It seems to me that this is likely to be analytically wrong–or, at least, far from the optimal policy under any expections scenario:

Janet Yellen: The Outlook for the Economy–May 22, 2015: “Given this economic outlook and the attendant uncertainty…

…how is monetary policy likely to evolve over the next few years? Because of the substantial lags in the effects of monetary policy on the economy, we must make policy in a forward-looking manner. Delaying action to tighten monetary policy until employment and inflation are already back to our objectives would risk overheating the economy. For this reason, if the economy continues to improve as I expect, I think it will be appropriate at some point this year to take the initial step to raise the federal funds rate target and begin the process of normalizing monetary policy. To support taking this step, however, I will need to see continued improvement in labor market conditions, and I will need to be reasonably confident that inflation will move back to 2 percent over the medium term.

After we begin raising the federal funds rate, I anticipate that the pace of normalization is likely to be gradual. The various headwinds that are still restraining the economy, as I said, will likely take some time to fully abate, and the pace of that improvement is highly uncertain. If conditions develop as my colleagues and I expect, then the FOMC’s objectives of maximum employment and price stability would best be achieved by proceeding cautiously, which I expect would mean that it will be several years before the federal funds rate would be back to its normal, longer-run level…

It is one of Herbert Simon’s principles that one should model the most striking features of a situation, take the model as your guide, solve for the optimal policy for your oversimplified model, and then hope that the optimal solution to the oversimplified model is a good solution to the real world policy problem.

In the case of the Federal Reserve, the natural way to model it’s task is as an optimal control problem. In such a problem, the optimal path for your control–which is, in this case, the short-term safe nominal interest rate that the Federal Reserve sets–is one in which it is expected to drift up or down only slowly. And whenever new information arrives, the optimal policy is for the control path to jump until once again the control variable is at a level at which you expect it to drift one way or the other only slowly.

All this is true assuming that one can either lay raise or lower one’s control variable as one wishes.

If your control variable has a bound–like the zero lower bound on interest rates–the optimal control policy is different. The fact that you cannot lower your control variable below its bound adds an extra term to the math. This extra term makes it unpleasant to be even near the bound. So you should take steps to stay away from it–which means lowering your control variable closer to the bound as you get near it. And the nearer to it you are, the more you lower it below what it would be if there were no bound constraining it.

This bound principle has the implication that if do you wind up at the bound, you want to get off of it as soon as possible in a way that makes it highly unlikely you will wind back at it. Hence you stay at the bound until your optimal policy in the absence of the bound is well away, and then you move your control variable rapidly until it once again is expected to drift only slowly.

Thus Janet Yellen’s declaration today makes no sense: from an optimal control of you, you want to wait to raise interest rates until the economy is sufficiently strong that the appropriate interest rate raise is a substantial one.

The Federal Reserve knows the logic of this optimal control argument at least as well as I do. But so far I have not heard or seen anywhere a coherent explanation of why it does not or even might not apply right now.

A good day yesterday at the University of California center in Sacramento, which is in the basement on K St. a couple of blocks away from the California state capital. 20 students, and then 100 for the lecture. (And I do not yet have the URL for the videotape.)

I started out saying: I find my peers, as they age, become increasingly unwilling to mark their beliefs to market. They increasingly turn their smarts and their cleverness to rationalizing why they can still believe what they believed in their 20s. This is not wise. This is, in fact, very dumb. And this is boring.

I said: I do not want to be boring here today. You do not want me to be boring here today. So let me go against this type of the aging middle-aged professor. Let me, instead, spend my time this lunchtime detailing four points in economics at which the world has surprised me over the past decade, and in which as a result reality has led me to shift my beliefs.

In brief:

• The world has turned out to be more Keynesian than I would have imagined a decade ago.
• Low-tax low-service U.S. state level political economy has proved to be ineffective as an economic development model. I was always pretty sure that it was a lousy bet from the standpoint of societal welfare. But a decade ago I thought it at least boosted state-level GDP. Now I do not.
• The success of the implementation of Obamacare has raised my estimation of the administrative competence of the government.
• And the aggregate economic costs to America of local NIMBYism now appear to me to be much larger than I would have thought reasonable decade ago: we are no longer a country in which people can afford to move to places where they will be more productive and more highly paid because high-productivity places refuse to upgrade their residential density.

