Must-Read: Welcome to Diane!
: Diane Whitmore Schanzenbach: “Diane Whitmore Schanzenbach is the [new] director of The Hamilton Project…
…and a senior fellow at the Brookings Institution…. Diane studies issues related to child poverty, including education policy, child health, and food consumption. She graduated magna cum laude from Wellesley College in 1995 with a bachelor’s degree in economics and religion, and received a doctorate in economics in 2002 from Princeton University…
Must-Read: In which Olivier Blanchard says that, currently, DSGE models have “much too much in them to be fully understood”. There is a rationale for studying a model that we do not understand–if and only if it makes predictions that fit the world. If one has such a model that makes reliable predictions, studying it is a not-implausible road to understanding the world, because maybe, just maybe, an understanding of the model will carry an understanding of the world along with it as a bonus. And there is a rationale for taking models we understand and seeing where and how they fit the world in order to help us iterate toward a better model that fits better.
But is there a case for investigating models we (a) do not understand that (b) do not fit the world? Even if we were to reach the point of understanding the model and how it works, what would that gain us?
: Reconstructing Macroeconomics: Suppose you are writing two textbooks, one undergrad, one grad…
…In the undergraduate textbook, it seems to me that when teaching the IS-LM, we have the same interest rate on the IS and the same interest rate on the LM. Basically, the policy rate that the central bank chooses by the LM curve goes into the IS curve when corrected for expected inflation. I think what we have learned is that these [two interest rates] can be incredibly different. So I would have an r and an rb, and have a machine in the middle–the banking system which would, depending on its health, determine the spread. It seems to me that if I want to communicate one message, that message is what I would communicate to undergrads. At the graduate… DSGE model… two mechanisms… are central. The first is leverage…. The second is liquidity…. I am hoping that someday we will put it together and have a simple way of thinking about leverage and a simple way of thinking about liquidity…. We are at the stage at which the DSGE models have much too much in them to be fully understood…
Must-Read: Matthew Yglesias puts his finger on a strong antinomy between right-wing economics and right-wing sociology. Right-wing (and some other) sociology puts a great deal of blame on the breakdown of social connections that lead people to act benevolently toward others who are not kin–for example, Banfield’s blaming of southern Italian poverty on “immoral familism”: “a dynamic of low trust, excessive localism, and extreme reliance on family networks”. Right-wing economics requires that in making their economic decisions people and businesses focus only on how they themselves profit. But, as Matt points out, the corporation that is acting immorally if it maximizes anything other than its stock price bears more than a passing similarity to the bureaucrat who regards himself as acting immorally if he does not embezzle and transfer funds to his family.
A market economy is based on human gift-exchange psychology. And is remains, in large part, based on value-for-value gift-exchange rather than on the mutual pursuit of advantage in a network of con games. And wherever it does turn into a con game, it tends to break down:
: Sounds like a lot of money: “Robert ‘Making Democracy Work: Civic Traditions in Modern Italy’ Putnam…
…isn’t a conservative. When I asked Tyler Cowen how he explains Southern Europe he pointed to Edward Banfield’s ‘Moral Basis of a Backward Society’. Francis Fukuyama has also treated the subject well in his recent books ‘The Origins of Political Order’ and ‘Political Order and Political Decay’…. Southern Europeans are stuck in a dynamic of low trust, excessive localism, and extreme reliance on family networks. There is a lack of impartiality in institutions and an ethic that ‘doing what’s right for my family’ rather than ‘following the law’ is the right thing to do. A country that gives you the mafia rather than a correctly functioning legal system and police services is also not going to give you highly effective schools or job training programs. What nobody seems to think is that Greece is poorer than Denmark or Spain is poorer than Germany or Italy is poorer than France because those countries spend more money on their welfare states. It’s convenient that people don’t think that because it’s not true….
The… relevance of Southern Europe to the United States is the current high social prestige enjoyed by the twin ideas that the social responsibility of a corporation is to be profitable and that the primary moral and legal obligation of a corporate manager is to enrich shareholders. These ideas combine to create a toxic moral climate…. In a healthy society, a business leader might invest time and resources in rent-seeking, but he wouldn’t brag about doing so and certainly he might choose to take the honorable path and not do it. But the current paradigm in the implicit US political philosophy is that he has a moral obligation to divert resources away from R&D and toward lobbying… find ways to trick customers into overpaying… violate regulations if the Net Present Value of paying the fines when you are caught exceeds the cost of compliance… [thus] replicat[ing] Banfield’s amoral familism, but with shareholders replacing the nuclear family as the local of ethical thinking. This is all further exacerbated by the ideas of Public-Choice Economics which tend to move from (correctly) asserting that government institutions’ performance is often undermined to some extent by the self-interest of government officials to a kind of perverse fatalism which suggests that wholly selfish and inept behavior is all that is possible from public institutions.
Must-Read: (2003): Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others: “Existing proposals to escape from a liquidity trap and deflation…
…including my Foolproof Way,’ are discussed in the light of the optimal way to escape. The optimal way involves three elements: (1) an explicit central-bank commitment to a higher future price level; (2) a concrete action that demonstrates the central bank’s commitment, induces expectations of a higher future price level and jump-starts the economy; and (3) an exit strategy that specifies when and how to get back to normal. A currency depreciation is a direct consequence of expectations of a higher future price level and hence an excellent indicator of those expectations. Furthermore, an intentional currency depreciation and a crawling peg, as in the Foolproof Way, can implement the optimal way and, in particular, induce the desired expectations of a higher future price level. I conclude that the Foolproof Way is likely to work well for Japan, which is in a liquidity trap now, as well as for the euro area and the United States, in case either would fall into a liquidity trap in the future.
A growing number of papers measuring U.S. wealth inequality and its continuing growth were published over the past year. One of those key papers, by economists Emmanuel Saez of the University of California-Berkeley and Gabriel Zucman of the London School of Economics, finds that the share of wealth held by the top 0.1 percent of families in the United States grew from about 7 percent in the late 1970s to 22 percent in 2012. Yet it’s important to note that Saez and Zucman’s results and similar estimates look at the distribution of wealth before accounting for the impact of taxation. A new paper looks at the post-tax distribution of wealth and finds that the federal income tax system is doing significantly less to reduce wealth inequality than in the past. And there are signs that the federal tax system in recent years might actually be increasing wealth inequality.
The paper by economists Adam Looney at the Brookings Institution and Kevin B. Moore at the U.S. Federal Reserve looks at trends in wealth inequality from 1989 to 2013 using data from the Fed’s Survey of Consumer Finances. This survey is particularly useful for measuring for wealth inequality because the survey oversamples families at the very top of the income and wealth ladders.
What Looney and Moore are looking at specifically is the mechanical impact of total income taxes on wealth inequality. Two trends emerged during the period of 1989 to 2013 that affected the relationship between taxes and wealth inequality. The first is the increasing ownership of tax-deferred assets among U.S. families. These assets include 401(k) retirement plans and the capital gains on a financial asset that hasn’t been sold yet (also known as unrealized capital gains). Families up and down the wealth ladder have increased their holding of these kinds of assets, but those at the top are by far more likely to hold a lot more of them. Almost every family in the top 1 percent has unrealized capital gains compared to 25 percent of the bottom 90 percent of families.
These unrealized capital gains are obviously unequally distributed—the difference between pre-tax wealth inequality and post-tax wealth inequality. These tax-deferred capital gains will be realized and taxed eventually, yet at the same time that more assets have been deferred from taxation the two authors find that federal income tax rates have been on the decline, both on ordinary income (essentially wages and salaries) and on capital gains.
Looney and Moore show how these rate cuts, particularly for realized capital gains, resulted in significant declines in the effective tax rates for these kinds of assets. While rates declined for every taxpayer, they declined the most for families in the top 1 percent. In 1989, the rate was quite similar for all wealth levels, but starting in 1998 the rates started to diverge, with the rate for the top 1 percent declining the most. The authors point to the large decline in the capital gains tax rate—from 28 percent to 15 percent during this time period—as the main driver of this decline in top tax rates.
The result of an effective tax cut that favors those at the top is, unsurprisingly, a decreasing reduction in wealth inequality. One way Looney and Moore show this is by comparing the share of pre-tax wealth owned by different sections of the population to the share of post-tax wealth they own. For the top 1 percent, the after-tax share is lower than the pre-tax share from 1989 to 2007, but the difference is declining over this period of time. But by 2010, the post-tax share of the top 1 percent is actually larger than the pre-tax share.
In short, the federal income tax code seems to be increasing wealth inequality.
One possible concern is how the timing of the Great Recession in 2007-2009 affects the two authors’ finding that the tax code shifted from doing less to reduce wealth inequality to outright increasing inequality right after 2007. Maybe the change is due to the huge collapse in housing prices, which resulted in a big hit to unrealized capital gains and the actual value of housing wealth for households in the bottom 90 percent of the wealth spectrum. Looney and Moore don’t include deferred housing capital gains in their analysis due to complications in how those gains have been taxed over the years. So it’s possible that this omission makes tax liabilities for the bottom 90 percent of households high as a share of total wealth, reducing their post-tax wealth, and thus increasing wealth inequality.
Looney and Moore’s analysis is, as they note, the first attempt to analyze trends in post-tax wealth inequality. So their paper is just the beginning of the investigation into this area. But if their results hold up they would have strong implications for how we think about the tax code and wealth inequality.
Must- and Should-Reads:
Might Like to Be Aware of:
: Optimal Fiscal Policy: “I testified in the House Budget Committee this AM…
…[with Ryan Silvey from Missouri, John B. Taylor from Stanford, and Chris Edwards from Cato], and have many excellent war stories to share. But no time to do so now.
Well! Jared, where are the war stories? We demand them.
Jared continues:
Roughly speaking, the position of the majority R’s is that you should always balance the budget for… I just sat with these folks for two long hours and I can’t really finish that sentence.
Partly for moral reasons. One witness blamed ‘Keynesianism for the decline in beneficial “Victorian fiscal morality”.’ Another had a macro-model that maintained, contrary to the CBO’s analysis of the R[epublican]’s budget resolution, that the deep near term cuts would boost, not hurt, growth, because forward-looking households would realize that R[epublican] spending cuts would eventually lead to greater investment, more tax cuts, and higher incomes in the future, so they’d spend more today to offset the cuts. One member, touting the folk’ism that since families have to balance their budgets, the Feds should too, took issue with my point that in fact, families borrow long-term all the time for things like college and homes. He asked me if I make more than I spend. I told him I certainly went into debt to pay for college, and he said he did too!
Another R[epublican] member went on about how much he hated government debt and I had the chance to ask him, ‘so, why did you guys pass $570 billion in non-offset tax cuts?!’ I think he answered, not unreasonably, something like, ‘well, maybe that’s something we can put on the table.’
The longer this continues, the more clear it becomes to me that Alan Greenspan’s setting the Federal Reserve’s inflation target at 2%/year and Ben Bernanke’s formalization of that–and perhaps more so making it an effective upper bound on the inflation the Federal Reserve will tolerate even for the short run without taking action–were disasters. If the past seven years have taught us anything, it is that central banks do not have the will and may not have the power to aim for full employment even in the medium run at the zero lower bound without the assistance of fiscal policy. And if the past seven years have taught us anything, it is that in today’s political-economic environment the expansionary fiscal policy phantom is just as phantasmal as the confidence fairy.
Failing the sudden appearance of said phantom, restructuring the procedures of monetary policy in order to summon the inflation-expectations imp may be, like Obi-Wan Kenobi, our only hope.[1]
Sooner or later we are going to have an economy stuck in a depressed state in or near the liquidity trap and then another big negative shock will hit from somewhere. Maybe that shock is coming from China right now. And should that happen, we will look back to the happy days of 2009.
