Must-Read: Martin Sandbu**: The Importance of Corbynomics: “A good place to start is by the two competing letters from economists…

…for and against Corbynomics. One, in the Guardian, insisted that Mr Corbyn’s opposition to fiscal austerity was mainstream economics. The other, in the Financial Times, argued that nationalising industries and printing money to fund investment was not. If this is a war of letters, it is a phoney kind of war, since both can be true at the same time (as Simon Wren-Lewis has pointed out.) But together, the two letters make up as good a list as any of the main traits of the economic policy that Mr Corbyn has suggested he wants to pursue.

Must-Read: Paul Krugman: Labour’s Dead Center: “One crucial piece of background to the Corbyn surge…

…the implosion of Labour’s moderates…. Every candidate other than Mr. Corbyn essentially supported the Conservative government’s austerity policies…. accepted the bogus justification… pleading guilty to policy crimes that Labour did not, in fact, commit….

Was the last Labour government fiscally irresponsible?… On the eve of the economic crisis of 2008… debt was lower, as a share of G.D.P., than it had been when Labour took office a decade earlier, and was lower than in any other major advanced economy except Canada…. There has never been any hint that investors, as opposed to politicians, were worried about Britain’s solvency: interest rates on British debt have stayed very low…. There was never any need for a sharp turn to austerity…. The whole narrative about Labour’s culpability for the economic crisis and the urgency of austerity is nonsense… consistently reported by British media as fact.

And all of Mr. Corbyn’s rivals for Labour leadership bought fully into [it]… accepting the Conservative case that their party did a terrible job…. Why Labour’s moderates have been so hapless. Consider the contrast with the United States…. Part of the answer is that the U.S. news media haven’t been as committed to fiscal fantasies, although that just pushes the question back a step. Beyond that, however, Labour’s political establishment seems to lack all conviction…

Must-Read: Bluntly, your macroeconomic model–whatever it is–needs to mimic a Simsian VAR in-sample. If it does not, it has no claim on our attention: it is imposing assumptions that are neither the true structure nor even useful epicycle-like forecasting hypotheses. And if it cannot fit the data we have, it has no ability to claim to provide useful policy multipliers.

The Lucas critique remains true: a model can mimic a VAR and still not be useful for the purpose of providing policy multipliers. But the anti-Lucas critique–that a model that does not mimic a VAR has no claim to our attention for any purpose whatsoever–is much truer:

Ray Fair (2010): Convergence in Macroeconomics: Hoisted from Ray Fair’s Archives: “There have been a number of recent papers arguing…

…that there has been considerable convergence in macro research and to the good. Blanchard (2009, p. 2)… Woodford (2009, pp. 267, 269)… Chari et al. (2009, p. 242) state: “Viewed from a distance, modern macroeconomists… are all alike.”… Galí and Gertler (2007, p. 26)… state: “Overall, the progress has been remarkable. A decade ago it would have been unimaginable that a tightly structured macroeconometric model would have much hope of capturing real-world data, let alone of being of any use in the monetary policy process.”… There has been convergence… [to what] I will call ‘macro 2’, [which] dominates… refereed journals….

My non-macro friends often ask why macroeconomists cannot just compare models in terms of how well they fit the data and choose the model that fits best?… It is not, however, common…. The only case I am away of is in Fair (2007, Table 1), where a DSGE model in Del Negro et al. (2007) is compared to the US model in Fair (2004)…. The four-quarter-ahead RMSE for real GDP for the DSGE model is 2.62%, which compares to 1.33% for the US model in which autoregressive equations are specified for the exogenous variables…. The eight-quarter-ahead RMSE for the DSGE model is 6.05%, which compares to 1.84% for the US model. The DSGE model is thus not accurate. This is, of course, only one example, and in future work more comparisons like this should be done…

I am with Ray fair here: Whenever somebody shows up with a DSGE model that they attempt to use for any purpose, my first question is: how does this fail to mimic a VAR? My second question is: how much do the factors in the model that caused it to fail to mimic a var–the factors that we know are wrong–corrupt your answers to the question of interest right now? My third question is: what validation can you present that this is in fact a useful linear approximation to the emergent properties generated by the true microfoundations–which true microfoundations your model definitely lacks?

More often than not, presenters give little evidence of having thought about any of these three questions before…

Must-Read: There are a lot of instructive comparisons that can be made around the European periphery–Finland, Latvia, Greece, Spain, Portugal, Ireland, Iceland. They pretty much all lead to the conclusion that given the Austere way the euro has been implemented, it has been a huge mistake for everybody except Germany and Holland–for whom the lower currency value and thus greater export competitiveness produced by the eurozone has been an enormous benefit–a benefit that should make them very eager to pay the fiscal union transfers needed in the eurozone’s current situation.

Paul Krugman**: Poland Versus Greece: “Yannis Ioannides and Christopher Pissarides… talk about the ways lack of structural reform…

…hurts Greek productivity and competitiveness…. It’s very, very wrong to point to factors limiting Greek productivity and claim that these factors are the ‘cause’ of the Greek crisis. Low productivity exacts a price from any economy; it does not normally, or need not, create financial crisis and a huge deflationary depression. Consider… Greece and Poland…. Poland has not had a Greek-style crisis, or indeed any crisis at all. Instead, it has powered through the turmoil…. By adopting the euro Greece first brought on massive capital inflows, then found itself in a trap, unable to achieve the needed real devaluation without incredibly costly deflation. Every time someone asserts that the Greek problem is really on the supply side, you should ask… why this should lead to collapse. Greece… should have real wages only about 60 percent as high as Germany’s. It should not have 25 percent unemployment.

Commercial bankers, you see, are not rentiers. Rather, they are intermediaries. And they are intermediaries who find an economy in which interest rates are likely to kiss the zero lower bound a very difficult environment in which to operate.

Thus if I were a commercial banker working for or advising the Federal Reserve, I would think like this:

The interest rate on relatively safe loans is going to bounce around with the state of the business cycle, as the Federal Reserve leans one way or another and as speculators expect the Federal Reserve to keep leaning or to normalize. But there is a fixed point of reference: The average around which the interest rate on relatively safe loans will bounce around will be equal to the rate of real profit, minus the yield discount for relative safety, plus the expected inflation rate.

Commercial banks need a wedge of about 300 basis points between their cost of funds and the returns on the loans they make. They need this wedge in order to operate their networks of ATMs, keep open their branches, and pay for their administrative processes. Commercial banks cannot pay negative interest on deposits. And commercial banks really do not want to sock their depositors with unexpected fees: that is a way for a bank to become a much smaller bank relatively quickly.

That means that:

• either there has to be a wedge of at least 300 basis points between the nominal interest rate on the loan banks make and zero
• or the commercial banking business model does not work.

If the average interest rate is below zero, then banks banks have to reach for yield. They must thus get into the business of making risky loans–loans that they are not equipped to judge well, and are made into situations rife with adverse selection and moral hazard.

Thus Commercial banks have a hard time making their business model work when the Federal Reserve target and the market expected inflation rate is, say, 2% per year. They would have a much easier time making their business model work when the Federal Reserve target and the market expected inflation rate were 4% per year.

Now combine this insight with the mechanics of maintaining an inflation target: When the actual inflation rate is less than 4% per year, the Federal Reserve should–slightly paradoxically–lower interest rates in order to boost spending and so get the inflation rate back up. And conclude that the commercial bankers and their allies in the Federal Reserve–the 36 Class “A” banker directors of the regional Federal Reserve Banks, the 36 Class “B” non-banker directors of the regional Federal Reserve Banks who are chosen by member banks to “represent” labor, agriculture, consumers, etc., but who do so mostly in the breach, and the regional Federal Reserve Bank Presidents who come out of the banking sector–ought to be among the strongest advocates of not raising interest rates now, and the strongest advocates of raising the 2% per year inflation target to 4% per year.

They are not.

Why not? Perhaps it is just that they do not believe in the Fisher Effect–do not believe that the average level of nominal interest rates would be 200 basis points higher under a 4% per year inflation target than under a 2% per year target.

Any other candidate explanations?

