Joe Stiglitz: Reconstructing Macroeconomic Theory to Manage Economic Policy: Any theory of deep downturns has to answer these questions…

What is the source of the disturbances? Why do seemingly small shocks have such large effects? Why do deep downturns last so long? Why is there such persistence, when we have the same human, physical, and natural resources today as we had before the crisis?… The apparent liquidity trap today is markedly different from that envisioned by Keynes in the Great Depression, and why the Zero Lower Bound is not the central impediment to the effectiveness of monetary policy in restoring the economy to full employment.

Daron Acemoglu et al.: Offshoring and Skill-Biased Technical Change: “When labour is sufficiently cheap abroad…

…firms have incentives to offshore low-skill tasks and invest in skill-biased technologies at home…. The production structure of Apple’s iPod illustrates some of the potential effects…. Though most production jobs are offshored, a significant number of high-skill engineering jobs and low-skill retail jobs are created in the US, and more than 50% of the value added of the iPod is captured by domestic companies. With more limited offshoring, some of the production jobs may have stayed within the US borders, increasing the demand for the services of low-skill production workers. But this would have also increased the cost and price of iPods, reducing employment not only in engineering and design occupations but also in retail and other related tasks…. The reason for this switch in the direction of technological progress is that more offshoring increases the demand for labour abroad and thus wages in the East. In turn, the closing of the wage gap between countries mutes the price effect that was fuelling skill-biased innovation…. Offshoring first increases wage inequality in the West. However, as offshoring continues, technical change eventually changes direction and may even lower the skill premium…

Martin Wolf: Why Inequality Is Such a Drag on Economies: “A report written by the chief US economist of Standard & Poor’s…

…and another from Morgan Stanley, agree that inequality is not only rising but having damaging effects on the US economy… two economic consequences… weak demand and lagging progress in raising educational levels…. The costs to society of rising inequality go further–the greatest costs are the erosion of the republican ideal of shared citizenship…. As the US Supreme Court seeks to bend the constitution to the will of plutocrats, the peril is to the politically egalitarian premises of the republic. Enormous divergences in wealth and power have hollowed out republics before now. They could well do so in our age.
Yet even for those who do not share such concerns, the economic costs should matter…

Joshua Brown: “Do we need to fire Pimco?”: “In February of 2011, [Bill] Gross loudly proclaimed…

…[that] Pimco Total Return had taken its allocation to US Treasury bonds down to zero. As recently as the previous December, Pimco Total Return had been carrying as much as 22 percent of its AUM in Treasurys…. Gross compounded the move by being extremely vocal about his rationale–he went so far as to call Treasury bonds a ‘robbery’ of investors given their ultra-low interest rates and the potential for inflation. He talked about the need for investors to ‘exorcise’ US bonds from their portfolios, as though the asset class itself was demonic. He called investors in Treasury bonds ‘frogs being cooked alive in a pot’. The rhetoric was every bit as bold as the fund’s positioning. It’s really hard to pound the table like this and then be flexible in the aftermath…”

Yes, Bill Gross’s judgment in February 2011 that U.S. Treasuries were overbought has been an absolute disaster for PIMCO’s Total Return Fund vis-a-vis the market portfolio:

Holdings of ten-year U.S. Treasuries gained 20 cents on the dollar between Gross’s bet and the summer of 2012, as interest rates collapsed in the summer of 2011 and took another lurch downward in the spring of 2012. (They recouped 14 of those cents between the summer of 2012 and the end of the summer of 2013 “Taper Tantrum”, but today stand ten cents above their February 2011 value.

That being said, from Bill Gross’s perspective the belief that bonds as of February 2011 were overbought must have been irresistible, and not for reasons that were clearly wrong at the time. Since the start of 2008, 10-year Treasuries had been trading in a 2.5%-4% range appropriate for a safe asset in a low-inflation economy on the edge of or in the midst of a significant depression:

But at some point relatively soon, it seemed to Gross back in 2011, the economy had to recover to something like normal–in which case 10-year Treasuries ought to return to their 4%-5% trading range of the post-dot.com era:

if not to their 5%-7% trading range of the fast-growth 1990s:

And, Bill Gross thought, there was already light at the end of the tunnel: the economy was recovering, and the only things keeping expectations of recovery over the next five years from pushing up 10-year Treasury rates now was that the Federal Reserve was artificially restricting the supply of 10-year Treasuries via quantitative easing. And so when QE II ended, Gross was confident, Treasury rates would jump sharply–and Treasury bondholders would lose bigtime.

So what went wrong? Why did Gross’s expectations as of the winter of 2011 turn out to be so wrong? The standard answer is that long-term rates will not normalize until investors expect the normalization of short rates within half a decade, that short rates will not normalize until the Federal Reserve is confident that the zero lower bound crisis is over and will not return, and that that confidence is further away now 3.5 years later than it was back in February 2011. The IS curve needs to shift out and to the right in order to create an environment in which the Federal Reserve is comfortable normalizing short-term rates, and why should that happen?

But is that really an adequate answer? Didn’t, in the Hicksian language of the past paragraph, Bill Gross have good reasons to expect the IS curve to shift out and to the right? He must have. The puzzle is: what were they?

http://delong.typepad.com/2014-09-29-bill-grosss-directional-bet.numbers

Ryan Avent: Monetary Policy: Why Is the Fed Planning to Fail?: “THE members of the Federal Open Market Committee…

…are not overly fond of being stuck at the zero lower bound (ZLB) [as they have been] since December of 2008…. Policy-making since then has been a monetary mess…. I’ll put things more plainly. Central bankers should hate the ZLB. Whether or not policy at the ZLB tends to raise financial instability, the central bank simply can’t do its job when its main interest rate is at zero. Since December of 2008 the Fed has failed miserably on both of its primary objectives: maximum employment and stable prices…. In a ZLB world the Fed does not do its job. That is a serious problem for the American economy and the Fed. It is quite possibly the most serious problem the Fed could conceivably have.

So why is the Fed so determined to find itself right back at the ZLB in future, assuming it ever leaves it in the first place?… The fed funds rate rose to 5.25% prior to the Great Recession and nonetheless tumbled to the ZLB. The 2001 recession was far milder, yet in battling it the Fed reduced interest rates from a high of 6.5% down to 1%…. There is plenty of uncertainty regarding precisely how much cushion one needs between the federal funds rate and the ZLB, yet we can be pretty safe in concluding that roughly four percentage points counts as ‘not nearly enough’…. Let’s be clear about this. The central bank can choose the inflation rate it wants… so there is absolutely no reason why the Fed ought to find itself stuck with too low a full-employment interest rate…. One would think the Fed would want to be damn sure to get well away from the ZLB….

The Fed is going to intentionally undershoot its inflation target on average over the next three years, thereby ensuring that it returns to the ZLB during the next downturn, thereby ensuring that it continues to undershoot its inflation target while also missing its maximum employment target. And one can’t be completely sure, but I think the reason they intend to do this is because they fear that setting and hitting a higher inflation target would call into question their credibility…

Over at Project Syndicate: The extremely sharp but differently-thinking Peter Thiel:

Peter Thiel: Robots Are Our Saviours, Not the Enemy: “Americans today dream less often of feats that computers will help us to accomplish…

…[and] more and more we have nightmares about computers taking away our jobs…. Fear of replacement is not new…. But… unlike fellow humans of different nationalities, computers are not substitutes for American labour. Men and machines are good at different things. People form plans and make decisions…. Computers… excel at efficient data processing but struggle to make basic judgments that would be simple for any human…. [At] PayPal… we were losing upwards of $10m a month to credit card fraud…. We tried to solve the problem by writing software…. But… after an hour or two, the thieves would catch on and change their tactics to fool our algorithms. Human analysts, however, were not easily fooled…. So we rewrote the software… the computer would flag the most suspicious trans­actions, and human operators would make the final judgment. This kind of man-machine symbiosis enabled PayPal to stay in business…. Computers do not eat…. The alternative to working with computers… is [a world] in which wages decline and prices rise as the whole world competes both to work and to spend. We are our own greatest enemies. Our most important allies are the machines that enable us to do new things…

Let us start with my six-fold schema about how humans have, historically, added economic value–via our legs, our fingers, our mouths, our brains, our smiles, and our minds:2

1. Our legs and other large muscles have moved things to where we need them to be.
2. Our fingers have rearranged things into patterns that we need.
3. Our brains have served as ideal cybernetic control loops for keeping all kinds of economic matter-and-energy-manipulation and information-flow processes on track.
4. Our mouths (and, later, our fingers via writing) have informed and entertained us all.
5. Our smiles have pleased one another, and also helped keep us all pulling roughly in the same direction.
6. Our minds have thought up new important and interesting things to do, and genuinely new ways to do old things.

