A world off-balance on monetary policy

Posted on by Brad DeLong

Nouriel Roubini writes:

Nouriel Roubini: “Worries about a hard landing in China… China is more likely to have a bumpy landing than a hard one…

…[but] investors’ concerns have yet to be laid to rest…. Emerging markets are in serious trouble…. The Fed probably erred in exiting its zero-interest-rate policy in December…

And it is not clear how the Federal Reserve can correct what is now widely-recognized as a probable error.

First, the Federal Reserve would have to be willing to admit that the asymmetric loss function meant that exiting zero last December was a probable error.

It was a probable error in retrospect today, and was unwise in prospect last December. Right now we are worried about global deflation. It is difficult to envision an alternative counterfactual scenario today in which we are equally worried about global inflation and equally regret that the Federal Reserve did not exist zero last December. When there is a substantial loss associate with a Type A error and only a minor loss associated with a Type B error, one risks making the Type B error unless the odds are overwhelming. The odds last December were to overwhelming.

The problem for the Federal Reserve is that admitting it made a policy error last December requires an all-but-explicit climbdown from the last two years’ worth of public risk judgments, and an explanation of why, given the obvious asymmetries, those public risk judgments were explained. And there is no face-saving way to undertake such a climbdown.

Second, the Federal Reserve would have to take steps to neutralize the contractionary pressure its policy move in December and the previous telegraphing of that move have put on the world economy. And that would be a difficult task indeed.

It looks like Ben Bernanke is about to go through the options. And that will definitely be worth reading.

Must-read: Ed Balls: “Echoes of the 1930s must focus finance ministers’ minds”

Posted on by Brad DeLong

Must-Read: Ed Balls: Echoes of the 1930s must focus finance ministers’ minds: “The lesson of the global financial crisis of 2009 is that…

…when the G20 gets going, it can act in a decisive and co-ordinated way. However, we should not have to wait for the crisis to hit before our financial leaders take the action needed to deal with it…. One problem is focus. Back in 2009, the whole world was alive to the risk of global depression. Not so today. Europe is focused on Brexit and the refugee crisis; America is in pre-election paralysis; meanwhile Asian countries are trying to convince everyone there is no need for panic…. Stagnating growth, fragile investor confidence, fears of competitive devaluation spreading mistrust, isolationist politicians flourishing in the polls–the echoes of the 1930s should be enough to focus minds on making the case for co-operation, open markets and finding new policies to deliver more inclusive economic growth…. Listen to the OECD and IMF on fiscal activism. Countries with room for manoeuvre should boost growth through infrastructure spending. That includes the US, Germany and, yes, Britain too. Medium-term fiscal consolidation is vital. But a slide in growth will make things worse. And the cost of funding these investments is very low.

Must-read: German Lopez: John Ehrlichman: “Real Reason for the Drug War Was to Criminalize Black People and Hippies”

Posted on by Brad DeLong

Must-Read: Is this plausible? In my experience, when X quotes Y saying that Y and his posse are mustachio-twirling villains, it is usually either:

  1. X is misquoting Y.
  2. Y has had a major change of heart and is trying to shock his posse into recognition that, however well-intentioned they had been, their course of action had been disastrous.

But it is rarely the case that Y and his posse actually were the conscious and malevolent mustachio-twirling villains that Y’s quote says they were.

Of course, for Richard Nixon one does have to make exceptions:

German Lopez: [Nixon Official John Ehrlichman: Real Reason for the Drug War Was to Criminalize Black People and Hippies: “A new report by Dan Baum for Harper’s Magazine…

… John Ehrlichman, who served as domestic policy chief for President Richard Nixon when the administration declared its war on drugs in 1971. According to Baum, Ehrlichman said in 1994 that the drug war was a ploy to undermine Nixon’s political opposition–meaning, black people and critics of the Vietnam War:

At the time, I was writing a book about the politics of drug prohibition. I started to ask Ehrlichman a series of earnest, wonky questions that he impatiently waved away. ‘You want to know what this was really all about?’ he asked with the bluntness of a man who, after public disgrace and a stretch in federal prison, had little left to protect:

The Nixon campaign in 1968, and the Nixon White House after that, had two enemies: the antiwar left and black people. You understand what I’m saying? We knew we couldn’t make it illegal to be either against the war or black, but by getting the public to associate the hippies with marijuana and blacks with heroin, and then criminalizing both heavily, we could disrupt those communities. We could arrest their leaders, raid their homes, break up their meetings, and vilify them night after night on the evening news. Did we know we were lying about the drugs? Of course we did.