Back in the late 1990s the Federal Reserve Bank of Boston ran a conference about what to do should we find ourselves at the zero lower bound.
I found myself thinking over and over again of something my great uncle Phil from Marblehead Massachusetts used to say. He once took a sailing safety examination. One question was: “What should you do if you are caught on a lee shore in a hurricane?” His answer was: “You never get caught on a lee shore in a hurricane!” He was correct. If you want to minimize financial, monetary, and economic instability, you work very very hard indeed to make sure that you are never in a position where short-term safe nominal interest rates are constrained by the zero lower bound.
And the consequences of such constraint are such that back in 1992 although Larry Summers and I were very enthusiastic about reducing inflation from 10%/year to 5%/year, we were very wary of reducing it from 5%/year to 0:
Lawrence Summers and J. Bradford DeLong (1992): Macroeconomic Policy and Long-Run Growth: “Even leaving dramatic instances of policy failure like the Depression aside,
we suspect it would be a mistake to extrapolate the results on the benefits…. On almost any theory of why inflation is costly, reducing inflation from 10 percent to 5 percent is likely to be much more beneficial than reducing it from 5 percent to zero…. And there are potentially important benefits of a policy of low positive inflation…. A large easing of monetary policy, as measured by interest rates, moderated but did not fully counteract the forces generating the recession that began in 1990. The relaxation of monetary policy seen over the past three years in the United States would have been arithmetically impossible had inflation and nominal interest rates both been three percentage points lower in 1989. Thus a more vigorous policy of reducing inflation to zero in the mid-1980s might have led to a recent recession much more severe than we have in fact seen…
What are the drawbacks of a 4%/year inflation target, really? Commercial banks are very happy–in such an environment they can invest their customers’ deposits in liquid Treasury securities and well-collateralized loans and be confident of a profit if they focus their attention on efficient customer service. Few people will face a situation in which their bosses will go bankrupt unless they either diss them by cutting their nominal wages or fire them.
In the past century, the United States has had three-month Treasury Bill rates below 1/2%/year for fully one-quarter of the time. Used to be able to say that the Great Depression and World War II were special. Today it is much much harder to say that…
[1] Now can somebody remind me why Lars Svennson is confident that a crawling-peg exchange-rate target would summon the inflation-expectations imp, and Paul Krugman is not?
**Must-Read: A set of model runs backing up the judgment of the very sharp–and, alas!, late–Federal Reserve Governor Ned Gramlich: increases in interest rates large enough to discourage a housing bubble would me much too large for there to be even a faint prayer that the economy could escape a damaging recession. Much better, Ned Gramlich thought, to use macroprudential regulation to keep leverage capable of causing systemic risk from emerging. Much better, Alan Greenspan thought, do stand ready to intervene to clean up the mess after the crash and so build a firewall between financial distress and the real economy of spending, production, and employment.
History has, I think, already judged. It is good to have Jorda and company here to report history’s verdict:
: Interest Rates and House Prices: Pill or Poison?: “Wild swings in asset prices over the past 20 years and the associated boom-bust cycles…
…have sparked considerable debate about how monetary policy might play a stabilizing role…. Jeremy Stein (2014), argued for using interest rate policy to reduce financial market vulnerability and as a complement to regulation and supervision. Such an approach entails a tradeoff: Raising interest rates to curb financial risk could mean deviating from the dual mandate, therefore entertaining higher unemployment and lower inflation. A recent paper by Ajello et al. (2015) is among the first to explore this tradeoff quantitatively…. We… ask how much interest rates would have had to rise to keep housing prices under control. Our rough figures suggest interest rates would have needed to rise around 8 percentage points to completely avoid the boom-bust cycle. However, such a boost also could have caused significant damage to the Fed’s main objectives of full employment and price stability…
Must-Read: Rudi Dornbusch (2001): Remarks Prompted by Rogoff’s Mundell-Fleming Lecture https://www.imf.org/EXTERNAL/PUBS/FT/STAFFP/2001/00-00/pdf/rd.pdf:
This is not part of the program, but it’s an unavoidable remark.