In this schema, the very smart but differently-thinking Peter Thiel’s makes his argument that robots are not our enemies but our saviors.1 It is thus: Globalization made it possible for workers elsewhere in the world to compete for slots using our legs (1) and our fingers (2) in the global division of labor that had previously been near-exclusive property of American workers, and had allowed workers elsewhere in the world to use their new-found bargaining power to extract resources for their own consumption. This was to the detriment of America’s blue-collar working and middle classes.

Computers and robots, however, are different. They do not consume anything except a little electricity. Robots and computers are becoming able to substitute not just for human legs and fingers but also for human brains as cybernetic control loops (3)–instead of having humans scrutinize every item in every batch of 1,000,000 transaction for indicia of fraud, PayPal can have computers approve the first 999,000 of the batch and then pass the 1,000 that might be fraudulent on not for mindless screening but for thoughtful consideration. One worker can thus do what PayPal would have had to hire a thousand workers to do a generation ago. And because computers do not eat, that thousand-fold increase in productivity will redound to the benefit of America’s white-collar middle class. Globalization lowered the wages of America’s blue-collar workers because it meant others could and would do what they did more cheaply, and then themselves consumed the value created. But computers mean that America’s white-collar workers–and the surviving blue-collar workers who oversee the large robotic factories and warehouses–can do more valuable stuff, and the computers that assist them do not consume anything.

Perhaps.

It is my sense that Peter Thiel is running, in a sophisticated and non-obvious way, into the old diamonds-and-water economic paradox. The way the eighteenth century economists phrased it: Without water we all die, while without diamonds we all live happily, yet water is free and diamonds are incredibly expensive even though the first is essential and the second is nearly useless. Why? The answer, of course, is that the value of water in a market economy is set not by the total usefulness of water–nearly infinite–nor by the average usefulness of water–very large–but by the–very low–marginal value of the last drop of water consumed, which is very low (east of the Mississippi and north of Naples, at least). The wages and salaries of blue- and white-collar workers in the robot-computer economy of the future will be not the (very high) labor productivity of the one blue-collar worker on the shop floor making sure all the robots are in their places or the one white-collar worker reprogramming the software ‘bots and adjudicating the edge cases, but rather by what the rest of the blue-collar and white-collar workers who find themselves outside the highly-productive computer-robot economy can find that adds value. The newly-industrialized Manchester that horrified Friedrich Engels when he worked there in the 1840s had the highest level of labor productivity the world had hitherto seen. But the wages of the workers in Manchester’s factories were set not by their extraordinary productivity as they were assisted by the most advanced machines in the world, but by what they could get were they to return to the potato fields of pre-famine Ireland.

So the key question is not: will robots and computers make human labor in the goods-, high-tech services, and information-producing sectors infinitely more productive? It will. The key question is: as robots and computers push human labor out of occupations in which it is valued for what its legs, its fingers, and its brains as cybernetic-control-loops can do, can we keep the occupations of everyone not lucky enough to find a job in the high-productivity sector from being the twenty-first century equivalent of digging potatoes in 1843 Galway? Huge numbers of us will have to find valuable things to do with our mouths, our smiles, and our minds. What will those occupations be? And what will make them valuable–that is, in high demand?

From 1850-1970 or so, rapid technological progress was accompanied by first wages rising as fast as total productivity and then by an extraordinarily long-run equalization of the distribution of income as every machine installed to substitute for human legs (1) and human fingers (2) created more jobs in machine-minding as cybernetic control loops (3) and information transmission and control (4) than it destroyed in routine muscle power- or dexterity-work. And rising real incomes all around produced a great increase in leisure, and thus in demand for smiles (5) and the products of minds (6).

Will the same be true as machines take over what used to be routine brainwork as cybernetic control loops (3) just as they took over big muscle-work (1) and dexterity-work (2)? Maybe. But all of Peter Thiel’s argument rests on that bet. And it is not a bet he examines.

