…There is, however, substantial uncertainty around these projections. How should this uncertainty affect monetary policy? In standard models uncertainty has no effect…. [But] the zero lower bound on nominal interest rates implies that the central bank should adopt a looser policy when there is uncertainty… a delayed liftoff is optimal…. Raising rates early might lead to excessively weak growth… raising rates later might lead to inflation…. Near the zero lower bound, monetary policy tools are strongly asymmetric and can deal with the second scenario much more easily than with the first. We… provide a quantitative evaluation of this…. Finally, we present narratives from Federal Reserve communications that suggest risk management is a longstanding practice, and econometric evidence that the Federal Reserve historically has responded to uncertainty, as measured by a variety of indicators.
Afternoon Must-Read: Vivekinan Ashok et al.: Support for Redistribution in an Age of Rising Inequality
“Keep the government’s hands off my Medicare!” was supposed to be a joke at the expense of a small uninformed fringe, not a typical and widespread reaction:
…[with] substantial heterogeneity by demographic groups…. The two groups who have most moved against income redistribution are the elderly and African-Americans…. The elderly trend is uniquely American…. One story consistent… is that they worry that redistribution will come at their expense, in particular via cuts to Medicare. We find that the elderly have grown increasingly opposed to government provision of health insurance…. For blacks, controlling for their declining support of race-targeted aid explains a large portion of their differential decline in redistributive preferences…
Afternoon Must-Read: Martin Weale and Tomasz Wieladek: Macroeconomic Effects of Asset Purchases
…an asset purchase announcement of 1% of [annual] GDP leads to a statistically significant rise of .58% (.25%) and .62% (.32%) rise in real GDP and CPI for the US (UK). In the US, this policy is transmitted through the portfolio balance channel and a reduction in household uncertainty. In the UK, the policy seems to be mainly transmitted through the impact on investors’ risk appetite and household uncertainty.
Today’s Must-Must Read: Peter Gosselin and Jennifer Oldham: If Economists Were Right, You Would Have a Raise by Now
…Mainstream analysts such as Mark Zandi, chief economist of Moody’s Analytics Inc. in New York, say the recession that began in December 2007 was so deep and damaging it left a large pool of untapped labor that’s not fully reflected in the unemployment rate. Companies can draw on this pool without having to raise pay. Despite its size, Zandi said, the economy now is adding jobs at such a clip that this labor pool will be drained quickly and wages finally will start rising again. ‘There are already early signs of the wage revival and by this time next year it will be undeniable,’ he said.
Analysts such as Mary Daly, the associate research director at the Federal Reserve Bank of San Francisco, trace recent slow wage growth to another aspect of the 2007-2009 recession: Employers didn’t cut the wages of workers they retained. Now that employers have resumed hiring, they’re doing so at the same or lower pay, which is holding back wage growth, Daly and colleague Bart Hobijn wrote in a Jan. 5 San Francisco Fed paper. The implication is that as the expansion continues, wages eventually will start growing again…
Morning Must-Read: Izabella Kaminska: Closed-System Blockchains
…Blockchain is always going to be more expensive than a central clearer, because a multiple of agents have to do the processing job rather than just one…. It’s all very enticing… as long as the service… is being subsidised by investment flows or an altruistic network of computer processors…. You’ve just found a genius way of passing on your clearing costs to a network of unsuspecting volunteers and speculators. Even better than that, they don’t seem to notice the huge favour they’re doing for big financial businesses, because they’ve become so distracted by the idea of not depending on banks, they’ve overlooked that in the process they’ve become poorly-paid bank employees instead…
Morning Must-Read: Greg Ip: How Europe’s Easy Monetary Policy Crossed the Atlantic
…ending the day at $1.09…. The ECB’s QE has often been portrayed as currency war…. The term… is misleading. When one country’s currency falls because of easy monetary policy, its trading partners often ease as well to limit the damage of an appreciating currency. The net result is a tit-for-tat monetary expansion that boosts demand in everyone’s economy…. Denmark and Switzerland… Sweden… Thailand and Korea…. Central banks always seek to set the overall level of financial conditions which are a combination of short and long-term interest rates, equity prices and currencies, but they don’t get to choose the contribution of each. Faced with a stronger currency, the natural response is to lower interest rates in hopes of achieving the same economic goals with a different mix of instruments. Don’t call it a currency war. Call it textbook economics.
Testing the permanent income hypothesis
The permanent income hypotheses is one of a class of assumptions that economists make about how people smooth their spending over time. These assumptions predict that people prefer to spread their consumption smoothly over their life based on their expected lifetime earnings. Variations of the permanent income hypothesis are frequently used to simplify the mathematics behind economic models so that they are easily solvable.
