…Asness and Brown undertook a certain intellectual exercise, motivated by their impression that lots of people believe that the record of temperatures over the past century, taken by itself, implies that we face dangerous climate change. They show that it doesn’t, but readily admit that climate scientists don’t just work from this one set of recent temperatures, but use lots of other data too, and also take everything we know about the physics of the Earth system into account as well…. My concern is… with the potential for misunderstanding on the part of others… like the editors at Fortune (it would appear), may actually prefer to mis-understand. Asness and Brown themselves… have also complained about the misleading perspective furthered by Fortune….
Usually, the more information one brings to bear on a problem, the better one does on that problem…. This situation is directly analogous to the analyses offered by Asness-Brown (Team A) and climate scientists around the world (Team B). It’s not that Asness and Brown don’t know about all this other information, of course. It’s just that, in the present paper, making the most accurate prediction IS NOT their purpose. They limit their analysis to the temperature record from 1880 to the present because, as they see it, lots of people mistakenly believe that this temperature record alone is strong evidence for rapid and highly problematic rising temperatures over the next century…. Their analysis aims to stop such confusion, by showing quite clearly that simple mathematical extrapolation of the temperature record alone does not suggest such rapidly rising temperatures. They… acknowledge that… other information might very well lead to a very different conclusion. But that’s another matter, and not the topic of their paper….
The editors at Fortune … completely missed the point. I’m quite certain a few other people will miss it as well. In fact, I wouldn’t be surprised if the Asness-Brown draft soon becomes widely cited within certain circles as delivering a definitive disproof to claims of rapid warming…. I think (and so I believe do Cliff Asness and Aaron Brown) that the projections of Team B, the world’s climate science community, ought to be considered as likely to be the more accurate.
Afternoon Must-Read: Barry Eichengreen: Why Our Success in Managing the 2008 Banking Crisis Was the Mother of Failure
…that our very success in avoiding a repeat of the worst crisis in 80 years means that we are likely to experience another such crisis in considerably less than 80 years. Because we avoided complete collapse of the banking and financial system like that which occurred in the 1930s, the prevailing system was not discredited to the same extent. The opponents of financial reform were able to regroup and mount resistance to more far-reaching regulatory action of a sort that I’m convinced is still necessary to limit risks to financial stability. This is not to argue that we would have been better off letting the banking and financial system collapse in 2008-9. But the irony is that success was also the mother of failure.
Afternoon Must-Read: Dan Drezner: Austerity Is Still Popular Despite an Abject Record of Failure
: Austerity Is Still Popular Despite an Abject Record of Failure: “Authoritarians and aspiring authoritarians do not think of economic liberalism as an existential threat in the same way that they view political liberalism…
…There are models out here–think Singapore–of polities that are economically open while still preserving less-than-democratic political structures. Furthermore… in the short run, a rapidly growing economy makes life easier for authoritarian rulers…. The far greater challenge comes from Greece and Spain than Russia…. Greece and Spain… have had to endure a half-decade that is worse than they endured at the start of the Great Depression. One of the things that genuinely surprised me in research *The System Worked* was how robust public polling support was for free markets and free trade across the world. Over time, the one exception to that rule was the Southern European economies. And the most fascinating thing about the post-2008 period was the rise of austerity economics and its continued political popularity despite an abject record of failure. The power of austerity is a testament to the fact that power and interest alone cannot explain the global political economy. Ideas–even bad ones–matter as well…
Why the Hegemony of the New Keynesian Model?
The baseline New Keynesian model was not, originally, intended to become a workhorse.
It was intended as a proof-of-concept: to demonstrate that introducing very small market-imperfection frictions into a DSGE framework generated very Keynesian-monetarist conclusions. But the extraordinary shortcuts needed for tractability were and are a straitjacket that makes it extremely hazardous for policy analysis. It cannot fit the time series. And when it does fit the time series, it does so for the wrong reasons.
So why require everything to fit in this Procrustean Box?
This is a serious question–closely related to the question of why models that are microfounded in ways we know to be wrong are preferable in the discourse to models that try to get the aggregate emergent properties right.
Over at Project Syndicate: The Monetarist Mistake
Over at Project Syndicate: The Monetarist Mistake:
Two months ago here, I briefly noted that I had found the best explanation for why the collective economic policymakers of the North Atlantic have left and continue to leave the job of fighting and guiding recovery from our Lesser Depression at most half-done. The best explanation is to be found in my friend, teacher, and patron, Barry Eichengreen’s Hall of Mirrors.