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Must- and Shall-Reads:

• Rex Nutting: The Fed would be crazy to worry about runaway wages
• Nicholas Bagley: Medicine as a Public Calling
• Economist: Free exchange: Goldilocks Nationalism

1.Stephen Golub et al: The Federal Reserve in the run-up to the Global Crisis: “Both Greenspan and Bernanke subscribed to Bernanke and Gertler’s (2001) view that identifying bubbles is very difficult, pre-emptive bursting may be harmful, and that central banks could limit the fallout from systemic financial disturbances through ex post interventions. The successful response to the 2001 dot-com bubble boosted the Fed’s confidence in this strategy. On this basis, Blinder and Reis (2005: 73) conclude ‘[Greenspan’s] legacy … is the strategy of mopping up after bubbles rather than trying to pop them’. The 2001 crisis, however, did not feature leverage and securitisation, unlike in 2008…. Several of the Fed’s institutional routines likely reinforced its complacency. One such feature is the scripted nature of FOMC meetings…. Moreover, the priority on reaching consensus on interest-rate policy limits scope for sustained consideration of broader economic concerns. Further, FOMC staff briefings and FOMC discussions centre on the staff’s ‘Greenbook’ economic analyses and projections, which reinforces the tendency for consensus. Former Governor Meyer jokingly refers to the Greenbook as ‘the thirteenth member of the FOMC’…”

1. Nicholas Bagley: Medicine as a Public Calling: “The debate over how to tame private medical spending tends to pit advocates of a single-payer approach against those who would prefer to harness market forces to hold down costs. When it is mentioned at all, the possibility of regulating medicine as a public utility is dismissed as a political impossibility — or, worse, as anathema to the American regulatory tradition. Yet there is a rich history in the United States of subjecting private businesses that wield undue power to economic regulation. Growing out of an ancient common law practice of imposing special duties on innkeepers and common carriers, the body of law governing the regulation of “public callings” had evolved by the early twentieth century into a comprehensive challenge to the principles of laissez faire. The rise of the modern medical industry in the years after the Second World War prompted the enactment of federal and state laws emerging from this tradition and directed at the business of medicine. Although the last two decades of the twentieth century saw many of these laws give way to a resurgent belief that market forces ought to guide the distribution of health-care services, an important strain of the law has always treated modern medicine as a public calling. Now that the Affordable Care Act has eased concerns about the uninsured, a stubborn set of economic problems in the medical industry — supply imbalances, access restrictions, and abusive and discriminatory pricing — may spur renewed interest in laws reflecting the principles of public utility regulation. Indeed, nascent interest in such laws suggests that we may already be heading that direction.”

2. Gavyn Davies: Labour under-utilisation in America: “If there is still a large margin of slack in the labour market, despite tumbling unemployment figures, the Fed is unlikely to tighten monetary conditions very much in the next couple of years. Slack will also keep the wages share in national income low, thus boosting the profits share further. The utilisation of labour resources in America is thus critical not only for monetary policy, but also for the outlook for US equities. The academic discipline of labour economics, which has not really been centre stage since the wage-push inflation of the 1970s, is therefore very much back in vogue…. Despite the fact that the official unemployment rate has fallen close to the Fed’s estimates of its ‘natural’ or equilibrium rate, few empirical labour economists seem to believe, at least with any certainty, that labour resources are near full utilisation at present…. The hawkish case is still represented by some regional presidents on the FOMC… Fisher…. Almost all economists in policy circles acknowledge that there is great uncertainty here…”

3. Gillian Tett: After a Life of Trend Spotting, Bill Gross Missed the Big Shift: “The power balance between governments and the bond market has shifted. These days it is governments that are intimidating–or, at least, wrongfooting–the bond gurus… unorthodox monetary policy… is shaping bond prices now. And that is making it difficult for bond titans such as Mr Gross to recreate their old magic…. During most of his career, Mr Gross wielded brilliant trend-spotting skills…. Recently his performance has crumbled. This year his flagship fund is in the bottom 20 per cent of industry tables, measured by returns. This partly reflects the fact that low interest rates have cut returns across the board…. But Mr Gross also has been wrongfooted by government. In January 2010 he declared that the British bond market was ‘sitting on a bed of nitroglycerine’, suggesting UK sovereign bond yields would rise. It seemed a rational bet, given that the UK had a 7 per cent structural budget deficit…. Similarly, there was sound logic to Mr Gross’s declarations in 2010 and 2013 that the bull market in bonds was over. But instead of rising, yields fell to new lows in the US and Europe. That is partly because markets are ‘under the spell’ of unconventional monetary policy, as the Bank for International Settlements says…”