This is an incredibly blunt, shocking response — one with troubling implications for the 45-year-old war on drugs. But it’s not implausible. Although black Americans aren’t more likely to use or sell drugs, they’re much more likely to be arrested for them. And when black people are convicted of drug charges, they generally face longer prison sentences for the same crimes, according to a 2012 report from the US Sentencing Commission. Ehrlichman claimed this was a goal of the drug war, not an unintended consequence. And Baum cites this as one of many reasons to end the drug war once and for all.

Yes, expansionary fiscal policy in the North Atlantic would solve many of our problems. Why do you ask?

Posted on by Brad DeLong

The highly-estimable Jared Bernstein has a very nice piece today. It attempts to sum up a great deal about the state of the economy in a very short space with five super-short equations;

  • One is about our current likely-to-be-chronic inequality problems.
  • Two are about our demand-management and maintaining-employment problems.
  • Two more strongly suggest that the solutions to our problems are extraordinarily simple. They say that in our current dithering and paralysis we are frozen out of fear of dangers that simply do not exist. Thus we are leaving very large and very gourmet free lunches on the table.

So, first, let us listen to Jared:

Jared Bernstein: Five Simple Formulas: “Here are five useful, simple… inequalities…

…Each one tells you something important about the big economic problems we face today or, for the last two formulas, what we should do about them. And when I say ‘simple,’ I mean it….

[1] r>g… that if the return on wealth, or r, is greater than the economy’s growth rate, g, then wealth will continue to become ever more concentrated….

[2] S>I… Bernanke’s imbalance…. Larry Summers’ ‘secular stagnation’ concerns offer a similar, though somewhat more narrow, version. For the record, I think this one is really serious (I mean, they’re all really serious, but relative to r>g, S>I is underappreciated)…. In theory, there are key mechanisms in the economy that should automatically kick in and repair the disequilibrium…. Central bankers, like Bernanke and Yellen, tend to discuss S>I and the jammed mechanisms just noted, as ‘temporary headwinds’ that will eventually dissipate (Summers disagrees). But while it has jumped around the globe—S>I is more a German thing right now than a China thing (Germany’s trade surplus is 8 percent of GDP!)—the S>I problem has lasted too long to warrant a ‘temporary’ label….

[3] u>u… Baker/Bernstein’s slack attack…. For most of the past few decades—about 70 percent of the time, to be precise—u has been > than mainstream estimates of u, meaning the job market has been slack…. From the 1940s to the late 1970s, u*>u only 30 percent of the time, meaning the job market was mostly at full employment….

[4] g>t… [Richard] Kogan’s cushion…. For most of the years that our country has existed (he’s got data back to 1792!), the economy’s growth rate (g again) has been greater than the rate the government has to pay to service its debt, which I call t. Kogan calls it r since it’s a rate of return, but it’s not the same r as in Piketty (which is why I’m calling it t)….

[5] 0.05>h… the DeLong/Summers low-cost lunch…. When the private economy is weak, government spending can be a very low-cost way to lift not just current jobs and incomes, but future growth as well…. The ‘h’ stands for hysteresis, which describes the long-term damage to the economy’s growth potential when policy neglect allows depressed economies to persist over time…. As an increase in current output by a dollar raises future output by at least a nickel, the extra spending will be easily affordable. But how do we know if 0.05>h? In a follow-up paper for CBPP’s full-employment project, D&S, along with economist Larry Ball, back out a recent number for h that amounts to 0.24, multiples of the 0.05 threshold, and evidence that, at least recently, h>0.05…

The Piketty inequality, [1] r>g, tells us that we are going to be hard-put to become less of a plutocracy than we are now. Consider Donald Trump. He is, or was back before he decided to concentrate on making money by renting his name out as a celebrity to those who could do management, a lousy manager and a lousy investor. Depending on whether you choose a New York real estate benchmark or a broad stock market benchmark, Trump now is between a quarter and a half as wealthy as he would be if he had simply been a passive investor throughout his career. And that is if he is truly as wealthy as he claims to be. In an environment in which most money feels that it has to be prudent, the plutocracy which can’t afford to take risks has the power of compound interest raising its economic salience over time.

