Category: Equitablog

Convergence to the Long-Run Macroeconomic Omega Point and Inflation Targeting: Nick Rowe’s View

Nick Rowe enters what I am starting to call: The Omega Point Discussion:

Nick Rowe: Back propagation induction does not work under inflation targeting: “Suppose you lived in a world where, whenever the price level fell/rose by 1%…

the central bank responded by decreasing/increasing the base money stock by the same 1%. A world like that would not have a long-run Omega point, from which some present equilibrium can be pinned down by back propagation induction.

That’s the sort of world we live in, under the inflation targeting regime. A drunk doing a random walk does not have a destination, from which we can infer his route by working backwards. His long run variance is infinite.

Stop arguing about whether a market macroeconomy is or is not inherently ultimately self-equilibrating. It’s a stupid question. It depends. It depends on the monetary regime.

Instead, let’s solve the stupid question by adopting a nominal level path target.

I commented:

Touché…

You do realize that only me, David Glasner, and a few other people will understand this? That it needs to be unpacked at considerably greater length if you want it to have reach?

Yours,

Brad DeLong

Actually, however, Nick Rowe is not quite right. An adverse nominal demand shock not only cuts prices but also raises unemployment and reduces capacity utilization. Those put downward pressure on future inflation. The cut in prices leads an inflation-targeting central bank to proportionally cut the money stock, yes. But the reduction in forecast future inflation leads the central bank to then give back some of that money-stock reduction.

Thus: convergence to the Omega Point is not eliminated. It is, however, attenuated. The arrival of the economy at a state within shouting distance of the Omega Point is not pushed off to the infinite future. It is, however, pushed off to the more distant future. And convergence is certainly much slower than under monetary policy rules with more reasonable nominal monetary anchors in them.

But all this is, or ought to be, part of a much broader discussion about how long it is before the long run arrives, and whether back-propagation induction-unraveling is an important mechanism in the world or, rather, only an “as if” metaphor of some sort. That broader discussion should be, I now think, in three parts:

• Waiting for the Long Run
• What Happens in the Short Run
• Is Back-Propagation Induction-Unraveling Really a Thing?

Must-Read: The four most interesting things about Chief Justice John Roberts’s decision in NFIB vs. Sibelius–the original ObamaCare case–were:

• That Justices Thomas, Alito, Scalia, and Kennedy decided to write a dissent that was grounded neither in black-letter law nor in their deeply-held conceptions of justice nor in keeping the path open for relatively-conservative technocratic policymaking, but rather in tactical partisanship
• That Justices Breyer and Kagan were willing to sign on to the intellectually-incoherent Medicaid expansion piece of the opinion in order to safeguard–or obtain–Chief Justice Roberts’s vote, and that Roberts was willing to horse-trade–or threaten–as part of this bargain.
• That no Republican state governor and few Republican state legislators wanted to be confronted with the choice between causing substantial fiscal problems for their states by rejecting the Medicaid expansion or endorsing ObamaCare by accepting the Medicaid expansion.
• That Chief Justice Roberts and his clerks did not have antennae sensitive enough to pick up on the fact that nearly all Republican office-holders at the state level would be furious at the court for forcing them to make the Medicaid expansion choice.

All this makes it very difficult to forecast whether Chief Justice Roberts will join the four partisan horsemen who wanted to hear King vs. Burwell, deliver another astonishing blow to both the health-care system and the public finances of red states, and confront red-state Republican office-holders with yet another lose-lose political dilemma with respect to exchange establishment:

Sahil Kapur: A Republican Supreme Court Victory on Obamacare Could Backfire in 2016 Swing States: “If Republicans get their way at the Supreme Court this month…

…and wipe out Obamacare premium subsidies for millions of Americans, the ensuing damage to their party in 2016… would be particularly perilous in swing states…. Florida… 1.3 million residents would lose an average of $294 per month in health insurance tax credits and face a remarkable 359 percent premium hike…. Wisconsin… 166,000 residents… $315 in monthly tax credits… 252 percent premium increase…. Ohio… where Senator Rob Portman faces reelection, 161,000 people… $255… 190 percent premium hike…. Iowa… 34,000 people… $263… 244…. New Hampshire… Senator Kelly Ayotte is up for reelection… 30,000… $264 in tax credits… 218 percent premium hike…. Pennsylvania… Senator Pat Toomey faces a reelection fight… 349,000 residents… $227… 177 percent…. Indiana…160,000 people…$320… 271 percent…. North Carolina… 458,000 residents… $316… 336 percent….

