Should-Read: Oscar Jorda, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, AND Alan M.Taylor􏰀: The Rate of Return on Everything, 1870–2015: “This paper answers fundamental questions that have preoccupied modern economic thought since the 18th century…

…What is the aggregate real rate of return in the economy? Is it higher than the growth rate of the economy and, if so, by how much? Is there a tendency for returns to fall in the long-run? Which particular assets have the highest long-run returns? We answer these questions on the basis of a new and comprehensive dataset for all major asset classes, including—for the first time—total returns to the largest, but oft ignored, component of household wealth, housing. The annual data on total returns for equity, housing, bonds, and bills cover 16 advanced economies from 1870 to 2015, and our new evidence reveals many new insights and puzzles….

On risky returns… residential real estate and equities have shown very similar and high real total gains, on average about 7% per year. Housing outperformed equity before WW2. Since WW2, equities have outperformed housing on average, but only at the cost of much higher volatility and higher synchronicity with the business cycle. The observation that housing returns are similar to equity returns, yet considerably less volatile, is puzzling…. Before WW2, the real returns on housing and equities (and safe assets) followed remarkably similar trajectories. After WW2 this was no longer the case, and across countries equities then experienced more frequent and correlated booms and busts…. One could add yet another layer to this discussion, this time by considering international diversification. It is not just that housing returns seem to be higher on a rough, risk-adjusted basis. It is that, while equity returns have become increasingly correlated across countries over time (specially since WW2), housing returns have remained uncorrelated….

On safe returns… the real safe asset return has been very volatile over the long-run, more so than one might expect, and oftentimes even more volatile than real risky returns…. Viewed from a long-run perspective, it may be fair to characterize the real safe rate as normally fluctuating around the levels that we see today, so that today’s level is not so unusual. Consequently, we think the puzzle may well be why was the safe rate so high in the mid-1980s rather than why has it declined ever since…..

On the risk premium… the risk premium has been volatile…. Our data uncover substantial swings in the risk premium at lower frequencies that sometimes endured for decades, and which far exceed the amplitudes of business-cycle swings. In most peacetime eras this premium has been stable at about 4%–5%. But risk premiums stayed curiously and persistently high from the 1950s to the 1970s, persisting long after the conclusion of WW2. However, there is no visible long-run trend, and mean reversion appears strong. Curiously, the bursts of the risk premium in the wartime and interwar years were mostly a phenomenon of collapsing safe rates rather than dramatic spikes in risky rates. In fact, the risky rate has often been smoother and more stable than safe rates, averaging about 6%–8% across all eras….

On returns minus growth… “r ≫ g”… The only exceptions to that rule happen in very special periods: the years in or right around wartime. In peacetime, r has always been much greater than g. In the pre-WW2 period, this gap was on average 5% per annum (excluding WW1). As of today, this gap is still quite large, in the range of 3%–4%, and it narrowed to 2% during the 1970s oil crises before widening in the years leading up to the Global Financial Crisis. However, one puzzle that emerges from our analysis is that while “r minus g” fluctuates over time, it does not seem to do so systematically with the growth rate of the economy. This feature of the data poses a conundrum for the battling views of factor income, distribution, and substitution…

Should-Read: Prospect Magazine: Back to school: top economists on what their subject needs to learn next: Learn to prevent—we’re out of cure:

The crisis and its aftermath showed that the North Atlantic economies could not maintain full employment by following the Keynesian road. The idea that when the private sector sits down the public sector should stand up—that consistent durable prosperity can be achieved by having government step in as a spender of last resort—proved unsustainable. It also showed that full employment could not be maintained by following the monetarist road: the idea that successful regulation could keep finance on a sound footing, or at least a steady enough footing for central banks to manage, also proved unsustainable.