But this begs a question: Are the permanent income hypotheses and its variants reasonable assumptions? Because this hypothesis was developed and popularized in an era before data were sufficient to make them readily testable, it is important to periodically revisit these long held beliefs as new information becomes available. In a new National Bureau of Economic Research working paper, Michael Gelman and Matthew D. Shapiro at the University of Michigan, Shachar Kariv and Steven Tadelis at the University of California, Berkeley, and Dan Silverman of Arizona State University does just that—looking at whether and how government workers smoothed their consumption during the 2013 government shutdown.
The authors examine the consequences of the 16-day federal government shutdown in October 2013, when Senate Democrats and House Republicans could not pass a spending bill in large part due to disagreement over defunding the Affordable Care Act. According to an Office of Management and Budget report, the shutdown resulted in a combined total of 6.6 million lost work days amounting to $2.5 billion in compensation and lowered that quarter’s Gross Domestic Product by billions of dollars.
Using detailed data on spending and earnings from the Mint program (a free website/app used to track individual finances), the authors find that consumption dropped sharply among government workers. This spending drop occurred even though the shutdown would have little if any impact on their lifetime earnings because they knew they would be paid later for the time they did not work. The reaction of the workers, then, is at odds with commonly used versions of the permanent income hypothesis.
The authors did find that some of the drop in consumption was because people delayed paying certain bills, such as their mortgage bill or some credit card debt. While this allowed some of the workers to partially smooth their spending over time, there still was a real drop in consumption by most of the government workers impacted by the shutdown. Thus, the majority of these workers did not smooth out their earnings over time based on their expected long-term earnings but rather immediately reacted to the situation at hand.
This finding is important because it provides real insight into how people respond to income shocks, which has implications for how we think about credit constraints, unemployment, and other economic issues. Because people respond to short-term shocks in their income by dramatically cutting back on their spending, programs such as unemployment insurance that replace income immediately for displaced workers could be much more effective at smoothing consumption than temporary tax cuts that are not seen until April 15. Currently, strong interpretations of the permanent income hypothesis predict the unemployment policies and tax cuts deliver equivalent outcomes.
This new work by Gelman, Kariv, Shapiro, Silverman, and Tadelis is important because it pushes back against a set of flawed but long-held beliefs about how the economy works that can lead to bad policy. By bringing data to the debate, these authors are helping to advance the science of economics.
Things to Read at Nighttime on March 18, 2015
Must- and Should-Reads:
- Morning Must-Read: : Survival of the Fittest Might Have Actually Been Survival of the Richest
- Nighttime Must-Read: : The Disappointing Unseriousness of the House GOP’s Budget
- : Strong Currents Keep Interest Rates Down
- Afternoon Must-Read: : Are recoveries from Financial Crises Always Slow?
- Today’s Must-Must Read: : Thoughts about monetary and fiscal policy in a post-inflation world
- : The Worldwide Deficit of High-Quality Debt
- Lunchtime Must-Read: : On Paul Krugman’s: ‘John and Maynard’s Excellent Adventure’
- Morning Must-Read: : Are Retirees Falling Short?
- : “Currency appreciation will be a drag; this implies a policy of slower monetary tightening is in order…”
- : “Safety net programs cut poverty nearly in half in 2013, lifting 39 million people out of poverty… rebut[ting] claims that government programs do little to reduce poverty…”
Might Like to Be Aware of:
Nighttime Must-Read: James Pethokoukis: The Disappointing Unseriousness of the House GOP’s Budget
…This new plan just assumes tax revenue as a share of GDP stays steady. Seems unlikely…. But the biggest problem with the House budget isn’t faulty math but a faulty premise. House Republicans apparently believe the federal debt is at unsustainable levels, needs to be reduced ASAP, and eventually eliminated… that the federal debt is America’s biggest problem. But where’s the evidence? Low interest rates are hardly signaling investor alarm. And… our currency is the world’s reserve…. The big economic danger… is chronic slow growth from having to sharply raise taxes if we don’t restructure entitlements in a way that promotes savings and work… along with trimming tax breaks for the wealthy. If there is a good economic reason for actually paying off the national debt–much less making it a key goal–I am unaware of it.
What Game Is the Federal Reserve Playing?
The Federal Reserve:
- Now expects to be more patient in their plans of when and how far they will raise interest rates than they were last December.
- Just removed the sentence in which they said they would be patient from their post-meeting statement.