Page 136 – Equitable Growth

U.S. tax policy for equitable growth

Posted on June 14, 2018June 14, 2018 by Emilie Openchowski

With the launch of our new website, we are reintroducing visitors to our policy issue areas. Informed by the academic research we fund, these issue areas are critical to our mission of advancing evidence-based ideas that promote strong, stable, and broad-based economic growth. Through the rest of June and early July, our expert staff are publishing posts on our Value Added blog about each of these issue areas, describing the work we do and the issues we seek to address. The following post is about Taxes.

Tax policy is an important tool for improving economic performance and ensuring that the benefits of economic growth are broadly shared. Taxes support the living standards of the American public by providing the revenues necessary to pay for public investment in children, families, and infrastructure, for social insurance and safety net programs, for national defense, and for many other public programs that support our quality of life. Taxes also affect the choices people make in both positive and negative ways and, as a result, influence the level and distribution of income, consumption, wealth, and broader measures of economic well-being.

Equitable Growth’s work on tax policy aims to improve our understanding of the relationships between taxation, inequality, and economic growth to develop the knowledge base that can guide the pursuit of policies that promote strong, stable, and broad-based growth. In this pursuit, economic growth is defined by increases in economic well-being—not only in Gross Domestic Product. Measures of economic well-being reflect both the costs and the benefits of increases in output, while GDP often includes the benefits while ignoring the costs. And they include, to the extent possible, the benefits of public programs.

Central to these efforts is work that provides useful analytic frameworks in which to evaluate the economic effects of changes in tax policy so that policymakers, the public, and the press have the most relevant information available to them in making their decisions. A recent issue brief, “If U.S. tax reform delivers equitable growth, a distribution table will show it,” explains why tax distribution tables can be interpreted as an approximation to the impact of changes in tax law on the well-being of the American public. Combined with an estimate of a proposal’s impact on the deficit, which measures its fiscal sustainability, policymakers have the two key pieces of information they need to make their decisions.

A more recent piece, “Assessing the economic effects of the Tax Cuts and Jobs Act,” explains the relationship between the estimates shown in the distribution tables used to evaluate potential tax legislation before it is enacted and the economic effects that would be observed after such legislation is enacted—and thus also why, in assessing whether the tax legislation enacted last year delivers the benefits proponents promised, the key test is its impact on wage rates and deficits. Of course, in assessing the impact of any piece of enacted legislation, an important challenge will be in determining the counterfactual, or what would have happened had the legislation never been enacted. A recent presentation for the Society of Government Economists, “U.S. Inequality and Recent Tax Changes,” provides back-of-the-envelope estimates of these impacts and highlights the distinction between changes in income and changes in economic well-being.

Equitable Growth also supports original academic research examining the effects of the tax system. Priority questions identified in our 2018 request for proposals included:

How does the tax system affect economic inequality, including inequality in incomes, earnings, consumption, wealth, and broader measures of well-being?
When is there a trade-off between redistribution and productivity?
When and how do market failures create a role for corrective taxes, and how do such taxes affect inequality, living standards, and growth?
How do wealth, wealth transfer, and capital taxes differ in their implications for the level and growth rate of output, the distribution of output, and living standards?

More broadly, Equitable Growth aims to advance the conversation on taxation with new policy options. In “Taxing for Equitable Growth,” Heather Boushey and I identify three priority areas for redesigning the tax system—corrective taxation, the treatment of investment income, and the treatment of domestic business income—in addition to the need for policymakers to raise additional revenues in a progressive manner.

In conversation with Michael Strain

Posted on June 14, 2018September 24, 2018 by Emilie Openchowski

“Equitable Growth in Conversation” is a recurring series where we talk with economists and other social scientists to help us better understand whether and how economic inequality affects economic growth and stability.

In this installment, Equitable Growth’s Executive Director and Chief Economist Heather Boushey talks with Michael R. Strain, the John G. Searle Scholar and the director of economic policy studies at the American Enterprise Institute, about the importance of government data collection for our democracy and our understanding of the U.S. economy over time and into the future.

[Editor’s note: This conversation took place on April 30, 2018.]

Heather Boushey: Michael Strain, thank you so much for being here today. This is just great.

Michael Strain: I’m very happy to be here.

Boushey: I want to get right into the questions I want to ask you today. You write a lot about about government data collection with Diane Schanzenbach, the director of the Institute for Policy Research and Margaret Walker Alexander Professor of Human Development and Social Policy at Northwestern University. And you say that working on data together is a small investment with a big payoff. Can you explain that? What’s the payoff of government data? Who’s using it? What are they getting out of it? Explain to me why you and Diane think it’s a big bang for the buck.

Strain: It’s a big bang for the buck for two reasons. One is the cost of mistakes. Think about what government data are used for by policymakers. The Federal Reserve, for example, looks at information on unemployment, looks at information on price inflation, and then tries to decide what to do with interest rates. Or consider Social Security benefits, which are adjusted by policymakers based on a price index that the government produces. If the price index or if the unemployment rate are measured with a little bit of error, then Social Security benefits could be too low, or they could be too high, or the Fed could tighten too early, or the Fed could tighten too late.

When you consider how large a check the federal government writes for Social Security benefits every month, when you figure how important interest rate decisions are to private businesses, those small errors really add up. And they really result in big expenditures for Social Security, big macroeconomic effects. So, when you compare the cost of producing those statistics to the cost of errors—even small errors—then the cost-benefit really works out such that you want those data to be as accurate as possible.

The other big bang for the buck is that businesses use government data to decide what items to put on the shelves by using information about the demography of their local customer base. Businesses use government data to decide where to open distribution centers, where to open warehouses, and where to open new stores, and where to do all sorts of things. Businesses are just constantly relying on data. So, relative to a lot of things the government does, data are pretty cheap to produce, and we might as well do it right.