4. Felix Salmon: A Radical Response: “Martin Wolf paints a picture of a global economy being wrecked both by freedom of capital… and by the imprisonment of 18 European countries in a fixed currency system…. It’s a worldview in which central bankers, rather than their commercial brethren, are the people who really determine whether the world crashes and burns: The Jamie Dimons simply end up acting in accordance with the incentives that the Alan Greenspans put in place…. Wolf… has withering scorn for what central bankers have wrought… persuasively argues that central banks should target a much higher rate of inflation, noting that, in the eurozone, “inflation of 3 to 4 percent a year would not be a disaster” and would actually be very helpful…. Wolf… says the French economist Thomas Piketty’s recommendation of a global wealth tax “is unquestionably too ambitious.” Yet Wolf’s own recommendations are more ambitious… attempts to prevent corporations from accumulating cash; an end to the tax-deductibility of interest payments; a scaling back of international banks… a mass refinancing of European sovereign debt into eurobonds… a radical change in debt contracts to make them much more equitylike; and, of course, that idea about abolishing ­fractional-reserve banking…. Despite Wolf’s attempts to don the garb of a revolutionary, this book is actually something more familiar, and more depressing: a wonkish eschatology of how the global economy, and Europe’s in particular, is doomed…. THE SHIFTS AND THE SHOCKS: What We’ve Learned — and Have Still to Learn — From the Financial Crisis. By Martin Wolf.”

Should Be Aware of:

• Adam Ozimek: Enough Already With [Pierre-Emmanuel Gobry’s] Sweeping Claims That Economics Is Unscientific
• Paul Shankman: The Trashing of Margaret Mead: Anatomy of an Anthropological Controversy
• Ed Luce: Obama’s Faustian pact with the Saudis

1. Paul Krugman: The New Classical Clique: “International macro went in a different direction, for reasons I’ll get to in a bit. So I have some sense of what was really going on…. While both Wren-Lewis and Waldmann hit on most of the main points, neither I think gets at the important role of personal self-interest. New classical macro was and still is many things–an ideological bludgeon against liberals, a showcase for fancy math, a haven for people who want some kind of intellectual purity in a messy world. But it’s also a self-promoting clique…. Economics as a discipline being what it is, attacks on Keynesian economics as being inconsistent with rational behavior were bound to get some traction, and the stagflation of the 1970s certainly helped that attack, even if it was less relevant than claimed. Animus against government activism also played a key role…. Once the thing had gotten going, however, I think you understand its dynamics much better if you stop assuming that the motives of the movement’s leaders were pure. Consider the extremism of Lucas and Sargent (pdf) in the early days, declaring Keynesian economics a complete failure–or Lucas talking about how Keynesian papers were greeted with ‘giggles and whispers’…. Ken Rogoff wrote about the ‘scars of not being able to publish sticky-price papers during the years of new neoclassical repression’…. The clique’s dominance became self-perpetuating–and impervious to intellectual failure. OK, I know the members of the clique will be outraged–distorting incentives only apply to other people, only bureaucrats hijack institutions to serve their personal aggrandizement, etc… As they say in Minnesota, ya sure, you betcha…. Unfortunately, the rise of the new classical clique had consequences far beyond the academy, because it ended up playing an important role in the failure of policy to effectively confront the Lesser Depression.”

Stephen Golub et al: The Federal Reserve in the run-up to the Global Crisis: “Both Greenspan and Bernanke subscribed to Bernanke and Gertler’s (2001) view…

…that identifying bubbles is very difficult, pre-emptive bursting may be harmful, and that central banks could limit the fallout from systemic financial disturbances through ex post interventions. The successful response to the 2001 dot-com bubble boosted the Fed’s confidence in this strategy. On this basis, Blinder and Reis (2005: 73) conclude ‘[Greenspan’s] legacy … is the strategy of mopping up after bubbles rather than trying to pop them’. The 2001 crisis, however, did not feature leverage and securitisation, unlike in 2008…. Several of the Fed’s institutional routines likely reinforced its complacency. One such feature is the scripted nature of FOMC meetings…. Moreover, the priority on reaching consensus on interest-rate policy limits scope for sustained consideration of broader economic concerns. Further, FOMC staff briefings and FOMC discussions centre on the staff’s ‘Greenbook’ economic analyses and projections, which reinforces the tendency for consensus. Former Governor Meyer jokingly refers to the Greenbook as ‘the thirteenth member of the FOMC’…