Ultimately prosperity is unlikely to be maintained without competent democratic government, and that has proven shaky since the slump. The big question is: what institutional—and perhaps political—changes are necessary to avoid another wild swing? In all likelihood we’ve only a decade to build better institutions of economic management. And we have not yet begun…

What other people say:

Larry Summers: Get to grips with vicious cycles: The central lesson of 21st century economic experience is that modern economies are not self-equilibrating systems. Indeed, modern economies are often dominated by positive feedback effects that destabilise. Margin calls, bank runs, portfolio insurance, option hedging all cause more selling of assets as their values go down. When selling causes lower prices, which cause more selling, the market mechanism is in trouble. We now understand how it can give way to long-term economic problems such as secular stagnation, where excessive saving drags down demand and economic growth slows.

The challenge is to prevent vicious cycles from developing and to contain them when they start. This will mean more, smarter government policy, not a retreat into market fundamentalism….

Martin Wolf: Pathology, prophylactics and palliatives: Macroeconomics needs to grapple with three linked questions. First, what causes financial crises? Second, what policies would best reduce the risks of such crises? Third, what should the policy response be to crises once they have happened?

On the first, how should we understand the interaction between the financial and monetary systems and the real economy? Sometimes the economy seems to depend on a combination of asset-price bubbles with the unsustainably rapid growth of debt. Why should this be so? On the second, are there more sustainable ways to generate demand? Might redistribution of income towards spenders be the answer? What role can government spending play?

On the third, are there alternatives to a combination of heavy government borrowing with supportive monetary policy? This combination has brought recovery. But the indebtedness built up before the crisis has, in part, just shifted onto the public sector. Moreover, even the private sector’s deleveraging has been modest. Economies remain fragile. Macroeconomics is, alas, not healthy….

Barry Eichengreen: Get to work on jobs: The global crisis and populist backlash laid bare the fact that American “blue-collar workers” had been left behind by technology and globalisation. President Trump promises to rescue them by “making coal great again” and taxing steel imports. We need a better way.

The conventional wisdom used to be that if manufacturing jobs can’t be recaptured from robots and China, then the solution is better service-sectors jobs—jobs that were presumed to be safe from automation and import competition because they require situational adaptability, interpersonal skills and oral communication. But now advances in artificial intelligence raise questions about the future of even those jobs.

Still, jobs requiring workers to combine practical services, communication and empathy—care workers, for example—should remain safe for the foreseeable future. So the pressing question becomes how to better prepare workers for these particular tasks. This requires rethinking education, training and the nature of work itself—a process that has only just begun.

Jim O’Neill: Learn to learn from China: The presumption used to be that China would have to learn from the west if it wanted to keep developing, especially when it comes to the political system. But 20 per cent of the Chinese now pull in a western-style income of $40,000-plus per year—that’s 260m people living on western-style incomes, far more than in any actual western country except the US. So the question becomes: what can we learn from China?

In addition to detailed areas like maths tuition (where the UK is already running pilots based on the best Chinese schools) two big areas stand out. First, when it comes to big changes, we should ensure everyone is informed and prepared; the circumstances of the EU referendum is the kind of thing that makes Beijing doubt the wisdom of western-style democracy.

And then there is macro-economic policy. For at least 20 years, Beijing has shown it can head off problems, and deal with crises. Western experts have repeatedly predicted a UK-style housing bubble-and-burst for China, but its authorities have pricked bubbles before they grew too big. Bankers and hedge funds bemoan how hard it is to predict what Chinese policymakers will do next. But the Chinese authorities see their role as being to fix real problems, not to provide clarity to market participants….

Tim Congdon: Figuring out (again) where the banks fit in: Some big questions in economics come and go, but one is there all the time: how are national income and output determined, and what does the answer mean for unemployment and inflation? Economists flopped this exam question when it was put to them in the Great Recession of 2008. In the coming decade, they will be trying to do better.

Keynes is supposed to have supplied a good reply. Unfortunately, in the last 20 years, central banks have instead preferred “New Keynesianism,” a three-equation model which has been widely described as the workhorse of modern macroeconomic analysis.

But in 2008, it was useless. Not one of the equations referred to the banking system, or the quantities of bank credit and money, even though it is obvious that banks were important in the Great Recession. One of the equations (the so-called “Taylor rule”) prescribed heavily negative interest rates to deal with the slump. This would have been fine, except that interest rates cannot go much beneath zero. New Keynesianism ought long ago to have been sent to the knacker’s yard.