But I have short shrift to both the argument of the book, and to its praise. It is the best book on 2008-present that has yet been written. And Eichengreen’s book’s central argument deserves to be the centerpiece of a much larger discussion. READ MOAR
So let me try to launch one piece of that discussion today:
Hall of Mirrors traces our tepid and inadequate response to the crisis in 2007-2009 to the triumph of monetarism. In the 1960s and 1970s monetarist economists advanced their particular economyc-historical interpretation of the causes of the 1930s Great Depression. And the sometime disciples of Milton Friedman overwhelmed their Keynesian and Minskyite peers.
The Great Depression, Friedman and his co-author Anna Jacobson Schwartz had argued in their 1963 Monetary History of the United States, was a failure of government. It was due solely and completely to the failure of the 1929-1933 Federal Reserve to properly and aggressively expand the monetary base in order to keep the economy’s money stock on a stable growth path. No decline in the money stock, no Great Depression. The government’s failure to follow a “neutral” monetary policy–the active disturbance by government incompetence of what was by nature a stable full-employment market economy–was the only reason for the Great Depression.
This interpretation made a certain kind of coherent sense. However, it could be sustained the so-called velocity of money, the speed with which people spent the cash in their pockets and the demand deposits in their banking accounts, varied little with changes in interest rates. And it involved some fast talk and fast dancing as to what a “neutral” monetary policy was.
But suppose the velocity of money was interest-elastic. Then the open-market operations undertaken to expand the money supply would have pushed down interest rates. They would so cause a further fall in monetary velocity. And so that would have made Freedman and Schwartz’s cure impotent.
And, it turned out, what Friedman and Schwartz called a “neutral” monetary policy in the Great Depression would have required that the Federal Reserve flood the zone with liquidity and buy bonds and print cash at a rate never before imagined.
If money demand were, contrary to what Friedman and Schwartz supposed, highly interest-elastic, then to have successfully stopped the Great Depression in its tracks would have required Keynesian expansionary fiscal and Minskyite supportive credit-market policies. And the argument that a “neutral” monetary policy is government hands-off as opposed to activist Keynesian fiscal and Minskyite credit policies was never fully credible.
The monetarists won the economic-historical and ma beat in the 1960s and 1970s. Peter Temin’s Did Monetary Forces Cause the Great Depression pointed out convincingly that there was no surprise in anything the Federal Reserve did–no place where interest rates jumped up as it deviated from what people were expecting–and at most minor and irregular downward pressure on liquidity. But that didn’t matter. Why not? Because the debate wa really two debates:
At one level, the debate between monetarists, Keynesians, and Minskyites was a simple empirical matter of reading the evidence: Was the interest-elasticity of money demand in a serious downturn low, as Milton Friedman claimed, or high, as in John Maynard Keynes’s and John Hicks’s liquidity trap? Were financial markets a near-veil because the money stock was a near-sufficient statistic for predicting total spending, as Milton Friedman claimed, or was the credit channel and its functioning of decisive importance, as Minsky warned?
At the second level, however, the debate was over whether market failure or government failure was the bigger threat. The Great Depression had, before Friedman and Schwartz’s Monetary History, been seen as an unanswerable argument that market failure was potentially so dire as to require the government to take over direction of the whole economy. And that created a presumption that there might be other, smaller market failure might require a government to be interventionist indeed not just in macro but in micro as well. But if the Great Depression could be understood as a failure of government, then the cognitive dissonance between its reality and right-of-center economists’ presumption that government failure was always the bigger threat could be erased.
Of course, the textbook Friedmanite cure was tried á outrance over 2008-2010 and proved insufficient. That is decisive evidence that Friedman and his monetarists were wrong about the Great Depression as well. There are thus no people today who have properly done their homework who would say, as Ben Bernanke said to Milton Friedman and Anna Schwartz in 2002:
You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.
But, even in the 1970s, the empirical evidence did not weigh strongly enough on the monetarist side to account for its decisive victory.
The completeness of the victory must, I think be attributed to the fact that political economy is always polluted by politics: so polluted that, as John Stuart Mill lamented back in the 1800s, there is no position so absurd that it has not been advanced by some political economist of note and reputation, and I would add because it is convenient to their intellectual-political commitments.