Meanwhile, Obamacare beneficiaries in states like California and New York, which set up their own exchanges, would be untouched…. Congressional Republicans have not coalesced around a contingency plan…. ‘We could be looking at a moment of chaos,’ [Senator] Johnson told Bloomberg…. Walker said Congress must act…. ‘States didn’t create this problem, the federal government did. And they should fix it.’ House Majority Leader Kevin McCarthy of California said this week Republicans won’t release their response legislation before of the Court’s ruling…. Wyoming Senator John Barrasso… met with House Republicans to emphasize that the party needs to be ready to respond quickly…

Must- and Should-Reads:

• Paul Campos: “A settlement… [with] a non-disclosure provision… enforced by court orders if necessary…. Extortion, which is a serious crime…. On one level, the distinction between these two situations is perfectly clear, as Richard Nixon used to say. On another, it’s troubling that we allow people to buy silence regarding their crimes, as long as the appropriate paperwork is drawn up first.”
• Brian Levy: Bill Easterly and the Denial of Inconvenient Truths
• Paul Krugman: Backward Induction and Brad DeLong
• Tierney Sneed: Pennsylvania Rolls Out Back-up Plan In Case SCOTUS Rules Against Obamacare)
• Must-Read: Matthew Yglesias: GDP Measures GDP
• Nouriel Roubini: The Liquidity Time Bomb
• Matthew Yglesias: People Worrying About a Technology Bubble Keep Making This Mistake
• Must-Read: Gavyn Davies: Technology, Inflation, and the Federal Reserve
• Must-Read: Mark Thoma: To Overcome Rising Inequality, Workers Need More Bargaining Power
• Much More than a Must-Read: Paul Krugman: The Case of the Missing Minsky
• Must-Read: Mike the Mad Biologist: Thoughts on the Promises of Big Genomics

Over at Equitable Growth—The Equitablog

• Kavya Vaghul: Education, housing, and U.S. economic inequality
• Nick Bunker: Job losses, recessions and the U.S. labor market moving forward

Might Like to Be Aware of:

• Dylan Matthews: Most gun deaths are suicides, not homicides. That’s a strong case for gun control.
• Matthew YglesiasNewsletter

Must-Read: This isn’t really a “must-read”. It is more of a “must think about”. As readers know by now, I am much less satisfied with Paul Krugman’s declaration that economics today is in more-or-less good shape with respect to the “Bagehot” and the “Keynes” questions–what to do when the economy suffers from manias, panics, and crises; and how thereafter to restore full employment without running unwarranted risks. It is a fact that the Bagehot Rule was not applied fully in 2008-2009. And that many economists were dragging their heels and providing ammunition to those politicians who did not want to apply the Bagehot rule. And it seems to me that there are more analytical holes in the Hicks-Hansen-Wicksell approach to depression economics than Paul recognizes, at least in his more triumphalist moods.

But he is 100% correct in his complaints about continued neglect of the Minsky question…

Paul Krugman: The Case of the Missing Minsky: “Gavyn Davis has a good summary of the recent IMF conference on rethinking macro…

…Mark Thoma has further thoughts… disappointed… decrying:

the arrogance that asserts that we have little to learn about theory or policy from the economists who wrote during and after the Great Depression.

Maybe surprisingly, I’m a bit more upbeat than either. Of course there are economists, and whole departments, that have learned nothing, and remain wholly dominated by mathiness. But it seems to be that economists have done OK on two of the big three questions raised by the economic crisis…. First, a buildup of vulnerability…. Second, the acute phase of crisis, with bank runs or their functional equivalent…. Then a long period of depressed employment and activity, which still isn’t over…. I think of these as the Minsky question… the Bagehot question… and the Keynes question….

On the Keynes question, it’s true that we haven’t had a radical change in thinking, but that’s mainly because the old thinking still works pretty well…. The answer for people asking who would be the new Keynes turns out to be that Keynes is the new Keynes. Or maybe that’s Hicks…. We have had a flowering of empirical work, and… econometric evidence…. Look… at Nakamura/Steinsson… or at… Blanchard…. On the Bagehot question… failure to realize that shadow banking had recreated the risk of bank runs, and failure to appreciate the problems of leverage because there is no room for such problems in representative-agent models. But it wasn’t very hard to fix these problems, or at least apply workable patches… creation of a somewhat messy, inelegant, but usable set of models [was] quite easy. And here too we have seen a flowering of empirical work, e.g. Mian and Sufi….