The main intellectual challenge for economics now, just as it was when Keynes was writing, is to identify how the banking system—with its alleged masters of the universe, and its undoubted manias, delinquencies and pathologies—interacts with the rest of the liberal capitalist democracies of today.

Crisis, Rinse, Repeat: Key economic data from the periods following the 1929 stock-market crash and the 2007-2008 financial crisis suggest that the current recovery has been unnecessarily anemic. If policymakers refuse to heed the lessons of the New Deal era, then the next crisis is destined to be as prolonged as the last.

When the economic historians of the late 21st-century compare the Great Recession that started in 2007 with the Great Depression that started in 1929, they will write two things:

1. They will write that the initial policy response to the crises by the Federal Reserve and the Treasury was first rate in 2007 and after but fifth rate in 1929 after—what could have been a post-2007 repeat of the Great Depression in terms of the crash in production and employment was instead moderated to a painful episode.

2. But they will also write that while the post-business cycle trough policy response of President Franklin Roosevelt, the Congress is elected by American voters in the Federal Reserve was if not first at least second rate and laid the foundations for rapid recovery and satisfactory equitable growth; the post-business cycle trough policy response of President Barack Obama’s, the Congresses elected by American voters, and the Federal Reserve was at best third rate and did not lay foundations for rapid recovery or satisfactory equitable growth.

United States national income and national income per capita peaked in 2007 just before the Great Recess Ion. Two years later, into thousand nine, national income per capita was 5% below its peak. Four years later, in 2013, output per capita retained its peak. And this year, 2018, if we are lucky, national income per capita will stand 8% above its previous peak of 11 years ago.

There is no comparison with the Great Depression. Four years after the business cycle peak of 1929 national income per capita was down 28% from its peak. In the great depression, output per capita did not retain its peak level for a full decade.

Thus there is no comparison with the Great Depression—save that 11 years after the pre-Great Depression Business cycle peak output for worker was 11% higher and growing rapidly, well this year output per worker is only 8% higher than the pre-Great Recession peak and growing slowly. Plotting relative performance since the peak on the same axes, this year the lines will cross. And given how much better a relative starting position policymakers had in late 2009 than Franklin Delano Roosevelt and his team had in early 1933, that is appalling.

Democrats blame Republicans for turning off the fiscal stimulus spigot in 2010 and then refusing to turn it back on. Republicans say… nothing comprehensible or coherent. They say things like:

• It must be the fault of Barack Obama, via Dodd-Frank or ObamaCare.
• Maybe it’s the fault of all those people who want to work but are useless—the “zero marginal product workers”.
• Anyone who does not have a job must not really want one.

There is much more truth in the Democratic assignment of blame. But not everything can be blamed on fiscal austerity. And a considerable amount of inappropriate fiscal austerity in the early stages of the recovery is properly laid at the door of Barack Obama and his team.

Most worrisome, however, is that policy during the anemic recovery is not perceived as a failure by either those at the tiller at the time or by their successors. With a few honorable exceptions, Federal Reserve policymakers tend to say that they did the best they could given the fiscal headwinds imposed on them. With a few honorable exceptions, Obama administration policymakers tend to say that they stopped a second Great Depression, and that during the recovery they did their best given how they were hobbled by the Republican congressional majorities. And Republican economists tend to either be silent or say that the policies—both fiscal and monetary—pursued by the Obama administration and by the Bernanke Fed were dangerously inflationary, and that we have been lucky to escape the fate of Greece—or Zimbabwe.

Christina and David Romer tell us that in the post-WWII period economies that run into a serious financial crisis have levels of production ten years later fully 10% lower if they had neither monetary nor fiscal policy space to deal with the crisis. We will run into a serious financial crisis: that has been the rule for modern capitalist economies since at least 1825. And there is nothing in view that suggests that, when we do, we will have both the will to use monetary and fiscal policy and the space available.