To admit that the monetarist cure was inadequate would be to admit that the Great Depression had deeper roots then a failure of technocratic management on the part of central banks charged with maintaining a neutral monetary policy and a stable money supply growth rate. Such deeper roots in severe market failures would not be consistent with a belief that social democracy had been oversold, and that government failure was almost invariably a worse danger than market failure. There was thus an extremely strong elective affinity between a mainstream economics profession caught up in the gathering neoliberal currents of the age and the Friedmanite interpretation of the Great Depression.
It was the completeness of the victory that made policymakers in 2008-2010 unwilling to apply the Keynesian and Minskyite cures to severe downturns enthusiastically enough and on a large enough scale to adequately deal with the problems that emerged.
And so when 2008 came, the economists advising the North Atlantic’s governments and central banks were not ready.
Labor’s share lost?
Since its publication, Thomas Piketty’s “Capital in the Twenty-First Century” has been criticized for a variety of reasons. The most recent wave has centered on his assertion that the share of income going to labor is on the decline. As the headline to a piece by the Wall Street Journal’s Greg Ip put it, “Thomas Piketty Says Labor’s Share of Income Is Declining, But Is It?”
Ip highlights three different bits of research that question the declining trend in the labor share that Piketty (and others) have found. The first paper is by Benjamin Bridgman of the U.S. Bureau of Economic Analysis. Bridgman points out that the most-cited data about the labor and capital shares is “gross,” meaning it doesn’t account for the deprecation of capital goods. Because machinery and computers wear down over time, part of income must be plowed back into buying more equipment. If depreciation has increased, then the share of net income going to capital might not have increased and the labor share might not have declined. Bridgman’s analysis shows that depreciation has increased, which reduces the trend decline in the labor share of income. But that labor share still appears to be on the decline.
Other research finds similar trends when accounting for depreciation. Research by the University of Chicago’s Loukas Karabarbounis and Brent Neiman finds that the gross and the net labor share have both been on the decline. A paper by Piketty and the London School of Economics’ Gabriel Zucman looking at the capital share also accounts for depreciation as they note that they “always use net-of-depreciation income and output concepts.”
The second piece that Ip cites is a post by the Manhattan Institute’s Scott Winship that also raises the issue of depreciation in the measurement of the labor share. But Winship notes that there might be measurement issues related to the income going to the self-employed or proprietors. These payments are registered as capital in the official accounts, but most likely should be counted as labor income. This concern has been noted by previous research, specifically a paper by Michael Elsby, of the University of Edinburgh, Bart Jobijn, of the Federal Reserve Bank of San Francisco, and Aysegul Sahin of the Federal Reserve Bank of New York. Yet after accounting for the labor income of the self-employed, they still find that the U.S. labor share has been on the decline.
The final paper Ip highlights is by Massachusetts Institute of Technology PhD student Matthew Rognlie and was discussed last week as part of the Brookings Papers on Economic Activity. Rognlie makes two main contributions to the debate. The first is to point out that the increase in the net capital share of income is driven almost entirely by the housing sector. In other words, the form of “capital” that seems to receiving income instead of labor is housing. (As Ip notes, Rognlie isn’t the first to point this out.) The second is to show that outside of housing, the capital share seems to be driven by increases in “mark-up,” a term that describes increased profits due to monopolies in the U.S. economy.
On Rognlie’s first point, work by Piketty and Zucman does break down the capital share and does break out the contribution of housing. They find, like Rognlie, that housing capital is an increasing share of income. But if you take out housing, Piketty and Zucman find the capital share in the United States is still increasing.
Rognlie’s second point about market power and monopolies is the one that poses the biggest problem to Piketty’s famous “r > g” (the return on capital is greater than the rate of economic growth) inequality. Rognlie finds that the movement in the non-housing sector is not driven by changes in the value of capital, as Piketty states, but rather by monopoly profits.
Given that Piketty’s book is at its heart a prediction about the future, it’s impossible to disprove it in the here and now. Rognlie’s work and others might cast doubt on its predictions. But the future will be the final arbiter. For now, we simply have another story about what possibly drove inequality in the past and will drive it in the future.
Reading the Federal Reserve’s Tea Leaves Dot Plots
It is always instructive to look at the materials that the Federal Reserve’s Federal Open Market Committee pumps out, especially their semi-anonymized (hi, Charlie Evans, with your 3% longer-run value) estimates of what the appropriate federal funds rate would be.