Must- and Should-Reads:

• Must-Read: David Roberts: Jon Chait Wrote an Optimistic Take on Climate Change. Is it justified?
• Must-Read: Jared Bernstein: The Press Calls Him on It!
• Must-Read: Harriet Torry and Jon Hilsenrath: Lesson for Fed: Higher Interest Rates Haven’t Been Sticking
• Austan Goolsbee: “I mean, who looks at the economy and says: ‘You know what went wrong in the 2000s? We didn’t cut high income people’s taxes enough'”
• Dave Weigel: “Christie says the official low unemployment # is bunk: ‘There’s someone in the Perkins building who just throws darts at a dartboard.'”
• Bill Black: Now the DOJ Admits They Got it Wrong
• Diane Coyle (1997): The Weightless World: Strategies for Managing the Digital Economy

Might Like to Be Aware of:

• J-F. Dubeau: Why Inkshares Matters to Readers and Writers of Fantasy and Science Fiction
• Joe Romm: Here’s Why 2016 Could Be Even Warmer Than 2015* Andrew Kaczynski: Ted Cruz, Who Repeatedly Vouched For John Roberts [in 2005], Slams Him At Length
• Bryan Lowry: Brownback’s Office Attacks ‘Ever-Litigating’ [Kansas] School Districts
• Andrew Flowers: The Science Of Grading Teachers Gets High Marks
• Alice Domurat Dreger: Opioids: An “n of 1” Reflection

As I said, my reading of the Great Depression era–FDR’s New Deal, Neville Chamberlain’s announcement that it was the policy of HMG to reverse the deflation that had occurred since 1929, Takahashi Korekiyo’s policies in Japan before his very untimely murder by militarist-fascist captains and majors–had convinced me that expectational effects were a thing. Thus I anticipated that Abenomics was likely to be a substantial huge success. 1979-1984 had taught us the limits of the expectations channel: that at the worker- and the manager-level expectations of inflation and deflation were likely to be adaptive and backward-looking. But Roosevelt, Chamberlain, and Takahashi in the 1930s gave me confidence in the expectations channel as far as money demand and investment were concerned. Thus I believed that the announcement effect of Abenomics stood a very good chance of working very well indeed.

I expected it to (1) reverse Japan’s deflation, (2) raise asset prices substantially, (3) bring price inflation and inflation expectations into line with its targets, and (4) spur a strong recovery. Why? Because I believed expectations relevant for financial markets were forward-looking, and reasonable forecasts that could be affected by credible policy announcements. (1) and (2) have happened. (3) and (4) have not.

Slides from Adam Posen’s Discussion of Hausman and Wieland’s Abenomics update:

Does Abenomics Support or Discredit Standard [New-Keynesian] Macro?

• The forward-looking expectations/crediblity centered view of monetary policy comes off poorly

  • Ball and others had warned us that you really need real growth and wage rises to get inflation up
  • Combo of exchange rate movement and the BOJ program should have been “credible” by any standard
  • May be a little unfair, in that the combination of labor market changes and global forces can account for a rather large share of the ‘shortfall’ in inflation (i.e., core targeting was more successful)
  • Hidden surprise is that unlike 1990s/early 2000s, clean banks and balance sheets, still no effect
  • Remains the issue of response to shocks (which I agree is the proper definition of anchoring)

• Fiscal policy comes closer to being as expected, at least in the short-run

  • Multipliers on fiscal policy not unexpectedly large, but persistence of shock was as surprise
  • The authors’ showing the uniformity of consumption impact across ages/credit status may just illustrate the (sole) relative importance of liquidity constraints which are largely absent in Japan today
  • Much more troubling with respect to fiscal theories of price level, debt-sustainability, and distinctions of permanent/temporary tax impacts

• Three surprises/challenges for me with respect to overall policy assessment

  • Hidden surprise is that unlike 1990s/early 2000s, clean banks and balance sheets, still limited effect
  • Should we stop talking about credbility?–if forward-looking matters, shouldn’t there be Ricardian effects of fiscal policy and/or a stock market response to VAT hike?
  • If labor flexibility and shareholder rights-enhancing reforms don’t work when tried, does this mean that structural reform is overrated?

What Are the Puzzles Abenomics Presents to Macro?

• Remember, the message of Japan 1990-2003 is that policy worked as expected [by simple IS-LM]

  • Has something changed?
  • Japan is more open and more market-oriented now than in 2003 which goes other way

• Underscores the misleading emphasis on (simple? or just flexible?) forward-looking expectations–even amongst well-informed businesses and investors

• Challenges us to further examine the global forces (still tbd) behind inflation levels and consumption/savings trends–especially since not simple RBC looking either

• Highlights the puzzles in trade balance and exchange rate pass-through:

  • How can depreciation have large effects on exports volumes but not imports?
  • How can depreciation affect a huge chunk of the economy and not (first-round) affect general inflation?

