Category: Equitablog

Back before 2008, we neoclassical new Keynesian-new monetarist types were highly confident that the U.S. macroeconomy as then constituted had very powerful stabilizing forces built into it: if the unemployment rate rose above the so-called natural rate of unemployment, the NAIRU, it would within a very few years return to normal.

This is why we were confident:

1948-2014: Share of Deviation of Unemployment from Trend Erased After…

...1 Yr    ...2 Yrs    ...3 Yrs    With NAIRU trend...

33.7%      67.4%       88.3%       Cubic
32.4%      63.6%       84.1%       Quadratic
31.8%      61.5%       80.5%       Linear
27.8%      52.5%       69.2%       No Trend

Standard errors? Bootstrapping the three-year forecast cubic-trend model with 10,000 replications produced a mean estimated coefficient of 84.3% with a standard error of the estimate of 17.4%-points–half again as large as the OLS estimated standard error.

We were wrong.

If you have R, and wish to play with the Rmarkdown files, take a look:

• RMarkdown File: https://www.dropbox.com/s/egv37ytaz4lyc2h/2014-09-29%20Unemployment%20Rate%20Mean%20Reversion.Rmd?dl=0
• Output File: https://www.dropbox.com/s/q11gbj64u2f31m9/2014-09-29_Unemployment_Rate_Mean_Reversion.html?dl=0
• RMarkdown File: https://www.dropbox.com/s/uffbtork0dre3ku/2014-09-29_Unemployment_Rate_Mean_Reversion_Simple_Bootstrap.Rmd?dl=0
• Output File: https://www.dropbox.com/s/ztw7kjve1ia98gt/2014-09-29_Unemployment_Rate_Mean_Reversion_Simple_Bootstrap.html?dl=0

Larry Elliott: IMF warns period of ultra-low interest rates poses fresh financial crisis threat: “The Washington-based IMF said…

…that… the risks to stability… c[o]me from the… shadow banking system… hedge funds, money market funds and investment banks that do not take deposits from the public. José Viñals, the IMF’s financial counsellor, said:

Policymakers are facing a new global imbalance: not enough economic risk-taking in support of growth, but increasing excesses in financial risk-taking posing stability challenges…. Risks are shifting to the shadow banking system in the form of rising market and liquidity risks. If left unaddressed, these risks could compromise global financial stability.

The stability report said low interest rates were “critical” in supporting the economy because they encouraged consumers to spend, and businesses to hire and invest. But it noted that loose monetary policies also prompted investment in high-yield but risky assets and for investors to take bigger bets. One concern is that much of the high-risk investment has taken place in emerging markets, leaving them vulnerable to rising US interest rates…. The IMF said there was a trade-off between the upside economic benefits of low interest rates and the money creation process known as quantitative easing and the downside financial stability risks… developments in high-yielding corporate bonds were “worrisome”, that share prices in some western countries were high by historical norms, and that there were pockets of real estate over-valuation…

I have come to the conclusion that those who say that quantitative easing has increased systemic financial-market risks have simply not thought hard enough about what quantitative easing is. In quantitative easing the central bank takes duration risk off of the private sector’s balance sheet and onto the governments, that is, the taxpayers’. The ratio of risk to be borne to private-sector risk-bearing capacity falls. The presumption is that this makes financial markets less, not more, vulnerable to systemic risk. You could tell some kind of complex contrarian story with demand and supply curves that slope in non-obvious ways. But none of those who say that quantitative easing increases systemic risk make such arguments–and if they understood quantitative easing properly, they would understand that they need to and feel impelled to do so.

The argument that ultra-low interest rates and the anticipated continuation of ultra-low interest rates for a considerable time period raises systemic financial risks is less mired in the, well, mire. But it, too, is not obvious. An economy sinks into depression when households, savers, and businesses in aggregate believe that they are short of the assets they need to hold to ensure liquidity–that after subtracting off assets they are holding as savings vehicles they do not have enough cash and enough safe nominal assets that could be pledged to immediately raise cash. As a result, the aggregate of households, savers, and businesses try to cut their spending below their income in order to build up their liquid cash and safe collateral balances; but since my income is nothing more than your spending, they fail and so production, income, and spending fall until the private sector finds itself so poor that it no longer seeks to build up its liquid cash and safe collateral balances.

