Must-Read: Tim Duy: Fed Once Again Overtaken by Events

Posted on by Brad DeLong

Must-Read: That the Brexit crisis would happen was unforeseeable. That the odds were strongly that some negative shock would hit the global economy was very foreseeable indeed. And yet the Fed since 2014 has been actively making sure that it is unprepared.

10 Year Treasury Constant Maturity Rate FRED St Louis Fed

Starting with Bernanke’s abandonment in 2013 of a policy bias toward further expansion and acceptance of a need for interest rate normalization and the resulting Taper Tantrum, there has been a dispute between the markets and the Fed. The markets have expected the Federal Reserve to try to normalize interest rates and fail, as the economy turns out to be too weak to sustain higher rates. The Federal Reserve has always expected to be able in less than a year or so to successfully liftoff from zero and embark on a tightening cycle, raising interest rates by about one percentage point per year.

The markets have been right. Always:

Tim Duy: Fed Once Again Overtaken By Events: “A July hike was already out of the question before Brexit, while September was never more than tenuous…

…Now September has moved from tenuous to ‘what are you thinking?’… as market participants weigh the possibility of a rate cut…. Internally they are probably increasingly regretting the unforced error of their own–last December’s rate hike…. Uncertainty looks to dominate in the near term. And market participants hate uncertainty. The subsequent rush to safe assets… is evident…. Direct action depends on the length and depth of the financial turmoil currently underway. I think the Fed is far more primed to deliver such action than they were a year ago. And that… will minimize the domestic damage from Brexit.

The Fed began 2015 under the direction of a fairly hawkish contingent that viewed rate hikes as necessary to be ahead of the curve on inflation. Better to raise preemptively than risk a sharper pace of rate hikes in the future…. [But] asset markets were telling exactly the opposite, that there was far less accommodation than the Fed believed. Fed hawks were slow to realize this, and, despite the financial turmoil of last summer, forced through a rate hike in December. I think this rate hike had more to do with a perceived need to be seen as ‘credible’ rather than based in economic necessity. I suspect doves followed through in a show of unity for Chair Janet Yellen. They should have dissented.

Markets stumbled again in the early months of 2016, and, surprisingly, Fed hawks remained undeterred. Federal Reserve Vice Governor Stanley Fischer scolded financial market participants for what he thought was an overly dovish expected rate path. And even as recently as prior to the June meeting, Fed speakers were highlighting the possibility of a June rate hike, evidently with the only goal being to force the market odds of a rate hike higher. But I think that as of the June FOMC meeting, the hawkish contingent has been rendered effectively impotent…. I suspect the Fed will be much more responsive to the signal told by the substantial drop in long-term yields that began last Friday (as I write the 10 year is hovering about 1.46%) then they may have been a year ago….

I expect some or all of…. Forward guidance I. Fed speakers will concur with financial market participants that policy is on hold until the dust begins to settle…. Forward guidance II…. Watch for the balance of risks to reappear – it seems reasonable to believe they have shifted decidedly to the downside. Forward guidance III. This would be an opportune time for Chicago Federal Reserve President Charles Evans to push through Evans Rule 2.0. No rate hike until core inflation hits 2% year-over-year…. Forward guidance IV. A lower path of dots in the next Summary of Economic projections to validate market expectations…. Rate cut. Former Minneapolis Federal Reserve President Narayana Kocherlakota argues that the Fed should just move forward with a rate cut in July. I concur…. If all else fails. If some combination of 1 through 5 were to fail, the Fed will turn to more QE and/or negative rates…

I am thinking of Stan Fischer on January 5, 2016 on interest rates:

Well, we watch what the market thinks, but we can’t be led by what the market thinks. We’ve got to make our own analysis. We make our own analysis, and our analysis says that the market is underestimating where we are going to be. You know, you can’t rule out that there is some probability they are right because there’s uncertainty. But we think that they are too low…

Even though the markets had been right and the Fed wrong for the previous three years, as of January 2016 Fischer was claiming that market expectations were irrationally pessimistic and that the Fed understood the state of the economy.

I would very much like to hear Stan Fischer give a speech early next month laying out how he has over the past six months marked to market his beliefs about the state of the economy and the correct economic model.

The roles of firms and pay decisions in rising U.S. income inequality

Posted on by Bridget Ansel
New research looking at the role of inter-firm and intra-firm inequality finds different results depending on the size of the firm.

The newest frontier in research about the rise of income inequality in the United States is the role of firms, or more specifically inter-firm inequality and intra-firm inequality. Inter-firm inequality is due to changes within firms rather than due to changes in workers’ education, skills or capabilities. Intra-firm inequality is about rising corporate executive pay across many companies. Almost a year ago, a paper about inter-firm inequality sparked interest in this area as it showed that almost the entirety of increased income inequality since the early 1980s was due to rising inter-firm inequality. A new version of that paper, released last week, adds more texture to our understanding of the role of firms in rising income inequality.

