Tag: Fiscal Policy

Inclusive Growth?: PIIE Conference

Posted on by Brad DeLong
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http://tinyurl.com/dl20161117a

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PIIE: Conference on Income Inequality and Inclusive Growth: “Keynote Speaker: Paul Krugman (Graduate Center, City University of New York)

November 17, 2016 8:30 AM to 2:00 PMADD TO

The Peterson Institute for International Economics (PIIE) and the McKinsey Global Institute (MGI) will cohost a conference on income inequality and inclusive growth on November 17, 2016. Paul Krugman, Nobel laureate and Distinguished Professor of Economics at the Graduate Center of the City University of New York, will conclude the conference with a keynote address, titled “After the Elephant Diagram,” at 12:15 pm.

The conference morning will consist of two panel discussions. The first panel (8:45–10:15 am) will focus on global inequality and begin with a presentation by MGI partner Anu Madgavkar on MGI’s new report, Poorer than their parents: A new perspective on income inequality. (link is external) Sandra Black, member of the US Council of Economic Advisers, will offer her remarks drawing on the CEA’s recent research on the topic. Paolo Mauro, assistant director of the African department at the International Monetary Fund, will share his insights from his PIIE Working Paper, The Future of Worldwide Income Distribution.

The second panel (10:30 am–12:00 pm) will focus on inclusive growth policy ideas for the next US administration. The panelists include Brad DeLong, professor of economics at the University of California, Berkeley; William Spriggs, chief economist at the AFL-CIO; Jonathan Woetzel, McKinsey & Company senior partner and MGI director; and Jeromin Zettelmeyer, senior fellow at PIIE since September and previously director-general for economic policy at the German Federal Ministry for Economic Affairs and Energy.

Note to Self: I Still Fail to Understand Ken Rogoff’s Medium-Long Term Macroeconomic Optimism…

Posted on by Brad DeLong

Ken Rogoff: “In nine years, nobody will be talking about ‘secular stagnation’. I’ve been debating Larry on this for a year, and I started saying ‘in ten years…, and so for consistency I now say ‘in nine years…”.

10 Year Treasury Constant Maturity Rate FRED St Louis Fed

This is a wager that the full-employment long-run in which money and its associates are a veil that does not affect or disturb the Say’s Law operation of the economy will come not more than 18 years after the shock of 2017–or at least that whatever remnants of the effects of that shock on the business cycle come 2025 will be dwarfed the effects of other business cycle shocks subsequent to now.

I do know from experience that one disagrees with Ken Rogoff at one’s grave intellectual peril. But is he correct here? I really cannot follow him to the conclusion he wants me to reach…

Things to reread and chew over:

  • Paul Krugman (2015): The Inflationista Puzzle: “Traditional IS-LM analysis said that the Fed’s [expansionary QE] policies would have little effect on inflation; so did the translation of that analysis into a stripped-down New Keynesian framework that I did back in 1998, starting the modern liquidity-trap literature. We even had solid recent empirical evidence: Japan’s attempt at quantitative easing in the naughties…. I’m still not sure why relatively moderate conservatives like Feldstein didn’t find all this convincing back in 2009…”

  • J. Bradford DeLong (2015): New Economic Thinking, Hicks-Hansen-Wicksell Macro, and Blocking the Back Propagation Induction-Unraveling from the Long Run Omega Point

  • Paul Krugman (2015): Backward Induction and Brad DeLong: “Brad DeLong is, unusually, unhappy with my analysis in a discussion of the inflationista puzzle–the mystery of why so many economists failed to grasp the implications of a liquidity trap, and still fail to grasp those implications despite 6 years of being wrong. Brad sorta-kinda defends the inflationistas on the basis of backward induction; I find myself somewhat baffled by that defense…”

  • Paul Krugman (2015): Rethinking Japan: “Secular stagnation and self-fulfilling prophecies: Back in 1998… I used a strategic simplification… [assumed] the Wicksellian natural rate… would return to a normal, positive level at some future date. This… provided a neat way to deal with the intuition that increasing the money supply must eventually raise prices by the same proportional amount; it was easy to show that this proposition applied only if the money increase was perceived as permanent, so that the liquidity trap became an expectations problem… [so] that if the central bank could “credibly promise to be irresponsible,” it could gain traction even in a liquidity trap. But what is this future period of Wicksellian normality of which we speak?… Japan looks like a country in which a negative Wicksellian rate is a more or less permanent condition. If that’s the reality, even a credible promise to be irresponsible might do nothing…. The only way to be at all sure of raising inflation is to accompany a changed monetary regime with a burst of fiscal stimulus…. While the goal of raising inflation is, in large part, to make space for fiscal consolidation, the first part of that strategy needs to involve fiscal expansion. This isn’t at all a paradox, but it’s unconventional enough that one despairs of turning the argument into policy…”

  • Paul Krugman (2015): St. Augustine and Secular Stagnation: “The assumption here is that the neutral rate will eventually rise so that monetary policy can take over the job of achieving full employment. What if we have doubts about whether that will ever happen? Well, that’s the secular stagnation question… a situation in which the neutral interest rate is normally, persistently below zero. And this raises a puzzle: If we worry about secular stagnation, should we then say that St. Augustine no longer applies, because better days are never coming? No. The way to deal with secular stagnation, if we believe in our models, is to raise the long-run neutral interest rate…. If we can do this via structural reform and/or self-financing infrastructure investment, fine. If not, raise the inflation target. And how do we get to the higher target inflation rate, when monetary policy is having trouble getting traction? Fiscal policy! If you’re really worried about secular stagnation, you should advocate a combination of a raised inflation target and a burst of fiscal stimulus to help the central bank get there. So the St. Augustine approach is right either way, with secular stagnation suggesting the need to be even less chaste in the short run.”

  • J. Bradford DeLong (2015): Must-Read: Paul Krugman: Rethinking Japan: “Paul Krugman’s original argument assumed that the economy would eventually head towards a long-run equilibrium in which flexible wages and prices would make Say’s Law hold… [with] the price level would be proportional to the money stock. That now looks up for grabs. It is the fact that that is up for grabs that currently disturbs Paul. Without a full-employment Say’s Law equilibrium out there in the transversality condition to which the present day is anchored by intertemporal financial-market and intertemporal consumer-utility arbitrage, all the neat little mathematical tricks that Paul and Olivier Blanchard built up at the end of the 1970s to solve for the current equilibrium break in their hands…. There is… more. Paul Krugman’s original argument also assumed back-propagation into the present via financial-market… and consumer-satisfaction intertemporal… arbitrage of the effects of that future well-behaved full-employment equilibrium. The equilibrium has to be there. And the intertemporal arbitrage mechanisms have to work. Both have to do their thing…”

  • J. Bradford DeLong (2015): The Scary Debate Over Secular Stagnation: Hiccup… or Endgame?

  • Paul Krugman (2015): On Being Against Secular Stagnation Before You Were for It

  • Duncan Weldon (2016): Negative Yields, the Euthanasia of the Rentier, and Political Economy: “I understand the mechanics of engine that took us here but not what the driver was thinking…”

  • J. Bradford DeLong (2015): Just What Are the Risks That Alarm Ken Rogoff?: “This part of Ken Rogoff’s piece appears to me to be very much on the wrong track: ‘Ken Rogoff: Debt Supercycle, Not Secular Stagnation: Robert Barro… has shown that in canonical equilibrium macroeconomic models small changes in the market perception of tail risks can lead both to significantly lower real risk-free interest rates and a higher equity premium…. Obstfeld (2013) has argued cogently that governments in countries with large financial sectors need to have an ample cushion, as otherwise government borrowing might become very expensive in precisely the states of nature where the private sector has problems…’ We need to be clear about what the relevant tail-risk states that Ken Rogoff is talking about are…. [They are that] even though it was sold at a high price and carries a low interest rate, the issuing of government debt is very expensive to the government [because] when the time comes in the bad state of the world for it to raise the money to amortize the debt, it finds that it really would very much rather not do so. It is clear if you are Argentina or Greece what the risk is: it is of a large national-level terms-of-trade or political shock, something that you can insure against by investing in the ultimate reserves of the global monetary system. If you are the United States or Germany or Japan or Britain, what is the risk? What is the risk that cannot be handled at low real resource cost by a not-injudicious amount of inflation, or of financial repression?”

  • J. Bradford DeLong (2015): Watching a Discussion: The Omega Point

Fiscal Expansion Needs to Be Done Right

Posted on by Brad DeLong
10 Year Treasury Constant Maturity Rate FRED St Louis Fed

Fiscal expansion now is really a no-brainer:

  • borrow at unbelievably low rates;
  • use it to put people to work doing useful things to make America more productive;
  • if we are near full employment, it will also push up interest rates, restore equilibrium to the banking sectors, and reduce the chances of future bubbly financial vulnerabilities;
  • if we are not near full employment, it will pull people back into the labor force and raise production and employment now as well as in the future.

What’s the downside? Implementation. Larry Summers thinks it will be very badly implemented indeed:

Larry Summers: A Badly Designed US Stimulus Will Only Hurt the Working Class: “Rüdiger Dornbusch made an extensive study of… populist economic programmes….

Over the medium- and long-term they were catastrophic for the working class in whose name they were launched. This could be the fate of the Trump programme given its design errors, implausible assumptions and reckless disregard for global economics…. Tax credits for equity investment and total private sector participation that will not cover the most important projects, not reach many of the most important investors, and involve substantial mis-targeting…. The highest return infrastructure investments–such as improving roads, repairing 60,000 structurally deficient bridges, upgrading schools or modernising the air traffic control system–do not generate a commercial return and so are excluded….

Trump’s global plan… rests on a misunderstanding…. The plan seems to assume we can pressure countries not to let their currencies depreciate…. [But] not even US presidents… can repeal the laws of economics. Populist economics will play out differently in the US than in emerging markets. But the results will be no better…

Back in 1980 there were a great many people who thought they had Reagan’s approval and baton for:

  • cutting interest rates,
  • returning to the gold standard,
  • balancing the budget,
  • boosting military spending
  • cutting taxes,
  • cutting “weak claims” to federal dollars by successful rent seekers,
  • cutting off federal support to “weak claimants” who did not look or act like real America.

All six of these factions were correct: they all did have Reagan’s approval baton. But few of these goals were consistent with the others. The final policy outcome in the 1980s was random. It was disastrous for midwestern manufacturing, disastrous for fiscal stability, a negative for economic growth, but an extremely strong positive for the rich and superrich whose taxes were cut the most.

Because the last group speaks with a loud voice, there are lots of people today who think that Reagan’s economic policies were, in some vague way they do not understand, a success. But that is the wrong lesson. The right lesson is: incoherent and contradictory policy goals produce largely-random policies that are very unlikely to turn out well.

Principles that Should Govern American Fiscal Policy

Posted on by Brad DeLong
Employment Level 25 to 54 years FRED St Louis Fed

Well, that was a very interesting election night. Our failure in 2000 to introduce into the running code (as opposed to the specification document) of our constitution that electors switch votes so that the national popular vote winner wins the electoral college cost us dear in 2000, and may cost us even more today…

You may ask: How is one to judge what to do in such times? The answer is clear: As one has ever judged. Good and evil have not changed since yesteryear, nor are they one thing among Elves and another among Men. It is a human’s part to discern them, as much in the Golden Wood as in his own house. What would have been good policy yesterday would still be good policy today. What would have been bad policy yesterday would still be bad policy today. So we play our position.

I therefore set forth seven principles that should govern good technocratic fiscal policies that promise to enhance America’s societal well-being :

  • Preserve Our Credit
  • Our National Debt a National Blessing
  • Right Now Our National Debt Is too Low
  • International Agencies Agree
  • Benefits from a Higher Deficit If We Are at Full Employment
  • Benefits from a Higher Deficit If We Are Not at Full Employment

  • A Strong Argument for More Government Purchases Rather than Tax Cuts for the Rich

  • Preserve Our Credit: President-elect Donald Trump has been told by many that our national debt is too high and dangerous. He has responded as one would expect a real estate developer would respond. He has proposed taking steps to shake the confidence of our creditors, and then to buy back our debt, at a heavy discount, thus removing the danger. This is a substantial misreading of the situation. Market confidence in the credit worthiness of the United States of America is an extremely valuable asset, from which we derive much benefit, and which it would be folly to throw away.

  • Our National Debt a National Blessing: In fact, at the moment, with interest rates where they are now and are expected to be for the foreseeable future, our national debt is not a burden but a blessing. It is not a drain on the Treasury but a source of wealth for the Treasury. If we do our accounts using a reasonable benchmark–setting our goal to be keeping our available physical space constant–we find that, at the levels of interest rates we see now and expect to see for the foreseeable future, a lower national that would not allow us to lower but would require us to raise taxes in order to maintain the given level of spending. The United States right now is not in the position of a cash-strapped borrower forced to pay interest. The United States right now is, rather, in the position of something like the medieval Medici bank, which people pay to safeguard their money.

  • Right Now Our National Debt Is too Low: The fact is that our national debt, right now, is not a burden but a profit center. That implies that, whatever you think of the long-term multi-generational fiscal outlook, right now our national debt is not too high but too low. That is the case unless one confidently anticipates a rapid and substantial increase in interest rates in the relatively near future. This was, in fact, one of the major lesson of the big article that Larry Summers and I wrote for the Brookings Institution back in 2012.

  • International Agencies Agree: Note that, after four years of argument, the IMF and other international agences agree with Larry and my technocratic judgment that right now our national debt is too low, and thus that good economic policy requires higher deficits right now, not budget balance.

  • Benefits from a Higher Deficit If We Are at Full Employment: Right now, only the extremely rash would definitely claim to know one way or the other whether the United States is at full employment–whether further increases in the employment-to-population ratio would (1) start an inflationary spiral and require the Federal Reserve to raise interest rates to lower employment back down to its current level, or (2) bring large numbers of discouraged workers back into the labor force and make America richer. If the answer is (1), there are still substantial benefits to an economic policy stance, right now and for the foreseeable future as long as the global configuration of savings supply and investment demand is not transformed, with a larger deficit and tighter money and hence higher interest rates. Higher interest rates would restore the health of the banking sector. Higher interest rates might discourage the blowing of potentially dangerous bubbles. The drawback of raising interest rates–the reason that the Federal Reserve has not done so–is that it lowers employment. But if that reduction in employment is offset by an increase in the deficit that boosts employment, hit becomes a no-drawbacks policy.

  • Benefits from a Higher Deficit If We Are Not at Full Employment: Right now, only the extremely rash would definitely claim to know one way or the other whether the United States is at full employment–whether further increases in the employment-to-population ratio would (1) start an inflationary spiral and require the Federal Reserve to raise interest rates to lower employment back down to its current level, or (2) bring large numbers of discouraged workers back into the labor force and make America richer. If the answer is (2), there are massive benefits to an economic policy stance of running larger deficits–the benefit of raising employment and making people richer, and making those people richer who have suffered the most since the subprime crisis and crash of 2008.

  • A Strong Argument for More Government Purchases Rather than Tax Cuts for the Rich: If America does decide to run larger deficits, there are large benefits from choosing to do so by increasing government purchases than by cutting taxes, especially for the rich. Increasing government purchases puts to work and improves the lot of the people who have suffered the most since the subprime crisis and crash of 2008. And cutting taxes–especially for the rich–has much smaller effects on the balance between savings and the capital inflow on the one hand and investment and government borrowing on the other. Since the effectiveness of the policy in putting people to work and in creating space for the Federal Reserve to raise interest rates to a healthy level without harming employment depends on this investment-savings balance, there is much more bang for a buck of government purchases than from a buck of tax cuts.

Note to Self: Inadequate Musings on Elements of Rogoff’s Debt Supercycle Hypothesis

Posted on by Brad DeLong
Real Gross Domestic Product for European Union 28 countries © FRED St Louis Fed

It is, once again, time for me to think about Ken Rogoff’s hypothesis: his claim that right now the world economy as a whole is depressed because we are in the down phase of a debt supercycle–dealing with a debt overhang.

I have never been able to make enough sense of Rogoff’s perspective here to find it convincing.

I should, however, warn people that when I fail to see the point of something that Ken Rogoff has written, the odds are only one in four that I am right. The odds are three in four that he is right, and I have missed something important:

One way to view the situation is that there have been four serious diagnoses of the ills of the Global North. They are:

  • A Bernanke global savings-glut.
  • A Krugman-Blanchard return to “depression economics”.
  • A Rogoffian-Minskyite crisis of overleverage and debt overhang
  • A Summers secular-stagnation chronic crisis.

The policies recommended by the different diagnoses do differ.

  • A Bernanke global savings-glut chronic crisis requires shifts in global governance that reduce incentives to run large trade surpluses and a redistribution of world income to those with lower marginal propensities to save.
  • A Krugman-Blanchard return to “depression economics” requires larger automatic stabilizers, a higher inflation target, and perhaps a return of fiscal policy to preeminence
  • A Rogoffian-Minskyite temporary crisis of overleverage and of excessive underwater debt requires debt writedowns and financial-intermediary recapitalizations.
  • A Summers secular-stagnation chronic crisis of insufficiently-profitable risk-adjusted investment opportunities requires a shift in responsibility for long-run expenditure from private to government–” a more-or-less comprehensive socialization of investment”, as some guy once wrote.

Let me put the other three to the side, and focus on Rogoff here…

A principal implication of Rogoff’s hypothesis is that, if it is true, that there is no complete and quick fix : recovery is inevitably a lengthy process–although good policies can accelerate and bad policies retard full recovery.

As I understand it, the down phase of what Ken Rogoff calls a debt supercycle can be generated by some or all of:

  • a collapse of market risk tolerance, or of trust in the credit channel, itself generated by one or more of:
    • a failure to mobilize society’s risk bearing capacity,
    • inadequate capitalization of financial intermediaries,
    • a collapse in the reputation of financial intermediaries: either trust that they are long-term greedy, or confidence in their competence, or both.
  • a rise in fundamental riskiness.
  • the past issue of too much risky debt.
  • the past issue of too much risky debt that has become or is now perceived to be risky.
  • a decline in expectations of how much future cash flow there will be available for potential debt servicing.

How long it takes to work off a debt supercycle and rebalance the economy depends on the speed of the processes of:

  • economic growth, which raises cash flow for potential debt servicing.
  • capital depreciation, which by raising the profit rate also raises cash flow for potential debt servicing.
  • debt write-offs.
  • the normal pace of debt amortization.
  • unexpected inflation writing down nominal debts.
  • other forms of financial repression.

As long as we remain in the down-phase of the debt supercycle, even low interest rates do little to encourage the investment spending needed to drive the economy to full employment. Why? Because investment spending requires not just positive expected value given the interest rate, but also the commitment of risk bearing capacity, which is absent because of the debt overhang.

My first reaction is that the right way to deal with this is to rebalance the economy by undertaking economic activities that do not require the deployment of risk bearing capacity to set them in motion. Governments with exorbitant privilege that have ample fiscal space should borrow and spend–most desirably on things that raise potential output in the future, but other worthwhile activities that create utility are also fine.

As I wrote: We have underemployment. We have interest rates on government debt and thus the debt amortization costs of the government far below any plausible rate of return on productive public investments (or, indeed, any plausible social rate of time discount geared to a sensible degree of risk aversion and the trend rate of technological progress). Under such circustances, at least reserve currency-issuing governments with exorbitant privilege should certainly be spending more, taxing less, and borrowing.

But Rogoff seems to disagree:

Kenneth Rogoff (2011): The Second Great Contraction: “Many commentators have argued that fiscal stimulus has largely failed… because it was not large enough…

…But, in a “Great Contraction,” problem number one is too much debt. If governments that retain strong credit ratings are to spend scarce resources effectively, the most effective approach is to catalyze debt workouts and reductions…. Governments could facilitate the write-down of mortgages in exchange for a share of any future home-price appreciation…. Europe could perhaps be persuaded to engage in a much larger bailout for Greece (one that is actually big enough to work), in exchange for higher payments in ten to fifteen years if Greek growth outperforms…

And:

Kenneth Rogoff (2015): world’s economic slowdown is a hangover not a coma: “Vastly increased quality infrastructure investment… a great idea. But… not… a permanently sustained blind spending binge…

…What if a diagnosis of secular stagnation is wrong? Then an ill-designed permanent rise in government spending might create the very disease it was intended to cure…. There can be little doubt that a debt super cycle lies behind a significant part of what the world has experienced over the past seven years. This resulted first in the US subprime crisis, then the eurozone periphery crisis, and now the troubles of China and emerging markets. The whole affair has strong precedent…. America’s experience–whether one looks at the trajectory of housing and equity prices, unemployment and output, or public debt–has uncannily tracked benchmarks from past systemic financial crises. This is not to say that secular factors are unimportant. Most financial crises have their roots in a slowing economy that can no longer sustain excessive debt burdens…

Rogoff seems to have a counter. He seems to think that borrow-and-spend by governments with fiscal space will, or perhaps may, lead, ultimately, to disaster. Why? Because the fiscal space was never really there. The increase in debt issue will transform even the government’s old safe debt into risky debt. And the overhang of risky debt will be increased, worsening the problem.

The counter to that, of course is helicopter money: money printing- and financial repression-financed expansionary fiscal policy rebalances the economy at full employment without any risk of incurring a larger overhang of risky debt further down the road.

And Rogoff’s response to that is… what?

Relevant:

Paul Krugman: Airbrushing Austerity: “Ken Rogoff weighs in on the secular stagnation debate, arguing basically that it’s Minsky, not Hansen…

…that we”re suffering from a painful but temporary era of deleveraging, and that normal policy will resume in a few years…. Rogoff doesn”t address the key point that Larry Summers and others, myself included, have made–that even during the era of rapid credit expansion, the economy wasn’t in an inflationary boom and real interest rates were low and trending downward–suggesting that we”re turning into an economy that “needs” bubbles to achieve anything like full employment. But what I really want to do right now is note… people who predicted soaring interest rates from crowding out right away now claim that they were only talking about long-term solvency… people who issued dire warnings about runaway inflation say that they were only suggesting a risk, or maybe talking about financial stability; and so on down the line…. In Rogoff’s version of austerity fever all that was really going on was that policymakers were excessively optimistic, counting on a V-shaped recovery; all would have been well if they had read their Reinhart-Rogoff on slow recoveries following financial crises. Sorry, but no….

David Cameron didn’t say “Hey, we think recovery is well in hand, so it’s time to start a modest program of fiscal consolidation.” He said “Greece stands as a warning of what happens to countries that lose their credibility.” Jean-Claude Trichet didn’t say “Yes, we understand that fiscal consolidation is negative, but we believe that by the time it bites economies will be nearing full employment”. He said: “As regards the economy, the idea that austerity measures could trigger stagnation is incorrect … confidence-inspiring policies will foster and not hamper economic recovery, because confidence is the key factor today.” I can understand why a lot of people would like to pretend, perhaps even to themselves, that they didn’t think and say the things they thought and said. But they did.

And this part of Ken Rogoff’s piece appears to me to be on the wrong track:

Ken Rogoff: Debt Supercycle, Not Secular Stagnation: “Robert Barro… has shown that in canonical equilibrium macroeconomic models…

…small changes in the market perception of tail risks can lead both to significantly lower real risk-free interest rates and a higher equity premium…. Martin Weitzman has espoused a different variant of the same idea based on how people form Bayesian assessments of the risk of extreme events…. Those who would argue that even a very mediocre project is worth doing when interest rates are low have a much tougher case to make. It is highly superficial and dangerous to argue that debt is basically free. To the extent that low interest rates result from fear of tail risks a la Barro-Weitzman, one has to assume that the government is not itself exposed to the kinds of risks the market is worried about, especially if overall economy-wide debt and pension obligations are near or at historic highs already. Obstfeld (2013) has argued cogently that governments in countries with large financial sectors need to have an ample cushion, as otherwise government borrowing might become very expensive in precisely the states of nature where the private sector has problems…

Ken Rogoff’s Hooverismo…: Hoisted from the Archives from Three Years Ago

Posted on by Brad DeLong
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Just what is Ken Rogoff’s argument that the Cameron-Osborne-Clegg government in Great Britain was correct to hit the British economy over the head with the austerity hammer in the spring of 2010, anyway?