In such a situation the government, by trading its cash and its safe collateral liabilities for risky financial assets and four currently-produced goods and services both:

1. creates more of what the private sector wants to hold, and so reduces or eliminates the gap between current and desired holdings of liquid cash and safe collateral.

2. lowers interest rates and so increases the value of the future relative to the present, providing a direct financial incentive both to spend now on the creation of long-duration real assets and to spend now out of what are now more valuable anticipations of future income.

On the one hand, higher asset valuations and higher levels of production and income greatly reduce the risks associated with financial assets backed by real wealth of one form or another. On the other hand, the tilting of the intertemporal relative price structure greatly increases the incentive to create long-duration financial assets–which will inherently be speculative, and some of which will partake to some degree of the unhedged out-of-the-money put or even the Ponzi nature. Which of these effects will be larger? For small reductions in interest rates, the first-order effect on the value of existing collateral assets in making finance safer will outweigh the second-order creation of new long-duration assets in making finance riskier. To the extent that prudential regulation is effective–or even exists–the range over which reductions in interest rates will improve stability is larger. To the extent that the economy is already flush with long-duration financial assets–which it is–the range over which reductions in interest rates will improve stability is larger.

The first-class study of this I know finds no evidence of the IMF’s contention that policies of ultra-low interest rates have laid the foundations for increased risks of systemic financial instability in the United States. Outside the United States? Yes, times of low interest rates in the core are times of opportunity–cheap financing is available to finance economic development–but also times of danger–are their financial markets robust enough to control and manage the hot-money fluctuations?–in the periphery. But how much weight does the argument that prudential policy in the periphery may go wrong have in militating against policies that–correctly–aim at appropriate internal balance in the core?

I am now more inclined to view worries that ultra-low interest rate and quantitative easing policies raise risks of future financial instability as the last-gasp argument of the austerians–as one more attempt to find an argument, any argument, to justify universal bankruptcy and the war on the Keynesian Mammon of Unrighteousness.

Peter Piot: ‘In 1976 I discovered Ebola–now I fear an unimaginable tragedy’: “I still remember exactly…

…One day in September, a pilot from Sabena Airlines brought us a shiny blue Thermos and a letter from a doctor in Kinshasa in what was then Zaire. In the Thermos, he wrote, there was a blood sample from a Belgian nun who had recently fallen ill from a mysterious sickness in Yambuku, a remote village in the northern part of the country. He asked us to test the sample for yellow fever. We had no idea how dangerous the virus was. And there were no high-security labs in Belgium. We just wore our white lab coats and protective gloves. When we opened the Thermos, the ice inside had largely melted and one of the vials had broken. Blood and glass shards were floating in the ice water. We fished the other, intact, test tube out of the slop and began examining the blood for pathogens, using the methods that were standard at the time…

The Bundesbank’s Jens Weidmann appears to have no clue that the ECB (and thus the Bundesbank) is failing in its mission to stabilize inflation at a level “near to but below 2%/year”, and no desire to actually have it accomplish its assigned mission:

Brian Blackstone and Hans Bentzien: Bundesbank’s Weidmann Criticizes ECB’s Stimulus Measures: “German Bundesbank President Jens Weidmann criticized the European Central Bank’s decision…

…to buy private-sector bonds and signaled his fierce opposition to purchasing government bonds, underscoring his reluctance to back additional stimulus measures to combat weakness in the eurozone economy. Mr. Weidmann said he stands by the conservative principles that have characterized the Bundesbank throughout its nearly 60-year history: keeping inflation low; protecting the central bank’s balance sheet from risks and strict separation from the financial needs of governments…. Mr. Weidmann said he is aware of the risks of too-low inflation…. However, ‘the trough of inflation should soon be behind us’, Mr. Weidmann said…. He was similarly skeptical of fiscal stimulus, despite low government borrowing costs…. ‘The cyclical situation and outlook do not require fiscal stimulus’ in Germany, he said…. ‘The concept of an independent central bank clearly focused on price stability is neither old-fashioned nor outdated’, he said. ‘It is about not falling into the trap of “This time is different”‘.