Boushey: I understand you wrote that the amount of money that the federal government spends on government statistical agencies is about one-fifth of 1 percent of the federal budget. That’s not a lot. Is that your understanding of what the number is?

Strain: Yes, it’s not a lot.

Boushey: It’s really small. I often think of the weather services, right? All of the data that we have on what’s going on with the weather is coming from government data and satellites. We are getting it through all of these private entities that are, maybe, presenting it in prettier graphics or ways that we can understand, but you need to have that data accurate for us to make good decisions about what to wear in the morning.

Strain: Yes, and that’s a good example of how much government data kind of intersect with our day-to-day lives in ways that we may not even know. A lot of people pull up an app on their phone every morning to see what the weather’s going to be. But not that many people who are doing that really understand that the Federal Statistical System is what’s allowing that information to be possible.

Boushey: So, my next question. Why should this be a government function rather than a private-sector function? After all, the private sector produces a lot of data from the club card at the grocery store or the drug store when it tracks all of your purchases or your bank or whatnot. And there’s some overlap with what private-sector entities do and what government statistical agencies do and what academics do. So, why is it that having government data is so important?

Strain: Certainly, the data revolution from private-sector businesses is great. And all that data is a really important complement to the data that are produced by the government—a positive development for both researchers and businesses especially. But I think looking at data that are generated by private businesses as a complement to government statistics, rather than as a substitute for government statistics, is the right way to look at it.

The data that government produces are designed to be nationally representative. You want to know what the unemployment rate is for the U.S. economy as a whole. You want to know what’s happening to the prices that a representative consumer is facing in the aggregate. That’s not what private businesses are doing. They want to know about their customer base; they want to know about their potential customer base. The data they’re gathering are often gathered as a part of doing business, and so they are just not directly comparable.

In addition, part of the design of some of these government datasets is based on the desire to be able to make comparisons over long periods of time. You want to be able to ask, “What is the median income in 2018?” and then be able to compare that to median income in 1998. And to be able to have that comparison be meaningful, you need to make sure you’re measuring the same thing over time. Private businesses just aren’t in a position to have that as a goal, and that wouldn’t be a good goal for them, for the most part.

So, there are important functions that government data serve that are not well-served by the kind of efforts that private businesses engage in when they’re kind of creating all this data. But, again, they’re complementary. And they’re both important.

Boushey: If the president made you data czar for a day, give me a couple of places where you would focus to make government data collection better, more comprehensive?

Strain: I think the most immediate need right now is making sure that the 2020 decennial census is adequately funded and is as successful as we need it to be, which may seem like a weird answer when you’re thinking about immediate need since it’s now 2018. But it really does take many years of planning and preparation to execute a successful decennial census. The census is not a standard government survey, where you pick 20,000 or 200,000 households. This is an exercise that requires everybody to be counted. If you don’t fill out the form online or fill out the pencil-and-paper form and mail it back in, then the government has to send somebody to your house with a clipboard. That’s the extent to which the government takes this seriously.

And it should be taken seriously because it’s required by the Constitution. It’s how we apportion seats in the U.S. House of Representatives across the states, among other functions. Because it’s an enumeration, because everybody’s counted, the decennial census is used as a benchmark for many, many, many other government data products. And so, if there are errors in the decennial census, we live with those for 10 more years. Because we benchmark other government surveys against the census data, if the census data are wrong, then the benchmark’s wrong—and the other surveys are wrong, too.

So, we have to make sure this is adequately funded. We have to make sure the census has the resources it needs. If part of being a data czar means I get to appoint a head of the Census Bureau, I would do that, too. Because, currently, there is not a head of the Census Bureau.

Boushey: I could not agree with you more that this is just absolutely mission critical. You wrote a piece on this, and in your very first paragraph, you talk about how it’s required by the Constitution, Article I, Section 2.

Strain: That’s right.

Boushey: And that data are used for so many things. How can you know how many people should be in House districts, or other state and local districts, if you don’t have a good count of the people? Every year, hundreds of billions of dollars of federal funding is given to the states based on population. And those population estimates come from the decennial census.

Strain: Even in addition to all of that—which is, obviously, critically important to the functioning of our democracy—there are just all sorts of downstream ramifications to making sure that the 2020 census is as accurate as it can be. And it’s not receiving the amount of attention that I think it should. And in part that’s because it’s two years away, and in Washington anything that’s more than three days away is in the distant future. But this really is such a big undertaking that it really does require years and years of planning.

Boushey: A big part of this undertaking is going out into the field and making sure that the technology works, and that people know how to ask the right questions. But because of funding issues this year, they were supposed to do four tests but they’re only going to do one. Which, as a researcher, makes me a little anxious. And I understand they’re using new technology this year—they’re going totally online.

Strain: That’s one of the reasons why we need those end-to-end tests, to see if people are actually comfortable doing that. If the Census Bureau decides, “OK, this group of people, for whatever reason, are going to be more likely to respond online, so we’re going to send them the online-only version” and half of them don’t respond, then the bureau can’t just say, “Oh, OK, we tried.” The bureau has to send the paper-and-pencil version; it has to send somebody to these people’s houses. And that’s when you start racking up the expenses and the amount of taxpayer dollars you need. If we spend a little more money now, we’ll probably save money on the total cost conducting the census.

Boushey: That’s the second time you’ve mentioned that part of what we’re looking at with the data issues is making smart investments and doing the right thing up front so that we’re not paying more in the end. I think that’s a really important theme. I would also note that the previous time we did the census in 2010, it was in the middle of the Great Recession. And so a lot of people needed jobs, so it was easier, probably, to find census-takers than it would be now, when we’re closer to full employment. I don’t know if they’ll have to pay more for that, but I would imagine that getting people to go out there with pen and paper is going to be more expensive or harder to find people than before.

Strain: Yes, that could be the case.