Ken, of course, was generous far beyond reason. For a man on a new job to put his credibility on the line that much. I appreciate it. I have a slight contest with him whether not labeling your axes or closing off the light on the overhead–which of the two is a better educational strategy. We’ll all see what future generations learn from that.
I want to use the presence of so many friends and students to make an acknowledgement beyond Ken. I was very fortunate, as an undergraduate, to have a teacher who said, “go to America”. He sits in this room. [Editor’s Note: Prof Alexandre Swoboda, Graduate Institute of International Studies, Geneva].
I was immensely lucky to go to Chicago at its very best time, when people were fighting about what was the right model, there was an assumption that no one knew what it was. Our teachers were fighting about it. I was immensely lucky to have Mike Mussa as a colleague/teacher both in Chicago and Rochester, and much of what I learned comes from him. He knows it.
So there are the debts.
And then there was the great luck to stand around while all the ingredients were thrown around. There was sticky prices that we had in our first graduate year. They had become flexible under the impact of inflation by the time we graduated. Expectations had suddenly emerged from Phelps, Friedman,and Lucas. Rational expectations were just thrown at us. We had all these ingredients to make our omelets. Mike and I did that in looking, really, for the same effects.
So the message is: stand around while guys lay out the ingredients while there isn’t a settled view, and you are allowed to do your own [view], and maybe you are lucky.
I think the extra piece that is important for any teacher is the students. It’s not the tenure committee. It’s the students that drive you. And at MIT we are just fantastically blessed with generations and generations of students that challenge you by the day.
And, in the end, I think that’s where the good luck of getting ahead comes from. And it’s a blessing that continues.
Thank you very much.
Rogoff’s Mundell-Fleming Lecture:
Must-Read: I think Paul Krugman gets one wrong today:
: Sarcasm and Science: “Paul Romer… [thinks] Lucas and his followers were driven into their adversarial style…
…by Robert Solow’s sarcasm:
I suspect that it was personal friction and a misunderstanding that encouraged a turn toward isolation…. They circled the wagons because they thought that this was the only way to keep the rational expectations revolution alive…
It’s true that people can get remarkably bent out of shape at the suggestion that they’re being silly and foolish…. But Romer’s account of the great wrong turn [in Chicago economics] still sounds much too contingent to me, and not just because, as he himself says, rational expectations quickly took over much modeling at MIT….
As I perceived it… there were two other big factors. First, there was a political component. Equilibrium business cycle theory denied that fiscal or monetary policy could play a useful role in managing the economy, and this was a very appealing conclusion on one side of the political spectrum. This surely was a big reason the freshwater school immediately declared total victory over Keynes… and why it could not back down when the… doctrine was found wanting.
Second… was the toolkit factor. Lucas-type models introduced a new set of modeling and mathematical tools… that required a significant investment of time and effort to learn… [and] let you impress everyone with your technical proficiency. For those who had made that investment, there was a real incentive to insist that models using those tools, and only models using those tools…
But New Keynesian models use those tools! And full-fledged RBC-DSGE models use a quite different set of tools, derived from Prescott’s papers rather than Lucas’s! And those who used those tools best of all–most incisively and creatively, cough, Rudi Dornbusch, cough–had absolutely no tolerance for the bullshit at all. And besides, as Paul Krugman often notes, the intrusion of Lucas-silliness into international macroeconomics got nowhere.
Not to mention: Milton Friedman’s rhetorical style was more finely-honed to draw blood than Robert Solow’s. Chicago was always most famous as a place with a style that was notoriously the most adversarial in economics. Why would anyone who had faced a Stigler or a Friedman have any reason to fear a Samuelson or a Solow?