The newly updated paper, “Firming Up Inequality,” is by economists Jae Song of the Social Security Administration, David J. Price of Stanford University, Fatih Guvenen of the University of Minnesota, Nicholas Bloom of Stanford, and Till von Wachter of the University of California, Los Angeles. Relying on Social Security Administration data, the researchers’ top line result is this: The increase in inter-firm inequality is responsible for just under 70 percent of the rise in income inequality from 1981 to 2013, with the other 30 percent due to rising intra-firm inequality.

Thirty percent is, of course, is not insignificant, but the co-authors’ results do put inter-firm inequality squaring at the center of rising income inequality. Inter-firm inequality, by definition, includes two trends: increased firm earnings premiums (the boost to your earnings by working at a particular firm) and increased sorting of high-earning workers to high-paying firms and low-earning workers to low-paying firms. Both inter-firm inequality trends contribute about the same amount to rising income inequality, according to the results in the paper. This means the total rise in income inequality is roughly evenly split between rising intra-firm inequality, rising firm earnings premiums, and increase sorting. Interestingly, this division is very similar to results found using West German data.

But the really interesting results of updated paper have to do with firm size. Song and his co-authors run their analysis restricting their data to firms with less than 10,000 employees and those over that threshold. Firms below the 10,000-worker threshold employ about 70 percent of the U.S. workers and the larger firms employ the other 30 percent. The roles of inter-firm and intra-firm inequality are fairly different among these groups of firms.

For firms with fewer than 10,000 workers, inter-firm inequality played a larger role in increased income inequality, accounting for 87 percent of the overall increase, with 43 percent coming from increased firm earnings premiums and 33 percent from increased sorting. But for firms with more than 10,000 employees, intra-firm inequality was responsible for about half of the increase in income inequality. It’s not the sole factor, but it plays a much larger role for bigger firms than in the whole universe of firms. This rise in intra-firm inequality inside these firms is driven by two trends: declining earnings for workers in the bottom half of the firm’s pay scale and rapidly increasing pay for the top managers in these large firms.

These results are very important for thinking about the forces driving income inequality. Much of the prior research on the rise of income inequality was focused on understanding what might have increased intra-firm inequality. But now it seems that increased sorting and firm earnings premiums are just as important. Understanding why some firms can pay much better than others and why sorting has gone up (and how those factors differ by firm size) are now very important questions for researchers seeking to understand the rise of income inequality. The firm has now returned to an important role in our understanding of the labor market.

As this paper shows, data like those from the Social Security administrative have the potential to reveal nuances that were unseen until now. High-quality administrative data could really help inform our understanding of the role of firms in income inequality at more refined levels of analysis. This could be vital for interpreting the U.S. economic inequality and growth. Here’s to hoping more research comes soon.

Must-Read: Steve Cecchetti and Kermit Schoenholtz: A Primer on Helicopter Money

Posted on by Brad DeLong

Must-Read: Ummm… But aren’t the objections to expansionary fiscal policy today all that they involve governments taking on interest rate risk–that that is not a risk governments today ought to bear? And so isn’t the fact that helicopter money extinguishes that risk and is a more stable fiscal policy than bond-financed spending the entire point?

So I don’t understand…

Steve Cecchetti and Kermit Schoenholtz: A Primer on Helicopter Money: “Helicopter money is not monetary policy…

…It is a fiscal policy carried out with the cooperation of the central bank…. If the yield curve still has any upward slope, issuing reserves rather than long-term bonds to finance fiscal expenditure will appear cheaper in terms of current debt service. However, this apparent saving is an illusion because it ignores interest rate risk…. Helicopter money may strain the relationship between the fiscal and monetary authority… creating a situation commonly known as ‘fiscal dominance.’… A central bank does not face rollover risk, so a fiscal expansion financed by central bank money is more stable than one financed by bond issuance…. But is rollover risk really a concern for the government of most advanced economies? We doubt it….

Helicopter money today is… expansionary fiscal policy financed by central bank money. And, if interest rates have fallen to the ELB, it is neither more nor less powerful than any bond-financed cut in taxes or increase in government spending in combination with QE.

Monday DeLong Smackdown: Olivier Blanchard on How the Eurozone Can Be Strengthened After Brexit

Posted on by Brad DeLong

A high-quality DeLong smackdown! Keep ’em coming, please…

Olivier Blanchard: How the Eurozone Can Be Strengthened After Brexit: “Brexit raises fundamental questions…. Meanwhile, Europe must continue to function…

…In this context that a large number of prominent economists from different European countries, ranging from those who desire more political integration to those who are more skeptical, have written what they see as the essential next steps to reinforce the architecture of the eurozone…. The purpose of the project, which started long before Brexit, was twofold. First, assess the nature of the challenges and the progress to date…. Second, assess the degree of agreement among ‘experts’ about the remaining challenges and solutions. If you look at the diversity of people on the list, the answer to the second question is that, in contrast to the often strident disagreements in the press, there is, indeed, surprisingly large agreement among experts….

