Tag: Larry Summers

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.

The Need for Expansionary Fiscal Policy

Posted on by Brad DeLong
Sisyphus Greek mythology Britannica com

I understand that we are Sisyphus here. And I accept that:

Je laisse Sisyphe au bas de la montagne! On retrouve toujours son fardeau. Mais Sisyphe enseigne la fidélité supérieure qui nie les dieux et soulève les rochers. Lui aussi juge que tout est bien. Cet univers désormais sans maître ne lui paraît ni stérile ni futile. Chacun des grains de cette pierre, chaque éclat minéral de cette montagne pleine de nuit, à lui seul, forme un monde. La lutte elle-même vers les sommets suffit à remplir un coeur d’homme. Il faut imaginer Sisyphe heureux.

But would people who ought to know better please stop adding weights to the stone that we are trying to roll uphill?

Thus I find myself quite annoyed by the sharp and usually-reliable Greg Ip this morning…

Let me back up: Here’s the story so far:

(1) They say that North Atlantic governments cannot afford to spend more to boost their economies via expansionary fiscal policy right now. We point out that current interest rates on Treasury debt are so low low private company would pass up the ability to borrow to stimulate and invest.

(2) They then say that maybe interest-rate will jump up a lot, soon, and thus make borrow to spend to stimulate and invest a bad deal. We point out that financial markets certainly do not expect any such thing. And we points out that, if you are truly worried about longer-run debt sustainability, the standard calculations tell us that debt- and amortization-to-GDP ratios will be lower with aggressive borrow and spend to stimulate and invest policies then with austerity.

(3) They then say that financial markets are irrational and wrong–it interest-rate will go up, will go up soon, and will go up far. We point out that fearful financial markets have been better forecasters then their hopes of imminent normalization every year for the past decade.

(4) They then say: let’s ignore those interest rates and pretend they are not telling us anything about the benefits and costs right now of fiscal expansion. We reply: you are economists–economists are supposed to take prices seriously, not throw the information in them away.

(5) They then say: nevertheless, running up the nominal debt through expansionary fiscal policy is somehow risky. We say: do helicopter money, which does not run up the debt.

(6) They then say: but even a half booming economy will take the pressure off of governments and bureaucrats to undertake urgent and important structural reforms. We ask: what evidence can you point to to support any claim that useful structural reform is easier and I low-pressure that in a high-pressure economy?

And we are met with silence.

And then they go back to parroting their talking point (1) again.

Greg Ip: Needed: A Contingency Plan for Secular Stagnation: “What if Larry Summers is right…

…[and there is] a chronic deficiency of investment relative to savings that has trapped the world in a state of low economic growth largely resistant to monetary policy[?] Events… have strengthened Mr. Summers’s case…. Formerly skeptical economists are less so: Both the International Monetary Fund and the Federal Reserve have implicitly warmed to Mr. Summers’s thesis. With yields taking another leg down after Britain’s vote to leave the European Union, the evidence of secular stagnation, Mr. Summers says, is stronger than ever. If he’s right, the world needs a contingency plan. The most direct response is more expansionary fiscal policy (i.e. lower taxes or higher spending), which would bolster demand and push interest rates up.

But policy makers are rightfully wary about acting in the face of so many contradictory signals. In the U.S., unemployment is moving lower and stocks are hitting new highs. Bonds could be pricing in secular stagnation, or merely a greater bias toward hyper-stimulative monetary policy by central banks…

Why are policy makers rightfully wary? All Ip says is:

Paolo Mauro of the Peterson Institute for International Economics notes that countries have often overestimated their long-term potential growth, resulting in too-high deficits and debts…

Um. No. The arithmetic tells us that at current interest rates fiscal expansion right now will not raise but lower the debt- and amortization-to-GDP ratios. Unless Mauro wants to take that on–which he does not–his piece is irrelevant for that reason alone. Moreover, Mauro seems to think that we have been overestimating long-term potential growth and correcting estimating long-term interest rates. That is wrong. We have been overestimating both long-term interest rates and long-term potential growth. If you overestimate both by the same amount, the biases induced in your estimates of the right current debt-to-GDP ratio are offsetting. The right level of the debt-to-GDP ratio is primarily a function of r-(n+g), the difference between the real interest rate r on Treasury debt and the real growth rate g of productivity plus the real growth rate n of the labor force. A reduction in r accompanied by an equal or smaller reduction in (n+g) is not a first-order reason to reduce government spending or the deficit right now. And that is what we have.

Here Larry Summers is right. Greg Ip is wrong. Larry has by now written a huge amount about his. Yet Ip counterposes his body of work to one working paper by Paulo Mauro that is, as best as I can see, irrelevant to secular stagnation arguments and concerns.

Why is it irrelevant? Mauro does correctly point out that lower future growth is a reason to slow the future growth of real government spending. But what Mauro does not point out is that such a fall in projected future growth is a reason to cut the level of spending now–or to avoid increases in the level of spending that would otherwise be good policy now–only if the slower expected growth is unaccompanied by an equal reduction in Treasury interest rates. Our reduction in expected future economic growth appears to have accompanied by a larger reduction in Treasury interest rates.

This opinions-of-shape-of-earth-differ-both-sides-have-a-point framing is… beneath what Greg ought to be writing. If he thinks Larry is wrong–or even that the anti-Larry case is arguable–he needs to find and quote real arguments that have real relevance here, and more than one of them, not a single piece from the Peterson Institute that is off-point.

Must-Read: Greg Ip: Needed: A Contingency Plan for Secular Stagnation

Posted on by Brad DeLong

Must-Read: Um. No. Larry Summers is right. The sharp and usually-reliable Greg Ip is wrong. This opinions-of-shape-of-earth-differ-both-sides-have-a-point framing is simply wrong.

The right level of the debt-to-GDP ratio is primarily a function of r-(n+g), the difference between the real interest rate r on Treasury debt and the real growth rate g of productivity plus the real growth rate n of the labor force. A reduction in r accompanied by an equal or smaller reduction in (n+g) is not a first-order reason to reduce government spending or the deficit now–or to postpone or cancel plans to increase the deficit right now that would otherwise be good policy

Greg Ip: Needed: A Contingency Plan for Secular Stagnation: “If Larry Summers is right…

…the most direct response is more expansionary fiscal policy…. But policy makers are rightfully wary about acting in the face of so many contradictory signals. In the U.S., unemployment is moving lower and stocks are hitting new highs. Bonds could be pricing in secular stagnation, or merely a greater bias toward hyper-stimulative monetary policy by central banks…

Why are policy makers rightfully wary? All Ip says is:

Paolo Mauro of the Peterson Institute for International Economics notes that countries have often overestimated their long-term potential growth, resulting in too-high deficits and debts…

And chasing the link:

Paulo Mauro: Fiscal Policy in the Era of Stagnation: “Policymakers often mistake a long-lasting growth slowdown for a temporary slowdown…

…and systematically fail to increase the primary fiscal surplus sufficiently when the long-run economic growth rate declines. Economic history provides several examples of debt crises or near-crises caused by unexpected, long-lasting slowdowns in economic growth that were not recognized in time…. Ignoring a permanent slowdown in the rate of economic growth can lead to policy mistakes. For example, a country projecting a stable government debt ratio of 100 percent of GDP over the next decade or two would experience an increase in that ratio to 140 percent in 10 years if growth turns out to be 1 percentage point lower than assumed. As deficits rise, the ratio would balloon to more than 200 percent after 20 years…

Source: P. Mauro, R. Romeu, A. Binder, and A. Zaman, 2013, A Modern History of Fiscal Prudence and Profligacy (link is external), IMF Working Paper 13/5, Washington: International Monetary Fund.

The implication Ip takes from this is simply wrong. Slower future growth is a reason to slow the future growth of real government spending. It is a reason to cut the level of spending now–or to avoid increases in the level of spending that would otherwise be good policy–only if the slower expected growth is unaccompanied by an equal reduction in Treasury interest rates. But that is not the case: our reduction in expected future economic growth is accompanied by a larger reduction in Treasury interest rates.

Must-Read: Larry Summers: When the best umps blow a call

Posted on by Brad DeLong

Must-Read: I think Larry Summers gets this wrong. Under Rivlin, Reischauer, Orszag, and Elmendorf the CBO was a national treasure. Otherwise… Not so much. Hit and miss.

Remember June O’Neill talking about how many people would lose their jobs from health care reform, and never once telling the reporters she briefed that in her models people hadn’t “lost” their jobs, they quit jobs they did not want to have and were made happier thereby?

And now we have an assumed-but-hidden 2%/year real rate of return on government infrastructure investment driving an analysis:

Larry Summers: When the best umps blow a call: “The Congressional Budget Office is an American national treasure…

…Without the impartial objectivity it brings to the budget process, our country would make much worse policy. Baseball without an umpire would be a very different game, and similarly the making of budget policy without CBO would be a very different and inferior activity. However, even the best umps occasionally blow a call, and I am afraid that is what CBO has done in its recent infrastructure report…

Must-Read: Larry Summers: A Remarkable Financial Moment

Posted on by Brad DeLong

Must-Read: Larry Summers: A Remarkable Financial Moment: “10 and 30 year interest rates today reached all time low levels of 1.32 percent and 2.10 percent…

…Record low 10 year interest rate were also registered in Germany, France, Switzerland and Australia.  Notably Swiss 50 year interest rates are now for the first time negative.  Rates out 15 years are negative in Germany and 9 years in France. Such rates would have seemed inconceivable a decade ago and very unlikely even a couple of years ago…. Extraordinarily low rates reflect both subtarget expected inflation even over long horizons and very low real interest rates…. Remarkably the market does not now expect a full Fed tightening until early 2019. This is despite all the Fed speeches expressing optimism about the economy and a desire to normalize interest rates… very low long term real rates, sluggish growth expectations, concerns about the ability even over the fairly long term to get inflation to average 2 percent, and a sense that the Fed and the world’s major central banks will not be able to normalize financial conditions in the foreseeable future….

Policymakers still have not made sufficiently radical adjustments in their world view to reflect this new reality of a world where generating adequate nominal GDP growth is likely to be the primary macroeconomic policy challenge for the next decade. Having the right world view is essential if there is to be a chance of making the right decisions.  Here are the necessary adjustments…. Neutral real interest rates are likely close to zero going forward…. Second, as counterintuitive as it is to central bankers who came of age when the inflation of the 1970s defined the central banking challenge, our problem today is insufficient inflation…. Evidence from markets and some surveys suggests that inflation expectations are becoming unhinged to the downside…. In a world where interest rates over horizons of more than a generation are far lower than even pessimistic projections of growth, traditional thinking about debt sustainability needs to be discarded…. The conditions Brad Delong and I set out in 2012 for expansionary fiscal policy to pay for itself are much more easily satisfied today than they were at that time.

Fourth, the traditional suite of structural policies to promote flexibility are not especially likely to be successful in the current environment…. In the presence of chronic excess supply structural reform has the risk of spurring disinflation rather than the contributing to a necessary increase in inflation. There is in fact a case for strengthening entitlement benefits so as to promote current demand…. Traditional OECD-type recommendations cannot be right as both a response to inflationary pressures and deflationary pressures.  They were more right historically than they are today…. Treatments without accurate diagnosis have little chance success.  We need to begin with a much clearer diagnosis of our current malaise than policymakers have today.  The level of interest rates provides a very strong clue.

Must-Read: Larry Summers: Fed’s Current Strategy Ill Adapted to the Realities

Posted on by Brad DeLong

Must-Read: Larry Summers is right.