Must- and Shall-Reads:

• Jérémie Cohen-Setton: The Fed and the Secular Stagnation Hypothesis
• Ian Millhiser: The Glaring Falsehood That Could Steal Health Care Away From Millions Of Americans
• Jamie Condliffe: Earth Has Been Getting Warmer Way Faster Than We Thought
• Sarah Kliff: “CHOICE Project’s teenage participants had significantly lower abortion and birth rates than women nationwide. They use better contraceptives, too…. There’s actually a financial challenge for clinics to offer the most effective birth control. And you need a clinic to be stable…. Clinics have to be okay when teens are half an hour late, and not cancel their appointment. The idea is really taking down any barriers that exist right now. I’m hoping the momentum builds enough where people start chipping away at these barriers.”
• Hefei Wen et al.: The Effect of Substance Use Disorder Treatment Use on Crime: Evidence from Public Insurance Expansions and Health Insurance Parity Mandates
• Paul Krugman: Voodoo Economics, the Next Generation

1. Roger Farmer: NAIRU theory–closer to religion than science: “According to the NRH, unemployment differs from its natural rate only if expected inflation differs from actual inflation…. The probability that average expected inflation over a decade will be different from average actual inflation should be small. If the NRH and rational expectations are both true simultaneously, a plot of decade averages of inflation against unemployment should
   reveal a vertical line at the natural rate of unemployment…. This prediction fails dramatically…. Defenders of the Natural Rate Hypothesis might choose to respond to these empirical findings by arguing that the natural rate of unemployment is time varying. But I am unaware of any theory which provides us, in advance, with an explanation of how the natural rate of unemployment varies over time. In the absence of such a theory the NRH has no predictive content. A theory like this, which cannot be falsified by any set of observations, is closer to religion than science.”

2. Mohamed El-Erian: US midterm elections offer limited prospect for economic change: “The main question is not whether the midterms will change the gridlock in Washington that undermines economic growth, accentuates inequalities, and holds back prosperity; it is whether companies and individuals can decouple even more forcefully from yet another ‘do-little’ Congress…. There is little chance of change in the polarisation and dysfunction paralysing Congress…. The fiscal stance would not be altered to provide for higher and better balanced aggregate demand; supply responsiveness would not be enhanced by stepped-up investments in infrastructure, education, labour market strengthening and other areas that improve productivity; medium-term operational uncertainty would not be reduced by greater clarity on corporate tax reform; and damaging debt overhangs would not be lifted…. For stock markets to continue to prosper, the private sector would have to decouple even more from Washington…. It would require much bigger emphasis on longer-term investments in areas that, notwithstanding the continued shortfalls in Congress, unleash underused resources and expand longer-term potential. And the scale and scope would need to validate the current level of excessive risk-taking by financial markets lest that, in itself, becomes a consequential headwind to economic growth and stability…”

3. Tim Duy: Is There a Wage Growth Puzzle?: “It would appear that in the face of severe contractions, wage adjustment is slow. Now consider the 1985-1990 period… wage growth is stagnant until unemployment moves below 6%…. Thus, it is premature to believe that there has been a breakdown in this relationship. So far, the response of wages is exactly what you should have expected in light of the 1980’s dynamics…. After 1992, wage growth tends to move sideways until unemployment sinks below 6%…. Oh–and real wage growth has reverted to the pre-Great Recession trend–pretty much exactly where you would expect it to be given the level of unemployment. Honestly, this one surprised me. Which suggests that labor market healing has progressed much further than many progressives would like to admit. Many conservatives as well…. Bottom Line: Be cautious in assuming that this time is different. The unemployment and wage growth dynamics to date are actually very similar to what we have seen in the past. Low wage growth to date is not the ‘smoking gun’ of proof of the importance of underemployment measures. There very well may have been much more labor market healing that many are willing to accept, even many FOMC members. The implications for monetary policy are straightforward–it suggests the risk leans toward tighter than anticipated policy.”

