Must-Read: Claudia Sahm: Telling Macro Stories with Micro:

Economists are avid storytellers…

A good story paper in economics, according to David Romer, has three characteristics: a viewpoint, a lever, and a result…. Blog or media coverage… focuses on the result…. Economists… spend more time on the lever, the how-did-they-get-the-result part…. The viewpoint matters… but it usually holds across many papers.

Best to focus the new stuff. Except when the viewpoint comes under scrutiny, then the stories can really change…. One long-standing viewpoint in economics is that changes in the macro-economy can largely be understood by studying changes in macro aggregates. Ironically, this viewpoint even survived macro’s push to micro foundations with a “representative agent” stepping in as the missing link between aggregate data and micro theory…. An ever-growing body of research and commentary is helping to identify times when differences at the micro level are relevant for macro outcomes….

In the past nine years, have seen models that condition on aggregate measures of income, wealth, interest rates, sentiment, and credit conditions do a pretty good job explaining the changes in aggregate consumer spending…. Adding micro heterogeneity to macro models is one in a long list of possible improvements. Adding a more realistic financial sector, exploring non-linearities, relaxing rational expectations, and extracting a better signal from noisy aggregate data are all in the queue too…. I suspect the Representative Agent is not getting voted off macro island any time soon….

Economics is not supposed to be about economists, but sometimes our stories can feel that way, especially to non economists. And to be fair, the viewpoints that economists bring to their work do have an impact on the results, if nothing else by what we choose to study…

Must-Read: Brad Setser: What To Do When Countries With Fiscal Space Won’t Use It?:

Fiscal policy alone doesn’t determine the current account….

And, well, a significant share of many countries’ current account is now coming from investment income earned abroad, and that can fluctuate in strange ways. But there is a potential adding-up issue if all the large surplus economies in East Asia deliver on their planned fiscal consolidations. The first order impact of fiscal consolidation in all three should be a bigger external surplus in all three. By forecasting that away, the IMF runs the risk of understating the drag fiscal consolidation in East Asia might pose to global demand.

Must-Read: Heidi Shierholz: The Myth of Job Polarization:

In the first few years of the recovery, growth was very strong in very low-wage jobs that pay $10 per hour or less. This is typical…

…in the early phase of a recovery, when jobs are being added but the labor market still has a lot of slack, there tends to be disproportionate growth in low-wage jobs. The strong growth in low-wage jobs was offset by weak growth in middle-wage jobs…. Since 2013 the pattern has shifted. There has been a notable decline in the number of workers in very low-wage jobs…. The last few years saw disproportionate gains in middle- and high-wage jobs. In particular, there has been extremely strong growth in jobs with wages between $12 and $18 per hour. Jobs in the $19-$35 range saw growth that was roughly in line with what would have been expected given the overall level of job growth. And there was strong growth in jobs that paid more than $35 per hour…. As the labor market has strengthened, the pattern of very strong growth in low-wage jobs and weak growth in middle-wage jobs in the first few years of the recovery has shifted…

Must-Read: Tim Duy thinks, I believe correctly, that the Fed is confusing its own past policy errors with economic laws:

Tim Duy: Is Pushing Unemployment Lower A Risky Strategy?:

Fed hawks are pushing for a rate hike sooner than later in an effort to prevent the economy from “overhearing”…

…argued to set the stage for the next recession…. John Williams:

History teaches us that an economy that runs too hot for too long can generate imbalances, potentially leading to excessive inflation, asset market bubbles, and ultimately economic correction and recession. A gradual process of raising rates reduces the risks of such an outcome…. If we wait too long to remove monetary accommodation, we hazard allowing imbalances to grow, requiring us to play catch-up, and not leaving much room to maneuver. Not to mention, a sudden reversal of policy could be disruptive and slow the economy in unintended ways….

William Dudley….