The global investment shortfall inequality, [2] S>I, and the labor-market slack inequality, [3] u>u*, tell us that our major and chronic economic problem here in the Global North is and is for the next generation likely to be an excess of prudent saving looking for acceptable vehicles and of potential workers looking for jobs. This is in striking contradiction to the era 1945-1980 in which our major and chronic economic problems were a potential inflation-causing excess of liquidity and governments that believed or hoped to control inflation via financial repression longer than was feasible. This “secular stagnation” problem of chronic slack demand and excess prudent saving has in fact, been the major and chronic economic problem in the Global North since 1980 in Europe and since 1990 in Japan. But we here in the United States paid little notice until the problem spread to us at the start of the 2000s.

Richard Kogan’s observation [4] g>t is this: The United States economy is not and has not been dynamically inefficient in a growth-theory capital-intensity sense. It has, however, been chronically short of federal government debt valued as a prudent investment vehicle for savers. The Treasury’s borrowing operations have, therefore, been on balance not a cost reducing the resources that can flow through from taxes to useful government expenditures, but rather a profit center. A national debt is thus, in Alexander Hamilton’s words, a national blessing. And in the range of debt the U.S. has possessed, a larger national debt has been a national blessing not just for the country as a whole but even from the narrow perspective of the Treasury, in that it is made it easier for the Treasury to balance its books.

And one of the major points of DeLong and Summers (2012), [5] 0.05>h, is that at current levels of debt and interest rates the United States does not run increasing risks but rather runs reduced risks by aggressively borrowing and spending. Whatever you think the risks of a U.S. debt crisis are, they are greater with a higher debt-to-GDP ratio. But the current configuration of the U.S. and Global North economies is such that higher government deficits now reduce the projected debt-to-GDP ratio and the associated debt-financing burden however serious you think that debt-financing burden is. And this will remain the case until (a) interest rates “normalize” (if they ever do), and (b) the economy reattains potential output (if it ever does).

The corollary, of course, is that state governments and the Republican Congressional Caucus and even Treasury Secretaries Jack Lou and Tim Geithner and President Barack Obama have been both retarding the short- and long-run growth of the American economy and raising the long-term risks of financial crisis by focusing so much on reducing the government deficit.

In my view, the economics of Abba Lerner—what is now called MMT—is not always right: It is not always possible for the government to spend freely to attain full employment, use monetary policy to keep the debt under control, and rely on rising inflation as the only signal needed of whether and when policy needs to be tightened. Why not? Because it is possible that the bond market can get itself into an unsustainable position, in which underlying inflationary pressures are masked until it is too late to rebalance government finances without a financial crisis.

But, in my view, right now the economics of Abba Lerner is 100% correct. The U.S. (and Europe!) should use expansionary fiscal policy to rebalance the economy at full employment and potential output. And interest rates are so low that doing so does not require any additional monetary policy steps to keep the debt under control.

Japan, alas, confronts us with a difficult and much more devilish program of economic policy. Partial and nearly painless debt repudiation via inflation and financial repression seems to me to be the best way forward—if that can be attained. But more on that anon.

Firm wage setting and the rise of U.S. income inequality

Posted on by Bridget Ansel
Workers at the Facebook office in Menlo Park, California. New research investigates the role of high-paying firms in wage inequality.

Rents and the role of firms in wage setting are becoming an increasingly popular area of research and conversation when it comes to income inequality in the United States. Generally, the conversation around income inequality and its causes focused more on the characteristics of workers (such as their level of education) than on the characteristics of the firms at which they work. That’s because in the competitive labor market models that economists tend to favor, firms are not as important as market forces when it comes to setting the wages of workers. In these models, firms don’t have the power to set wages.

Yet a new wave of research shows that perhaps adherence to this model of the labor market might be mistaken. A new paper by economists David Card at the University of California, Berkeley, Ana Rute Cardoso at the Institute for the Study of Labor, Joerg Heining at the Institute of Employment Research, and Patrick Kline at University of California-Berkeley takes a look at the evidence for firms being major contributors to the rise of income inequality. Economists, of course, have known for some time that there’s a large variation in the level of pay across firms. And anyone who’s taken a look at the U.S. economy recently knows that, too. Facebook pays a whole lot more than McDonalds or its many franchisees. But is that because one of those two companies can choose the wages they pay workers or because highly-paid workers end up at one of those two firms?

