Must-Read: : Oh Noes! Paul Krugman Has Caught the Tweetstorm Disease!: “Paul Krugman Is, I Think, Highly Likely to Be Correct on the Policy Irrelevance of the Risk Premium. The Mystery Is Why the Very Sharp Ken Rogoff Takes a Different View…
Tag: Fiscal Policy
Must-Read: Storify: The Puzzling Aversion to Expansionary Fiscal Policy: ‘Low interest rates are not really low’, or something…
Must-Read: : The Puzzling Aversion to Expansionary Fiscal Policy: ‘Low interest rates are not really low’, or something…
Must-Read: Ken Rogoff (2015): Debt Supercycle, Not Secular Stagnation
Must-Read: For a year and a half now I have been trying to understand what this passage means, especially the “in a world where regulation has sharply curtailed access for many smaller and riskier borrowers, low sovereign bond yields do not necessarily capture the broader ‘credit surface’ the global economy faces”. In a world in which n + g > rsafe, why isn’t issuing more safe debt, rolling it over forever, and spending the resources buying useful stuff not win-win ex ante for everyone? Who are supposed to be the losers from this, in the sense that acting on these price signals reduces well being because they are “distorted” and “do not necessarily capture the broader ‘credit surface’ the global economy faces”?
(2015): Debt Supercycle, Not Secular Stagnation: “Low real interest rates mask an elevated credit surface…
…What about the very low value of real interest rates? Low rates are often taken as prima facie by secular stagnation proponents, who argue that only a chronic demand deficiency could be responsible for steadily driving down the global real interest rate. The steady decline of real interest rates is certainly a puzzle, but there are a host of factors. First, we do not actually observe the true economic real interest rate; that would require a utility-based price index that is extremely difficult to construct in a world of rapid change in both the kinds of goods we consume and the way we consume them. My guess is that the true real interest rate is higher, and perhaps this bias is larger than usual. Correspondingly, true economic inflation is probably considerably lower than even the low measured values that central banks are struggling to raise.
Perhaps more importantly, in a world where regulation has sharply curtailed access for many smaller and riskier borrowers, low sovereign bond yields do not necessarily capture the broader ‘credit surface’ the global economy faces (Geanokoplos 2014). Whether by accident or design, banking and financial market regulation has hugely favoured low-risk borrowers (governments and cash-heavy corporates), knocking out other potential borrowers who might have competed up rates. Many of those who can borrow face higher collateral requirements. The elevated credit surface is partly due to inherent riskiness and slow growth in the post-Crisis economy, but policy has also played a large role. Many governments, particularly in Europe, have rammed down the throats of pension funds, banks, and insurance companies. Financial repression of this type not only effectively taxes middle-income savers and pensioners (who receive low rates of return on their savings) but also potential borrowers (especially middle-class consumers and small businesses), which these institutions might have financed to a greater extent if they were not required to be so overweight in government debt.
Surely global interest rates are also affected by the massive balance sheet expansions that most advanced-country central banks have engaged in. I don’t believe this is as important as the other effects I have discussed (even if most market participants would say the reverse). Global quantitative easing by advanced countries and sterilised intervention operations by emerging markets have also surely had a very large impact on bringing down market volatility measures.
The fact that global stock market indices have hit new peaks is certainly a problem for the secular stagnation theory, unless one believes that profit shares are going to rise massively further…
Must-Read: Antonio Fatás and Lawrence H. Summers: The Permanent Effects of Fiscal Consolidations
Must-Read: : The Permanent Effects of Fiscal Consolidations: “The global financial crisis has permanently lowered the path of GDP in all advanced economies…
…At the same time, and in response to rising government debt levels, many of these countries have been engaging in fiscal consolidations that have had a negative impact on growth rates. We empirically explore the connections between these two facts by extending to longer horizons the methodology of Blanchard and Leigh (2013) regarding fiscal policy multipliers. Our results provide support for the presence of strong hysteresis effects of fiscal policy. The large size of the effects points in the direction of self-defeating fiscal consolidations as suggested by DeLong and Summers (2012). Attempts to reduce debt via fiscal consolidations have very likely resulted in a higher debt to GDP ratio through their long-term negative impact on output.