4. Alessandro Speciale: German Factory Orders Slump Most Since 2009: “Deteriorating confidence is undermining a rebound in Germany’s economy from a second-quarter slump. The 18-nation euro region is struggling to sustain its recovery amid rising political tension with Russia over its support of separatists in Ukraine and inflation that’s running at a fraction of the European Central Bank’s definition of price stability. ‘Geopolitical risks, especially the crisis in Eastern Ukraine, have made companies cautious about their investment plans, despite very favorable fundamental and funding conditions’, said Christian Schulz, senior economist at Berenberg Bank in London. ‘Once these uncertainties fade confidence and thus investment should rebound’…”

5. Robert Waldmann: Phillips curves with Anchored Expectations: “I will assume that unemployment is a function of actual inflation minus expected inflation. I will also assume that people are smart enough that no policy will cause them to make forecast errors of the same sign period after period after period…. I will assume that perfect inflation forecasting causes unemployment to be 5%… [and] unemployment is linear in the inflation expectations error…. Under bounded rationality with hypothesis testing…. Forecasting rules are ordered from a first rule to a second, etc. When agents use rule n they also test the null that rule n gives optimal forecasts against the alternative that rule n+1 gives better forecasts. They switch to rule n+1 if the null is rejected at the 5% level…. I will assume that rules are also ordered so if rule n gives persistent underestimates of future inflation, rule n+1 gives higher forecasts…. Learning about the Fed Open Market Committee restarts each time a new Fed chairman is appointed…. The data used to test the current rule against the next one are only those accumulated with the current chairman… [who] are replaced at known fixed intervals…’

6. Simon Wren-Lewis: More Asymmetries: Is Keynesian Economics Left-Wing?: “I’m often perplexed by those who dispute Keynesian ideas…. A whole revolution in macroeconomic theory was based around a movement that wanted to overthrow Keynesian ideas…. The people who built these models did not describe them as assuming monetary policy worked perfectly: instead they said it was all about assuming markets worked. As a description this was at best opaque and at worst a deliberate deception. So why is there this desire to deny the importance of Keynesian theory coming from the political right?… Monetary policy is state intervention…. To someone of a neoliberal or ordoliberal persuasion they are discomforting. At the macroeconomic level, things only work well because of state intervention. This was so discomforting that New Classical economists attempted to create an alternative theory of business cycles where booms and recessions were nothing to be concerned about, but just the optimal response of agents to exogenous shocks…. Keynesian theory is not left wing, because… it is just about how the macroeconomy works. On the other hand anti-Keynesian views are often politically motivated, because the pivotal role the state plays in managing the macroeconomy does not fit the ideology. Is this asymmetry odd? I do not think so–just think about the debate over climate change…. To claim that the majority of anti-Keynesian views were innocent of ideological preference would be like–well like trying to pretend that monetary policy has no role in stabilising the business cycle…”

7. Paul Krugman: Why Weren’t Alarm Bells Ringing?: “Focusing, as Martin Wolf does, on the measurable factors–the ‘shifts’–that increased our vulnerability to crisis is incomplete…. Rising… debt… shadow banking… international imbalances… helped set the stage…. But intellectual shifts–the way economists and policymakers unlearned the hard-won lessons of the Great Depression, the return to pre-Keynesian fallacies and prejudices–arguably played an equally large part…. Say’s Law–the false claim that income is automatically spent–made a comeback. So, incredibly, did liquidationism, the view that any effort to ameliorate the pain of depression would postpone needed adjustment…. When policymakers rejected orthodox economics, what they did by and large was to reject it in favor of doctrines like ‘expansionary austerity’…. And this makes me a bit skeptical about Wolf’s proposals…. The Shifts and the Shocks is an excellent survey of how we arrived at the mess we’re in, and Wolf’s substantive proposals… wide deposit insurance, higher inflation so that the burden of adjustment is better share… are all worthy and laudable. But the gods themselves contend in vain against stupidity. What are the odds that financial reformers can do better?”