Thus we can see, comparing January 2012 when the Federal Reserve began publishing its dot-plots to today, the Federal Reserve collectively and slowly come to recognize current reality. Back at the start of 2012 the FOMC participants all thought that in the “longer run”–which at the beginning of 2012 I take to be next year, 2016–the federal funds rate ought to be back at its normal mid-expansion level, which they all took to be in the 3.75%-4.5% per year range. Today, of course, only one participant (Charles Plosser?) still thinks the federal funds rate ought to be in that range next year, and at the very bottom of it.
And we can see, comparing November 2013 to today, the Federal Reserve stick to its guns as to the anticipated pace of policy tightening set in motion with Ben Bernanke’s mid-2013 announcement that it was time to stop searching for further extraordinary monetary policy actions to boost the economy. The median FOMC participant in November 2013 thought that by the end of 2015 the federal funds rate should by 0.75%, and by the end of next year 1.75%. The median FOMC participant today thinks that by the end of 2015 the federal funds rate should be 0.5-0.75%, and by the end of next year 1.75%-2.00%.
This staying-the-course on the pace of tightening is interesting and somewhat surprising because of two facts. First, only one of the three key cyclical indicators–only the unemployment rate of the triple that is unemployment, labor-force participation, and production relative to projected past trends–has improved at anything like the rate expected. Second, the FOMC’s view of the Wicksellian “neutral” or “natural” nominal short-term safe rate of interest has fallen from a medium value of 4.25% in January 2012 to 4.0% in November 2013 to 3.75% today. If one thinks, as one should, of monetary ease or tightness as deviations from the Wicksellian “neutral” rate, an 0.75% rate as of today is thought to be about the same as a 1.25% rate back three and a quarter years ago.
And, of course, back in 2007 we firmly believed that for a healthy economy near but not beyond full employment, with a 2% per year target inflation rate, the appropriate federal funds rate would be 5%–as it as in 2996-7, as it had been from 1995-1998, before the 1998 decision to ease and the 2000 decision that the economy was overheated. 3.75% is far below that level.
Yet I find myself frustrated by one lack: the meeting participants fail to give their estimates of what the 10-year Treasury bond yield associated with their preferred funds path would be. I don’t know how they think the shifts since 2007 both in the economy and in how we view the economy have affected the “neutral” or “natural” long-term safe interest rate in relation to the short-term rate. So the thinking of FOMC participants remains more opaque to me than I would wish. What is their expectation of the gearing from the short to the long-term interest rate? And at what short-term interest rate do they expect the yield curve to invert? (Of course, even if I knew their implicit appropriate 10-year bond yield forecasts, much of their thinking would still remain opaque–only less opaque).
Things to Read at Night on March 27, 2015
Must- and Should-Reads:
- Evening Must-Read: : How to Cut Taxes and Help the Poor
- : Wikileaks Releases Trans-Pacific Partnership Investment Chapter
- Today’s Must-Must-Read: : What Do Americans Think Should Be Done About Inequality?
-
: Risk-Sharing and Student Loans
Might Like to Be Aware of:
Today’s Economic History: John Maynard Keynes on the Trade Cycle
…is mainly due to the way in which the marginal efficiency of capital fluctuates…. By a cyclical movement we mean that as the system progresses in, e.g., the upward direction, the forces propelling it upwards at first gather force and have a cumulative effect on one another but gradually lose their strength until at a certain point they tend to be replaced by forces operating in the opposite direction… until they too, having reached their maximum development, wane and give place to their opposite…. [And] the substitution of a downward for an upward tendency often takes place suddenly and violently, whereas there is, as a rule, no such sharp turning-point when an upward is substituted for a downward tendency….
With a First-Quarter-of-2015 Projected Real GDP Growth Rate of 1.3%/Year…
…the U.S. economy will have grown at a rate of:
- 2.8%/year over the past four quarters.
- 2.5%/year over the past eight quarters.
- 2.2%/year over the past twelve quarters.
If you think that the growth rate of potential output post-2009 is 2.2%/year, we are in exactly the same position relative to potential output that we were in March of 2012. And thus monetary and fiscal policy looking forward should be the same now as they should have been in March of 2012.
And if you think that the growth rate of potential output post-2009 has been less than 2.2%/year, you need to explain why–and you need to explain why it has not been due to low-pressure-economy policies, and why given that high-pressure economy policies right now are not a no-brainer.