view, and you are allowed to do your own [view], and maybe you are lucky.

I think the extra piece that is important for any teacher is the students. It’s not the tenure committee. It’s the students that drive you. And at MIT we are just fantastically blessed with generations and generations of students that challenge you by the day.

And, in the end, I think that’s where the good luck of getting ahead comes from. And it’s a blessing that continues.

Thank you very much.

Rogoff’s Mundell-Fleming Lecture:

• Ken Rogoff (2001): Dornbusch’s Overshooting Model After Twenty-Five Years: The Mundell-Fleming Lecture https://www.imf.org/external/np/speeches/2001/112901.htm

Must-Read: I think Paul Krugman gets one wrong today:

Paul Krugman: Sarcasm and Science: “Paul Romer… [thinks] Lucas and his followers were driven into their adversarial style…

…by Robert Solow’s sarcasm:

I suspect that it was personal friction and a misunderstanding that encouraged a turn toward isolation…. They circled the wagons because they thought that this was the only way to keep the rational expectations revolution alive…

It’s true that people can get remarkably bent out of shape at the suggestion that they’re being silly and foolish…. But Romer’s account of the great wrong turn [in Chicago economics] still sounds much too contingent to me, and not just because, as he himself says, rational expectations quickly took over much modeling at MIT….

As I perceived it… there were two other big factors. First, there was a political component. Equilibrium business cycle theory denied that fiscal or monetary policy could play a useful role in managing the economy, and this was a very appealing conclusion on one side of the political spectrum. This surely was a big reason the freshwater school immediately declared total victory over Keynes… and why it could not back down when the… doctrine was found wanting.

Second… was the toolkit factor. Lucas-type models introduced a new set of modeling and mathematical tools… that required a significant investment of time and effort to learn… [and] let you impress everyone with your technical proficiency. For those who had made that investment, there was a real incentive to insist that models using those tools, and only models using those tools…

But New Keynesian models use those tools! And full-fledged RBC-DSGE models use a quite different set of tools, derived from Prescott’s papers rather than Lucas’s! And those who used those tools best of all–most incisively and creatively, cough, Rudi Dornbusch, cough–had absolutely no tolerance for the bullshit at all. And besides, as Paul Krugman often notes, the intrusion of Lucas-silliness into international macroeconomics got nowhere.

Not to mention: Milton Friedman’s rhetorical style was more finely-honed to draw blood than Robert Solow’s. Chicago was always most famous as a place with a style that was notoriously the most adversarial in economics. Why would anyone who had faced a Stigler or a Friedman have any reason to fear a Samuelson or a Solow?

Must-Read: The very sharp Ken Rogoff calls for Europe to undertake The Acceptable Year of the Lord–cancel the debts, and redistribute the land:

Kenneth Rogoff: A New Deal for Debt Overhangs?: “The International Monetary Fund’s acknowledgement that Greece’s debt is unsustainable could prove to be a watershed moment…

…There have been basically three schools of thought…. The… troika… holds that the eurozone’s debt-distressed periphery… requires strong policy discipline to prevent a short-term liquidity crisis from morphing into a long-term insolvency problem… bridge loans… giving them time to fix their budget problems and undertake structural reforms…. A second school of thought also portrays the crisis as a pure liquidity problem, but views long-term insolvency as an outside risk…. The problem is not that the debt of countries on the eurozone’s periphery is too high, but that it has not been allowed to rise nearly high enough…. Northern Europe could easily have solved the problem by co-signing periphery debt…. The periphery countries should then have been permitted not only to roll over their debt, but also to engage in full-on countercyclical fiscal policy for as long as their national governments deemed necessary…. The eurozone suffered a crisis of competence, not a crisis of confidence…. In fact, piling loans atop already-high debt burdens in the eurozone’s periphery entailed a significant gamble, particularly as the crisis erupted….

A third point of view is that, given the massive financial crisis, Europe’s debt problem should have been diagnosed as an insolvency problem from the start, and treated with debt restructuring and forgiveness, aided by moderately elevated inflation and structural reform…. National governments would have had to use taxpayer funds to recapitalize northern European banks–especially in France and Germany–that lent too much to the periphery. And transfers would have been needed to recapitalize the periphery banks. But at least then the public would have understood… reality…. Debt restructuring would have given Europe the reset it needed. Yes, there would have been risks, as IMF chief economist Olivier Blanchard has pointed out, but running those risks would have been well worth it….

Europe’s experience ought to spur a full rethink of the global system for administering sovereign bankruptcies. That could mean bringing back older IMF proposals for a sovereign bankruptcy mechanism, or finding ways to institutionalize the Fund’s recent stance on Greek debt. There is no free lunch in Europe, and there never was; but there are much better ways to deal with unsustainable debt.