Must-Read: Jonathan Chait: Why ‘Fix the Debt’ Just Can’t Quit Paul Ryan
Must-Read: I concur with Jonathan Chait here: “Fix the Debt” has lost its way, and does not look like it will ever be able to find it again. People funding it and working for it should be well advised to go and find something else more productive to do with their money and time…
: Why ‘Fix the Debt’ Just Can’t Quit Paul Ryan: “Last week, House Republicans released a plan for a gigantic, regressive tax cut…
…Since gigantic tax cuts increase the budget deficit, you would think an organization devoted to the singular mission of reducing the deficit would oppose it. But no. The anti-deficit lobby Fix the Debt released a statement of qualified praise, which I ridiculed. Fix the Debt responds with a new, brief defense of its position. What its argument actually reveals is its denial about the state of the Republican Party. Here is the relevant portion of Fix the Debt’s response:
We don’t endorse the plan, but we do welcome it because it puts tax reform on the agenda in Washington. It also moves in the right direction by eliminating or limiting many of the tax breaks that complicate the tax code and shrink the tax base. Tax reform should contribute to deficit reduction, and definitely not increase deficits. We hope that the new plan will spur discussion and bipartisan negotiation on reform that will simplify the tax code, make the country more competitive, and help to fix the debt.
The nub of the argument is that the Republican plan, while admittedly imperfect, ‘moves in the right direction.’ But if you define the right direction as reducing the debt, then the plan doesn’t move in the right direction. It moves in the wrong direction. The Republican plan is for massive cuts in tax rates, including the complete elimination of the estate tax. It is true that the proposal gestures vaguely in the direction of closing loopholes and expenditures, but it does not define what these would be. What’s more, the plan’s authors have made clear that the proposal will be a net tax cut.
So how can Fix the Debt claim that a plan to increase the debt can ‘help to fix the debt’? It can only be understood as an extension of the organization’s dysfunctional enabling relationship…. During President Obama’s first term, anti-deficit activists came up with a plan that they hoped would induce Republicans to abandon their fanatical opposition to higher tax revenue. First, they would get Democrats to support cuts to Social Security and Medicare as part of the trade. And second, the higher revenue would come not in the form of tax-rate increases but instead by reducing loopholes and [tax] expenditures…. In reality, Republicans refused to go for this deal. They didn’t just refuse once. They refused time after time. In 2010, the Simpson-Bowles commission came up with a plan that traded revenue-increasing tax reform for cuts to retirement programs, and leading Republicans like Paul Ryan all rejected the deal. Then, in 2011, Obama tried to strike a similar bargain with House Republicans when they held the debt ceiling hostage, but they rejected it again. That standoff led to the creation of a ‘supercommittee’ that was tasked with creating another version of the revenue-increasing tax-reform-for-retirement-cuts deal, which predictably failed again. And then, when the Bush tax cuts were set to expire at the end of 2012, the Obama administration hoped the pressure of an imminent tax increase would force Republicans to make some version of the deal, but once again they refused, instead using their leverage to minimize the tax hit on upper-income households…. The debt-hawk theory on how Republicans could be induced to give up their fanatical opposition to higher revenue failed….
Conceding that this is the Republican position would subvert Fix the Debt’s entire theory of change. So instead the group continues to reside in a fantasy world where the GOP can be coaxed into doing the thing it has proven extensively it won’t do. In this fantasy world, a Republican using the words ‘tax reform’ means a step toward ‘discussion’ and ‘bipartisan negotiation’ and, ultimately, a result that would be the precise opposite of what Republicans actually want to do.
Time to Play Whack-a-Mole with the Expansionary-Austerity Confidence-Fairy Zombie Once Again!
Four readings on the expansionary austerity zombie:
Reading #1: Paul Krugman (2015):
: Views Differ on Shape of Macroeconomics (2015): “The doctrine of expansionary austerity…
…the claim that slashing spending would actually boost demand and employment, because it would have such positive effects on confidence that this would outweigh the direct drag–was immensely popular among policymakers in 2010, as the great turn toward austerity began. But the statistical underpinnings of the doctrine fell apart under scrutiny: the methods Alberto Alesina used to identify changes in fiscal policy did not, it turned out, do a very good job, and more careful work found that historically austerity has in fact been contractionary after all. Moreover, the experience of austerity programs seemed to confirm what Keynesians new and old had warned from the beginning–that the negative effects of austerity are much larger under conditions where they cannot be offset by conventional monetary policy. So at this point research economists overwhelmingly believe that austerity is contractionary (and that stimulus is expansionary)…. For now at least expansionary austerity has virtually collapsed as a doctrine taken seriously by researchers. Nonetheless, Simon Wren-Lewis points us to Robert Peston of the BBC declaring
I am simply pointing out that there is a debate here (though Krugman, Wren-Lewis and Portes are utterly persuaded they’ve won this match–and take the somewhat patronising view that voters who think differently are ignorant sheep led astray by a malign or blinkered media).
