…Never underestimate the ingenuity of inflation truthers…. His latest investor letter recycles all these ideas, inveighing against the Fed’s ‘fake prices,’ ‘fake money,’ and ‘fake jobs,’ before zeroing in on where inflation is really showing up–his wallet: ‘Check out London, Manhattan, Aspen and East Hampton real estate prices, as well as high-end art prices, to see what the leading edge of hyperinflation could look like.’ That’s right: Paul Singer thinks Weimar-style inflation might be coming because he has to pay more for his posh vacation homes and art pieces…. The Fed, you see, isn’t worried about the Billionaire Price Index. It’s worried about inflation on goods and services we all face…. Just because the super-rich are bidding up the prices of houses in the Hamptons doesn’t mean that middle-class people, whose wages are flat, are going to bid up the price of, well, anything…. If this is the best the inflation truthers can do, they should probably follow Mark Twain’s advice and keep their mouths closed…
Category: Equitablog
Afternoon Must-Read: Hugo Panizza: Rashomon in Euroland
…but a more stable euro zone requires expansionary fiscal policy now…. The problem is that northern countries do not want to implement expansionary fiscal policy…. Public debt is riskier in countries that cannot print their own currency… and the fiscally fragile periphery cannot implement expansionary policy without a backstop that can rule out debt runs. The only institution that can play this role is the European Central Bank…. If peripheral countries undershoot ECB’s ‘close, but below 2%’ inflation target, somebody needs to overshoot it. If Germany wants peripheral countries to become more like Germany, Germans may need to become more like southern Europeans….The euro zone is flirting with deflation and yet there are members of the ECB board who oppose a more aggressive policy stance. It would be good to know what economic model they have in mind. Charles Wyplosz asked; Mr Weidmann did not answer.
Afternoon Must-Read: Kevin Drum: Are Central Banks Losing Their Credibility on Inflation?
…which have persistently undershot their own inflation targets despite having enormous incentives to at least meet them as they try to recover from the Great Recession…. Everyone has assumed all along that if they were sufficiently motivated, central banks could always generate high inflation…. But what if it turns out that in practice it’s all but impossible for a modern central bank to meet even a modest inflation target during a severe economic downturn? How do we know whether this is due to lack of will; lack of technical firepower; or lack of political support? And how long does it take before markets decide it doesn’t much matter? After all, at some point there’s no practical difference between unwillingness and inability…. The longer this goes on, the more their credibility gets shredded. It’s a mystery why this isn’t an issue of bigger concern.
Can more effective management of household debt help foster equitable growth?
In the wake of the Great Recession, policymakers and economists alike need a better understanding of the implications of unfettered private debt. In the last three decades, household debt has expanded dramatically, while wages and income have remained stagnant. This debt, however, was not accumulated evenly across the income distribution. Barry Cynamon of the Federal Reserve Bank of St. Louis and Steven Fazzari of Washington University in St. Louis show that the vast majority was concentrated among households in the bottom 95 percent of the income distribution.
This is not just a story about debt and inequality, but one with much greater consequences for overall economic stability. Amir Sufi at the University of Chicago and Atif Mian at Princeton University demonstrate that it was exactly this unequal distribution of household debt which helped spark the housing and finance crises that led to the Great Recession of 2007-2009. Between 2002 and 2005, mortgage debt and household income became negatively correlated, leading to expanded debt among those whose incomes were declining.
What happened next is familiar to us all: home foreclosures piled up, and those directly and indirectly affected by falling housing prices cut back sharply on spending. This drop in consumption was not evenly distributed. Sufi and Mian show that while national overall consumption fell by about five percent in the United States, the hardest-hit counties saw consumer spending drop by almost 20 percent. The vast majority of these counties were comprised of low-income homeowners whose wealth was almost entirely tied up in home equity.
In order to better understand the implications of these recent patterns in private consumption and debt accumulation, the Washington Center for Equitable Growth awarded one of its inaugural grants to Will Dobbie, assistant professor of economics at Princeton University. His grant proposal posits that research and evidence from the Great Depression of the 1930s shows that debt forgiveness can help mitigate the most severe effects of a deep recession, especially when targeted at the hardest hit regions. Despite the historical evidence on the efficacy of debt forgiveness as an effective policy lever, little is known about the modern-day effects of debt forgiveness on either the debtors themselves or the economy as a whole.
