Tag: Austerity

Must-read: Simon Wren-Lewis: “The ‘Strong Case’ Critically Examined”

Posted on by Brad DeLong

Simon Wren-Lewis: The ‘Strong Case’ Critically Examined: “The deficit obsession that governments have shown since 2010…

… has helped produce a recovery that has been far too slow, even in the US. It would be nice if we could treat that obsession as some kind of aberration… but unfortunately that looks way too optimistic. The Zero Lower Bound (ZLB) raises an acute problem for… the consensus assignment… [of] leaving macroeconomic stabilisation to an independent, inflation targeting central bank) [and when you] add in [fiscal] austerity… you get major macroeconomic costs. ICBs appear to rule out the one policy (money financed fiscal expansion) that could combat both the ZLB and deficit obsession….

Many macroeconomists do see the problem, but the solutions they propose are often just workarounds… [q]uantitative Easing… NGDP targets… a higher inflation target… mean that in response to a sharp enough recession, we would still regret no longer having the possibility of undertaking a money-financed fiscal stimulus.

I also think there is a grain of truth in the argument that ICBs created an environment where deficit obsession became easier…. Ask the following question: in the absence of ICBs, would our deficit obsessed governments actually have undertaken a money financed fiscal stimulus? To answer that you have to ask why they are deficit obsessed. If it is out of ignorance (my Swabian syndrome), then another piece of macro nonsense that ranks alongside deficit obsession is the evil of printing money in any circumstances. I suspect a patient suffering Swabian syndrome would also be subject to this fallacy. If the reason is strategic (the desire for a smaller state) the answer is obviously no. We would simply be told it could not be done because it would open the inflation floodgates.

Must-read: Simon-Wren Lewis: “The Strong Case Against Independent Central Banks”

Posted on by Brad DeLong

Must-Read: Simon Wren-Lewis: The Strong Case Against Independent Central Banks: “In the post war decades there was a consensus…

…that achieving an adequate level of aggregate demand and controlling inflation were key priorities for governments. That meant governments had to be familiar with Keynesian economics…. A story some people tell is that this all fell apart in the 1970s with stagflation. In the sense I have defined it, that is wrong. The Keynesian framework had to be modified… but it was modified successfully. Attempts by New Classical economists to supplant Keynesian thinking in policy circles failed…. The more important change was the end of Bretton Woods and the move to floating exchange rates. That was critical… allowed the creation of what I have called the consensus assignment. Demand management should be exclusively assigned to monetary policy, operated by ICBs pursuing inflation targets, and fiscal policy should focus on avoiding deficit bias. The Great Moderation appeared to vindicate this consensus.

However the consensus assignment had an Achilles Heel… the Zero Lower Bound…. Although many macroeconomists were concerned about this, their concern was muted because fiscal action always remained as a backup. To most of them, the idea that governments would not use that backup was inconceivable…. That turned out to be naive. What governments and the media remembered was that they had delegated the job of looking after the economy to the central bank, and that instead the focus of governments should be on the deficit….

Macroeconomists were also naive about central banks. They might have assumed that once interest rates hit the ZLB, these institutions would immediately and very publicly turn to governments and say we have done all we can and now it is your turn. But for various reasons they did not. Central banks had helped create the consensus assignment, and had become too attached to it to admit it had an Achilles Heel….

Economists knew that the government could always get the economy out of a demand deficient recession, even if it had a short term concern about debt. The fail safe tool to do this was a money financed fiscal expansion. This fiscal stimulus paid for by the creation of money was why the Great Depression could never happen again. But the existence of ICBs made money financed fiscal expansions impossible when you had debt-obsessed governments, because neither the government nor the central bank could create money for governments to spend or give away…

Must-read: Simon Wren-Lewis: “Understanding the Austerity Obsession”

Posted on by Brad DeLong

Must-Read: Simon Wren-Lewis: Understanding the Austerity Obsession: “The diagnosis in the case of the Republican party in the US is reasonably clear…

…The main economic goal is to cut taxes, particularly for the very rich. That requires, sooner or later, less public spending. What about evidence that more public investment would help everyone?… This group suffers from the delusion that the only way to help the economy is to tax the rich less and starve the beast that is the state… infect[ion] by the neoliberal ideology virus….