A particular risk of late and fast is that the unemployment rate could significantly undershoot the level consistent with price stability. If this occurred, then inflation would likely rise above our objective. At that point, history shows it is very difficult to push the unemployment rate back up just a little bit in order to contain inflation pressures. Looking at the post-war period, whenever the unemployment rate has increased by more than 0.3 to 0.4 percentage points, the economy has always ended up in a full-blown recession…. This is an outcome to avoid….

I don’t know that there is a law of economics where the unemployment can never be nudged up a few fractions of a percentage point. But I do think there is a policy mechanism…. Rhe Fed tends to overemphasize the importance of lagging data such as inflation and wages and discount the lags in their own policy process. Essentially, the Fed ignores the warning signs of recession, ultimately over tightening…. For instance, an inverted yield curve traditionally indicates substantially tight monetary conditions. Yet even after the yield curve inverted at the end of January 2000, the Fed continued tightening through May of that year, adding an additional 100bp to the fed funds rate. The yield curve began to invert in January of 2006; the Fed added another 100bp of tightening in the first half of that year. This isn’t an economic mechanism…. This is a policy error….

Bottom Line: The Fed thinks the costs of undershooting their estimate of the natural rate of unemployment outweigh the benefits. I am skeptical they are doing the calculus right on this one. I would be more convinced they had it right if I sensed that placed greater weight on the possibility that they are too pessimistic about the natural rate. I would be more convinced if they were already at their inflation target. And I would be more convinced if their analysis of why tightening cycles end in recessions was a bit more introspective. Was it destiny or repeated policy error? But none of these things seem to be true.

Must-Read: Larry Summers is right: forward guidance and large-scale QE are unlikely to be powerful enough tools for the Fed to deal with the next recession. This is especially true given the Fed’s current policy posture. Large-scale QE is, I believe, primarily useful as a signal of forward guidance. And the Federal Reserve’s current eagerness to tighten monetary policy without any visible signals of an overheating high pressure economy is greatly undermining its ability to credibly engage in forward guidance in the future:

Lawrence Summers: The Fed’s Complacency About Its Current Toolbox Is Unwarranted:

I was disappointed in what came out of Jackson Hole for three reasons…

The Fed should have signaled a desire to exceed its two percent inflation target during periods of protracted recovery and low unemployment…. Even apart from the desirability of allowing inflation to rise above two percent in a happy economic scenario GDP, labor market and inflation expectations data all make a compelling case against a rate increase….

My second reason for disappointment… was that Chair Yellen… was too complacent to conclude that:

even if average interest rates remain lower than in the past, I believe that monetary policy will, under most conditions, be able to respond effectively.

This statement may rank with Ben Bernanke’s unfortunate observation that subprime problems would be easily contained. Rather I believe that countering the next recession is the major monetary policy challenge before the Fed…. It is more than 50 percent likely that we will have a recession in the next 3 years. Countering recessions requires 400 or 500 basis points of monetary easing. We are very unlikely to have anything like that much room for easing when the next recession comes.

Chair Yellen, relying… on… David Reifschneider using the FRBUS model, comes to the relatively serene conclusion that by using forward guidance and QE… the Fed will likely able to respond adequately to the next recession with its existing tool kit.  I think this conclusion is unlikely to be right…. There is an important methodological point here: distrust conclusions reached primarily on the basis of model results.  Models are estimated or parameterized on the basis of historical data.  They can be expected to go wrong whenever the world changes in important ways.  Alan Greenspan was importantly right when he ignored models and maintained easy policy in the mid 1990s because of other more anecdotal evidence that convinced him that productivity growth had accelerated. I believe a similar skeptical attitude towards model results is appropriate today….

I wonder what credibility Fed forward guidance is likely to have given the utter disconnect over many years between Fed and market views regarding future rate and the track record so far of the Fed being wrong and the market being right…. Even if unconventional policy could be highly efficacious in moving long term rates and even if QE induced moves in long rates were potent, there is the question of how much room there is to bring down long rates. Reifschneider… shows that with a big recession rates would likely approach -6 percent, or even -9 percent, but for the zero lower bound.  I find the idea that forward guidance and QE could do the anything like the work of 600, let alone 900, basis points of rate cutting close to absurd…