All this, I said, has powerful political consequences. And the politics of the last decade has also been very surprising to me. But I did not have time to get into that in any depth…

Must-Read: William Lazonick: Stock buybacks: From retain-and reinvest to downsize-and-distribute: “Stock buybacks are an important explanation for both the concentration of income…

…among the richest households and the disappearance of middle-class employment opportunities in the United States over the past three decades. Over this period, corporate resource-allocation at many, if not most, major U.S. business corporations has transitioned from ‘retain-and-reinvest’ to ‘downsize-and-distribute,’ says William Lazonick in a new paper…. Lazonick also challenges many of the notions associated with maximizing shareholder value, an ideology that has come to dominate corporate America. Lazonick calls for a decrease, or even a ban, in stock buybacks so companies will be able to use these funds to finance capital expenditures but more importantly to attract, train, retain, and motivate its career employees. And some of the funds made available by a buyback ban can even flow to the government, he argues, as tax revenues for investments in infrastructure and human knowledge that can underpin the next generation of innovation.

Must-Read: Christopher L. Foote and Christopher F. Goetz (2005): The Impact of Legalized Abortion on Crime: Comment: “This comment makes three observations about Donohue and Levittʹs [2001] paper on abortion and crime…

…First, there is a coding mistake in the concluding regressions, which identify abortionʹs effect on crime by comparing the experiences of different age cohorts within the same state and year. Second, correcting this error and using a more appropriate per capita specification for the crime variable generates much weaker results. Third, earlier tests in the paper, which exploit cross‐state rather than within‐state variation, are not robust to allowing differential state trends based on statewide crime rates that pre‐date the period when abortion could have had a causal effect on crime.

Must-Read: Nicholas Bagley: Wreck the RUC: “The American Medical Association/Specialty Society Relative Value Scale Update Committee (RUC)….

…Rife with conflicts of interest and not especially transparent, the RUC is a specialist-dominated committee that ‘donates’ more than $8 million of its own services each year to Medicare, presumably out of the goodness of its heart…. Since CMS has been starved of the resources necessary to independently review physician services, the agency has little choice but to rubber-stamp most of the RUC’s recommendations…. Doing the job right would cost real money, but it’d be a pittance when compared to the $70 billion spent on physician payments in 2013. If we insist on running Medicare on a shoestring, we shouldn’t be surprised when it doesn’t work very well. Sometimes you get what you pay for.”

Must- and Should-Reads:

• Pros And Cons Of Raising The Minimum Wage
• Allison Preiss: RELEASE: 1 Million Entrepreneurs Went Missing in the U.S. Economy Before Recession
• Must-Read: John Cassidy: A Fascinating Minimum-Wage Experiment Is About to Unfold
• Hillary Clinton produces first campaign listicle for social media
• Must-Read: Richard Kogan et al.: Difference Between Economic Growth Rates and Treasury Interest Rates Significantly Affects Long-Term Budget Outlook
• Must-Read: Dan Davies: Time for a Delivery of Eurofudge
• Must-Read: Paul Krugman: Stop-Go Austerity and Self-Defeating Recoveries

Over at Equitable Growth—The Equitablog

• Kavya Vaghul: What about commuting to new economic opportunities?

Might Like to Be Aware of:

• Ev Williams: “Anyone can write something as a response and that response is public, meaning it has a public URL and can be shared. However, it’s only seen at the bottom of the original post if one or more of the following apply: It’s from the same author as the original post. It’s recommended by said author. Or — for those logged into Medium — it’s written or recommended by someone you follow. In other words: No one will see shitty comments at the bottom of your post unless you recommend them or they follow the people who make the shitty comments (in which case, they might not think they’re shitty). And you can make sure everyone sees the good ones”
• Hillary Clinton produces first campaign listicle for social media

Fiscal Policy and Economic Growth

Fiscal Policy and Economic Growth

J. Bradford DeLong
U.C. Berkeley

May 21, 2015
UC Center, Sacramento

What Is the Government’s Impact on Economic Growth?

• Federalism
  • Global government (to the extent that such a thing exists)
  • National government
  • State government
  • Local government
• Modes of operation
  • Building capacities
  • Insuring people
  • Opening markets
  • Regulating economic activity
• Ideologies
  • Laissez-faire
  • Developmental state
  • Republic of virtue
  • Redistribution

My Task Today: Bringing You the News

• What have we learned over the past ten years or so as we have watched governments act and react to the changing world?
• I think that we have learned—or perhaps I have learned:
  • At the global/national level, government spending in general is much more beneficial than we had thought
    • As long as there is a backstop bond-purchaser-of-last-resort
  • At the state level, slimming down the government for the sake of slimming it down has not worked
  • At the administrative level, the government appears better at structuring markets and complex administrative tasks than I had thought.
  • At the local level, our restrictions on infill and density have been very, very expensive.

A Victory for “Keynesianism” of an Unexpectedly-Large Magnitude

• Blanchard and Leigh (2012)
• Small open-country multiplier of 2
• Large closed-economy multiplier of 3 or more
  • Consumption spending
  • Business investment
  • The non-appearance of the “Confidence Fairy”

But What About Greece and Spain?