8. Thomas Piketty, Heather Boushey, Anwar Shaikh:

Should Be Aware of:

• John Scalzi: Aiming for the Market
• Serena Ryder
• Alex O’Brien: Retired NSA Technical Director William Binney Explains Snowden Docs
• Frank Bruni: The Catholic Church’s Gay Obsession
• Noah Smith: On “Asian Values”
• David Kravets: At 650% interest, that online payday loan is a steal

1. Charlie Stross: Cameron v Churchill: “The European Convention on Human Rights was intended to enshrine the UN Universal Declaration of Human Rights in law for Europe. The UN UDHR was passed by the UN General Assembly in December 1948 as a response to the horrors of the second world war. In no small part, the ECHR was pushed for by a fellow called Winston Churchill, who said: ‘In the centre of our movement stands the idea of a Charter of Human Rights, guarded by freedom and sustained by law. It is impossible to separate economics and defence from the general political structure. Mutual aid in the economic field and joint military defence must inevitably be accompanied step by step with a parallel policy of closer political unity. It is said with truth that this involves some sacrifice or merger of national sovereignty. But it is also possible and not less agreeable to regard it as the gradual assumption by all the nations concerned of that larger sovereignty which can alone protect their diverse and distinctive customs and characteristics and their national traditions all of which under totalitarian systems, whether Nazi, Fascist, or Communist, would certainly be blotted out for ever.’ So. Conservative-in-name Prime Minister David Cameron today promised to repeal the Human Rights Act, the legislation enshrining in UK law a chunk of supranational legislation put in place by notable former Conservative prime minister Winston Churchill as an anti-totalitarian measure. Coinciding with Home Secretary Theresa May’s attempt at reintroducing a universal surveillance regime of which the Stasi or KGB would have been proud, and her avowed desire to gag unpalatable political views from the media, you’ve got to wonder where all this is intended to go…”

2. Anna Spiegel: Back to Hell: Ray’s Hell-Burger Is Reborn: “‘We’re rolling out the welcome mat for vegetarians’, says Landrum, who’s added a selection of ‘hot and buttered’ grilled cheeses made with brioche Texas toast. Simple, griddled American or more elaborate combinations such as pepper jack, avocado, and charred jalapeños can all be ordered with house-made tomato soup for dunking. Carnivores can always opt to add a slab of bacon or get a sidecar of chili instead of soup.  The good burger news doesn’t stop here. Guests at Ray’s the Steaks can try a new lineup of patties fashioned out of meat specially dry-aged for the dish. The ‘inferno burger’ menu takes on a Dante theme. There’s a good chance you’re going to taste heaven—followed by some level of inner torment—when ordering the ‘third circle’ topped with foie gras, bone marrow, and porcini mushrooms Hell-Burger. 1650 Wilson Blvd., Arlington…”

3. Christopher Mims: Tech World Vexed by Slow Progress on Batteries: “There is no Moore’s law for batteries. That is, while the computing power of microchips doubles every 18 months, the capacity of the batteries on which ever more of our gadgets depend exhibits no such exponential growth. In a good year, the capacity of the best batteries in our mobile phones, tablets and notebook computers—and increasingly, in our cars and household gadgets—increases just a few percent. It turns out that storing energy safely and reliably is hard in a way that miniaturizing circuits is not. A pound of gasoline contains more than 20 times as much energy as a pound of lithium-ion batteries. And then there’s the expense: The battery pack in a Tesla Model S costs approximately $30,000…”