I must say I do not really see why Rogoff insists that there has to be a choice between position (2) which he scorns and position (3) which he embraces. When the world returns–if it ever does–to a regime in which the safe interest rate is greater than the growth rate of the economy, there may well have to be hard decisions made about the necessity for debt writedowns and financial repression to deal with genuine insolvency problems. But as long as the interest rate r is and is expected to be less than the growth rate g, there is no such necessity. Better (as the Syriza government of Greece found) to focus on flows and restoring full employment now than on writing down debt stocks that have little impact in the short run.

The way I like to put it is that it looks to me like the last time Robert Lucas of University of Chicago did his homework was back in the fall of 1979. It was then that Paul Volcker shifted Federal Reserve policy and made disinflation job number one. Yet the models that tracked how expensive in terms of elevated unemployment and idle capacity that policy was were not the rational-expectations models of Chicago-Rochester-Minneapolis. They were, rather, the adaptive-expectations models of the Federal Reserve-MIT-Princeton. And Lucas’s response was to put his fingers in his ears and say: “I CAN’T HEAR YOU!”

We are thinking about this, again, now because Lucas’s “methodological” commitment to modeling economies by assuming that businesses never have any idea that if they cut the quantity they produce they will be able to charge a higher price has annoyed Paul Romer–that Lucas and company are clinging to intellectually-destructive “Stigler conviction” rather than scientific “Feynman integrity”.

In my view, having strong views and being an aggressive advocate for them is not a bad thing. Failing to understand that the point of the enterprise requires that you be willing to mark your beliefs to market is.

Apropos of all this, M.G. Ziegler:

M.G. Ziegler: Wrong Positions, Strongly Held: “It is often said that many of the best thinkers/doers/leaders in history have one thing in common…

…strong positions… weakly held… feel strongly about the ‘right’ way… yet they’re malleable… if persuaded otherwise… a weird yet powerful trait. You need to… convince everyone… you believe 100 percent… while also having a history of changing the stance you’re so forcefully stating…. It’s a great trait… And it’s one that few people can pull off. Most people seem to be on the polar ends of it: they hold weak positions loosely, or they hold strong positions firmly. So, they can’t make up their minds or they never change their minds. Hard to know which is worse….

But there’s actually a type of person who is far worse than either of these. Someone who has the wrong position, strongly held…. The person who always very matter-of-factly states something, when they’re often talking out of their ass. They have absolutely no idea what they’re talking about, but because they’re saying it so forcefully, people believe them…. Who would spout bullshit as fact? Well, a lot of people, actually. But again, most of the time people tend to do this in a meek manner…. Bullshit sensors immediately go berserk. But the ‘wrong position, strongly held’ folks often evade these detectors…. Which is why this is so dangerous.

I would advise you the obvious: to avoid these people. But it’s so hard to know who they are–at least at first. It’s easier to trust no one. But again, human nature will get in the way here. So I guess the only thing to do is to always do your homework on something someone tells you. Hold their position, but hold it weakly.”

Must-Read: The very sharp Zeynep Tufekci mourns the loss of the thick connectedness that was part of the bloggy web that she sees as having been lost in the move to the social web. A great deal of this is simply that back a decade ago when we were homesteading the noosphere settlement was just not that dense, and that the pioneer Little-Weblog-on-the-Prairie culture was bound to die. (How much bigger is the audience for the three things Ezra Klein has written in the past week then for the six things he wrote on August 3, 2005? Ezra? And both writing for a bigger audience and reading less deeply and much more broadly in individual writers will diminish connection.) But is there something more that is important?

Zeynep Tufekci: The Web of Relationships We Have to Save: “Here’s the good: Unlike a blogger, it’s very hard to isolate and ban Facebook or Twitter…

…Here’s the bad: these platforms have their own censorship mechanisms…. What happens when an anti-Dove (or insert your product) user-generated content goes viral (or tries to) in a platform in which that product is a key advertiser? Are we back to television which can never cover climate change while so dependent on car ads?

Here’s the ugly…. I have no way to tell my friends on Facebook that I ‘like’ their efforts for charity, or their babies, without Facebook also interpreting that to mean that it should show more and more of that type of content, the opposite of what I actually want…. Facebook will not prioritize a dark update from a friend whose husband is in an Egyptian jail, but will show me a cheery one she posts, simply because we all click on ‘like’ when we see a moment of happiness from her….

We were discussing the need to preserve links, and have them under our control…. A link… is a connection between people. The current attention economy and its obsession with numbers–and virality–obscures this core fact about what is beautiful about the web…. When we write, and link to each other, we are connecting to each other, not merely to content…. I don’t want to go back to a web of political blogs, read mostly by political people that is easily targeted and banned. But I do want to go forward to a web based on relationships, the flow of which is not manipulated on behalf of advertisers…. I don’t fear commercial platforms, per se, nor am I opposed to the intelligent use of appropriate and robust algorithms that can help enrich our experience. (I’m actually for it). The web we need to save is not this or that format, but our relationships, expressed in our links, our updates, our connections and more. There is much at stake.