Germany… is much more difficult to diagnose… Swabian syndrome: a belief that the economy is just like a household, and the imperative is to balance the books. This seems like a case of labelling rather than explaining a disease. There may be an allergy involved: an aversion to Keynesian economics, and anything that sounds vaguely Keynesian. But the microeconomic case for additional public investment in Germany is also strong… the German public capital stock has been shrinking for over a decade…. The nature of the illness in Germany is therefore more of a mystery….

The Conservative Party in the UK also seem to have the symptoms associated with Swabian syndrome…. Some… argue that in reality the party are feigning the symptoms as a means of winning elections, while still others claim that tests have revealed clear traces of the ideology virus. What has become clear is that the traditional way of treating the austerity obsession, which involves occasional counselling with well trained economists, is having little effect. We also now know that the financial crisis shock treatment only makes the neoliberal virus more virulent. Extended therapy is the only known cure for this virus. As for Swabian syndrome, our best hope may be that the public gradually develop an immunity to the disease as its consequences become clear.

Must-read: Paul Krugman: “Living with Monetary Impotence”

Posted on by Brad DeLong

Must-Read: [And no sooner do I write:]

There are three possible positions for us to take now:

  1. In a liquidity trap, monetary policy is not or will rarely be sufficient to have any substantial effect—active fiscal expansionary support on a large scale is essential for good macroeconomic policy.
  2. In a liquidity trap, monetary policy can have substantial effects, but only if the central bank and government are willing to talk the talk by aggressive and consistent promises of inflation—backed up, if necessary, by régime change.
  3. We are barking up the wrong tree: there is something we have missed, and the models that we think are good first-order approximations to reality are not, in fact, so.

I still favor a mixture of (2) and (1), with (2) still having the heavier weight in it. Larry Summers is, I think, all the way at (1) now…

But Paul Krugman goes full (1) as well:

Paul Krugman: Living with Monetary Impotence: “Check our low, low rates…

… Fiscal policy has been effective but procyclical…. Monetary policy has been countercyclical but ineffective…. Lender of last resort matters…. Otherwise, not so much…. Open market vs. open mouth operations…. String theory is hard to explain…. Surprise implication: stagnation is contagious.

Must-read: David Glasner: “Competitive Devaluation Plus Monetary Expansion Does Create a Free Lunch”

Posted on by Brad DeLong

Must-Read: The very sharp David Glasner says–correctly–that currency war is different from war-war. War war is a negative sum game. Currency war is a positive-sum game:

David Glasner: Competitive Devaluation Plus Monetary Expansion Does Create a Free Lunch: “Hawtrey explained why competitive devaluation in the 1930s was–and in my view still is–not a problem…

…Because the value of gold was not stable after Britain left the gold standard and depreciated its currency, the deflationary effect in other countries was mistakenly attributed to the British depreciation. But Hawtrey points out that this reasoning was backwards. The fall in prices in the rest of the world was caused by deflationary measures that were increasing the demand for gold and causing prices in terms of gold to continue to fall, as they had been since 1929. It was the fall in prices in terms of gold that was causing the pound to depreciate, not the other way around….

Depreciating your currency cushions the fall in nominal income and aggregate demand. If aggregate demand is kept stable, then the increased output, income, and employment associated with a falling exchange rate will spill over into a demand for the exports of other countries and an increase in the home demand for exportable home products. So it’s a win-win situation.

However, the Fed has permitted passive monetary tightening over the last eighteen months, and in December 2015 embarked on active monetary tightening…. Passive tightening has reduced US demand for imports and for US exportable products, so passive tightening has negative indirect effects on aggregate demand in the rest of the world…

Must-read: Dan Davies: Comment on “The Euro Area Crisis Five Years After the Original Sin”

Posted on by Brad DeLong

Must-Read: Dan Davies: Comment on “The Euro Area Crisis Five Years After the Original Sin”: “The IMF took two decisions on Greece, not one…

…They decided that they could lend without a debt restructuring, and they decided to implement a completely unprecedented front-loaded fiscal consolidation program. The first of these was the subject of the ‘mea culpa’ exercise, but the second has never been revisited… they actually defended it in the lessons-learnt paper…. It seems clear to me that it is the second mistake, not the first, which deserves the name ‘austerity’, and it is blindingly obvious that the overwhelming majority of the economic damage was done by the front-loaded nature of the fiscal cuts. (The IMF occasionally tries to claim that the headline number of the debt/GDP ratio had a negative effect on business confidence, but this seems pretty desperate to me when you’re trying to explain what happened to Greek GDP and the alternative explanation is simply the cut in government spending).
But having noted that the decision to slash and burn the primary deficit might have been a bad idea, Orphanides then spends the rest of the paper talking about the minor mistake which made hardly any difference!…

Must-read: Tim Duy: “FOMC Minutes and More”

Posted on by Brad DeLong

Must-Read: But being “behind the cycle” is good, no? On a lee shore you need more sea room, lest the wind strengthen, no?