Should-Read: That prime-age employment-to-population has been increasing without vacancies increasing tells us, I think, that the economy is not “overheating”, but rather getting closer to some medium-run concept of full employment as the hysteresis effects of the Great Recession are slowly being repaired: Nick Bunker: “What does this tell us?: “.@de1ong asked so here it is: the Beveridge Curve with the prime employment rate instead of U3…

…What does this tell us? Notice that most of the movement recently has been sideways as prime EPOP has increased & vacancies haven’t increased much. Like the U3 curve did as it started shifting back. In other words: this could be just another sign of remaining slack. Graphs collected here https://t.co/Hu6JPSorXJ. See you all on May 8th! (back to JOLTS Tuesdays!)…

Should-Read: Justin Fox is right in noting that Paul Ryan was always running a con game—that his aim was a more unequal country with lower taxes on the rich, not a country in which the federal government balanced its budget. But I would quarrel slightly with how he sets up this article. “Entitlement crisis” is a political framing that appeals not just to “very wealthy people and/or those with excellent health insurance”: it also appeals to lazy centrist journalists with no understanding of demography or policy, and no desire to learn. We never had—and do not have—a Social Security crisis. We had—but apparently no longer have (but it may return)—a health care cost explosion crisis. We still have a we-pay-too-much-for-the-health-care-we-as-a-country-get crisis. “Entitlement crisis” leads us away from getting value for our social insurance spending, and toward an unequal and unhappy society: Justin Fox: Paul Ryan’s Roadmap Was an Epic Fiscal Failure: “Paul Ryan did not cause the financial crisis. He has nonetheless failed pretty spectacularly… his actions have made the situation much worse than it had to be…

…I pin this on two main flaws in his approach: One has to do with the term “entitlement crisis,” the other with tax policy. The big problem with “entitlement crisis” is that it’s a political framing designed to appeal only to very wealthy people and/or those with excellent health insurance and retirement plans…. Improving Social Security, Medicare and Medicaid so that they can keep delivering benefits is a political project that, while fraught with pitfalls, has a chance of eventual success. Hacking at them to avert an “entitlement crisis” decades in the future appears to be a non-starter. The reason I keep putting “entitlement crisis” in quotes is, first, that “social insurance” better describes the programs than “entitlements” does and, second, that projected increases in social spending alone are unlikely to bring on a crisis. It is increasing government spending without also increasing government revenue that could, eventually, cause trouble….

Ryan got his way on tax cuts while making no progress whatsoever on that “entitlement crisis.” A 0.8 percent-of-GDP drop in tax revenue isn’t the end of the world. It is, however, a move in the wrong direction if you’re worried about growing fiscal imbalances…. Raising the tax burden, though, was never part of Paul Ryan’s plan. He wasn’t even willing just to hold it constant. Which would seem to mean that he was never all that serious about fixing America’s fiscal ills…

Should-Read: When 70% of newly employed workers are people who were not previously looking for a job, defining the labor force as the sum of employed and actively searching not employed makes very little sense: Josh Bivens: The fuzzy line between “unemployed” and “not in the labor force” and what it means for job creation strategies and the Federal Reserve: “Jobless people are classified into… either unemployed or not in the labor force…

…The unemployment rate is defined as the number of unemployed workers divided by the sum of employed and unemployed workers (or, the labor force). This rate tries exactly to capture what share of the adult population wants work, but hasn’t found it. This is why it is the most commonly referenced measure of “slack” in the labor market…. [But] the share of newly employed workers who were previously not searching for work is always high—well over half. Second, recent years have seen this share hit historic highs…. Because more and more jobs are being filled by people claiming to not have been looking for work it seems like the unemployment rate is becoming less useful as a clear-cut measure of labor market slack—this means we shouldn’t rely on it alone to decide whether or not the economy is at full employment…. It seems like Americans have plenty of appetite for new jobs (and particularly for good jobs). This means we should still be thinking hard about strategies for job creation—like I did in a recent paper. Finally, we don’t need policymakers who are committed to slowing the economy because they think unemployment has fallen low enough. Instead, we need policymakers willing to aggressively test just how fast the economy can grow before sparking inflation. The most important policymakers in this regard are the Federal Reserve, and this makes the next pick to head the Federal Reserve Bank of New York crucially important…