Must-Read: this remarkable tendency to abandon policies that a party has been committed to that have worked well… In my view, the Republican Party could be taking two will-deserved victory laps (and one not so well-deserved right now):

• The monetary policies of Republican Ben Bernanke gave the United States the best recovery from 2009 in the North Atlantic.
• The RomneyCare health care policies of Republican Mitt Romney have been successfully implemented and driven extraordinary increases in access to health insurance.
• The Republican Party’s drawing of a line in the sand in 2010–NO MORE MEDICARE CUTS!–Has strengthened and important 50-year-old part of America’s social fabric that works well.

Perhaps it is what the very sharp Rick Perlstein calls the “penumbras and emanations from Citizen’s United”. Never mind that the technocrats who staff Republican administrations and the voters like these policies, the billionaire moneybags do not–and it is the billionaire moneybags who count…

Paul Krugman: Zombies Against Medicare: “Medicare turns 50 this week…

…Before the program went into effect, Ronald Reagan warned that it would destroy American freedom; it didn’t, as far as anyone can tell. What it did do was provide a huge improvement in financial security for seniors and their families, and in many cases it has literally been a lifesaver as well. But the right has never abandoned its dream of killing the program. So it’s really no surprise that… ‘We need to figure out a way to phase out this program’….

What is somewhat surprising, however, is the argument he chose to use, which might have sounded plausible five years ago, but now looks completely out of touch. In this, as in other spheres, Mr. Bush often seems like a Rip Van Winkle…. While raising the Medicare age has long been a favorite idea of Washington’s Very Serious People, a couple of years ago the Congressional Budget Office did a careful study and discovered that it would hardly save any money…. Raising the Medicare age is a zombie idea, which should have been killed by analysis and evidence, but is still out there eating some people’s brains….

Conservatives want to do away with Medicare… [because] it’s the very idea of the government providing a universal safety net that they hate, and they hate it even more when such programs are successful…. What Medicare’s would-be killers usually argue… is that the program as we know it is unaffordable… that Medicare as we know it is incapable of controlling costs…. Now, this was always a dubious claim…. Medicare costs per beneficiary have consistently grown more slowly than private insurance premiums….

And then a funny thing happened… [ObamaCare’s] passage was immediately followed by an unprecedented pause in Medicare cost growth…. Right now is, in other words, a very odd time to be going on about the impossibility of preserving Medicare…. One can only guess that Mr. Bush is unaware of all this, that he’s living inside the conservative information bubble…. Meanwhile, what the rest of us need to know is that Medicare at 50 still looks very good…. The only real threat it faces is that of attack by right-wing zombies.

Must-Read: Marshall Auerbach was, of course, 100% right. The turn to severe austerity in 2010 by the then-newly elected Conservative-Liberal Democratic government looks to have cost Britain 4% of GDP in a slowing-down of recovery. It was not quite enough to knock the UK back into recession–in large part because the government in the end did less to cut spending than its manifesto had committed it to. But it was very damaging.

British Conservatives tell me to this day that this was all Melvyn King’s fault: that he could have eased monetary policy to offset the effect on spending, but did not do so, probably, they say, because he is a crypto-Labourite…

Marshall Auerback (2010): The United Kingdom Draws the Wrong Lessons from Canada: “The standard narrative of the Canadian experience in the 1990s is…

…in 1993, Canada’s budget deficit and debt-to-GDP ratios were the second highest amongst the G7 countries, after Italy’s, and the US financial press was unfavorably comparing Canada to Mexico. That year, with the IMF supposedly lurking at the door, the Liberal Government of Prime Minister Jean Chretien, and his Finance Minister, Paul Martin, laid out a goal to halve the budget deficit to three percent by 1998…. By 1998, the deficit was eliminated and overall debt was dropping quickly, amidst a rapidly growing economy….

Professor Mario Seccareccia… noted the real reasons for the “success” of the Chretien/Martin austerity programs: 1. High growth in the US, Canada’s largest trading partner, a sharply declining Canadian dollar… the implementation of the North American Free Trade Agreement… [and] an expansionary monetary policy…. Canada’s export boom of the 1990s is a miracle that could certainly not be repeated today, given the decline in global economic growth, and the extent to which the ailing manufacturing exports sector is now being hammered by the so-called “Dutch disease” as a consequence of the Canadian dollar’s relative strength…. The United Kingdom would hardly do any better today, given global recessionary pressures and the corresponding implosion of its largest export markets in Europe and the US.

If Prime Minister David Cameron is indeed preparing Britons for a Canadian-style attack on the deficit, he is acting on the basis of profoundly misguided historical information…