Wow. Yes, I suppose that ‘there is a debate’ — there are debates about lots of things, from climate change to evolution to alien spaceships hidden in Area 51. But to suggest that this debate is at all symmetric is just wrong — and deeply misleading to one’s audience. As for the claim that it’s somehow patronizing to suggest that voters are ill-informed when (a) macroeconomics is a technical subject, and (b) the media have indeed misreported the state of the professional debate — well, this is sort of an economic version of the line that one must not suggest that the Iraq war was launched on false pretenses, because this would be disrespectful to the troops. If you’re being accused of misleading reporting, it’s hardly a defense to say that the public believed your misinformation — more like a self-indictment…
The question to which “expansionary austerity” was relevant was never: can one substantially reduce the budget deficit without risking substantial recession? The answer to that was always yes: if fiscal contraction is supported by monetary expansion a outrance the decline in government purchases from spending reductions and in consumption spending from tax increases can be offset and more than offset by higher exports and higher investment spending. That is and has been standard Keynesian doctrine since the 1950s, at least. (Cf. the Economic Report of the President chapter that Robert Solow drafted in the early 1960s.)
The novelty of Alesina’s claim was not that monetary offset can neutralize the short-run contractionary effect of fiscal austerity. It was, rather, that summoning the Confidence Fairy could and many times had neutralized the short-run contractionary effect of fiscal austerity.
The question to which “expansionary austerity” purported to give the answer was: At the zero lower bound, where attempts to stimulate the economy through expansionary monetary policy have greatly reduced traction and are fraught, is the connection between lower deficits and more optimistic business animal spirits strong enough that one can one substantially reduce the budget deficit without risking substantial recession?
And back in 2010 Alberto Alesina very strongly said that the answer to that was “yes”: Reading #2:
Alberto Alesina: Fiscal Adjustments: Lessons from Recent History
Many even sharp reductions of budget deficits have been accompanied and immediately followed by sustained growth rather than recessions even in the very short run. These are the adjustments which have occurred on the spending side and have been large, credible and decisive…. Governments which have initiated thorough and successful fiscal adjustment policies have not systematically suffered at the polls… especially… when the electorate has perceived the sense of urgency of a crisis or in some cases in the presence of an external commitment. On the contrary, fiscally-loose governments have suffered losses at the polls…. Thus relatively painless (economically and politically) fiscal adjustments might be possible; whether government will take the opportunity remains to be seen…
“Many” and “even sharp” have been “immediately followed” because adjustments that “have been large, credible and decisive” and “have occurred on the spending side” have summoned the Confidence Fairy. Thus governments should “take the opportunity” for the “relatively painless (economically and politically) fiscal adjustments” that “might be possible” via expansionary austerity.
This was pretty much completely wrong. Many of Alesina’s adjustments were not policy adjustments at all–but rather unplanned side-effects of booms driven by other factors. The rest appeared, to me at least, to be due to the kind of expansionary monetary policy offset that the Clinton administration had planned and carried out over 1993-6 and that was not possible at the zero lower bound.
Nevertheless, it appears that Alesina is sticking to his guns here: Reading #3:
Alberto Alesina (2016) Fiscal Policy and Austerity: “Well, I think Paul Krugman has rather extreme views…
…But more importantly, he talks about his views as if they were obviously true, and anybody who would disagree with him was obviously wrong. And he exaggerates. And that I really prefer not to go into a discussion about his quotes.
But I think that the idea that the work about austerity that I and others have done has been discredited is wrong. In fact, the IMF, in 2010 wrote a rather pointed criticism about my work…. [The IMF’s] second point is whether whether there are cases where spending cuts accompanied by other policies can be expansionary, and the confidence argument that he makes fun of is actually confidence, one of the many aspects; and we can elaborate on that. But I think that there are several episodes in which fiscal spending cuts have been accompanied not by a recession, but by an expansion. So, I think that those kind of statements by Krugman are trying to push a view which is respectable but they are not proven by the facts. Or at least they are not supported by research….