Boushey: Another thing that could drag down the number of people who are responding is this new addition that the Department of Commerce decided to add, a question asking respondents if they’re citizens. You’ve written that this would damage the accuracy of the census. I want you to walk us through that argument. But first, I would like to preface it with a story about why my housemate in NewYork City in 2000 refused to fill out the census form because he was concerned about privacy. At the time, I was a researcher and I was using census data, so I asked, “What are you talking about? Why are you so anxious about doing this?” He had a college degree, had a good job, was not an immigrant, so there was no reason for him to be afraid, and yet he was. And it really struck me how hard it is to communicate to people that they should hand over their information to the government.

Strain: The best place to start is with what’s actually on the form. It’s very basic information. It’s a very short form, basic questions such as “How many people live in this home? What are their ages? What are their sexes?” Very, very basic stuff that your neighbors probably know about you just by observing you. The point is to count the population and make sure that we know how many people there are in the United States.

Even given how simple and basic that is, every 10 years, members of immigrant communities and members of certain minority communities get a little spooked by the prospect of handing over this basic information to the government—especially when the information is requested in person, which is what happens when you don’t fill out the initial form. And when the Census Bureau was out conducting some interviews trying to prepare for the 2020 census, it discovered that although during a typical year there’s some anxiety those communities, in 2017, there was much, much more anxiety among immigrants and among certain minority communities. It’s not hard to understand why. There’s a lot of really ugly rhetoric coming out of D.C. about immigrants, including from the president of the United States, both after he took office and, of course, while he was was a candidate. And so there’s this kind of atmosphere out there that makes people reluctant to fill out the form.

For people who use government data all the time for their research, that reaction may seem odd. But I think there’s no denying that it’s the case. Add on a really sensitive question about whether you’re a citizen, and the concern that I have—and that many others have—is that that’s going to really spike the anxiety level. Some members of these immigrant communities and these minority communities are already feeling more reluctant to answer the questions, or will answer the questions inadequately out of concern for their privacy, or whatever. But because of the way that immigrants have been discussed by top elected leaders, including the president, it’s understandable why it would be even more of an issue this time around.

Boushey: So, if it does turn out that the citizenship question depresses response rates among certain groups, what are the practical implications?

Strain: Well, it’ll end up costing more money because it means more people have to be hired to go and knock on doors.

Boushey: Last question. One of the things that we do here at Equitable Growth is that we are a grantmaking institution. We’ve funded about 130 scholars nationwide at universities and given away almost $3 million now, over the past almost-five years. As you’re thinking about these issues around data and data collection, what advice would you have for us? Is there any particular issue areas or kinds of data that you think we should be investigating or spending more of our resources to understand or work on?

Strain: We have a statistical system that’s kind of built around a 20th century economy. So, to the extent that you are figuring out ways to update this statistical system to account for the way that we live and work now would be important. But more importantly, to account for the ways that we might live and work 20 years from now, to really have a plan to have statistically valid surveys that capture the information that we want to capture is, I think, a very worthy research program.

Boushey: Thank you. This has been just illuminating. I really appreciate your time.

Strain: Thank you.

Our new website: a note to readers

Posted on June 13, 2018June 13, 2018 by Emilie Openchowski

Welcome to the new Equitable Growth website! We designed the new site to help further our mission of advancing evidence-backed ideas and policies that promote strong, stable, and broad-based economic growth. Please explore and tell us what you think.

Since our founding in 2013, we have funded the work of more than 130 scholars and built a broader network through in-house policy analysis, events, and convenings. By supporting research and bringing scholars and policymakers together to exchange ideas, we have learned a great deal and helped inspire a range of evidence-based policy approaches to addressing economic inequality and boosting broad-based economic growth.

Here is what we know. Strong economic growth was broadly shared in the United States through much of the mid-20th century, though significant disparities across demographic groups remained. But in recent decades, income and wealth inequality have been rising and mobility declining. Indeed, the gap between the wealthy and the rest of society is wider than it has been in nearly a century, and no longer can most children expect a better quality of life than their parents. Moreover, significant disparities across demographic groups, which began to close mid-century, persist today.

Equitable Growth’s new site highlights broad issue areas related to the topics I mentioned above and breaks them down into key areas.

If you are interested in the evidence-based policy analysis that flows from our grant program and in-house research, our Issues section provides information on a host of relevant topics.
If you are interested in original and groundbreaking academic research, you can view our Working Papers series or our Value Added blog, which features commentary and analysis.
If you are a scholar who is interested in applying for support from us, you’ll want to visit our Elevating Research section to learn about our grant program and the resources we offer.

If you’d like to receive updates on our latest research and analysis, please sign up to receive our weekly newsletter and other information. And if you want to know more about our organization, please read who we are and what we’re all about.

Thanks for visiting equitablegrowth.org. We hope you’ll be back.

Best,

Heather Boushey
Executive Director and Chief Economist

Janet Yellen joins Equitable Growth Steering Committee

Posted on June 13, 2018June 14, 2018 by David Evans

Washington, D.C. — The Washington Center for Equitable Growth announced today that former Federal Reserve chair and Council of Economic Advisers chair Janet L. Yellen has joined the organization’s Steering Committee.

Yellen, a professor emeritus at the University of California at Berkeley, served a four-year term as chair of the Board of Governors of the Federal Reserve System that ended in February 2018, and she chaired the White House Council of Economic Advisers from 1997 to 1999. She has also served as vice chair and as a member of the Federal Reserve Board of Governors and as president of the Federal Reserve Bank of San Francisco.

The Washington Center for Equitable Growth is a non-profit research and grantmaking organization dedicated to advancing evidence-backed ideas and policies that promote strong, stable, and broad-based economic growth. Equitable Growth works to build a bridge between academics and policymakers to ensure that research on equitable growth and inequality is relevant, accessible, and informative to the policymaking process. Its Steering Committee, which comprises leading economists and senior policymakers, provides guidance and approves overall direction for the organization.