Dobbie will study the effects of debt forgiveness since 2001. First, he will explore the role of non-profit credit counseling agencies that offer debt management plans to help debtors fully repay their debt within three to five years after negotiating creditor concessions on interest rates and fees. Second, he will look at for-profit debt settlement companies, which for a fee negotiate with a debtor’s creditors to settle the debt for a fraction of the balance. In both cases, Dobbie will examine the outcomes for debtors and their subsequent financial health, advancing our knowledge on the effectiveness of debt forgiveness programs. Identifying the best ways to reduce household debt may help policymakers advance programs targeted at those that need them most, especially lower income families.
More broadly, Dobbie’s research will help policymakers understand the implications of personal debt accumulation for an individual’s financial health, and the health of the overall economy. Household debt was a primary cause of the Great Recession and recent research suggests that the unequal debt overhang among homeowners is one reason that subsequent economic growth has remained tepid. Developing a better understanding of the effects of individual debt forgiveness could provide an additional tool to prevent future recessions and encourage more robust growth.
Things to Read on the Morning of November 6, 2014
Must- and Shall-Reads:
- : To seize future, state must seize innovation
- : EconoSpeak: Public Works, Economic Stabilization and Cost-Benefit Sophistry
- : Wealth Inequality and Savings
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: The Consequences of Mortgage Credit Expansion: Evidence from the U.S. Mortgage Default Crisis: “The sharp increase in mortgage defaults in 2007 is significantly amplified in subprime ZIP codes, or ZIP codes with a disproportionately large share of subprime borrowers as of 1996. Prior to the default crisis, these subprime ZIP codes experience an unprecedented relative growth in mortgage credit. The expansion in mortgage credit from 2002 to 2005 to subprime ZIP codes occurs despite sharply declining relative (and in some cases absolute) income growth in these neighborhoods. In fact, 2002 to 2005 is the only period in the past eighteen years in which income and mortgage credit growth are negatively correlated. We show that the expansion in mortgage credit to subprime ZIP codes and its dissociation from income growth is closely correlated with the increase in securitization of subprime mortgages.” -
: Japan on the Brink: “Japan’s current plan to hike consumption taxes a second time… has become… a sort of Rubicon for policy. And let me admit that people I respect–like Adam Posen, and some officials at international organizations–believe that Abe should go through with the hike. But I strongly disagree…. Right now, Japan is struggling to escape from a deflationary trap; it desperately needs to convince the private sector that from here on out prices will rise…. The pro-tax-hike side worries that if Japan doesn’t go through with the increase, it will lose fiscal credibility and… the bond vigilantes will attack. Why don’t I share that view? Partly because I don’t see how this supposed crisis of confidence is supposed to work…. When a country borrows in its own currency and doesn’t face inflationary pressure (quite the contrary), it’s very hard to see how a Greek-style crisis is even possible. Short-term interest rates are controlled by the Bank of Japan; long-term rates mainly reflect expected short rates. Yes, investors could push the yen down, but that would be a good thing from Japan’s point of view. Posen says stocks could crash, but I guess I don’t see why if interest rates stay low and corporate Japan becomes more competitive thanks to a weaker yen. Seriously: tell me how this is supposed to work… [how a] fear that Japan might eventually monetize some of its debt–isn’t actually a positive development. Meanwhile, it seems to me that Japan should be very, very afraid of losing momentum in the fight against deflation…. Could I be wrong?… Of course…. But it’s all about weighing the risks. Right now, the risk of losing anti-deflation credibility looks much worse than the risk of losing fiscal credibility. Please, don’t hike those taxes!” -
: Worthwhile Canadian Initiative: Neo-Fisherites and the Scandinavian Flick: “If you look at Sweden, reality just confirmed that beloved economic theory. The Riksbank raised interest rates because it was scared that low interest rates would cause financial instability. Lars Svensson resigned in protest. Then inflation fell, and the Riksbank needed to cut interest rates even lower than before…. If you don’t know how to drive a car, and you don’t even have a clue whether you turn the steering wheel clockwise or counter-clockwise if you want to turn right, one good strategy is to borrow a car, and a wide open field, and experiment. Make a random turn of the wheel, and see what happens. The recent data point in Sweden was a natural experiment like that…. Theory says, and the data confirm, and the advice of experienced practitioners confirms, that if it wants to raise inflation the central bank should first lower interest rates. Then, when inflation and expected inflation starts to rise, it can raise interest rates, higher than they were before. Then, and only then, does the Fisher effect kick in…. That is the Scandinavian flick we saw recently… the wrong way round…. Figuring out the intuition behind John Cochrane’s paper, to see what was really going on in his model, really drained me. Do I really have to wade through that Stephanie Schmidt-Grohe and Martin Uribe paper too, and reverse-engineer their result as well? I’m too old for this. Don’t any of you young whippersnappers have an economic intuition? Do you all get snowed by every fancy-mathy paper that comes along? I expect I will have to. Pray for me.” -