I do think that confidence is important, because we have empirical evidence suggesting that when there are spending cuts, the confidence of investors actually goes up, and the confidence of consumers goes down very little; while with tax increases, confidence of both consumers and business investors goes down quite a bit in many countries. So confidence has played a role. And then, there are many–as I said, austerity plans are a combination of many, many other policies. So, it matters what monetary policy does. It matters that sometimes, particularly in European countries, when there is a crisis and austerity is called for, then there is a productive opportunity to engage in other so-called “structural reform”–labor market reform and goods market reform, liberalization of various sectors, which help and that indeed has spurred growth. And of course monetary policy matters–we are saying in a situation which monetary policy is supportive and expansionary, that helps fiscal adjustment. So these are just the more important of many other factors which are left out from the basic Keynesian model…
My view: Alberto should simply not be saying this. If you want to claim that the Confidence Fairy channel–rather than the monetary offset channel–is important, you bring forward at least one regression or at least one case study in which a sharp, large, credible, and decisive policy of fiscal austerity has been rapidly followed by a substantial improvement in business confidence which then immediately drives sustained growth. If you don’t have that regression or that channel–if what you have is monetary-policy offset plus misspecification of your right hand-side variable–you do not have an economic argument.
Reading #4:
Franklin Delano Roosevelt (1933): First Inaugural Address: “our distress comes from no failure of substance. We are stricken by no plague of locusts…
…Compared with the perils which our forefathers conquered because they believed and were not afraid, we have still much to be thankful for. Nature still offers her bounty and human efforts have multiplied it. Plenty is at our doorstep, but a generous use of it languishes in the very sight of the supply. Primarily this is because rulers of the exchange of mankind’s goods have failed through their own stubbornness and their own incompetence, have admitted their failure, and have abdicated…. Stripped of the lure of profit by which to induce our people to follow their false leadership, they have resorted to exhortations, pleading tearfully for restored confidence. They know only the rules of a generation of self-seekers. They have no vision, and when there is no vision the people perish…
Must-Read: Steve Cecchetti and Kermit Schoenholtz: A Primer on Helicopter Money
Must-Read: Ummm… But aren’t the objections to expansionary fiscal policy today all that they involve governments taking on interest rate risk–that that is not a risk governments today ought to bear? And so isn’t the fact that helicopter money extinguishes that risk and is a more stable fiscal policy than bond-financed spending the entire point?
So I don’t understand…
: A Primer on Helicopter Money: “Helicopter money is not monetary policy…
…It is a fiscal policy carried out with the cooperation of the central bank…. If the yield curve still has any upward slope, issuing reserves rather than long-term bonds to finance fiscal expenditure will appear cheaper in terms of current debt service. However, this apparent saving is an illusion because it ignores interest rate risk…. Helicopter money may strain the relationship between the fiscal and monetary authority… creating a situation commonly known as ‘fiscal dominance.’… A central bank does not face rollover risk, so a fiscal expansion financed by central bank money is more stable than one financed by bond issuance…. But is rollover risk really a concern for the government of most advanced economies? We doubt it….
Helicopter money today is… expansionary fiscal policy financed by central bank money. And, if interest rates have fallen to the ELB, it is neither more nor less powerful than any bond-financed cut in taxes or increase in government spending in combination with QE.
Must-Read: Paul Krugman: A Question For the Fed
Must-Read: As I was just saying yesterday: Take the rate of profit–typically 6% to 7% per year–on the operating companies that make up the stock market. Subtract the risk premium–typically 4%. Add on the expected inflation rate–2.5% on the CPI basis. Get 4.5% to 5.5%. That is what the nominal interest rate on Treasury bills is likely to be in normal times toward the end of a healthy expansion. That provides a healthy amount of room for the Federal Reserve to cut interest rates to encourage spending and support the economy when a recession comes. But note that 5% of sea-room to cut interest rates when necessary was not nearly enough back in 2007-2010.
Now suppose that we are entering an age of secular stagnation. It will have a higher risk premium–say 5-6%. Slower growth will have an impact on the rate of profit for operating companies–knock, say, 1-2% off their typical value. Go through the math, and we get a likely nominal interest rate on Treasury in normal times toward the end of a healthy expansion of roughly 1-3%, not 5%.
The dot-plots tell us that the FOMC now thinks that it is headed for a 3% Treasury Bill rate–at the upper end of this range, but still very far from a 5% rate. And if we do live in a semi-permanent age of secular stagnation, this will not be a temporary inconvenience but, rather, a permanent structural fact.
That means that if the FOMC keeps its current inflation target then it will have only 3% of sea-room when the next big recession comes, whether next year, next decade, or a quarter century from now.
That means that if the FOMC keeps attempting to raise interest rates back to a 5% normal–or even, unless it is lucky, to a 3% normal–it will find itself continually undershooting its inflation target, and continually promising that rates will go up more real soon now as soon as the current idiosyncratic fit of sub-2% inflation passes.
I do not know anybody seriously thinking about all this who thinks that 3% of sea-room is sufficient in a world in which shocks as big as 2007-2010 are a thing. And I do not know anybody seriously thinking about all this who thinks that pressing for a premature “normalization” of interest rates is a good idea: It will deanchor inflationary expectations on the downside, and with rational market inflation expectations 1-2% below the “target” that means an equilibrium late-expansion Treasury Bill rate of not 1 to 3% but rather -1 to 2%.
Therefore either (a) the Federal Reserve really should raise its inflation target, or (b) the Federal Reserve should right now be screaming to high heaven about how it is the necessary and proper task of the rest of the government to do something, something big, something now to resolve our secular stagnation problem. And under no circumstances should the Fed be (c) pushing for probably premature “normalization” of interest rates.
Of course, the Fed could and should be doing both (a) and (b). But it seems to be doing neither–it seems to be doing (c).
Perhaps Janet’s thoughts on secular stagnation are part of process of trying to assemble an FOMC coalition to… do something… or at least beg others to do something…
But this intellect, at least, is pretty pessimistc.
: A Question For the Fed: “There is a near-consensus at the FOMC that rates must eventually move up…
….But… exactly?… Which component of aggregate demand do we believe will continue to strengthen in a way that will require monetary tightening to avoid an overheating economy? Here’s a look at two obvious candidates… as shares of potential GDP… deviations from the 1990-2007…. Nonresidential investment has basically recovered from the recession-induced slump. Residential investment is still a bit low by historical standards, but not as much as you might think…. So I don’t see an obvious reason to believe that current rates are too low. Yes, they’re near zero–but that in itself doesn’t mean too low. Like others, notably Larry Summers, I think the Fed is trying to return to a normality that is no longer normal.
Must-Read: Paul Krugman: Is Our Economists Learning?
Must-Read: : Is Our Economists Learning?: “Brad DeLong has an excellent presentation on the sad history of belief in the confidence fairy…
…and its dire effects on policy. One of his themes is the bad behavior of quite a few professional economists, who invented new doctrines on the fly to justify their opposition to stimulus and desire for austerity even in the face of a depression and zero interest rates.vOne quibble: I don’t think Brad makes it clear just how bad the Lucas-type claim that government spending would crowd out private investment even at the zero lower bound really was….
Two things crossed my virtual desk today that reinforce the point about how badly some of my colleagues continue to deal with fiscal policy issues. First, Greg Mankiw has a piece that talks about Alesina-Ardagna on expansionary austerity without mentioning any of the multiple studies refuting their results. And… as @obsoletedogma (Matt O’Brien) notes, he cites a 2002 Blanchard paper skeptical about fiscal stimulus while somehow not mentioning the famous 2013 Blanchard-Leigh paper showing that multipliers are much bigger than the IMF thought.
Second, I see a note from David Folkerts-Landau of Deutsche Bank lambasting the ECB for its easy-money policies, because: “by appointing itself the eurozone’s ‘whatever it takes’ saviour of last resort, the ECB has allowed politicians to sit on their hands with regard to growth-enhancing reforms and necessary fiscal consolidation. Thereby ECB policy is threatening the European project as a whole for the sake of short-term financial stability. The longer policy prevents the necessary catharsis, the more it contributes to the growth of populist or extremist politics.” Yep. That ‘catharsis’ worked really well when Chancellor Brüning did it, didn’t it?…
[In] the 1970s… stagflation led to a dramatic revision of both macroeconomics and policy doctrine. This time far worse economic events, and predictions by freshwater economists far more at odds with experience than the mistakes of Keynesians in the past, seem to have produced no concessions whatsoever.
Slides For: The Confidence Fairy in Historical Perspective
History of Economics Society :: June 17, 2016 :: Geneen Auditorium, Fuqua School of Business, Duke University, Durham, NC:
https://www.icloud.com/keynote/00033GAKBnIHC53Sv0UDhbqEw#2016-06-17_HES_Confidence_Fairy_in_Historical_Perspective | http://delong.typepad.com/2016-06-17-hes-confidence-fairy-in-historical-perspective.pdf