Where we have not, as far as I can tell, made much progress is the Minsky question. Why did the system become so vulnerable? Was it deregulation (or failure of regulation to keep up with institutional change)? Simple forgetting, as memories of past crises faded? Excessively loose policy? I have views, but I have to admit that there isn’t a lot of either fresh thinking or hard evidence here…. Minsky [is] still mostly missing… because asking how we got here may be less urgent than the question of what we do now… [and] because it’s hard…. behavioral economics doesn’t provide anything like as much guidance as it should. Still, I’m relatively positive in my assessment of the state of macroeconomics. Against mathiness and political ideology, the gods themselves contend in vain, but that’s not a problem with the models.

Mark Thoma: Has the Rethinking of Macroeconomic Policy Been Successful?: “There has been more progress on the theoretical front than I expected…

…particularly in adding financial sector frictions to the NK-DSGE framework and in overcoming the restrictions imposed by the representative agent model. At the same time, there has been less progress than I expected in developing alternatives to the standard models…. My biggest disappointment is how much resistance there has been to the idea that we need to even try to find alternative modeling structures… and the arrogance that asserts that we have little to learn about theory or policy from the economists who wrote during and after the Great Depression.

Gavyn Davies: Has the rethinking of macroeconomic policy been successful?: “The great financial crash of 2008 was expected to lead to a fundamental re-thinking…

…of macro-economics, perhaps leading to a profound shift in the mainstream approach…. That is what happened after the 1929 crash and the Great Depression…. Seven years after 2008 crash, there is relatively little sign of a major transformation in the mainstream macro-economic theory that is used, for example, by most central banks…. What about macro-economic policy? Here major changes have already been implemented, notably in banking regulation, macro-prudential policy and most importantly the use of the central bank balance sheet as an independent instrument of monetary policy. In these areas, policy-makers have acted well in advance of macro-economic researchers, who have been struggling to catch up….

I have… taken the liberty of organising Olivier’s summary and the conference material into the three tables below. Although highly simplified, the tables represent a snapshot of the current ‘state of the art’ in macro policy, at least as seen by today’s mainstream luminaries of the subject…. First, the state of the economy and fiscal policy. An important debate is on whether Lawrence Summers is right to warn about secular stagnation, and if so, why? There is certainly no consensus on this. Most central bankers say that they disagree with Summers (agreeing instead with Ken Rogoff that stagnation will disappear once debt deleveraging is over), but that may be because they do not want to face the policy consequences of him being proved right…. The most important issue, however, is left largely undiscussed…. Whatever economists may think, politicians seem to be far more convinced that a reduction in public debt is essential…. What would happen to the fiscal stance if faced with another recession is unknown…..

The pre-2008 mainstream view of traditional monetary policy, involving inflation targeting, enforced by variations in short rates, seems to have survived largely intact. There is relatively little support for running policy solely according to the Taylor Rule. But there is great uncertainty about how far central bank balance sheets should be reduced, and whether they should retain an independent role…. On regulation, there is widespread agreement that macro-prudential policy weapons are desirable, but little agreement on what they should be, or how they should be deployed….

There has been a decisive shift away from a belief in complete freedom of capital movements…. But the discussion on the need for co-operation between central banks when setting domestic monetary policy–a very live issue ahead of Federal Reserve tightening–was inconclusive….

The much more serious challenge of how policy should adjust in the event of another crisis… were not much addressed…. In the not-very-unlikely event of any of these threats manifesting themselves, there is no obvious ‘play-book’…. As in 2008, policy-makers would have to fend for themselves, but with far fewer options available to them.

Must-Read: Mark Thoma: To Overcome Rising Inequality, Workers Need More Bargaining Power: “Many people confuse free markets with the textbook ideal of competitive markets…

Markets that are free from government intervention are also free to accumulate a significant amount of market power. Rising inequality has more than one cause, and solving the problem will require us to attack on several different fronts. A good place to start would be for the government to take a much firmer stand against the economic power that firms have in both the product and labor markets.

Must-Read: Here Gavyn Davies falls into the trap noted by Matthew Yglesias. Underestimation of quality changes and of surplus has effects on the gap between measured GDP and societal welfare. But it has equal effects on the gap between estimated potential GDP and currently-attainable full-employment societal welfare. To first order, as best as I can see, it has no implications for any macroeconomic policy or macroeconomic performance debates.