The basic architecture is largely in place. Some strengthening is needed but does not require dramatic political steps. The most important set of measures to take is a strengthening of the European Stability Mechanism (ESM)…. The banking union is largely in place, and with it better tools to monitor and reduce financial risks…. More progress can be made without requiring much more political integration…. [In] public finances… fiscal rules have become too many, too messy, with too many loopholes…. In many countries, the issue is not so much deficits than the high level of expenditure, which in turn makes it difficult to balance budgets without resorting to excessive taxation…. Even under the best fiscal rules, current levels of debt together with low growth imply that sovereign debt default is not impossible. Defining responsibilities and the process for sovereign default is essential. This should and can be the role of the ESM…. States have to be willing to give up some control. Otherwise the ESM will not be able to do its job…. We have learned… that liquidity runs can… be very destructive. The European Central Bank (ECB) now has the tools to provide liquidity to banks…. It would be good if it could do the same to states….

Many would like to see more ambitious steps taken, from a common fiscal policy, to euro bonds, to euro-level deposit insurance, etc. And indeed, the line taken by some US commentators today (e.g., Bradford DeLong and Paul Krugman is that this is what our manifesto should have asked for…. Our goal was less ambitious and more realistic. It was to see if the eurozone could function and handle shocks without further political integration if political realities made it impossible for the time being. Our answer is a qualified yes, but it is surely not an endorsement of a do-nothing strategy.

Must-Reads: June 27, 2016

Posted on by Brad DeLong

Should Reads:

Must-Read: Danny Yagan: Enduring Employment Losses from the Great Recession?: Longitudinal Worker-Level Evidence

Posted on by Brad DeLong

Must-Read: Danny Yagan: Enduring Employment Losses from the Great Recession?: Longitudinal Worker-Level Evidence: “The severity of the Great Recession varied across U.S. local areas…

…Comparing two million workers within firms across space, I find that starting the recession in a below-median 2007-2009-employment-shock area caused workers to be 1.0 percentage points less likely to be employed in 2014, relative to starting elsewhere. These enduring employment losses hold even when controlling for current local unemployment rates, which have converged across space. The results demonstrate limits to U.S. local labor market integration and suggest hysteresis effects culminating in labor force exit.

Must-Read: Cardiff Garcia: Alan Taylor on financialisation, business cycles, and crises

Posted on by Brad DeLong

Must-Read: Cardiff Garcia: Alphachat: Alan Taylor on financialisation, business cycles, and crises: “With collaborators Oscar Jorda and Moritz Schularick, the authors summarise their decades-long work on financialisation, which we discussed with Alan…

…From the paper:

Our previous research uncovered a key stylized fact of modern macroeconomic history: the “financial hockey stick.” The ratio of aggregate private credit to income in advanced economies has surged to unprecedented levels over the second half of the 20th century. The goal of this paper is to show that with this “great leveraging” key business cycle moments have become increasingly correlated with financial variables. Our long-run data show that business cycles in high-debt economies may not be especially volatile, but are more negatively skewed. Higher debt goes hand in hand with worse tail events.

A great deal of modern macroeconomic thought has relied on the small sample of US post-WW2 experience to formulate, calibrate, and test models of the business cycle, to calculate the welfare costs of fluctuations, and to analyze the benefits of stabilization policies. Yet the historical macroeconomic cross country experience is richer. An important contribution of this paper is to introduce a new comprehensive macro-financial historical database covering 17 advanced economies over the last 150 years. This considerable data collection effort that has occupied the better part of a decade, and involved a small army of research assistants.

Must-Read: Laura Tyson and Eric Labaye: Jumpstarting Europe’s Economy

Posted on by Brad DeLong

Must-Read: Laura Tyson and Eric Labaye: Jumpstarting Europe’s Economy: “Not so long ago… ‘helicopter money’… seemed outlandish…

…But today a surprising number of mainstream economists and centrist politicians are endorsing the idea of monetary financing of stimulus measures in different forms…. After years of stagnant growth and debilitating unemployment, all options, no matter how unconventional, should be on the table…. The United Kingdom’s referendum decision to leave the European Union only strengthens the case for more stimulus and unconventional measures in Europe. If a large majority of EU citizens is to support continued political integration, strong economic growth is critical…. The wave of corporate investment that was supposed to be unleashed by a combination of fiscal restraint (to rein in government debt) and monetary easing (to generate ultra-low interest rates) has never materialized. Instead, European companies slashed annual investment by more than €100 billion ($113 billion) a year from 2008 to 2015, and have stockpiled some €700 billion of cash on their balance sheets.
This is not surprising–businesses invest when they are confident about future demand and output growth….

Proponents of helicopter money… rightly argue that it has the advantage of putting money directly into the hands of those who will spend it…. The boost to demand might give central banks the opening they need to move interest rates back toward historical norms. This could take the air out of incipient asset bubbles that might be forming…. A less risky and time-tested route for stimulating demand would be a significant increase in public infrastructure investment funded by government debt…. Yet governments across Europe have clamped down on infrastructure spending for years, giving precedence to fiscal austerity and debt reduction in the misguided belief that government borrowing crowds out private investment and reduces growth. But the crowding-out logic applies only to conditions of full employment, conditions that clearly do not exist in most of Europe today…

Must-Reads: June 26, 2016

Posted on by Brad DeLong

Should Reads: