Must-read: Simon Wren-Lewis: “Can Central Banks Make Three Major Mistakes in a Row and Stay Independent?”

Must-Read: Simon Wren-Lewis: Can Central Banks Make Three Major Mistakes in a Row and Stay Independent?: “Mistake 1: If you are going to blame anyone for not seeing the financial crisis coming…

…it would have to be central banks. They had the data that showed a massive increase in financial sector leverage. That should have rung alarm bells, but instead it produced at most muted notes of concern about attitudes to risk. It may have been an honest mistake, but a mistake it clearly was.

Mistake 2: Of course the main culprit for the slow recovery from the Great Recession was austerity, by which I mean premature fiscal consolidation. But the slow recovery also reflects a failure of monetary policy…. Monetary policy makers should have said very clearly… that fiscal stimulus would have helped them do that job….

What could be mistake 3: The third big mistake may be being made right now in the UK and US… supply side pessimism. Central bankers want to ‘normalise’ their situation… writing off the capacity that appears to have been lost as a result of the Great Recession…. In both cases the central bank is treating potential output as something that is independent of its own decisions and the level of actual output. In other words it is simply a coincidence that productivity growth slowed down significantly around the same time as the Great Recession. Or if it is not a coincidence, it represents an inevitable and permanent cost of a financial crisis. Perhaps that is correct, but there has to be a fair chance that it is not…. What central banks should be doing in these circumstances is allowing their economies to run hot for a time….

If we subsequently find out that their supply side pessimism was incorrect (perhaps because inflation continues to spend more time below than above target, or more optimistically growth in some countries exceed current estimates of supply without generating ever rising inflation), this could spell the end of central bank independence. Three counts and you are definitely out?

Yes, expansionary fiscal policy in the North Atlantic would solve many of our problems. Why do you ask?

The highly-estimable Jared Bernstein has a very nice piece today. It attempts to sum up a great deal about the state of the economy in a very short space with five super-short equations;

  • One is about our current likely-to-be-chronic inequality problems.
  • Two are about our demand-management and maintaining-employment problems.
  • Two more strongly suggest that the solutions to our problems are extraordinarily simple. They say that in our current dithering and paralysis we are frozen out of fear of dangers that simply do not exist. Thus we are leaving very large and very gourmet free lunches on the table.

So, first, let us listen to Jared:

Jared Bernstein: Five Simple Formulas: “Here are five useful, simple… inequalities…

…Each one tells you something important about the big economic problems we face today or, for the last two formulas, what we should do about them. And when I say ‘simple,’ I mean it….

[1] r>g… that if the return on wealth, or r, is greater than the economy’s growth rate, g, then wealth will continue to become ever more concentrated….

[2] S>I… Bernanke’s imbalance…. Larry Summers’ ‘secular stagnation’ concerns offer a similar, though somewhat more narrow, version. For the record, I think this one is really serious (I mean, they’re all really serious, but relative to r>g, S>I is underappreciated)…. In theory, there are key mechanisms in the economy that should automatically kick in and repair the disequilibrium…. Central bankers, like Bernanke and Yellen, tend to discuss S>I and the jammed mechanisms just noted, as ‘temporary headwinds’ that will eventually dissipate (Summers disagrees). But while it has jumped around the globe—S>I is more a German thing right now than a China thing (Germany’s trade surplus is 8 percent of GDP!)—the S>I problem has lasted too long to warrant a ‘temporary’ label….

[3] u>u… Baker/Bernstein’s slack attack…. For most of the past few decades—about 70 percent of the time, to be precise—u has been > than mainstream estimates of u, meaning the job market has been slack…. From the 1940s to the late 1970s, u*>u only 30 percent of the time, meaning the job market was mostly at full employment….

[4] g>t… [Richard] Kogan’s cushion…. For most of the years that our country has existed (he’s got data back to 1792!), the economy’s growth rate (g again) has been greater than the rate the government has to pay to service its debt, which I call t. Kogan calls it r since it’s a rate of return, but it’s not the same r as in Piketty (which is why I’m calling it t)….

[5] 0.05>h… the DeLong/Summers low-cost lunch…. When the private economy is weak, government spending can be a very low-cost way to lift not just current jobs and incomes, but future growth as well…. The ‘h’ stands for hysteresis, which describes the long-term damage to the economy’s growth potential when policy neglect allows depressed economies to persist over time…. As an increase in current output by a dollar raises future output by at least a nickel, the extra spending will be easily affordable. But how do we know if 0.05>h? In a follow-up paper for CBPP’s full-employment project, D&S, along with economist Larry Ball, back out a recent number for h that amounts to 0.24, multiples of the 0.05 threshold, and evidence that, at least recently, h>0.05…

The Piketty inequality, [1] r>g, tells us that we are going to be hard-put to become less of a plutocracy than we are now. Consider Donald Trump. He is, or was back before he decided to concentrate on making money by renting his name out as a celebrity to those who could do management, a lousy manager and a lousy investor. Depending on whether you choose a New York real estate benchmark or a broad stock market benchmark, Trump now is between a quarter and a half as wealthy as he would be if he had simply been a passive investor throughout his career. And that is if he is truly as wealthy as he claims to be. In an environment in which most money feels that it has to be prudent, the plutocracy which can’t afford to take risks has the power of compound interest raising its economic salience over time.

The global investment shortfall inequality, [2] S>I, and the labor-market slack inequality, [3] u>u*, tell us that our major and chronic economic problem here in the Global North is and is for the next generation likely to be an excess of prudent saving looking for acceptable vehicles and of potential workers looking for jobs. This is in striking contradiction to the era 1945-1980 in which our major and chronic economic problems were a potential inflation-causing excess of liquidity and governments that believed or hoped to control inflation via financial repression longer than was feasible. This “secular stagnation” problem of chronic slack demand and excess prudent saving has in fact, been the major and chronic economic problem in the Global North since 1980 in Europe and since 1990 in Japan. But we here in the United States paid little notice until the problem spread to us at the start of the 2000s.

Richard Kogan’s observation [4] g>t is this: The United States economy is not and has not been dynamically inefficient in a growth-theory capital-intensity sense. It has, however, been chronically short of federal government debt valued as a prudent investment vehicle for savers. The Treasury’s borrowing operations have, therefore, been on balance not a cost reducing the resources that can flow through from taxes to useful government expenditures, but rather a profit center. A national debt is thus, in Alexander Hamilton’s words, a national blessing. And in the range of debt the U.S. has possessed, a larger national debt has been a national blessing not just for the country as a whole but even from the narrow perspective of the Treasury, in that it is made it easier for the Treasury to balance its books.

And one of the major points of DeLong and Summers (2012), [5] 0.05>h, is that at current levels of debt and interest rates the United States does not run increasing risks but rather runs reduced risks by aggressively borrowing and spending. Whatever you think the risks of a U.S. debt crisis are, they are greater with a higher debt-to-GDP ratio. But the current configuration of the U.S. and Global North economies is such that higher government deficits now reduce the projected debt-to-GDP ratio and the associated debt-financing burden however serious you think that debt-financing burden is. And this will remain the case until (a) interest rates “normalize” (if they ever do), and (b) the economy reattains potential output (if it ever does).

The corollary, of course, is that state governments and the Republican Congressional Caucus and even Treasury Secretaries Jack Lou and Tim Geithner and President Barack Obama have been both retarding the short- and long-run growth of the American economy and raising the long-term risks of financial crisis by focusing so much on reducing the government deficit.

In my view, the economics of Abba Lerner—what is now called MMT—is not always right: It is not always possible for the government to spend freely to attain full employment, use monetary policy to keep the debt under control, and rely on rising inflation as the only signal needed of whether and when policy needs to be tightened. Why not? Because it is possible that the bond market can get itself into an unsustainable position, in which underlying inflationary pressures are masked until it is too late to rebalance government finances without a financial crisis.

But, in my view, right now the economics of Abba Lerner is 100% correct. The U.S. (and Europe!) should use expansionary fiscal policy to rebalance the economy at full employment and potential output. And interest rates are so low that doing so does not require any additional monetary policy steps to keep the debt under control.

Japan, alas, confronts us with a difficult and much more devilish program of economic policy. Partial and nearly painless debt repudiation via inflation and financial repression seems to me to be the best way forward—if that can be attained. But more on that anon.

Must-read: Danny Yagan: “The Enduring Employment Impact of Your Great Recession”

Must-Read: Danny Yagan: The Enduring Employment Impact of Your Great Recession: “In the cross section, employment rates diverged across U.S. local areas 2007-2009…

…and–in contrast to history–have barely converged [since]…. I… use administrative data to compare two million workers with very similar pre-2007 human capital: those who in 2006 earned the same amount from the same retail firm, at establishments located in different local areas. I find that, conditional on 2006 firm-x-wages fixed effects, living in 2007 in a below-median 2007-2009-fluctuation area caused those workers to have a 1.3%-lower 2014 employment rate…. Location has affected long-term employment and exacerbated within-skill income inequality. The enduring employment impact is not explained by more layoffs, more disability insurance enrollment, or reduced migration. Instead, the employment outcomes of cross-area movers are consistent with severe-fluctuation areas continuing to depress their residents’ employment. Impacts are correlated with housing busts but not manufacturing busts, possibly reconciling current experience with history. If recent trends continue, employment rates are estimated to converge in the 2020s–adding up to a relative lost decade for half the country.

Must-read: Laura Tyson: “Closing the Investment Gap”

Must-Read: Investment has been weak because demand growth has been weak–and because the residential-investment credit channel broke in 2007, and neither Barack Obama nor Tim Geithner nor Jack Lew nor Ed de Marco nor Mel Watt nor any congressional coalition has taken any steps to fix it.

This is a very important channel for “hysteresis”–especially if, like me, you believe in powerful external benefits from investment, especially equipment investment:

Laura Tyson: Closing the Investment Gap: “BERKELEY – The weakness of private investment in the United States and other advanced economies is… worrisome… perplexing…

…Through 2014, private investment declined by an average of 25% compared to pre-crisis trends.
The shortfall in investment has been deep and broad-based, affecting not only residential investment but also investment in equipment and structures. Business investment remains significantly below pre-2008 expectations, and has been hit hard again in the US during the last year by the collapse of energy-sector investment in response to the steep drop in oil prices….

The investment shortfall in the US coincides with a strong rebound in returns to capital. By one measure, returns to private capital are now at a higher point than any time in recent decades. But extensive empirical research confirms that at the macro level, business investment depends primarily on expected future demand and output growth, not on current returns or retained earnings. According to the IMF, this ‘accelerator’ theory of investment explains most of the weakness of business investment in the developed economies since the 2008 crisis. In accordance with this explanation, investment growth in the US has been in line with its usual historical relationship with output growth. In short, private investment growth has been weak primarily because the pace of recovery has been anemic….

As the accelerator theory of investment would predict, much R&D investment is occurring in technology-intensive sectors where current and future expected demand has been strong. There is also evidence that the distribution of returns to capital is becoming increasingly skewed toward these sectors…

What is the economy’s speed limit?

More on the very-sharp Ryan Cooper’s gotten one mostly wrong…

The two questions are (a) how much higher could expansionary fiscal and cooperative monetary policy permanently push annual GDP up above its current trend without triggering massive inflation, and (b) how large would the expansionary policies have to be to push the economy up that far? My guesses are 5% to (a)–that we could permanently raise annual GDP $800 billion relative to our current trajectory without triggering an upward spiral in inflation–and that we would need $300 billion more of annual government purchases. to get us there to (b).

Ryan Cooper:

Ryan Cooper: Who’s Afraid of John Maynard Keynes?: “Does the economy have room to grow?…

…Could we create many more jobs and wealth if we really tried, or have we reached the limits of what we can produce? This… is at the heart of a recent dispute among academic economists… nominally centered on Bernie Sanders’ economic plan, but also illustrates a major fault line in the practice of theoretical economics today…. [Gerald] Friedman… assumed a model in which Sanders’ huge stimulus would push the economy up to full capacity (meaning full employment and maximum output), after which it would stay permanently at a higher level…. However, the key assumption behind the mainstream model is that an economy always tends towards full employment…. [But] even by conservative assumptions we are still something like $500 billion under total economic capacity, productivity has been consistently very weak, and there is absolutely nothing on the horizon that looks like it will return us to the level of employment we had in 2007, let alone 1999…. What’s more, a Friedman-style model in which a stimulus delivered to a depressed economy returns it to full capacity, after which it stays there, is not ridiculous…

Let’s start with one of my favorite workhorse graphs:

Playfair equitable graphs

Starting in 2006 residential construction fell to the very bottom of the chart, and it has stayed there: more than 1.5%-points of GDP below its 2007-peak share of potential GDP. Starting in 2008 business investment fell to the very bottom of the chart, and then took a long tine to recover from its nadir of 2.5%-points below its 2007-peak share of potential GDP. Between 2007 and, say, the end of this year the cumulative shortfall has been some 18%-point years of residential construction not undertaken, and some 8%-point years of business investment not undertaken.

In a world with a capital-output ratio of 3 and a capital share of income of 30%, that shortfall would generate (under somewhat heroic analytical assumptions) a reduction of some 2.6%-points of GDP in the cumulative growth of potential output relative to what it would otherwise have been. That is the damage done to growth in America’s long-run economic potential from the investment shortfall since 2007. And then there is the equal or larger reduction in the growth in America’s long-run economic potential from the labor shortfall–workers not trained, workers not gaining experience, the breaking of ties to people who might hire you or might know of people who might higher you. Add up those two, and I get a 6%-point reduction in what our productive potential is relative to the pre-2008 trend. Thus 6%-points of the current gap between production now and the pre-2008 trend has been lost to the years that the locust hath eaten. And 5%-points remains as a gap that could quickly be closed by expansionary fiscal policy.

And we should close that gap. But a mere $140 billion or so of increased government spending is very unlikely to get us there. That would require a multiplier of nearly six–that only 17.5% of dollars earned as income from higher government spending leak out of the flow of spending on domestically-produced commodities either as savings or as spending on imports. And we know that it’s more like 33%-40% of dollars that so leak. That gives us a multiplier of 2.5-3. And that gives me my desire to see $300 billion more of government purchases.

What if we don’t get that extra spending? Well, perhaps we will get a residential construction boom to return us to economic potential. But don’t bet on it. Perhaps we will get an export boom to return us to economic potential. But don’t bet on it. Perhaps businesses will become wildly more optimistic about the future and a business investment boom will return us to economic potential. But don’t bet on it. Perhaps consumers will decide–after just living through 2007-2016–that they have not borrowed enough, and go on a spending spree to run their debts up further. But don’t bet on it.

No, if we don’t take active steps to boost spending, what will happen is not that economic growth will accelerate to return us to an economic potential that is itself growing at 2+%/year. What will happen is that low investment and underemployment will continue to do damage to the growth of potential and our economic potential will grow at 2-%/year until actual output is once again at potential output. But that will not be because actual has sped up its growth to catch up to potential. It will be because potential has slowed down to fall back to actual.

And the claim that in the long run (in which we are all dead) the economy’s actual level of output converges to potential? Four things can cause this to happen:

  1. Potential can slow.
  2. Something–a spending boom by somebody–can boost actual.
  3. Deflation can lead to lower interest rates as deflation carries with it a decline in the intensity of demand for a stable nominal stock of money. But in the modern world we certainly do not have inflation. We double-certainly do not have central banks that keep the nominal stock of money stable. And we triple-certainly have no room for interest rates to fall further
  4. The gap between potential and actual production can lead the central bank to lower interest rates. That cannot happen. It could lead the central bank to resort to additional extraordinary stimulative measures. But that is not going to happen either.

You may ask: Why can’t we recover more than 5%-points of the 11%-point gap between current production and what we thought back in 2007 was our trend growth destiny? If a low-pressure economy can reduce potential, why won’t a high-pressure economy increase potential? The key is easily recover. Easily. When a lack of markets or a lack of financing keeps investments that had obvious payoffs from being made, the costs are large. When a boom encourages investments to be made that look profitable only as long as the boom and the exuberance that accompanies it lasts, the long-run benefits are smaller. We as a country did benefit from MCI-WorldCom’s investments in the fiber-optic backbone in 1998-2000. But we did not benefit by nearly as much as MCI-WorldCom was calculating in its irrational exuberance bordering on fraud.

I would love to be wrong. I would love to discover that a high-pressure economy with spending more than halfway back to the pre-2008 trend would be consistent with relatively-stable inflation and with rapid-enough growth of economic potential to quickly catch us back up to that trend. But I don’t expect that that would be the case.

Must-read: Ryan Cooper: “Who’s Afraid of John Maynard Keynes?”

Must-Read: I think the very-sharp Ryan Cooper has gotten this mostly wrong. The two questions are (a) how much higher could expansionary fiscal and cooperative monetary policy permanently push annual GDP up above its current trend without triggering massive inflation, and (b) how large would the expansionary policies have to be to push the economy up that far? My guesses are 5% to (a)–that we could permanently raise annual GDP $800B relative to our current trajectory without triggering an upward spiral in inflation–and that we would need $300B more of annual government spending to get us there:

Ryan Cooper: Who’s Afraid of John Maynard Keynes?: “Does the economy have room to grow?…

…Could we create many more jobs and wealth if we really tried, or have we reached the limits of what we can produce? This… is at the heart of a recent dispute among academic economists… nominally centered on Bernie Sanders’ economic plan, but also illustrates a major fault line in the practice of theoretical economics today…. [Gerald] Friedman… assumed a model in which Sanders’ huge stimulus would push the economy up to full capacity (meaning full employment and maximum output), after which it would stay permanently at a higher level…. However, the key assumption behind the mainstream model is that an economy always tends towards full employment…. [But] even by conservative assumptions we are still something like $500 billion under total economic capacity, productivity has been consistently very weak, and there is absolutely nothing on the horizon that looks like it will return us to the level of employment we had in 2007, let alone 1999…. What’s more, a Friedman-style model in which a stimulus delivered to a depressed economy returns it to full capacity, after which it stays there, is not ridiculous…

Puzzled by Gerry Friedman…

A question about the estimable Gerry Friedman:

How can an increase in government spending of $1.4 trillion/year generate a $14 trillion increase in spending in the year 2026? But it really looks to me like he has both:

  • the very dubious assumption that all 10%-points of the shortfall from the trend as of 2007 can be made up relatively easily’, and
  • a multiplier of not the 3-in-and-near-a-liquidity trap I carry around in the back of my head, but 10.

But Friedman’s text claims his multiplier is not even 3, but less than 2, and averaging roughly 1…

In short: In his runs Friedman has government spending higher in 2026 by $1.4 trillion than in baseline. He has real GDP higher in 2026 by $14 trillion. What other components of real spending are higher by how much in order to make that real GDP number in the year 2016 higher than baseline by $14 trillion? And what mechanisms are making those components higher?

It’s fine to propose aspirational policies based on a hope that the world is such that things will break your way. It’s not so good to put the world breaking your way forward as a central-case forecast of what your policies will do. And it’s distressing that I cannot figure out how to make Friedman’s analysis hold together quantitatively even if I do allow the assumption that the entire output relative to the pre-2007 potential-output trend can be closed easily…

Must-read: Paul Krugman: “What Have We Learned since 2008?”

Must-Read: Paul Krugman: What Have We Learned since 2008?: “Some annoying propositions…

…”Complex” econometrics never convinces anyone. “Complex” includes multiple regression. Natural experiments rule. But so do “surprising” ex-ante predictions that come true…. “In the study of social phenomena, disorder is, it is true, the sole substitute for the controlled experiments of the natural sciences.” — Frank Graham…. Demand side: The liquidity trap as a baseline…. Predictions: * Little or no effect of even very large increases in monetary base. * No crowding out from deficits * Large fiscal multipliers. These were controversial predictions!….

Very little effect of monetary expansion. Certainly no inflation. Did QE do anything?… Feel the [debt] crowding out!… Things we didn’t expect: crucial role of liquidity…. Things we didn’t expect: negative rates…. But there is still presumably a lower bound set by storage costs for currency….

The supply side: what was the baseline? Probably the accelerationist Phillips curve…. But what’s missing is the acceleration, not the unemployment => inflation causation…. Strong evidence of downward nominal wage rigidity (courtesy Olivier Blanchard)…. Things we didn’t expect: Very strong hysteresis (maybe)….

What is the post-2008 experience trying to tell us? * Liquidity-trap economics passes with flying colors. * Fiscal policy effectiveness confirmed. * Monetary iffy at best. * Neo-paleo-Keynesian aggregate supply in short run. * Long run seems to reinforce, not diminish, that case.

Must-read: Robert Skidelsky: “The Optimism Error”

Robert Skidelsky: The Optimism Error: “When a slump threatened… a government could stimulate spending…

…by cutting interest rates and by incurring budget deficits. This was the main point of the Keynesian revolution…. In the 1980s… unemployment prevention became confined to interest-rate policy… by the central bank, not the government. By keeping… inflation constant, the monetary authority could keep unemployment at its ‘natural rate’. This worked quite well for a time, but… the world economy collapsed in 2008. In a panic, the politicians, from Barack Obama to Gordon Brown, took Keynes out of the cupboard, dusted him down, and ‘stimulated’ the economy like mad. When this produced some useful recovery they got cold feet….

Why had the politicians’ nerve failed and what were the consequences? The answer is that in bailing out leading banks and allowing budget deficits to soar, governments had incurred huge debts that threatened their financial credibility. It was claimed that bond yields would rise sharply, adding to the cost of borrowing. This was never plausible in Britain, but bond yield spikes threatened default in Greece and other eurozone countries early in 2010. Long before the stimulus had been allowed to work its magic in restoring economic activity and government revenues, the fiscal engine was put into reverse, and the politics of austerity took over. Yet austerity did not hasten recovery; it delayed it and rendered it limp when it came.

Enter ‘quantitative easing’ (QE). The central bank would flood the banks and pension funds with cash. This, it was expected, would cause the banks to lower their interest rates, lend more and, by way of a so-called wealth effect, cause companies and high-net-worth individuals to consume and invest more. But it didn’t happen. There was a small initial impact, but it soon petered out…. Institutions sat on piles of cash and the wealthy speculated in property. So we reach the present impasse…. Monetary expansion is much less potent than people believed; and using the budget deficit to fight unemployment is ruled out by the bond markets and the Financial Times. The levers either don’t work, or we are not allowed to pull them….

How much recovery has there been in Britain?… The OECD’s most recent estimate of this [output] gap in the UK stands at a negligible -0.017 per cent. We might conclude from this that the British economy is running full steam ahead and that we have, at last, successfully recovered from the crash…. But… although we are producing as much output as we can, our capacity to produce output has fallen…. Growth in output per person in Britain (roughly ‘living standards’) averaged 2.25 per cent per year for the half-century before 2008. Recessions in the past have caused deviations downward from this path, but recoveries had delivered above-trend growth…. This time it was different. The recovery from the financial crisis was the weakest on record, and the result of this is a yawning gap between where we are and where we should have been. Output per head is between 10 and 15 per cent below trend….

Why is it that the recession turned spare capacity into lost capacity? One answer lies in the ugly word ‘hysteresis’…. The recession itself shrinks productive capacity: the economy’s ability to produce output is impaired…. Much of the new private-sector job creation lauded by the Chancellor is… in such low-productivity sectors. The collapse of investment is particularly serious, because investment is the main source of productivity. The challenge for policy is to liquidate the hysteresis – to restore supply. How is this to be done?…

On the monetary front, the bank rate was dropped to near zero; this not being enough, the Bank of England pumped out hundreds of billions of pounds between 2009 and 2012, but too little of the money went into the real economy. As Keynes recognised, it is the spending of money, not the printing of it, which stimulates productive activity, and he warned: ‘If… we are tempted to assert that money is the drink which stimulates the system to activity, we must remind ourselves that there may be several slips between the cup and the lip.’ That left fiscal policy… deliberately budgeting for a deficit. In Britain, any possible tolerance for a deficit larger than the one automatically caused by a recession was destroyed by fearmongering about unsustainable debt. From 2009 onwards, the difference between Labour and Conservative was about the speed of deficit reduction…. From 2009 onwards the main obstacle to a sensible recovery policy has been the obsession with balancing the national budget…. ‘We must get the deficit down’ has been the refrain of all the parties….

It is right to be concerned about a rising national debt (now roughly £1.6trn). But the way to reverse it is not to cut down the economy, but to cause it to grow in a sustainable way. In many circumstances, that involves deliberately increasing the deficit. This is a paradox too far for most people to grasp. But it makes perfect sense if the increased deficit causes the economy, and thus the government’s revenues, to grow faster than the deficit…. In our present situation, with little spare capacity, the government needs to think much more carefully about what it should be borrowing for. Public finance theory makes a clear distinction between current and capital spending. A sound rule is that governments should cover their current or recurrent spending by taxation, but should borrow for capital spending, that is, investment. This is because current spending gives rise to no government-owned assets, whereas capital spending does. If these assets are productive, they pay for themselves by increasing government earnings, either through user charges or through increased tax revenues. If I pay for all my groceries ‘on tick’ my debt will just go on rising. But if I borrow to invest in, say, my education, my increased earnings will be available to discharge my debt….