Simon Wren-Lewis opens: Ken Rogoff on UK austerity: “Ken Rogoff’s article… is a welcome return to sanity…

…Rogoff focuses on what was always the critical debate: was austerity necessary because financial markets might have stopped buying government debt…. As critical pieces go, you couldn’t have a friendlier one than this…. Rogoff agrees that it was a mistake to cut back on public sector investment…. He says that austerity critics “have some very solid points”…. His comment after putting the austerity critics’ case is “perhaps” or “maybe”…

But… But… But…

About the Rogoff argument: If markets stop buying government debt, then they are buying something else: by Walras’s Law, excess supply of government debt is excess demand for currently-produced goods and services and labor. That is not continued deflation and depression, that is a boom–it may well be a destructive inflationary boom, and it may be a costly boom, but it is the opposite problem of an deflationary depression

So, by continuity, somewhere between policies of austerity that that produce deflationary depression due to an excess demand for safe assets and policies of fiscal license that produce inflationary boom caused by an excess supply of government debt, there must be a sweet spot: enough new issues of government debt to eliminate the excess demand for safe assets and so cure the depression, but not so much in the way of new issues of government debt to produce destructive inflation, right? Why not aim for that sweet spot? Certainly Cameron-Osborne-Clegg were not aiming for that sweet spot, and the John Stuart Millian using the government’s powers to issue money and debt to balance supply and demand for financial assets and so make Say’s Law true in practice even though it is not true and theory?

More urgent and important: In the spring of 2010 there was no sign of an inflationary boom with rising interest rates. There was no sign that there was going to be an inflationary boom soon. There was no sign that anybody in financial markets whose money moved market prices at the margin placed a weight greater than zero on any prospect of an inflationary boom at any time horizon out to thirty years.

Thus the question is: what do you do if there is no boom, are no signs of a boom, is no expectation that there will be a boom, is no excess supply of government debt right now, is no sign in the term structure of interest rates that people expect an excess supply of government debt in the near-future–if in fact looking out thirty years into the future via the term structure there is no sign that there will ever be any significant chance of an excess supply of government debt?

Ken Rogoff thinks that the answer is obvious: that you must then hit the economy on the head with the hammer of austerity to raise unemployment in order to guard against the threat of the invisible bond-market vigilantes, even though there is no sign of them–for, he says, they are invisible and silent as well. We must not try to infer expectations, probabilities, scenarios, and risks from market prices, but rather have St. Paul’s faith that austerity is necessary because of “the evidence of things not seen”.

The argument seems to be:

  1. We can’t trust financial markets that price the scenario in which people lose confidence in government finances at zero because financial markets are irrational–we cannot look at prices as indicators of when austerity might be appropriate, but must hit the economy on the head with the austerity brick and raise unemployment.

  2. Once interest rates rise as people lose confidence in government finances, it is then politically impossible for the government to run the primary surpluses needed–to cut spending and raise taxes–in order to service the debt without the implicit national bankruptcy of inflation

  3. Once interest rates rise as people lose confidence in government finances, it is not possible for the Bank of England to reduce the pound far enough to bring foreign-currency speculators who then expect the next bounce of the pound will be up into the market to reduce interest rates–or, at least, not possible without setting off an import price-driven inflationary spiral, and thus produce the implicit national bankruptcy of inflation.

  4. Greece! Argentina! You don’t want Britain to suffer the fate of Greece or Argentina, do you

Therefore, Rogoff argues, in order to guard against the possibility of a destructive fiscal dominance-inflation in the future, the Cameron-Osborne-Clegg government was wise to hit the British economy on the head with the austerity hammer and produce a longer, deeper, more destructive depression now.

Maybe the argument is really that the big policy mistake was made by Governor of the Bank of England–that Britain was in conditions of fiscal dominance, in which the Exchequer needed to balance the budget to preserve price stability and the Bank of England should have engaged in massive quantitative easing, aggressive forward interest- and exchange-rate guidance, and explicit raising of the inflation target in order to balance aggregate demand and potential supply, and that the unforgivable policy blunders were not Cameron-Osborne-Cleggs’ but King’s. But if that is what Rogoff means, it is not what he says.

So I am still left puzzled.

And so is Simon Wren-Lewis, who continues:

The argument here is all about insurance. The financial markets are unpredictable…. [What if] the Euro had collapsed[?] As Rogoff acknowledges, they might have run for cover into UK government debt, but… might have done the opposite…. The UK is not immune from the possibility of a debt crisis, so we needed to take out insurance against that possibility, and that insurance was austerity…. So let us agree that it was possible to imagine, particularly in 2010, that the markets might stop buying UK government debt. What does not follow is that austerity was an appropriate insurance policy….

Government needed to have a credible long term plan for debt sustainability…. I hope Rogoff would agree that in the absence of any risk coming from the financial markets, it is optimal to delay fiscal tightening until the recovery is almost complete. The academic literature is clear that, in the absence of default risk, debt adjustment should be very gradual, and that fiscal policy should not be pro-cyclical. So the insurance policy involves departing from this wisdom. This has a clear cost in terms of lost output, but an alleged potential benefit in reducing the chances of a debt crisis…. What the Rogoff piece does not address at all is that the UK already has an insurance policy, and it is called Quantitative Easing…. Rogoff says that, if the markets suddenly forsook UK government debt “UK leaders would have been forced to close massive budget deficits almost overnight.” With your own central bank this is not the case–you can print money instead…. We are talking about a government with a long-term feasible plan for debt sustainability, faced with an irrational market panic…. We never needed the much more costly, far inferior and potentially dubious additional insurance policy of austerity.