4. Simon Wren-Lewis: More Asymmetries: Is Keynesian Economics Left-Wing?: “In the textbooks it is suggested that Keynesian economics is what happens when ‘prices are sticky’. Sticky prices sound like prices failing to equate supply and demand, which in turn sounds like markets not working. Hence whether you believe in Keynesian theory depends on whether you think markets work, so it obviously maps to a left/right political perspective…. [But] output appears to be influenced by aggregate demand at least in the short run, which is at the heart of what most economists think of as Keynesian theory. So where do sticky prices come in?… [In] an imaginary world where the monetary authority fixes the money supply… [and firms] to stimulate demand for their goods, cut prices… interest rates will fall to encourage people to hold more money…. Lower interest rates provide an incentive to consumers and firms to increase demand, which in turn raises output…. [If] prices adjusted very quickly… [this] mechanism would work very quickly…. If prices were extremely flexible, we could ignore aggregate demand altogether…. Hence aggregate demand matters only if ‘prices are sticky’…. [In] the real world… monetary authorities… fix short term interest rates… are directly in charge of the correction mechanism…. [With] perfect knowledge… they could make sure aggregate demand equalled supply without any need for prices to change at all…. If prices were very flexible but the monetary authority… fail[ed] to stimulate… demand would still matter…. We could re-establish the link between Keynesian theory and price flexibility by assuming the monetary authority follows a rule which would make policy perfect if and only if prices moved very fast, but the key point remains…. Keynesian economics is not left wing, but it is about how the economy actually works, which is why all monetary policymakers use it…”

Paul Krugman: Why Weren’t Alarm Bells Ringing?: “Focusing, as Martin Wolf does, on the measurable factors–the ‘shifts’–that increased our vulnerability to crisis is incomplete….

…Rising… debt… shadow banking… international imbalances… helped set the stage…. But intellectual shifts–the way economists and policymakers unlearned the hard-won lessons of the Great Depression, the return to pre-Keynesian fallacies and prejudices–arguably played an equally large part…. Say’s Law–the false claim that income is automatically spent–made a comeback. So, incredibly, did liquidationism, the view that any effort to ameliorate the pain of depression would postpone needed adjustment…. When policymakers rejected orthodox economics, what they did by and large was to reject it in favor of doctrines like ‘expansionary austerity’…. And this makes me a bit skeptical about Wolf’s proposals…. The Shifts and the Shocks is an excellent survey of how we arrived at the mess we’re in, and Wolf’s substantive proposals… wide deposit insurance, higher inflation so that the burden of adjustment is better share… are all worthy and laudable. But the gods themselves contend in vain against stupidity. What are the odds that financial reformers can do better?

Thomas Piketty, Heather Boushey, Anwar Shaikh:

Simon Wren-Lewis: More Asymmetries: Is Keynesian Economics Left-Wing?: “I’m often perplexed by those who dispute Keynesian ideas….

…A whole revolution in macroeconomic theory was based around a movement that wanted to overthrow Keynesian ideas…. The people who built these models did not describe them as assuming monetary policy worked perfectly: instead they said it was all about assuming markets worked. As a description this was at best opaque and at worst a deliberate deception. So why is there this desire to deny the importance of Keynesian theory coming from the political right?… Monetary policy is state intervention…. To someone of a neoliberal or ordoliberal persuasion they are discomforting. At the macroeconomic level, things only work well because of state intervention. This was so discomforting that New Classical economists attempted to create an alternative theory of business cycles where booms and recessions were nothing to be concerned about, but just the optimal response of agents to exogenous shocks…. Keynesian theory is not left wing, because… it is just about how the macroeconomy works. On the other hand anti-Keynesian views are often politically motivated, because the pivotal role the state plays in managing the macroeconomy does not fit the ideology. Is this asymmetry odd? I do not think so–just think about the debate over climate change…. To claim that the majority of anti-Keynesian views were innocent of ideological preference would be like–well like trying to pretend that monetary policy has no role in stabilising the business cycle…”