: Millions More Votes Were Cast For Democrats In The Incoming Senate Than For Republicans: “When the new, GOP-controlled Senate opens its first session next January, it will be strikingly unrepresentative of the voters who elected its members… millions more Americans actually cast a vote for a Democratic Senate candidate than voted for a Republican candidate during the three election cycles that built the incoming Senate…. Republican Senate candidates outperformed Democrats by 2,733,121 votes in 2010, while Democrats outperformed Republicans by a much larger 10,867,709 votes in 2012…. [Our estimates] as of 9 a.m. Wednesday morning, was a total of 22,524,388 votes cast for Republicans and 19,594,164… in the 2014 cycle…. When the results from all three elections are combined, a total of 5,204,364 more votes were cast for Democrats than Republicans…” -
: 2015 Rate Hike ‘Inappropriate’ : “[He] said it would be ‘inappropriate’ for the Fed to lift rates at any point in 2015 as PCE, the central bank’s measure of inflation, is unlikely to reach 2 per cent until 2018…. He said that inflation below 2 per cent was ‘just as much of a problem’ as inflation above that level, adding that the Fed should clarify that its inflation objective is symmetric…. Traders currently bet the Fed will lift rates at its September meeting, according to Fed Funds Futures contracts analysed by Bloomberg.”
Should Be Aware of:
- California Weather Blog
- : What has been the best corporate Darwin Award? A decision made by a company that basically killed the business
- : A Rudderless Campaign Promises 2 More Years of Trench Warfare | Mother Jones
- : Bell Tolls for Obama Ahead of 2016
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: Jung Hyun Choi and I write about Income Inequality across Cities: “Negative labor market conditions, concentration of skilled workers, and racial segregation are positively associated with the level of income inequality. The level of inequality in these cites also tends to rise grow at a faster pace. While differences in the minimum wage level do not seem to have any association with income inequality across cities, we find some evidence that differences in unemployment insurance benefits and greater unionization lowered increases in the income inequality.” -
: Failed by #EconomicGrowth?: “Before 1850, both [China and Japan] were ruled by stable dictators[hips] who relied on bureaucrats to govern their domains…. In a large domain, the ruler’s inability to closely monitor bureaucrats creates opportunities for the bureaucrats to exploit taxpayers. To prevent overexploitation, the ruler has to keep taxes low and government small. Our dynamic model shows that while economic expansion improves the ruler’s finances in a small domain, it could lead to lower tax revenues in a large domain as it exacerbates bureaucratic expropriation…. We find that the state taxed less and provided fewer local public goods per capita in China than in Japan. Furthermore, while the Tokugawa shogunate’s tax revenue grew in tandem with demographic trends, Qing China underwent fiscal contraction after 1750 despite demographic expansion. We conjecture that a greater state capacity might have prepared Japan better for the transition from stagnation to growth…” -
: “What this narrative does not explain, however, is why China pursued such an inefficient mode of fiscal management. Given the challenges of graft and the fear of revolt, Sng and Moriguchi assume that it was the most rational or “optimal” course. The authors point to but dismiss lightly the question posed by Qing historians that the goals of the late imperial Confucian state might not have been compatible with “rational” state expansion. In other words, rather than fearing peasant revolt, the choice of tax rate might have to do with ideological reasons. Similarly, the idea that the Japanese state shared a “Confucian” outlook (p4) is overly simplistic, especially as consistently high levels of taxation in Tokugawa Japan undermine the idea that Tokugawa Japan was a “benevolent” state…”
Morning Must-Read: Atif Mian and Amir Sufi: The Consequences of Mortgage Credit Expansion
…is significantly amplified in subprime ZIP codes, or ZIP codes with a disproportionately large share of subprime borrowers as of 1996. Prior to the default crisis, these subprime ZIP codes experience an unprecedented relative growth in mortgage credit. The expansion in mortgage credit from 2002 to 2005 to subprime ZIP codes occurs despite sharply declining relative (and in some cases absolute) income growth in these neighborhoods. In fact, 2002 to 2005 is the only period in the past eighteen years in which income and mortgage credit growth are negatively correlated. We show that the expansion in mortgage credit to subprime ZIP codes and its dissociation from income growth is closely correlated with the increase in securitization of subprime mortgages.