And so is Paul Krugman: Phantom Crises:

Simon Wren-Lewis is puzzled by a Ken Rogoff column that sorta-kinda defends Cameron’s austerity policies. His puzzlement, which I share, comes at several levels. But I want to focus on… Rogoff’s assertion that Britain could have faced a southern Europe-style crisis, with a loss of investor confidence driving up interest rates and plunging the economy into a deep slump. As I’ve written before, I just don’t see how this is supposed to happen in a country with its own currency that doesn’t have a lot of foreign currency debt–especially if the country is currently in a liquidity trap, with monetary policy constrained by the zero lower bound on interest rates. You would think, given how many warnings have been issued about this possibility, that someone would have written down a simple model of the mechanics, but I have yet to see anything of the sort…. Suppose that investors turn on your country for some reason… a decline in capital inflows at any given interest rate, so that the currency depreciates. If you have a lot of foreign-currency-denominated debt, this could actually shift IS left through balance-sheet effects, as we learned in the Asian crisis. But that’s not the case for Britain; clearly, IS shifts right. If LM doesn’t shift, the interest rate will rise, but only because the loss of investor confidence is actually, through depreciation, having an expansionary effect….

My point is that… [the] claim that loss of foreign confidence causes a contractionary rise in interest rates just doesn’t come out of anything like a standard model. If you want to claim that it will happen nonetheless, show me the model!…

Furthermore, as Wren-Lewis says, even if there is somehow a squeeze on long-term bonds, why can’t the central bank just buy them up? Yes, this is “printing money”–but when you’re in a liquidity trap, that doesn’t matter. (Alternatively, you can take a consolidated view of the government and central bank balance sheets, in which case what we’re effectively doing is refinancing at the zero short-term rate.)…

And Matthew C. Klein: Ken Rogoff’s Latest Bad Argument for Austerity:

It’s been more than three years since the U.K.’s coalition government began aggressively raising taxes and cutting spending in an effort to reduce its deficit. Many economists now agree that this program retarded the recovery, producing a slump worse than the Great Depression. Yet Harvard economist Kenneth Rogoff, in a column in the Financial Times, argues that those measures made sense as a form of insurance against the sort of crisis that has afflicted countries in the euro area such as Spain and Italy. His case has two parts, neither of which is convincing.

First, Rogoff implies that the U.K. was vulnerable to the same sorts of shocks that battered Spain and Italy…. The comparison is misleading, however. Unlike the 17 countries of the euro area, which share a single currency, the U.K. uses its own… totally different from the euro area….

Rogoff’s second point is that previous episodes of high indebtedness in the U.K. were special cases that should not inform today’s policy makers…. Rogoff dismisses the gradual repayment of the U.K.’s World War II-era debts because it was only made possible by persistent rapid inflation. That’s true, but Rogoff himself has repeatedly argued that the rich world needs more inflation, rather than less. In fact, at the bottom of his most recent column, Rogoff says that it was a mistake not to have pursued “even more aggressive monetary policy.”

DRAFT: Did Macroeconomic Policy Play a Different Role in the (Post-2009) Recovery?

Posted on by Brad DeLong
Federal reserve bank of boston Google Search

J. Bradford DeLong
U.C. Berkeley
October 15, 2016

Federal Reserve Bank of Boston
60th Economic Conference
The Elusive “Great” Recovery: Causes and Implications for Future Business Cycle Dynamics

Abstract: How has macroeconomic policy been different in this recovery? In banking and regulatory policy, it has been distinguished from earlier patterns—or from what we thought earlier patterns implied for a shock this large and this persistent—in a relative unwillingness to apply the “penalty rate” part of the Bagehot Rule and in a slowness to restructure housing finance that are, for me at least, different than I had expected. In fiscal policy, the prolonged reign of austerity in an environment in which both classical and Keynesian principles suggest that it is time to run up the debt is surprising and unexpected, to me at least. In monetary policy it is more difficult to say what has been different and surprising in this recovery. There have been so many aspects of monetary policy and our expectations of what policy would be during a prolonged excursion to the zero lower bound that it is hard enough merely to say what monetary policy has been, and too much to ask how it has been different from whatever baseline view of what the policy rule would be that we ought to have held back in 2008.

Has Macro Policy Been Different since 2008?

Posted on by Brad DeLong
3 Month Treasury Bill Secondary Market Rate FRED St Louis Fed

Was macro policy different after 2008? I interpret that to be the question: “Did macro policy follow the same rule after 2008 that people had presumed before 2008 it would follow in a true tail event?” To answer that question requires determining just what policy rule people back before 2008 thought that the U.S. government was following. Let me propose four candidates for our (implicit) pre-2008 macroeconomic policy rule:

  1. Limit fiscal policy to automatic stabilizers, and follow a Taylor rule with John Taylor’s coefficients (Taylor).
  2. Follow Milton Friedman’s advice and target velocity-adjusted money: if nominal GDP is below trend, print more money and buy bonds; if that does not restore nominal GDP to either the trend level or the trend growth rate (depending on whether your favorite flavor has or does not have base-drift sprinkles), repeat (Friedman).
  3. Use open market operations to manipulate the short-term safe nominal interest rate to stabilize inflation and unemployment as long as you are not at the zero lower bound. At the zero lower bound credibly promise to be irresponsible in the future in order to raise inflation expectations by enough to push the real interest rate down to its negative Wicksellian neutral rate value, and so restore real macroeconomic balance (Krugman).
  4. Use open market operations to manipulate the short-term safe nominal interest rate to stabilize inflation and unemployment as long as you are not at the zero lower bound. At the zero lower bound resort to expansionary fiscal policy and do as much of it as needed, at least as long as interest rates on long-term government debt remain low (Blinder).

Were there any other live candidates for “the policy rule” back before 2008?

Unpleasant Fiscal Dominance?