• Why is low inflation so inertial not just sticky?

• Are we having to take more literally falling in and out of two states of the world–between recession-land and boom-world?

Those are Adam Posen’s take-aways from the Abenomics experience so far. Are they right?

I will have to think about this for quite a while…

Must-Read: I guess I must be more optimistic than David Roberts–I still think the odds are favorable that we will learn how to manage our climate before we have had 100,000,000 unnecessary and avoidable premature deaths from global warming:

David Roberts: Jon Chait Wrote an Optimistic Take on Climate Change. Is it justified?: “my favorite part is Chait’s straight talk…

…about the Republican Party:

The entire world is, in essence, tiptoeing gingerly around the unhinged second-largest political party in the world’s second-largest greenhouse-gas emitter, in hopes of saving the world behind its back.

Well put! And he calls climate denialism “a regional quirk in the most powerful country on Earth,” which captures both the absurdity and danger of it….

Chait’s optimisms decline in plausibility as the piece goes along. Technological innovation: 8…. US policy progress: 7…. International political progress: 6…. China political progress: 5. Chait is right to mock Republicans for saying that US action won’t make any difference because China won’t reciprocate–and then ignoring or dismissing it when China reciprocates. In fact, China is dumping enormous resources into clean energy and placing increasingly stringent limits on coal…. Developing country progress: 4….

The gaping hole in Chait’s piece? He has written the grassroots climate movement(s) out of existence. All he says about environmentalists is that they ‘sank into despair’ after the cap-and-trade bill failed…. It’s not just ‘environmentalists’ now–the climate justice movement is far broader than that and includes many other constituencies. And they did not sink into despair when the cap-and-trade bill (which they hated) died, they organized. Chait may not like the fact that the movement rallied around Keystone XL, but rally it did. And it’s beyond absurd that Chait mentions the closing of hundreds of coal plants in the US without mentioning the grassroots Beyond Coal movement…. Chait has always had a beef with the left activists in general and climate activists specifically… a bit personal… distorted his otherwise typically lucid political analysis…. It’s a little crazy to write about humanity getting serious about saving itself without even mentioning the growing grassroots movement that has dedicated itself to doing just that….

Overall optimism verdict: 7…. The status quo trajectory still leads to disaster. But… for the first time in my lifetime, it looks like it might be real fight.

Must-Read: Jared Bernstein: The Press Calls Him on It!: “The media, often pilloried for just reporting what the candidates tell them…

…performed notably well in this case, digging deeply into the numbers, referencing historical failures of these sorts of policies, and generally getting it factually correct. That’s worth applauding…. Granted, it wasn’t hard… Jeb’s economics’ team claims that supply-side magic dynamics offsets 65 percent of the tax cuts, an unbelievably large proportion…. But I still think we should give credit where it’s due…. Josh Barro… Catherine Rampell… John Cassidy… Bruce Bartlett…. The first partial analysis of the plan by experts (other than the economists associated with the campaign) was just released by the Citizens for Tax Justice. They report that 53 percent of the income tax cuts from the plan would go to the top 1 percent…. I don’t want to make too much of this spate of revealing analysis, but dare I dream? Could we actually be heading back to Factville!?…

Must-Read: Harriet Torry and Jon Hilsenrath: Lesson for Fed: Higher Interest Rates Haven’t Been Sticking: “In the seven years since the world’s central banks responded to the financial crisis…

…by slashing interest rates, more than a dozen banks in the advanced world have tried to raise them again. All have been forced to retreat… the eurozone, Sweden, Israel, Canada, South Korea, Australia, Chile and beyond…. [The] two central banks that haven’t raised rates since the crisis—the Fed and the Bank of England—have enjoyed stronger recoveries than others…. “Tightening too early can have very large costs, as it has had in the Swedish case,” said Lars Svensson, who quit as Riksbank deputy governor in 2013 in protest at the bank’s policy decisions…. Central banks can’t push rates higher in the long run than their economies can fundamentally bear, said Mr. Svensson. In the postcrisis environment, central banks have had trouble setting rates low enough to energize their economies, he said….

Fed officials now say they plan to move gradually. But their expectations for rates could still be too high. Officials in June estimated the Fed would raise the short-term federal-funds rate from near zero now to 1.625% by the end of 2016 and to 2.875% by the end of 2017. Investors have a different view… under 1% at the end of 2016 and under 1.5% at the end of 2017…