Gavyn Davies: Technology, Inflation, and the Federal Reserve: “Martin Feldstein argued that both the productivity growth rate and the level of real GDP are actually much higher…

…than shown in the official statistics, because the inflation rate is really much lower than the consumer price index figures are reporting… official statisticians are underestimating the rate at which technological change is improving the quality of what consumers are buying…. This argument is also made by Ken Rogoff, who thinks that future economic historians, perhaps using more sophisticated techniques, might view the current era as one of much more rapid growth in middle-class consumption than is currently believed…. If the genuine inflation rate, properly measured, is lower than the reported rate, monetary policy should stay easier for longer…. Fed chairwoman Janet Yellen mentioned productivity in passing at the end of her speech last Friday, but the FOMC needs to debate this much more seriously than it has done so far…

Must-Read: And another clarification-of-thought exercise from Matthew Yglesias. The displacement that is the rise of asset prices caused by a fall in safe interest rates may trigger a bubble. But the mere displacement itself–and the fact that asset prices will fall should interest rates rise and “normalize” is not a bubble: it is a carry trade, a tradeoff of higher returns now against a risk of capital loss later.

Study the thought of Matthew Yglesias diligently in an effort to attain correct thought and the true knowledge!

Matthew Yglesias: People Worrying About a Technology Bubble Keep Making This Mistake: “We’re… in something… a bubble of bubble calls…

…But here’s a crucial point: this isn’t what a bubble is. Low interest rates are not irrational exuberance. They’re not mass hysteria. They’re not hype. They’re not a search for a greater fool. They’re not overconfidence. They are very real…. If you want a safe financial asset these days, you need to accept a very low nominal rate of return. That genuinely makes other asset classes–everything from houses to ordinary stock shares to zany digital media startups–look more appealing…. And that makes it eminently reasonable for the price of riskier asset classes to be higher than they would be in a world of higher interest rates…. [This] is an example of asset prices being driven by the fundamentals. It’s the opposite of a bubble…. I think Spiegel means… that these conditions won’t last forever. Which is true…. But ‘future valuations will change in response to changing objective conditions’ is a totally different claim from ‘today’s irrational mania will evaporate and prove to have been a mirage.’

Most unicorns look like bubbles. General elevated prices of risky assets–and tech assets are really risky–are not.

Must-Read: I do not think Nouriel’s argument makes complete sense here, but I cannot put my finger on exactly what is wrong with it. Perhaps “liquidity” is being used in different senses? In one sense, the market is “liquid” when there are lots of assets that are not subject to moral hazard factors when you try to sell them–hence you can get a known amount of cash quickly. In another sense, the market is “liquid” when you can quickly change your position in assets that *might but haven’t been subject to moral hazard without taking a large haircut. Is using the same word “liquidity” for both creating confusion?

Nouriel Roubini: The Liquidity Time Bomb: “Before the 2008 crisis, banks were market makers in fixed-income instruments…

But with new regulations punishing such trading (via higher capital charges), banks and other financial institutions have reduced their market-making activity. So, in times of surprise that move bond prices and yields, the banks are not present to act as stabilizers…. As a result, when surprises occur… the re-rating of stocks and especially bonds can be abrupt and dramatic: everyone caught in the same crowded trades needs to get out fast… because many investments are in illiquid funds and the traditional market makers who smoothed volatility are nowhere to be found, the sellers are forced into fire sales. This combination of macro liquidity and market illiquidity is a time bomb…

Must-Read: Matthew Yglesias identifies and nails an important distinction: “mismeasurement” because GDP does not capture economic surplus has next to nothing to do with issues about capacity utilization, economic slack, and proper stabilization policy. It does, however, have a lot to do with debates about living standards, utopia, happiness, political economy, and inequality.

Matthew Yglesias: GDP Measures GDP: “Every few months I see chatter popping up indicating…

…that people think something or other — most recently it’s the consumer surplus associated with Facebook — shows that GDP isn’t being propelry measured. These critiques are almost always wrong. GDP is a measure of what it measures — monetized economic output. It is also the case that lots of things in life are not measured by GDP. Some of that is the fuzzy intangibles, but some of it is very concrete. A maid is GDP. Cleaning your own damn house is not. But either way, the house is either clean or it isn’t. But that’s not a measurement error. Cleaning your own house really isn’t market economic output.