A similar question arises when we think about the trend over time. Perhaps highly-paid workers are just being “better sorted” to the highly productive, highly profitable firms. To expand upon the example above, are workers better paid at Facebook compared to McDonalds because more highly educated workers are employed at Facebook-like firms or because Facebook pays higher wages than other similar firms.

To get at the answers, economists often account for the structure of a labor market by decomposing each worker’s wage into three “effects”—the human capital effect, the sorting effect, and the pure firm effect. The human capital effect measures the share of wage inequality that can explained by worker characteristics. The pure firm effect is the share that is explained by firm characteristics. And the sorting effect captures how much can be explained by high-paid workers being employed by high-profit firms. Discussions about the role of firms in inequality can sometimes lump these last two effect together. But they are actually quite distinct.

One of the big data trends in economics in recent years that enables economists to better understand the relationships among these three effects is the increased availability of data sets that link records about individual workers with their employers. These data sets (which are much more prevalent in developed economies outside the United States) help economists investigate the role of firms in wage inequality and how much “sorting” of workers can explain changes in income inequality. Work by Card and his coauthors finds a significant role for sorting in the increases in wage inequality in West Germany. In fact, sorting accounts for about of third of the increase in West German wage inequality between 1985 to 2009 while the pure firm (or in this case establishment) effect accounts for about 25 percent of the increase. Preliminary work from a team of researchers looking at the United States also finds a substantial role for sorting in the rise of U.S. wage inequality. In fact, they claim the firm effect is driven entirely by sorting.

How much of the rise in firm-driven inequality is due to sorting or pure firm effects has important implications for the rise of inequality. A role for pure-firm effects would indicate a large role for imperfect competition in our understanding of the labor market. In this regard, the role of rents and firms may be an important trend to consider, but it’s worthwhile to point out that much of the new research is based on data from different countries. And as Card and his authors point out, the role of firms and market power would indicate a need to be aware of the differences in the structures of labor markets. No “theory of everything,” as the authors put it, seems likely to answer the questions here.

Must-reads: March 22, 2016

Posted on by Brad DeLong

Rethinking the expectations channel of monetary policy

Posted on by Brad DeLong

From the “Meeting Report” section of the Fall 2015 Brookings Papers on Economic Activity:

”Fredric Mishkin elaborated on the issues that discussant Adam Posen had raised…

…regarding how demoralizing the outcomes from Japanese monetary policy have been. He had felt more strongly than Posen that expectations were very important and that managing expectations is a key element in good monetary policy. He and his colleagues expected much stronger effects in Japan from the expansion of its monetary policy. Japan’s outcome might demonstrate that raising inflation expectations is much more difficult than lowering them, and moreover this might be true globally.

Acknowledging that he is known to be a big proponent of inflation targeting, Mishkin said that when the focus is on how to keep inflation expectations down, it has worked well. But he and others have found it much more difficult to raise expectations, particularly during a long period of deflation. He noted that the general view about New Zealand’s experience is that the policy there anchored inflation expectations, that it had an expansionary impact by raising inflation expectations and thereby getting people to spend more. Yet one can see how difficult it has been to get the Japanese consumer to do the same…

”Brad DeLong seconded Mishkin’s comment…

adding that the macroeconomic situation in Japan has not developed necessarily to Japan’s advantage even though economists had strong reasons to think the expectations channel was present based on historical examples. In the 1930s, Franklin Roosevelt’s New Deal and Neville Chamberlain’s announcement as Chancellor of the Exchequer that his policy was to restore Great Britain’s price level to its pre-Depression state both demonstrated the power of the expectations channel. Indeed, the same happened when Japanese Finance Minister Takahashi Korekiyo announced his decision to go for reflation in Japan in the 1930s. It is a great puzzle that this time around it has not been working…

Indeed.

Add the failure of Abenomics to perform as expected–at least, as I had expected–to my list of major career analytical howlers, along with:

  • Central banks have the power and the will to return North Atlantic nominal GDP to its pre-2008 growth path…
  • Subprime is too small a market to be a major source of systemic risk…
  • Repealing Glass-Steagal would lead to a more efficient and less lavish and disruptive Wall Street…
  • NAFTA will tend to strengthen the peso, as capital is now attracted by guaranteed tariff- and quota-free access to the largest consumer market in the world…

The failure of Abenomics to perform as expected may well be the analytical error that is the sign of the deepest and most significant flaw in my Visualization of the Cosmic All. Ever since I was 20 or so I have operated with the rules of thumb that labor-market expectations are by and large backward-looking well financial-market expectations are by and large forward-looking. These rules of thumb have served me relatively well in the past. But they are not serving me well today.

Yes, I have long known that there is a noise trader term in asset prices. But I’ve always taken it to be a persistent additive deviation from the forward-looking expectational equilibrium price fundamental. It now seems that this is not good enough to help me properly understand the world. But with what should I replace it?

Must-read: Mohammed El-Erian: “Is the Perfect Storm Over for Markets?”

Posted on by Brad DeLong

Must-Read: The great and the good of the non-insane wing of Global North Neoliberalism seem–or so I read it–to now be calling for a transition to a two-handed growth-supporting economic policy: fiscal expansion (by governments with ample fiscal space) and “structural reform”. Their hope, I think, is that “structural reform” will reassure those who otherwise make a profession out of panicking over government debt levels–even governments that issue reserve currencies, possess exorbitant privilege, and that have debt currently valued by the markets as more precious than rubies. Their hope, I think, is that fiscal expansion will produce fast enough growth to make that plus “structural reform” genuinely win-win, and that the promise of enough fiscal expansion will quiet those Keynesians who otherwise would vociferously oppose what they see as yet another round of upward redistribution under the guise of “structural reform”.

Ah. But what are these “structural reforms”? Federal and state action to make it much easier to build infill and up zone housing in greater San Francisco is the only thing I can think of that commands general and universal assent (and even there, the bulk of we greater San Francisco home owners are in opposition):

Mohamed A. El-Erian: Is the Perfect Storm Over for Markets?: “LAGUNA BEACH – Earlier this year, financial markets around the world were forced to navigate a perfect storm…

…The longer these disturbances persisted, the greater the threat to a global economy already challenged by structural weaknesses, income and wealth inequalities, pockets of excessive indebtedness, deficient aggregate demand, and insufficient policy coordination. And while relative calm has returned to financial markets, the three causes of volatility are yet to dissipate….

First, mounting signs of economic weakness in China and a series of uncharacteristic policy stumbles there…. Second, there are still legitimate doubts about the effectiveness of central banks, the one group of policymaking institutions that has been actively engaged in supporting sustainable economic growth…. Third, the system has lost some important safety belts, which have yet to be restored. There are fewer pockets of ‘patient capital’…. OPEC… has stepped back from the role of swing producer on the downside….

All this came in the context of a US economy that continues to be a powerful engine of job creation. But markets were not voting on the most recent economic developments in the US. Instead, they were being forced to judge the sustainability of financial asset prices that, boosted by liquidity, had notably decoupled from underlying economic fundamentals….

Durably stabilizing today’s markets is important… for a system… [with] too much financial risk… requires a policy handoff… more responsible behavior… transition from over-reliance on central banks to a more comprehensive policy approach that deals with the economy’s trifecta of structural, demand, and debt impediments…

Must-Read: Heather Boushey: Home Economics

Posted on by Brad DeLong

Must-Read: Heather Boushey: Home Economics: “American businesses used to have a silent partner…

…the American Wife. She made sure the American Worker showed up for work well rested (he didn’t have to wake up at 3 a.m. to feed the baby or comfort a child after a nightmare), in clean clothes (that he neither laundered nor stacked neatly in the closet), with a lunch box packed to the brim with cold-cut sandwiches, coffee, and a home-baked cookie. She took care of all the big and small daily emergencies that might distract the American Worker from focusing 100 percent on his job while he was at work…. For decades, the American Wife gave American businesses a big, fat bonus….

This unspoken yet well-understood business contract is now broken. Moreover, it doesn’t look like we’re going back to it anytime soon. Nor should we. American families look different today. Wives—and women more generally—work outside the home because they need to and because they want to…