Blog You Need to Read: Tim Duy’s Fed Watch: Daily Focus
As all of you know by now, I am a big fan of Tim Duy of the University of Oregon and his Fed Watch. Here is a sample–ten very useful and informative takes from the past half-year or so:
- Another Kocherlakota Dissent – Tim Duy’s Fed Watch
- FOMC Recap – Tim Duy’s Fed Watch
- FOMC Meeting – Tim Duy’s Fed Watch
- The Labor Market Conditions Index: Use With Care – Tim Duy’s Fed Watch
- Is There a Wage Growth Puzzle? – Tim Duy’s Fed Watch
- Fisher on Wages – Tim Duy’s Fed Watch
- QEInfinity Not – Tim Duy’s Fed Watch
- Inflation Hysteria – Tim Duy’s Fed Watch
- Policy Induced Mediocrity? – Tim Duy’s Fed Watch
- Dudley Revisits Exit Strategy – Tim Duy’s Fed Watch
Always judicious, always giving a fair shake to all the currents of thought in the Federal Reserve, to the data, and to the live and serious models of how the economy works.
Read Tim Duy, and you have a sophisticated, broad, and truly balanced understanding of what the Federal Reserve is thinking, what it is doing, why it is doing it, and what the likely outcomes of its actions are. That is a package that is very hard to find anyplace else.
It still surprises me that Tim Duy does not get significantly more airplay in the general conversational mix than he does…
Who Really Thinks That Japan Is Argentina?: Daily Focus
…has become… a sort of Rubicon for policy. And let me admit that people I respect–like Adam Posen, and some officials at international organizations–believe that Abe should go through with the hike. But I strongly disagree…. Right now, Japan is struggling to escape from a deflationary trap; it desperately needs to convince the private sector that from here on out prices will rise…. The pro-tax-hike side worries that if Japan doesn’t go through with the increase, it will lose fiscal credibility and… the bond vigilantes will attack. Why don’t I share that view? Partly because I don’t see how this supposed crisis of confidence is supposed to work…. When a country borrows in its own currency and doesn’t face inflationary pressure (quite the contrary), it’s very hard to see how a Greek-style crisis is even possible. Short-term interest rates are controlled by the Bank of Japan; long-term rates mainly reflect expected short rates. Yes, investors could push the yen down, but that would be a good thing from Japan’s point of view. Posen says stocks could crash, but I guess I don’t see why if interest rates stay low and corporate Japan becomes more competitive thanks to a weaker yen. Seriously: tell me how this is supposed to work… [how a] fear that Japan might eventually monetize some of its debt–isn’t actually a positive development. Meanwhile, it seems to me that Japan should be very, very afraid of losing momentum in the fight against deflation…. Could I be wrong?… Of course…. But it’s all about weighing the risks. Right now, the risk of losing anti-deflation credibility looks much worse than the risk of losing fiscal credibility. Please, don’t hike those taxes!
I get that part of the argument is that Japan can hit the same nominal GDP growth target by pairing a looser monetary with a tighter fiscal policy, and should do so. And to the extent that that is what is at issue–a call for fiscal tightening coupled with even more aggressive monetary loosening to hit the same nominal GDP growth target, and that what is being advocated is not just an increase in taxes but an increase in taxes coupled with full monetary offset in the form of additional monetary goosing, I get the argument. I even agree with it.
But to the extent that it is more than that…
The basic model of the taxmongers is, I think, the following:
- E(π) = π + δ(rD – σ) :: Inflation Expectations
- π = E(π) + β(u* – u) :: Phillips Curve
- r = r* + γ(u – u) + θ(π – π) :: Monetary Policy
That is:
-
Inflation Expectations: Expected inflation E(π) is equal to current inflation π plus some parameter times the difference between debt amortization rD and the expected primary surplus of the government σ.
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Phillips Curve: Current inflation π is equal to expected inflation E(π) + a parameter times the difference between the natural rate of unemployment and the actual rate of unemployment.
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Monetary Policy: The higher either the gap between the current inflation rate π and the central bank’s target inflation rate π* or the higher the required gap between the natural rate of unemployment u* and the current unemployment rate u, the more the central bank must raise the interest rate r over the Wicksellian natural rate r* in order to achieve its monetary policy target–and then the higher is required debt amortization rD.