Tim Duy: FOMC Minutes and More: “The Fed may be turning toward my long-favored policy position…

…the best chance they have of lifting off from the zero bound is letting the economy run hot enough that inflation becomes a genuine concern. That means following the cycle, not trying to lead it. And I would argue that if the recession scare is just that, a scare, they are almost certainly going to fall behind the curve. The unemployment rate is below 5 percent and wage pressures are rising. The economy is already closing in on full-employment. If we don’t have a recession, then how much further along will the economy be by the time the Fed deems they are sufficiently confident in the economy that they can resume raising rates? And note the importance of clearly progress on inflation….

Bullard noted that the FOMC has repeatedly stated in official communication and public commentary that future monetary policy adjustments are data dependent. He then addressed the possibility that the financial markets may not believe this since the SEP may be unintentionally communicating a version of the 2004-2006 normalization cycle, which appeared to be mechanical…. You might forgive market participants for believing that the SEP infers some calendar-based guidance when Federal Reserve Vice Chair Stanley Fischer says things like:

WELL, WE WATCH WHAT THE MARKET THINKS, BUT WE CAN’T BE LED BY WHAT THE MARKET THINKS. WE’VE GOT TO MAKE OUR OWN ANALYSIS. WE MAKE OUR OWN ANALYSIS AND OUR ANALYSIS SAYS THAT THE MARKET IS UNDERESTIMATING WHERE WE ARE GOING TO BE. YOU KNOW, YOU CAN’T RULE OUT THAT THERE IS SOME PROBABILITY THEY ARE RIGHT BECAUSE THERE’S UNCERTAINTY. BUT WE THINK THAT THEY ARE TOO LOW. 

Saying the markets are wrong implies that the policy direction is fairly rigid. In any event, I am not confident there is yet much support for Bullard’s position…. Bullard has also gone full-dove. He remembered that he thought inflation expectations were supposed to be important, and the decline in 5-year, 5-year forward expectations has him spooked. And he thinks that the excess air has been released from financial markets, so his fears of asset bubbles has eased. Hence, the Fed can easily pause now….

Bottom Line: The Fed is on hold, stuck in risk management mode until the skies clear. If you are in the ‘recession’ camp, the path forward is obvious. The Fed cuts back to zero, drags its heals on more QE, and fumbles around as they try to figure out if negative rates are a good or bad thing. Not pretty. But if you are in the ‘no recession’ camp, it’s worth thinking about the implications of a Fed pause now on the pace of hikes later. Being on hold now raises the risk that by the time the Fed moves again, they will be behind the cycle.

Must-read: Barry Eichengreen and Charles Wyplosz: “How the Euro Crisis Was Successfully Resolved”

Posted on by Brad DeLong

Must-Read: When people ask me if Barry Eichengreen is in, I sometimes say: No, he is in the 1920s. But he will be coming back via time machine and in his office this afternoon.

Now I learn that I was wrong: that he has been visiting Charles Wyplosz, whose home base is a parallel universe in which the Euro crisis was successfully resolved in 2010:

Barry Eichengreen and Charles Wyplosz: How the Euro Crisis Was Successfully Resolved: “When the newly elected Greek government of George Papandreou…

…revealed that its predecessor had doctored the books, financial markets reacted violently. This column discusses the steps implemented by policymakers following this episode, which were essential in resolving the Crisis. What is remarkable, in hindsight, is the combination of pragmatism and reasoning based on sound economic principles displayed by European leaders. Instead of finger pointing, they acknowledged that they were collectively responsible for the Crisis….

A miracle [was] made possible by a combination of steely resolve and economic common sense. In their historic 11 February 2010 statement, European heads of state and government acknowledged that the Greek government’s debt was unsustainable. Rather than ‘extend and pretend’, they faced reality…. Greece, European leaders insisted, had to restructure its debt as a condition of external assistance…. Trichet, rather than opposing debt restructuring, opposed the Emergency Liquidity Assistance, noting that the ECB’s mandate limited it to lending against good collateral. German Chancellor Angela Merkel and French President Nicolas Sarkozy, not happy that their banks had recklessly taken positions in Greek bonds, agreed that those banks should now bear the consequences. If banks failed, then the German and French governments would resolve them, bailing in stakeholders while preserving small depositors. Chancellor Merkel was adamant: asking Greek taxpayers to effectively bail out foreign banks was not only unjust but would aggravate moral hazard….