“There are few economists with the depth of academic and policymaking experience that Janet Yellen possesses,” said Heather Boushey, Equitable Growth’s executive director and chief economist. “She has worked tirelessly, in her research and in her high government positions, to promote strong economic growth that benefits workers and to ensure that the American Dream is within reach for all.

“Moreover, Dr. Yellen personifies a critical element of the Equitable Growth mission. In her career, she has herself been a bridge between the academic research that is so critical to understanding inequality and economic growth and the world of policymaking, where she has sought to address these critical issues. We are fortunate to have the benefit of her guidance.”

Yellen is the Eugene E. and Catherine M. Trefethen Professor Emerita of Business Administration at the University of California at Berkeley and has been a faculty member there since 1980. Currently, she is a Distinguished Fellow in Residence at The Brookings Institution’s Hutchins Center on Fiscal and Monetary Policy. She is a member of the Council on Foreign Relations and the American Academy of Arts and Sciences, and has served as president of the Western Economic Association, vice president of the American Economic Association, and a fellow of the Yale Corporation.

“Equitable Growth is supporting critical research on the channels through which inequality affects economic growth and elevating evidence-based ideas to policymakers,” Yellen said. “How we achieve growth that benefits all is the fundamental economic question of the 21^st century, and I’m excited to have the opportunity to help guide the organization that is driving that conversation in Washington and nationally.”

What are the macroeconomic policy tools to counter secular stagnation in the United States?

Posted on June 12, 2018June 11, 2018 by Emilie Openchowski

Overview

The U.S. economy seems quite healthy these days. Overall economic growth, as measured by the Gross Domestic Product, has been growing at close to a 3 percent inflation-adjusted pace over the past year. Inflation is moving up toward the Federal Reserve’s 2 percent target. Long-term interest rates are increasing as well. These signs of progress, however, should not be cause for complacency. The economy may be on an even footing now, but the next recession could be difficult to fight. Policymakers need to contemplate how they will fight the next downturn in an era of secular stagnation.

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What are the macroeconomic policy tools to counter secular stagnation in the United States?

The economic growth of the past several years has happened as inflation-adjusted short-term interest rates were negative and, over the past year or so, fiscal policy stimulated growth with a rising federal budget deficit. Despite this stimulus, inflation is only just now approaching the Fed’s inflation target after almost six years of undershooting while inflation-adjusted GDP growth has been regarded as lackluster. More than four-and-a-half years after former Treasury Secretary Lawrence H. Summers revived the idea, the possibility of secular stagnation still looms over the U.S. economy.¹

Secular stagnation is a term for the macroeconomic consequences of an economy with a long-term excess supply of desired savings over desired investment. Since the 1970s, savers around the world and in the United States have increased the amount they wanted to save, increasing the supply of loanable funds. The market for savings and investment tries to find an equilibrium, as demand for savings has declined as well. The result has been declining interest rates. Robust growth will be difficult under these situations unless monetary and fiscal policy boost demand sufficiently or rising asset markets unsustainably increase private demand through credit and financial bubbles.² (See Figure 1.)

Figure 1

Traditional macroeconomic policy, particularly monetary policy, can deal with such a trend as policymakers can still push short-term rates to the equilibrium level. Eventually, however, the nominal interest rate hits its zero lower bound, and monetary policy becomes constrained. Grappling with this macroeconomic condition is vital for setting the conditions for strong, stable, and sustainable economic growth.

Several macroeconomists have turned their attention to the question of secular stagnation, its causes, and potential policy responses. A review of some of this research shows that taking secular stagnation seriously requires rearranging the macroeconomic policy toolbox. Fiscal policy becomes more important for stabilizing the economy, and monetary policymakers need to rethink which tools will be most useful in this macroeconomic era where they may have diminished power. Much more research is needed into this phenomenon, but the early research demonstrates that policymakers will have to be bold in an era of secular stagnation.

Modeling secular stagnation

The prospect of secular stagnation presents some issues for standard macroeconomic models—namely that secular stagnation cannot exist in them. In the models that influence the academic consensus of macroeconomic policy and the thinking of central bankers, the natural rate of interest can’t be below zero for long. Given that the premise of secular stagnation is that the natural rate of interest can be zero for quite some time, these models aren’t very helpful.

Many of the standard models assume that the interest rate is determined by how much a representative, average consumer discounts money in the future.³ Firstly, this sets aside the substantial amount of heterogeneity and inequality in the economy that recent research has found crucial for understanding macroeconomic policy. Secondly, this assumes that declines in the interest rates are only temporary. Models will assume that this “representative agent” becomes more impatient about the future, causing a temporary decline in the interest rate that eventually reverts. ⁴

Some new research has built models that allow for declining interest rates and extended periods of negative inflation-adjusted interest rates. Brown University economists Gauti Eggertsson, Neil Mehrotra, and Jacob Robbins have developed a model that not only includes these important interest rate features, but also allows for a broader set of factors to determine interest rates.⁵ Put simply, their model has the market for assets—set by the supply of and demand for savings—to be the source of interest rates.

Eggertsson, Mehrotra, and Robbins had to perform, as one of the co-authors put it, “open-heart surgery” on the standard models to answer questions about secular stagnation. Whereas in more standard models, the representative agent can look infinitely into the future, the agents in their models won’t live forever, and there are younger generations with which they can trade assets.

It’s this market for savings that allows for more interesting changes in interest rates. Shifts in the supply of desired savings or the demand for these savings determine the interest rate. A shift out in supply of savings, all things equal, will push down interest rates, while an increase in demand for savings, all things equal, will increase the interest rate. An increase in life expectancy, for example, will increase the supply of savings as workers have to save more for retirement. Assuming no other changes, this would push down the natural rate of interest.