Should-Read: Jag Bhalla: The Epistemic Vigilance We Evolved To Do Well: “Confirmation Bias Isn’t a Bug, It’s Operator Error…

…In _The Enigma of Reason+, Hugo Mercier and Dan Sperber (M&S), articulate an “argumentative theory of reasoning.” Their “interactionist” views contrast sharply from the prevailing individualist “intellectualism.” M&S call confirmation bias—discounting facts that contradict your beliefs—a “well-established but ill-explained” pattern which actually has evolutionary advantages. An analogy between reason and sight can enlighten here. Eyesight isn’t a direct window onto reality. It detects limited wavelengths, needs many interpretative steps between received light and sight, and suffers optical illusions (that are tellingly not survival-threatening). Likewise, reason isn’t an all-seeing, impartial, objective logic machine (roughly what intellectualist Enlightenment reason-lovers like Descartes and Kant believed). Our brains are built and “biased” to enable evolutionarily useful behaviors. And solving abstract logic problems is an evolutionary novelty (e.g., only possible after the invention of the technology of writing). So reason evolved mainly “to resolve the problems posed by living in collaborative groups.”…

M&S argue that reason’s two main functions, self-justification and persuasion, are tools “for social action.” But, they emphasize, there’s no evolutionary sense in being predisposed to pigheadedly sticking to your beliefs. You’re often better off changing your mind and using better ideas from trusted others (cognitive division of labor). So we evolved to be persuadable (by sufficiently good, trustworthy, reasons), as M&S describe in chapter 15 “The Bright Side of Reason.” M&S’s argumentative theory is often misrepresented as reason being like your inner lawyer’s win-at-all-costs “weapon.” But good lawyers know when to concede to stronger arguments. They negotiate in their clients’ better interests. And M&S say we have two inner lawyers, one very vigilant about reasons given by others, another lazy one arguing our side (with a sensible laziness). Not thinking too hard about your first justification and relying on the “epistemic vigilance” of co-reasoners is often a good division of “cognitive labor,” that efficiently generates better decisions (= clearly adaptive, if you can avoid being manipulated or misinformed).We’re well adapted for collective reasoning (unavoidably cooperative, self-deficient lives). And cognitive individualism is a recent, incoherent idea.

There’s much more in _The Enigma of Reason _(e.g., intuition’s role in all reasoning, or countering “dual systems” views, see Kahneman). And more work is needed (e.g. on trust, power, and intuition-shifting processes) but M&S’s work—perhaps better called the “negotiative theory of reasoning” or “social theory of reasoning”— represents progress. Individualist Enlightenment thinkers mostly haven’t enlightened us about our inalienably social minds. Rather, the “Age of Reason” has tended to promote unempirical, unevolutionary, over-rationalist, over-individualist thinking (=delusions). Clearer thinkers aren’t blinkered by the aspirational projections of solitary geniuses. They see how extensive cognitive division of labor, and reliance on the minds of others, means we exceed the capabilities of our individual minds…

Should-Read: Yes, the African-American experience puts the lie to any claim that it is “class not race” that is the overwhelmingly important factor. Any other questions?: Liz Hipple: New research on the relationship between race, place, and opportunity in the United States: “Raj Chetty and fellow researchers Nathaniel Hendren, Maggie R. Jones, and Sonya R. Porter released… “Race and Economic Opportunity in the United States: An Intergenerational Perspective”…

…The paper analyzes the impact of race on intergenerational mobility, that is, the chances that children will earn more—or less—than their parents when they grow up…. Even when black and white boys are raised in families with similar incomes, black boys go on to earn less than white boys. This difference is noticeable and persistent across all incomes for boys, whereas there’s almost no discernable difference among girls. In fact, black girls go on to earn slightly more than white girls raised in families with a similar income. This raises serious questions about why outcomes vary across gender…