Now is an ideal time for the government to be investing in the economy, because it can borrow at such low interest rates. But surely this means increasing the deficit? Yes, it does, but in the same unobjectionable way as a business borrows money to build a plant in the expectation that the investment will pay off. It is because the distinction between current and capital spending has become fuzzy through years of misuse and obfuscation that we have slipped into the state of thinking that all government spending must be balanced by taxes – in the jargon, that net public-sector borrowing should normally be zero. George Osborne has now promised to ‘balance the budget’ – by 2019-20. But within this fiscal straitjacket the only way he can create room for more public investment is to reduce current spending, which in practice means cutting the welfare state.

How can we break this block on capital spending? Several of us have been advocating a publicly owned British Investment Bank. The need for such institutions has long been widely acknowledged in continental Europe and east Asia, partly because they fill a gap in the private investment market, partly because they create an institutional division between investment and current spending. This British Investment Bank, as I envisage it, would be owned by the government, but would be able to borrow a multiple of its subscribed capital to finance investment projects within an approved range. Its remit would include not only energy-saving projects but also others that can contribute to rebalancing the economy – particularly transport infrastructure, social housing and export-oriented small and medium-sized enterprises (SMEs). Unfortunately, the conventional view in Britain is that a government-backed bank would be bound, for one reason or another, to ‘pick losers’, and thereby pile up non-performing loans. Like all fundamentalist beliefs, this has little empirical backing….

George Osborne has rejected this route to modernisation. Instead of borrowing to renovate our infrastructure, the Chancellor is trying to get foreign, especially Chinese, companies to do it, even if they are state-owned. Looking at British energy companies and rail franchises, we can see that this is merely the latest in a long history of handing over our national assets to foreign states. Public enterprise is apparently good if it is not British….

Setting up a British Investment Bank with enough borrowing power to make it an effective investment vehicle is the essential first step towards rebuilding supply. Distancing it from politics by giving it a proper remit would create confidence that its projects would be selected on commercial, not political criteria. But this step would not be possible without a different accounting system. The solution would be to make use of comprehensive accounting that appropriately scores increases in net worth of the bank’s assets…

Must-read: Jared Bernstein: “2015 Was Solid Year for Job Growth”

Must-Read: Jared Bernstein: 2015 Was Solid Year for Job Growth: “Payrolls were up 292,000 in December and the unemployment rate held steady at a low rate of 5%…

…in another in a series of increasingly solid reports on conditions in the US labor market. Upward revisions for the prior two months added 50,000 jobs, leading to an average of 284,000 jobs per month in the last quarter of 2015. In another welcome show of strength, the labor force expanded in December, leading the participation rate to tick up slightly.

December’s data reveals that US employers added a net 2.7 million jobs in 2015 while the unemployment rate fell from 5.6% last December to 5% last month. While the level of payroll gains did not surpass 2014’s addition of 3.1 million, it was otherwise the strongest year of job growth since 1999.

Simply put, for all the turmoil out there in the rest of the world, the US labor market tightened up significantly in 2015…. We are not yet at full employment. But we’re headed there at a solid clip, and that pace accelerated in recent months…

Graph Employment Rate Aged 25 54 All Persons for the United States© FRED St Louis Fed

I must say, when I look at this graph I find it very hard to understand the thought of all the economists who confidently claim to know that the bulk of the decline in the employment-to-adult-population ratio since 2000 is demographic and sociological. 4/5 of the decline in the overall ratio since 2000 is present in the prime-age ratio. More than 5/8 of the decline in the overall ratio since 2007 is present in the prime-age ratio.

It thus looks very much to me like the effects of slack demand–both immediate, and knock-on effects via hysteresis. And what demand has done, demand can undo. Perhaps it cannot be done without breaching the 2%/year inflation target, but:

  • That 2%/year inflation target is supposed to be an average, not a ceiling.
  • Since 2008:1, inflation has averaged not 2%/year but 1.47%/year.
  • There is thus a cumulative inflation deficit of 4.22%-point-years available for catch-up. And
  • The 2%/year inflation target was extremely foolish to adopt–nobody sane in the mid- or late-1990s or in the early- or mid-2000s would have argued for adopting it had they foreseen 2007-9 and what has happened since.
Consumer Price Index for All Urban Consumers All Items FRED St Louis Fed