Posted on by Brad DeLong
Sims highlights fiscal dominance at Jackson Hole Gavyn Davies

Paul Krugman appears confused:

Paul Krugman: Chris and the Ricardianoids:

Here’s [Chris] Sims on fiscal policy:

Fiscal expansion can replace ineffective monetary policy at the zero lower bound, but fiscal expansion is not the same thing as deficit finance. It requires deficits aimed at, and conditioned on, generating inflation. The deficits must be seen as financed by future inflation, not future taxes or spending cuts…

I think he’s saying that fiscal expansion works only if it leads to a rise in expected inflation…. [That] is certainly something I’ve heard from helicopter money types, who warn that something like Ricardian equivalence will undermine fiscal expansion unless it’s money-financed. But this is a misunderstanding of Ricardian equivalence, on two levels. First, as I’ve tried repeatedly to explain, a TEMPORARY increase in government purchases of goods and services will NOT be offset by expectations of future taxes even if full Ricardian equivalence holds. The kind of argument people like Robert Lucas made sounded Ricardian, but wasn’t–it was Ricardianoid. Second, less relevant to Sims but very relevant to other helicopter people, a deficit ultimately financed by inflation is just as much of a burden on households as one ultimately financed by ordinary taxes, because inflation is a kind of tax on money holders. From a Ricardian point of view, there’s no difference. So I’m trying to figure out exactly what Sims is saying…

As I understand where Sims and company are coming from, they are working in a model in which there are no government purchases. Or perhaps government purchases are useless, and so are not part of “true” real GDP. But in any event, either there is no difference between government purchases and tax cuts–hence no balanced-budget multiplier–or fiscal policy consists entirely of changes in taxes and transfers.

They are also working in a model in which total spending is given by something like:

C = C(r, W)

where W is the real wealth of the representative agent, and r is the real interest rate. The more wealth the more spending. The lower the real interest rate, the more spending.

The real interest rate is the difference between the nominal interest rate i and the inflation rate π:

r = i – π

And the economy is in a liquidity trap with i=0.

Now as I understand Sims, W is given by something like:

W = Y/r – T/(r + ρ)

where Y is the flow of income, T is the flow of taxes, and ρ is some sort of risk premium–that the finances of the government will become unstable and the government will not manage to collect its taxes.

Then the only ways fiscal policy can affect spending and output now are if:

  • deficits raise expectations of money-printing and so raise inflation π.
  • deficits raise expectations of future fiscal collapse and so increase current wealth by increasing the rate at which future tax liabilities are discounted.

And as I understand Sims, quantitative easing is counterproductive: it reduces the risk premium ρ, and so raises the present value of future tax liabilities and so reduces household wealth without doing anything to alter the real interest rate.

I think this is what is going on.

Is this a consistent model? I am not sure. Is this the model that Chris Sims has in mind that lies behind his talk? I am not sure. Is this the right model for the questions at hand? I am pretty sure it is not one of the first five models I would write does as most relevant.

Cf.: Gavyn Davies: Sims highlights fiscal dominance at Jackson Hole

Pyrrhus at Jackson Hole: A Monetary Policy “Victory” That Leaves the Central Bank in a Very Weak Position Blogging

Posted on by Brad DeLong
Real Potential Gross Domestic Product FRED St Louis Fed

Larry Summers says that he is disappointed along three dimensions at what came out of the Federal Reserve’s Jackson Hole Conference. I think Summers is right to be disappointed. Indeed, from my perspective, it was disturbing that there was not more connection between the academic papers on how the monetary policy toolkit might be expanded and the policy discussion.

Summers’s view is that the policy discussion is seriously awry: “near-term policy signals… on the tightening side… will end up hurting both the Fed’s credibility and the economy…. The longer-term discussion revealed… dangerous complacency about the… existing tool box…. [And] failure to seriously consider major changes in the current monetary policy framework…” I think that gets it right:

  • The Fed appears to me to be dangerously complacent,
  • Both with respect to the short-term macroeconomic situation,
  • And with respect to its ability to stabilize the economy over the longer term;
  • Hence its current policies appear to me to be dangerously blind to current realities,
  • And it is not seriously engaged in setting the stage so that the successors of current policymakers can have a chance at a quiet life.

So if these issues were not, in my view, properly discussed at Jackson Hole, where should people go to learn about them?

First, Summers. This morning Summers argues about the near-term policy and economic outlook:

Larry Summers: Disappointed by What Came Out of Jackson Hole:

I had high hopes… billed as a forum that would look at new approaches to the conduct of monetary policy…. The Federal Reserve system and its Chair are to be applauded for welcoming challengers and critics… meet[ing] with the “Fed Up” group…. The fact that the Fed has now recognized that the decline in the neutral rate is something that is much more than a temporary reflection of the financial crisis is a very positive sign. On balance though, I am disappointed….

The near-term policy signals were on the tightening side which I think will end up hurting both the Fed’s credibility and the economy…. The Fed has not earned the right to be intellectually complacent or to expect that others will have faith in its current policy framework…. The Fed has been too serene about the economic outlook…. When the Fed predicted last December that it would raise rates four times in 2016, market participants saw a disconnect from reality. It has been that way for a long time….

Disappointed by what came out of Jackson Hole Larry Summers

Disappointed by what came out of Jackson Hole Larry Summers 

Chair Yellen… basically repeated the existing Fed position that rates would be raised at some point when the data were clear that the economy was strong and inflation reaching two percent. Markets took the remarks as mildly dovish until Vice Chair Fischer was seen on CNBC as interpreting the Chair as implying that two rates increases by the end of the year were possible…. I [had] hoped that the Fed would make clear that it would tighten only when there appeared a real risk of inflation expectations rising above two percent. At a time when market forecasts of inflation on Fed’s preferred price index are in the range of 1.2 percent, this is very likely some time off. Some are skeptical of market measures of inflation expectations. Note that survey measures of long term inflation expectations for both professionals and consumers are near historical lows and if anything have declined over the last year…

Second, people should go read Paul Krugman. Basically, since at least 1998 Paul has been way ahead of the curve on many issues, one of which is the return of “depression economics” and the need for abandoning the belief that stabilization policy can successfully be conducted by independent central banks with a narrow monetary policy operations toolkit:

Paul Krugman: On Twitter:

Paul is citing himself from four years ago:

Paul Krugman (2012): Monetary Versus Fiscal Policy, Revisited:

One recurring complaint… is that [people] can’t figure out where I stand on monetary versus fiscal policy as a response to a deeply depressed economy…. Mike Woodford’s latest paper, especially taken in tandem with his paper last year at the Cambridge Keynes conference, actually explains it all…. Current monetary policy is indeed ineffective in a liquidity trap… there is still scope for central bank action in… credible commitments to keep monetary policy easy in the future…. The trouble is how to make those credible commitments… to convince the central bank itself that it’s a good idea… to convince the private sector that the central bank will not, in fact, just revert to type once the crisis is past. My judgment back in late 2008/early 2009 was that it would take a long time to get through those two stages….