These trends can also be thought of as changes in supply and demand for assets. In this case, the demand for assets is a way of presenting the same forces that drive the supply of desired savings. Think again about an increase in life expectancy. Workers needing to save more will need to put their money in assets to fund their retirements. Longer retirements would then increase the demand for assets. And since the price of a bond is inversely correlated with the interest rate, interest rates will go down as prices go up. While this is the framework that some papers use, this issue brief will examine shifts in the supply of and demand for savings.

Another way to think about this increase in the supply of savings is a decrease in the economy’s aggregate demand, or the total amount of demand in the economy. Increased demand for assets means that money that would have increased demand for current goods is now being saved to purchase goods and services at a later date. This is similar to how recessions, or temporary declines in aggregate demand, happen in Keynesian models. Something causes households or businesses to pull back on consumption and increase their savings, which leads to a decline in output. But in the long-run case, the market for supply moves to a new equilibrium with a lower interest rate.⁶

Other models looking at the decline in the natural rate of interest use the market for savings or assets as the key to understanding movements in the interest rate. Economists Adrien Auclert at Stanford University and Matthew Rognlie at Northwestern University look at how the increase in income inequality in the United States may have increased savings as high-income households increase their precautionary savings to protect themselves from income volatility.⁷ Similarly, Massachusetts Institute of Technology economist Ludwig Straub finds the increased savings of rich households had an important role in declining interest rates, though the reason for the increase differs from Auclert and Rognlie’s reason.⁸

Implications for fiscal policy

These modeling changes might be interesting in and of themselves, but what do they imply for policymakers? The implications for fiscal policy are greatest. In short, fiscal policy appears to be a much stronger stabilization tool than previously thought.

The dominant view of fiscal policy before the Great Recession of 2007–2009 was that it was an inefficient form of stimulus and that the stabilization of the macroeconomy should be left to central banks and monetary policy. This understanding is a product of the Great Moderation, the period of relative macroeconomic stability starting in the late 1980s and ending with the Great Recession. Many economists believed that more effective macroeconomic management, mainly via monetary policy, was responsible for a good part of the moderation.⁹

But the events of the Great Recession and research work since then highlights the important role of fiscal policy in stimulating the economy in the current environment. Jason Furman, during his time as the chair of the Council of Economic Advisers in the Obama administration, presented this new view of fiscal policy and the attendant policy implications.¹⁰ Research on the fiscal multiplier—a measure of how much economic activity a dollar of fiscal stimulus creates—has found that stimulus in the United States during the Great Recession of 2007–2009 was quite effective.¹¹

Yet the models of secular stagnation find fiscal policy to be an effective tool against secular stagnation in a different way. Remember that secular stagnation and declining interest rates are due to changes in the supply and demand for savings. In these papers, stimuative fiscal policy (rising budget deficits) leads to increases in interest rates that counteract secular stagnation by increasing the demand for savings and loans. Government debt, in these models, soaks up the excess savings in the economy. The government would act as a sort of “borrower of last resort,” a parallel to a central bank’s role as a “lender of last resort.”

What should the government do with the funds it borrows? According to the Eggertsson, Mehrotra, and Robbins model, it doesn’t seem to matter much: “The increase in government debt could be directed to the young, toward government spending, or distributed to the middle aged and the old in accordance with the fiscal rule.”¹² Auclert and Rognlie’s model finds that fiscal policy counteracts the negative impacts of recessions, the increasing inequality during recessions, so this suggests that polices that insure against falls of income for those who lose their job during recessions—unemployment insurance, for example—may be helpful.

But the while the distribution of the funds might not be important, the source of the funding is key for understanding the impact of fiscal policy. The highest multipliers are found when the increase in spending or reduction in taxes are funded entirely by debt. Remember, the problem of secular stagnation is an excess of savings. Fiscal policy is most effective if it can increase the demand for loans and push up interest rates (the price of loans). Financing an increase in spending with taxes or reducing spending to pay for a tax cut would reduce the amount of excess savings the government is using. In fact, Eggertsson, Mehrotra, and Robbins find that certain tax increases in their model would make the fiscal multiplier negative and actually reduce growth by increasing the amount of savings in the economy.

How should these results inform the thinking of fiscal policymakers? Fiscal policy is an important and powerful tool in a state of secular stagnation. Policymakers should be well aware of the context of fiscal policy and how increased government debt can be a solution. If policymakers are concerned about an economy where low interest rates imperil macroeconomic stabilization or that excessive savings might inflate a financial bubble, then increased government debt would help solve those problems.

Implications for monetary policy

Monetary policy in a state of secular stagnation faces a significant problem. Monetary policymakers try to bring the economy into equilibrium by changing the price of loans and credits via interest rates. Secular stagnation throws a wrench into the monetary policy machine as interest rates have dropped so much that policymakers have less control over them. Models of secular stagnation find that monetary policymakers could make some changes to their toolkit, but their ability to stabilize the economy on their own is still more constrained.

The problem for monetary policy during secular stagnation is the nominal zero lower bound. Interest rates can be thought of as the return on holding onto money. Central banks can make money less valuable to hold onto and make consumers and businesses more likely to spend that money if they lower interest rates. But if interest rates get to zero, central banks can’t (at least at the moment) push rates below zero. A negative nominal interest rate would mean that money in a bank account would decline in nominal (unadjusted for inflation) terms. The dollar figure in your bank account would go down. The thinking has long been that depositors would just with draw their money from bank accounts and hold them in cash, which has a fixed zero percent nominal interest rate. It always has the same value in nominal terms. Banks wouldn’t be able to charge the negative nominal interest rates.

Forward guidance

The current approach is to sidestep the issue of control over current interest and use promises around future interest rates as a policy tool itself. A central bank may promise to keep nominal interest rates at zero until unemployment or inflation hits certain levels. Forward guidance, as this is called, is premised on the assumption that households and businesses will be aware of this commitment and that they believe the central bank will hold firm to the commitment.