• Weisenthal (2011)
• Government bond markets can get into serious trouble when the government has no plans to pay…
  • But the bulk of the Eurozone financial crisis and its negative impact on European growth stems not from feckless governments (Greece)
  • It stems from fear of an unhandled panic
  • Government bonds are supposed to be safe…

$1000 Bills Left on the Sidewalk: Economic and Political
Economic

• IMF (2014)
• Four considerations
  • Economies still below full employment—and expected to remain so for a long time to come
  • Shortage of safe assets means government bonds are uniquely valuable, hence financing costs extremely low
  • Workers put back to work by fiscal expansion are more likely to stay attached to the labor force when full employment is again attained.
  • The work done has value
• In this unusual environment, government investment in “infrastructure”—which includes public health and education—is a genuine win-win-win free lunch
• Political
  • Relative U.S. performance has been very good
  • Lost opportunity for Republican victory lap

News on the Low State-Tax Road to Prosperity

• The news is not good
• Governor Sam Brownback of Kansas
  • Redirect entrepreneurial energy currently devoted to tax avoidance
  • Make unprofitable businesses profitable
  • With a Kansas population of 3 million and 1.4 million in Missouri within 40 miles of state line, steal businesses from Missouri
  • No sign of any effect at all…

News on the Government’s Ability to Restructure and Open Markets
* The news is much better than I had thought
* We basically did not have much of an individual-small group health insurance market
* We had grave doubts about the attractiveness of Medicaid
* ObamaCare has only been implemented in 2/3 of the country
* Another lost opportunity for a Republican victory lap

An Area Where Government Is Not Doing so Good—Especially in California

• Hsieh and Moretti (2014)
• Cities where people can make a lot of money have, for the first time in American history, not been the cities that have grown the fastest.
  • New York the biggest offender.
  • San Francisco, San Jose, Riverside than numbers 2, 3, and 4
• Failures of infrastructure development
• General NIMBYism
• 10% of potential 2009 GDP left on the table

Conclusion: Economic Surprises

• Both economic and political surprises to me over the past decade…
• Economic surprises:
  • The world appears significantly more “Keynesian” than I thought 10 years ago it could possibly be
  • That means a bigger government—especially in investment—with more debt outstanding
  • I used to think that state low-tax low-spending policies were bad for societal well-being but good for GDP—especially via job stealing. That looks much weaker
  • The government has been surprisingly competent at implementing ObamaCare
  • The costs of the capture of local government by anti-developmental NIMBY interests have been surprisingly large

Conclusion: Political Surprises

• The exit of the Republican Party from its historic role as the party of growth
  • Used to be for efficient and low-cost government, yes
  • But also for right-sized government: public investment, breaking-up of local anti-developmental lobbies, etc
• ObamaCare is RomneyCare—a Rube-Goldberged health-care reform plan with complexity arising in desire to be friendly to insurance companies and insurance markets
• The entrepreneurial rich have leveraged assets and benefit proportionally more from full employment—the successful economic policies of spending (TARP), financial guarantees, and monetary expansion (Federal Reserve) were originated by Paulson and Bernanke—both Republicans
• Yet they are not taking any victory laps…

Must-Read: Dan Davies: Time for a Delivery of Eurofudge: ““They pretend to pay us” — or in this case…

…“The institutions pretend to give Greece debt relief”. How much would it change things if the Eurozone partners were to agree to a 20% face value reduction in all of Greece’s liabilities? In my view, it would change things not at all. Greece needs, and one day will get, a much larger reduction than that, and everyone knows it (although plenty of people find it more convenient to suppress this knowledge and pretend they don’t). So announcing it would make no difference to the real debt burden on Greece, and no difference to the amount of repayment that the Eurozone can reasonably expect. But it would make things hugely politically easier for Syriza, which is beginning to realise that it is going to have to back down on some “red line”issues in order to get a deal.

Of course, a face value reduction would make things more difficult politically for some of the Eurozone partners, and would probably be impossible for the IMF to agree to. But a face-value constant NPV reduction would be less so — extending the term (again) and reducing the coupons (again). The IMF could even certify that this was equivalent to a debt reduction, and Yanis Varoufakis could certainly explain the equivalence on Greek television.

We should not be too far from a deal by now, and so everything hangs on whether it can be presented politically in an acceptable manner to both sides. For this reason, it’s worth everyone being a little less precious about fudging a few presentational issues. Because all of this capital is going to be needed for the structural reform debate, which is going to be a lot more difficult to pretend that something’s being done if it isn’t.