It then follows that the unemployment rate and the real interest rate will both be increasing functions of the fiscal financing gap rD-σ:
- u = u* + (δ/β)(rD – σ)
- r = r* + (γδ/β)(rD – σ) + θ(π – π*)
Taking differentials in response to a shock dr* to the Wicksellian natural rate r*, we get:
- du = D(δ/β)dr
- dr = dr* + D(γδ/β)dr
- du = [(δ/β)D/(1 – D(γδ/β))]dr*
Which tells us that if the debt D grows so large that Dγδ/β approaches one, even a very small adverse shock to the Wicksellian natural rate of interest dr* could cause the unemployment rate u to explode–unless the central bank abandons its monetary policy of inflation control, that is, of non-permanent-monetization of the debt.
For a country that does not borrow in its own currency, it is very easy to see why it must seek to avoid even a whisper of debt monetization. Such a whisper is an upward shock to E(π), and to the extent that is transmitted through to the current inflation rate such transmission produces an immediate jump in required debt service which makes the situation much worse.
But in a country that does borrow in its own currency and does control its own interest rates debt monetization and a resulting burst of inflation is no biggie: some of the debt is no-longer interest-bearing D that must be amortized but is money M. And to the extent that the rest of the debt has a duration greater than zero the increase in the price level reduces the value of the debt and thus the seriousness of the debt overhang problem.
Yes: I realize that this is arcana imperii. I do realize that I am not supposed to point out that reserve-currency issuing sovereigns with exorbitant privilege that thus control their own interest rates and borrow in their own currencies have a degree of freedom to use inflation as a tool of debt management that the Argentinas of the world do not. But an upward shift in expected inflation is what we are trying to generate here and now in Japan. And such an upward shift is only to be feared if Japan pretends that it is Argentina, and that it thus has no ability to monetize any of its debt.
If you are Argentina, then yes, sure: as Dγδ/β approaches one you get into the territory where a small upward shock to interest rates will cause either a Great Depression or force a price-spiral that, absent a currency reform, turns into hyperinflation.
But who thinks that Japan is Argentina?
Evening Must-Read: Paul Krugman: Japan on the Brink
…has become… a sort of Rubicon for policy. And let me admit that people I respect–like Adam Posen, and some officials at international organizations–believe that Abe should go through with the hike. But I strongly disagree…. Right now, Japan is struggling to escape from a deflationary trap; it desperately needs to convince the private sector that from here on out prices will rise…. The pro-tax-hike side worries that if Japan doesn’t go through with the increase, it will lose fiscal credibility and… the bond vigilantes will attack. Why don’t I share that view? Partly because I don’t see how this supposed crisis of confidence is supposed to work…. When a country borrows in its own currency and doesn’t face inflationary pressure (quite the contrary), it’s very hard to see how a Greek-style crisis is even possible. Short-term interest rates are controlled by the Bank of Japan; long-term rates mainly reflect expected short rates. Yes, investors could push the yen down, but that would be a good thing from Japan’s point of view. Posen says stocks could crash, but I guess I don’t see why if interest rates stay low and corporate Japan becomes more competitive thanks to a weaker yen. Seriously: tell me how this is supposed to work… [how a] fear that Japan might eventually monetize some of its debt–isn’t actually a positive development. Meanwhile, it seems to me that Japan should be very, very afraid of losing momentum in the fight against deflation…. Could I be wrong?… Of course…. But it’s all about weighing the risks. Right now, the risk of losing anti-deflation credibility looks much worse than the risk of losing fiscal credibility. Please, don’t hike those taxes!
Evening Must-Read: Nick Rowe Gets Tired of Whack-a-Mole…
…reality just confirmed that beloved economic theory. The Riksbank raised interest rates because it was scared that low interest rates would cause financial instability. Lars Svensson resigned in protest. Then inflation fell, and the Riksbank needed to cut interest rates even lower than before…. If you don’t know how to drive a car, and you don’t even have a clue whether you turn the steering wheel clockwise or counter-clockwise if you want to turn right, one good strategy is to borrow a car, and a wide open field, and experiment. Make a random turn of the wheel, and see what happens. The recent data point in Sweden was a natural experiment like that…. Theory says, and the data confirm, and the advice of experienced practitioners confirms, that if it wants to raise inflation the central bank should first lower interest rates. Then, when inflation and expected inflation starts to rise, it can raise interest rates, higher than they were before. Then, and only then, does the Fisher effect kick in…. That is the Scandinavian flick we saw recently… the wrong way round…. Figuring out the intuition behind John Cochrane’s paper, to see what was really going on in his model, really drained me. Do I really have to wade through that Stephanie Schmidt-Grohe and Martin Uribe paper too, and reverse-engineer their result as well? I’m too old for this. Don’t any of you young whippersnappers have an economic intuition? Do you all get snowed by every fancy-mathy paper that comes along? I expect I will have to. Pray for me.