The households in the Eggertsson, Mehrotra, and Robbins model are not “infinitely lived” (meaning there are multiple overlapping generations of agents in the model), so commitments about the future are less powerful than in other models. Furthermore, since the state of secular stagnation is permanent and interest rates will be near or at the zero lower bound for quite some time, then households might not believe that monetary policy will have traction anytime soon. In other words, people either don’t believe the central bank’s commitment or they don’t think it’s relevant to them. In the model, then, forward guidance is far less powerful than many models and policymakers believe.

Increasing the inflation target

One popular suggestion for counteracting the zero lower bound is to bypass the nominal bound by increasing the amount of inflation in the economy. Central banks may be bound by a nominal lower bound, but they can make the inflation-adjusted value of money lower by decreasing inflation-adjusted interest rates. With the Federal Reserve’s 2 percent inflation target, the lower bound on inflation-adjusted rates is negative 2 percent. But a higher inflation target—say, 4 percent—would reduce this bound to negative 4 percent (a 0 percent nominal interest rate minus 4 percent inflation).

The models from Auclert and Rognlie and from Eggertsson, Mehrotra, and Robbins both find that a higher inflation rate could be effective, but that central banks must not be timid and have to set the inflation target high enough. A shift to a 4 percent inflation target might not be large enough if the natural rate of interest has fallen below negative 4 percent. A higher inflation target would be able to solve many instances of secular stagnation, but there would be a chance that the central bank hasn’t gone far enough. Raising the inflation target could be a useful tool for fighting against secular stagnation, but it’s not powerful enough to fully solve the problem.

Negative nominal interest rates

What about getting rid of the nominal lower bound or at least significantly lowering it? While economists and central bankers had long regarded the zero lower bound on nominal interest rates as a solid border, it appears to be a bit porous. The European Central Bank and the Bank of Japan have both managed to set short-term nominal interest rates below zero. How is this possible? People were supposed to take their money out of bank accounts and convert it to cash if the possibility of negative nominal rates was raised. But it appears that money in a bank account and cash in a wallet (or under a mattress) are not perfect substitutes. The benefit of the convenience of having money in a bank account may outweigh the cost of seeing a nominal decline in the value of the account. Just how negative nominal interest rates can get is likely a function of demand for cash in an economy.¹³

Now that policymakers know it’s possible, the question is whether setting nominal interest rates below zero is an effective policy. In the Auclert and Rognlie model, moving the effective lower bound below zero has a sizeable effect. According to one exercise using their model, pushing the nominal lower bound a bit below negative 0.4 percent allows the U.S. economy to get back to a state of full employment. The Eggertsson, Mehrotra, and Robbins paper doesn’t allow for negative nominal interest rates, so it cannot look at the impact of negative rates. Other research by Eggertsson, however, takes a dim view of the expansionary effects of negative nominal rates.¹⁴ Better understanding the mechanics of negative nominal interest rates and how they function in secular stagnation seems to be a ripe area for policy-oriented macroeconomists to investigate—a trend that has started and hopefully will continue.

Conclusion

If secular stagnation is an enduring feature of the U.S. economy and new models of it are broadly correct, then the macroeconomic policy toolkit needs to change. Ignoring it could mean the recovery from the next recession will be weak and result in a material declining in living standards for millions of Americans through higher unemployment and lower wages.

The long-term decline in interest rates and excess savings means fiscal policy can no longer be thought of as a secondary concern. Increased federal budget deficits and higher federal debt in a state of secular stagnation are positives, as they will increase short-term growth and push interest rates up. How much U.S. government debt the market could handle isn’t known, but the lower interest rates of recent years and the experience of Japan—with its current debt-to-GDP ratio of about 250 percent and negative inflation-adjusted long-term rates—suggest that demand for high-quality government debt is quite high.

The power of monetary policy is diminished under secular stagnation, but monetary policymakers don’t appear to be impotent. Forward guidance may not have the power that the current consensus believes it does, but changes to inflation targets and pushing nominal interest rates below zero may hold some promise. Whether monetary policy could be further strengthened by changing the current regime of inflation targeting to a price-level target or a nominal GDP level target is an interesting possibility. The current debate among members of the Federal Open Market Committee will hopefully consider these questions moving forward.¹⁵

Of course, more research and thinking about these questions are needed. The papers reviewed in this brief are part of the beginning of what will hopefully become a large literature. Policymakers may well need all the help they can get in the years to come.

Brad DeLong: Nick Bunker on full employment in the United States

Posted on June 12, 2018June 11, 2018 by Emilie Openchowski

Nick Bunker has a very nice piece from late last month on wage growth and employment, as it bears on the question of whether the United States is at “full employment.” My take is that the U.S. economy probably is because at current unemployment and employment rates, if no additional shocks were to hit the economy, inflation would probably start creeping up very slowly, if things continued as they are as far as unemployment and employment rates. But we do not know. And the costs of getting this wrong and judging the economy at “full employment” prematurely are high, while the costs of getting this wrong and failing to judge the economy at “full employment” are small, notes Nick Bunker in his column “Puzzling over U.S. wage growth.” Bunker writes:

What’s happening in the labor market as a whole? … It’s not clear that the prime employment rate is fully stationary. There’s some suggestive evidence that this may be true, but more research and thinking on this issue is needed. Analysis of the data shows a weak relationship between the unemployment rate and a good measure of wage growth. The prime employment rate has a much stronger relationship and has done a good job predicting wage growth out of the sample it draws from. The relationship is holding up in practice. Economists and analysts may just need to figure out how it works in theory.