What about fiscal policy? As Mike pointed out in his earlier paper, fiscal stimulus in a liquidity trap doesn’t require that you convince the market that you’re going to behave differently once the crisis is past. It doesn’t depend on expectations at all; the government just goes out and creates jobs. So it made a lot of sense to argue for stimulus as the main immediate response to the slump. But isn’t fiscal stimulus also a hard sell politically? Yes, indeed….

So what should well-meaning economists do now, with both fiscal and monetary policy falling short? The answer is, campaign on both fronts, trying to convince influential players both that austerity is wrong and that the Fed needs to start signaling its willingness to see more inflation before it raises rates. And that’s more or less where I am.

That was true back in the fall of 2012. And that is still true. The Federal Reserve can, if it wants declare victory by pretending that the economy is at full employment (it might be; but it probably is not) and that inflation is effectively at its 2%/year core PCE target (yes, Stan Fischer, we are looking at you: there is a very small chance that it might be; but the odds are overwhelmingly that it is not), but it cannot pretend that it has set up the game board properly for today’s policymakers and their successors to deal with the next business cycle when it comes. For this, you need to read Jared Bernstein:

Jared Bernstein: Will the Federal Reserve Really Have What It Takes to Fight Off the Next Recession?:

No one knows when the next recession is going to hit… we just can’t accurately call these things…. There is, of course, a recession out there somewhere. The problem isn’t that we don’t know where; it’s that we’re not ready for it…. You simply cannot trust our Congress to act quickly and forcefully on countercyclical, discretionary fiscal policy (“discretionary” meaning the stuff aside from the automatic stabilizers)…. The Federal Reserve… likely [has a] limited-firepower problem…. The federal funds rate (FFR)… is sitting at less than half-a-percent, which gives them very little room to cut….Reifschneider… argues that this concern may be overblown, at least under certain conditions. His reasoning is threefold:

  1. If the recovery keeps going the Fed may have time to get rates back up to a needed perch.
  2. For reasons I’ve discussed in other posts, that perch is lower than it used to be.
  3. The FFR is not their only tool. There’s also quantitative easing (buying longer-term bonds to lower longer-term rates) and forward guidance (resetting people’s expectations by telling us that they’re going to keep rates low for a long time)….

I am not much comforted. There are a lot of “ifs” in Reifschneider’s story (all of which he is totally straight up about)…. Sure, I hope Reifschneider’s optimistic scenarios are correct. But I fear they’re not and we’d be crazy not to have a Plan B.

And Paul Krugman again:

Paul Krugman: On Fed Complacency:

Is the Fed really repeating its big mistake of the pre-crisis era, dismissing concerns about its ability to respond to recession? Jared Bernstein thinks so, and so do I…. The current state of thinking seems to be… Reifschneider, which argues… that by the time the next recession arrives, the Fed funds rate will have returned to a level that still leaves sufficient room to cut….

I can’t help but recall a 1999 paper by Reifschneider and John Williams about inflation targets and the risk of hitting the zero lower bound. They concluded that a 2 percent target should be enough to make this a minor concern… binding only 5 percent of the time, and ZLB episodes would last on average only 4 quarters…. We have just gone through an 8-year–32 quarter–ZLB episode, which accounts for more a quarter of the time that has passed since the beginning of the Great Moderation. Basically, that optimistic take was off by an order of magnitude. Shouldn’t that miss give the Fed pause now?

And you should also read Steve Matthews’s report on the conference, with reports of some policymakers understanding how dire the situation is:

Steve Matthews: Central Bankers Spurn Call for Radical Approach at Jackson Hole:

Yellen and three regional Fed bank presidents — Robert Kaplan of Dallas, Eric Rosengren of Boston and Loretta Mester of Cleveland — all urged fiscal policy makers to step up. “Central bankers, we are increasingly talking about this, about the need for fiscal policy and other economic tools beyond monetary policy,” Kaplan said during a luncheon Friday, although he cautioned it could be “many years” for there to be action…. “You can’t expect us to do the whole job,” Christopher Sims, Nobel Prize-winning economist from Princeton University, told Fed leaders on Friday. “So long as the legislature has no clue of its role in these problems, nothing is going to get done. Of course, convincing them that they have a role and there is something they should be doing, especially in the U.S., may be a major task”…

But they were not willing to call for institutional and policy reforms that will be needed in the highly-likely eventuality that fiscal policymakers do not recover their sanity:

Federal Reserve Chair Janet Yellen and her peers… re-affirmed their belief in power of monetary policy to stop economies from slipping into deflation. They were less keen on academic proposals that included the abolition of cash, raising their inflation targets, or keeping permanently large balance sheets…. Yellen, in her keynote address at the Kansas City Fed’s annual mountain retreat, said that additional tools remain “subjects for research” and were not being actively considered. Policy makers from Europe and Japan echoed her caution…. In stressing that monetary policy is adequate, Yellen and three other Fed officials at Jackson Hole urged structural reforms or a greater reliance on fiscal action…

Bank of Japan Governor Haruhiko Kuroda and Benoit Coeure, European Central Bank Executive Board member, both rejected the idea of a higher inflation target. Kuroda promised “ample space for additional easing” as needed, while Coeure said “we may need to dive deeper into our operational framework”…