[The] IMF staff’s debt-sustainability analysis showed that Greece’s debt was already too high for [any] large loan to be paid back…. The managing director quickly concluded that the expedient path was to ally with European leaders and embrace the priority they attached to debt restructuring. At the landmark meeting of the IMF Executive Board on Sunday 10 May, European directors overrode the objections of the US Executive Director. The Board agreed on a programme assuming a 50% haircut on Greek public debt…. Fiscal consolidation was still required but for the moment would be limited to 5% of GDP, which was just possible for Greece’s new national union government to swallow. 

In return for this help, Greece was asked to prepare a programme of structural reforms, starting with product market reform… [which] lowered prices and increased households’ spending power, thereby not worsening the recession…. Programme documents gave the Greek authorities considerable leeway in the design of these measures and acknowledged the reality that they would take time to implement. The Greek government having been reassured of IMF support commenced negotiations with its creditors. A market-based debt exchange, in which investors were offered a menu of bonds with a present value of 50 cents on the euro, was completed by the end of the year…

Must-read: Antonio Fatas: “A 2016 Recession Would Be Different”

Posted on by Brad DeLong

Must-Read: “The years that the locust hath eaten, the cankerworm, and the caterpiller, and the palmerworm…” –Joel 2:25 (KJV). The task of fiscal and monetary policymakers as of the start of 2009 was (1) to arrest the slide, (2) to trigger a strong recovery, and (3) to set the world economy in a situation in which future policymakers would have the room to maneuver so that future substantial adverse macroeconomic shocks–and there would be future substantial adverse macroeconomic shocks–could be neutralized. They (probably) accomplished (1), they (certainly) failed at (2), and they continue to fail at even starting at (3)–and the fact that it is now seven years and they have not even started this task somehow fails to exercise them:

Antonio Fatas: A 2016 Recession Would Be Different: “1. The Yield curve would be very steep…

…2. The real federal funds rate (or the ECB real repo rate) would be extremely low…. 3. And nominal central bank interest rates would be stuck at zero…. So maybe this tells us that a recession is not about to happen. But if it is, the lack of space to implement traditional monetary policy tools should be a big concern for policy makers. If a recession ends up happening, helicopter money will likely become a policy option.

Must-read: Martin Sandbu: “Four Takes on the Fed Fumble”

Posted on by Brad DeLong

Must-Read: That the Fed would be facing significant chances of recession and would be moving in the opposite policy direction than its peers over the winter was a serious risk of beginning a tightening cycle in December, and a risk that has now risen from a possibility to a probability.

What was the countervailing serious risk that starting the tightening cycle in December took off the table? I really do not see it…

Graph 5 Year 5 Year Forward Inflation Expectation Rate FRED St Louis Fed

Martin Sandbu: Four Takes on the Fed Fumble: “Remember September? Markets seemingly couldn’t wait for the Federal Reserve to raise interest rates…

…Now, however, markets seemingly can’t wait for the Fed to definitively snip the fledgling tightening cycle in the bud. And a growing chatter wonders whether the Fed made a mistake…. Market pricing now implies nearly a two-thirds probability that Fed policymakers will get past next September without a single further rate rise. The change in market sentiment is easy enough to understand… financial turmoil in China… slide in global stock markets… sharp US growth slowdown…. There are (at least) four different ways one may assess the Fed’s actions. First, the plain ‘the Fed goofed up’ view… Paul Krugman, Brad DeLong and Larry Summers. Free Lunch readers will know that this column shares their view on this issue… Jed Graham….

A second, perhaps more interesting, take is that in hindsight the Fed shouldn’t have raised rates, but that it couldn’t have known this at the time…. A third take… the mistake was to create expectations that caused financial conditions to tighten long before December…. A fourth view… the Fed was right to hike but wrong in thinking it would then proceed to lift rates through this year…. But… the arguments for a rise were… for the beginning of a sustained if gradual process. If that is now derailed, it removes much of the rationale for the first increase.

It also leaves open the question of what to do next…. Should the Fed reverse course? That is the view of Narayana Kocherlakota…