Indeed, in the late 1990s, Canada’s prime-age employment rate was 2 percentage points below the U.S. rate. Today, Canada’s prime-age employment rate is 4 percentage points above the U.S. rate. That suggests an awful lot of U.S. prime-age workers could be brought into employment. You are not going to convince me that Canada is a different place on a different continent. And you would have a very difficult time convincing me that the U.S. shortfall is “structural” in the sense that large chunks of it would not melt away in a higher-pressure economy. This graph below from Neel Kashkari of the Minneapolis Fed makes the point:

Why macroeconomics should further embrace distributional economics

Posted on June 11, 2018October 24, 2018 by Emilie Openchowski

Macroeconomics should further embrace distributional economics, and the tool that can work to redistribute wealth and income: monetary policy.

Ten years ago, some of the failings of macroeconomics models were made quite bare as the Great Recession ripped through the global economy. Economists were—and continue to be—criticized because their models seemed to lack any sort of connection to reality. Yet in one critical area, those charges don’t stick these days. Macroeconomists are increasingly not missing out on one of the biggest trends in the U.S. economy: high levels of income and wealth inequality.

A variety of new research projects in recent years shows how macroeconomists are engaging with the fundamental importance of the distribution of income and wealth to economic growth. As Princeton University economist Benjamin Moll observes in a recent presentation to his macro colleagues, it is hard to coherently think about macroeconomics if it ignores distribution.

The most famous example is Thomas Piketty’s Capital in the Twenty-First Century. The book is fundamentally about the interaction of economic growth and inequality—how the distribution of income between capital and labor is altered by economic growth. Perhaps a 700-page bestselling book might be an outlier in the economics profession, yet macroeconomists are clearly more interested these days in determining the sources of rising wealth inequality and potential policies to reduce it. Consider two papers by three New York University economists looking at rising U.S. wealth inequality or this attempt to understand how a wealth tax might actually increase economic growth.

What might be even more encouraging is that macroeconomists are considering how economic inequality—or “heterogeneity” as they sometimes call it—can alter key macroeconomic policy. Take monetary policy. When this is discussed in relationship to inequality, it often is held up as a policy that either reduces or increases inequality. A number of recent papers consider that changes to income and wealth inequality might reduce or increase the power of monetary policy.

Research by Stanford University’s Adrien Auclert provides a good example of this line of research. Monetary policy is powerful in Auclert’s model because simulative policy redistributes money toward households more likely to spend the additional dollar of income: low-income households, debtor households, and households who have frequent debt payments. Another paper by Greg Kaplan of the University of Chicago, Princeton’s Moll, and Giovanni Violante of New York University finds similar results.

In other words, monetary policy—the dominant policy tool for fighting recessions in recent decades—might be powerful exactly because it redistributes income and wealth. The distribution of economics resources should not be merely appended onto current macroeconomic models or considered a sideshow to the traditional questions of the field. Instead, economic inequality needs to be at the heart of our understanding of the macroeconomy. Equitable Growth is helping to increase the research investigating these topics though our grantmaking and to disseminate this new knowledge to the policymaking community.

Weekend reading: “not as contingent as you thought” edition

Posted on June 8, 2018June 8, 2018 by David Evans

This is a weekly post we publish on Fridays with links to articles that touch on economic inequality and growth. The first section is a round-up of what Equitable Growth published this week and the second is the work we’re highlighting from elsewhere. We won’t be the first to share these articles, but we hope by taking a look back at the whole week, we can put them in context.

Equitable Growth round-up
Earlier this week, the U.S. Bureau of Labor Statistics released the newest data from the Job Openings and Labor Turnover Survey which cover April. Here are four graphs using key data from JOLTS.

How many U.S. workers are in contingent jobs? How many are independent contractors? Kate Bahn set the stage for new data released these week answering just those questions.

John Williams takes the helm of the power Federal Reserve Bank of New York this month. He’s a fan of the Federal Reserve moving to a price-level target when it comes to monetary policy. Would this be a step in the right direction?

Links from around the web
The U.S. labor market hit a level that no one had seen in almost 50 years. Sho Chandra and Jeanna Smialek report on the ratio of unemployment to vacant jobs dropping below 1. [bloomberg]

The federal government this week released new data on contingent work and alternative work arrangements in the United States for the first time in 13 years. Despite the expectations of many that the data would show a big increase in nontraditional work, Ben Casselman writes that “you can see the gig economy everywhere but in the statistics.” [nyt]

Rising income inequality in the United States has manifested itself in many ways. One of the more prominent trends has been the decline of the middle class. Eleanor Kruase and Isabel V. Sawhill list seven reasons to worry about the middle class. [brookings]

Building off previous work, Jason Furman and Peter Orszag try to answer one of the most important questions about the U.S. economy: is slower productivity growth related to higher economic inequality? [piie]

Social scientists are coming to grips with the problem of replication as researchers have difficulty replicating the results of prior research. Anastasia Ershova and Gerald Schneider point out another wrinkle to this problem: updates of statistical software. [lse impact blog]

Friday figure

Figure is from “JOLTS Day Graphs: April 2018 Report Edition”

Brad DeLong: Worthy reads on equitable growth, June 1-7, 2018

Posted on June 7, 2018July 26, 2018 by Emilie Openchowski

Worthy reads on Equitable Growth:

That monetary policy is best which avoids creating needless unemployment while still maintaining confidence in the value of the unit of account. Yet surprisingly little thought has been devoted to figuring out which monetary policy jumps the highest with respect to this objective. Nick Bunker’s “Getting on the level with the Fed’s targeting of prices” makes this point: “John Williams’s move to New York is a sign that the Federal Reserve may soon reconsider its target for monetary policy. It’s not clear whether a new target would emerge from such a process or how radical a change current members of the [Federal Open Market Committee] would consider. The current inflation targeting structure may have gotten the U.S. economy to where it is, but it took some time. A quicker recovery from the next recession would be to the benefit of everyone in the U.S. economy. So, a rethink is needed. Hopefully it’s coming soon.
There was a lot of noise about how giving repatriated profits a tax break would boost investment in America. As near as I can see it, none of it was well-founded at all. Listen to what Kimberly Clausing has to say in “Equitable Growth in Conversation: Kimberly A. Clausing.” She points out in her conversation: “We are distorting repatriation decisions by having this repatriation tax. But I don’t think we’re dramatically changing the investments found in the United States. The companies that have profits abroad can borrow against them to finance any desired investment. And some of the money isn’t really truly abroad—it’s invested in U.S. assets.
Read Kate Bahn’s piece over on Slate: “Education Won’t Solve Inequality:Not without workers’ power too.” And looking forward to what we can learn from this BLS initiative that Kate also highlighted earlier this week: “New data on contingent workers in the United States.” The details break on Thursday, June 7.

Worthy reads not on Equitable Growth:

A very interesting study of what appears to be highly successful job search assistance in Nevada comes our way from Day Manoli, Marios Michaelides, and Ankur Patel in “Long-Term Effects of Job-Search Assistance: Experimental Evidence Using Administrative Tax Data.” They note: “Administrative tax data … examine the long-term effects of an experimental job-search assistance program operating in Nevada in 2009.”
I suspect that other countries will prove much more effective at compensating the losers from a trade war than President Donald Trump will be. Paul Krugman makes the point in “Oh, What a Stupid Trade War.” Krugman writes: “My professional training wants me to dismiss the jobs question as off-base. But … we … want to know whether the Trump trade war … would add or subtract jobs holding monetary policy constant, even though we know monetary policy won’t be constant. … This trade war will actually be a job-killer. … Trump is putting tariffs on intermediate goods. … Whatever gains there are in primary metals employment will be offset by job losses in downstream industries. … Other countries will retaliate. … We’re dealing with real countries … they have pride; and their electorates really, really don’t like Trump. This means that even if their leaders might want to make concessions, their voters probably won’t allow it. … This is a remarkably stupid economic conflict to get into. And the situation in this trade war is likely to develop not necessarily to Trump’s advantage.”

Getting on the level with the Fed’s targeting of prices

Posted on June 6, 2018June 8, 2018 by Emilie Openchowski

Price-level targets may help prices in the economy grow at a steady pace, but might not hold up well if the U.S. economy is hit by a supply-side shock.

For a bit more than a year now, the Federal Open Market Committee—the policy committee of the Federal Reserve—has made it clear that its inflation target for the U.S. economy is “symmetric.” The central bank wants annual inflation to be at a 2 percent rate, but sometimes it misses that goal. The symmetric target means the Federal Reserve should regard inflation a bit higher than 2 percent and a bit below 2 percent equally. Given that inflation (according to the Fed’s preferred measure) has been below 2 percent for almost six years, the central bank appears to be signaling that it won’t see a slight increase in inflation higher than 2 percent as a problem.

But what if the Fed didn’t just tolerate inflation above 2 percent, but rather tried to engineer such an overshoot? After years of inflation lower than 2 percent, perhaps the central bank could try to make up for those mistakes. It’s an idea that has gained new credence recently, as a key proponent of the idea has moved into a new position of increased influence.

John Williams, most recently the president of the Federal Reserve Bank of San Francisco, moves across the country this month to take the same position at the Federal Reserve Bank of New York. The New York Fed is uniquely powerful among regional Fed banks, as it always has a vote on monetary policy (the other banks rotate in and out of voting annually) and serves as the vice chair of the FOMC. Williams is well-known for his research on the declining “natural rate of interest” and, most importantly for this discussion, his advocacy for a price-level target.

A price-level target would require the Federal Reserve to keep the price level of the U.S. economy growing at a constant rate over time. If the Fed missed on the downside by, say, letting inflation only grow at 1 percent, it would have to make up for this miss by pushing up inflation for one year. Inflation might miss the target from year to year, but over time, prices in the economy should grow at a constant rate.

How would a switch to a price-level target help policymakers? In a period of low interest rates, research, including Williams’, shows that holding interest rates lower for longer than other monetary policy frameworks would help boost the economy more. A price-level target would be a systematic way to ensure that the central bank would follow this rule. It’s a rules-based approach to monetary policy that doesn’t micromanage central bankers.

But there is a potential flaw with a price-level target—it might not hold up well if the U.S. economy is hit by a supply-side shock. Say, for example, that oil prices suddenly increase or higher tariffs are imposed that push up prices in general across the economy. Either of those increases would be a one-time increase in the price level of the economy and a temporary increase in inflation. It’s unlikely that inflation will stay elevated after either such one-time shock. But if the Federal Reserve is targeting the price level, monetary policymakers would be required to tighten monetary policy to bring down inflation to compensate for the overshoot.

Fortunately, there’s another option for a level target that wouldn’t suffer from such a problem: nominal Gross Domestic Product, or GDP, before factoring inflation. David Beckworth at George Mason University’s Mercatus Center notes that a nominal GDP level target would have the merit of having the Federal Reserve focus just on changes in aggregate demand. A temporary price-level target, as proposed by former Fed Chair Ben Bernanke, might get around these concerns, but there is a possibility of supply-side shocks at the zero lower bound. Monetary policymakers need to strongly consider the probability of significant supply-side shocks to the U.S. economy in contemplating a move to a price-level target.

Of course, there’s the possibility that a shift in the Fed’s inflation target won’t change policymaker action much. Minneapolis Federal Reserve President Neel Kashkari has argued that the main obstacle to more aggressive monetary policy is a belief in “nonlinearity,” a concern that inflation will accelerate rapidly, perhaps uncontrollably, if policy is aggressive.

Either way, Williams’ move to New York is a sign that the Federal Reserve may soon reconsider its target for monetary policy. It’s not clear whether a new target would emerge from such a process or how radical a change current members of the FOMC would consider. The current inflation targeting structure may have gotten the U.S. economy to where it is, but it took some time. A quicker recovery from the next recession would be to the benefit of everyone in the U.S. economy.

So, a rethink is needed. Hopefully it’s coming soon.

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