If the Phillips Curve today still had the short-run slope in the gearing of expected inflation to recent past inflation that it appeared to have at the start of the 1980s, there might–but only might–be a case for the Federal Reserve’s current policy.

There is no reason for internal comity between the Board of Governors and the regional bank presidents to be a concern: Bernanke and Yellen have now had three full regional bank-appointment cycles to get bank presidents who are on the same page as the Board of Governors. The Federal Reserve always has and is understood to have the freedom to raise interest rates to maintain price stability when incoming data suggests that it is threatened: there is no need for talk to highball the chances of future rate increases when the current data flow does not suggest it will be needed. Thus I see no reasons at all to support a Fed policy posture other than that one that Larry Summers recommends: “signal[ling] its commitment to accelerating growth and avoiding a return to recession, even at some cost in terms of other risks…”

Larry Summers: Fed’s Current Strategy Ill Adapted to the Realities: “The current hawkish inclination of the Fed, with its chronic hope and belief that conditions will soon permit interest rate increases, is misguided…

…The greater danger is of too little rather than too much demand. A new Fed paradigm is therefore in order…. I would guess that from here the annual probability of recession is 25-30 percent. This seems to me the only way to interpret the yield curve. Markets anticipate only about 65 basis point of increase in short rates over the next 3 years. Whereas the Fed dots suggest that rates will normalize at 3.3 points, the market thinks that even 5 years from now they will be about 1.25 percent. Markets are thinking that recession will come at some point and when it does rates will go to near zero…. This implies that if the Fed is serious… about having a symmetric 2 percent inflation target then its near-term target should be in excess of 2 percent. Prior to the next recession–which will presumably be deflationary–the Fed should want inflation to be above its long term target…. The Fed’s dots forecasts refer to a modal scenario of continued recovery… [with] inflation rising to 2 percent only in 2018. Why shouldn’t they prefer a path with more demand, inflation at target sooner, more stimulus as recession insurance, and a small margin of extra inflation as a buffer against the next recession?….

The logic that led to the adoption of the 2 percent inflation target years ago suggests that it is too low now…. The case for a positive inflation target balances the benefits of stable money with the output cost of lowering inflation and two ways that positive inflation is helpful—the periodic need to have negative real rates, and inflation’s role in facilitating downward adjustment in real wages given nominal rigidities. All of the factors pointing towards a higher inflation target have gained force in recent years…. Experience has proven that Yellen was correct to be skeptical of the idea very low inflation rates would improve productivity. And it is plausible that the error in price indices has increased with the introduction of new categories of innovative and often free products…. If a two percent inflation target reflected a proper balance when it first came into vogue decades ago, a higher target is probably appropriate today….

Long term inflation expectations are depressed and declining…. The Fed has in the past counterbalanced declines in market inflation expectation measures by pointing to the relative stability in surveys-based measures. This argument is much harder to make now that consumer expectations of inflation have broken decisively below their all-time lows even as gas prices have been rising…. The Fed’s summary employment conditions index has been flashing yellow since the beginning of the year. Declines in this measure have presaged recession half of the time and uniformly been followed by rate reductions rather than rate increases….

The right concern for the Fed now should be to signal its commitment to accelerating growth and avoiding a return to recession, even at some cost in terms of other risks. This is not the Fed’s policy posture. Watching the Fed over the last year there is a Groundhog Day aspect. One senses they really want to raise rates and achieve a more ‘normal’ stance. But at the same time they do not want to tighten when the economy may be slowing or create financial turmoil. So they keep holding out the prospect of future rate increases and then find themselves unable to deliver. But they always revert to holding out the prospect of rate increases soon, partly for internal comity and partly to preserve optionality. Over the last 12 months nominal GDP has risen at a rate of only 3.3 percent. We hardly seem in danger of demand running away. Today we learned that Germany has followed Japan into negative 10 year rates. We are only one recession away from joining the club…

Must-Read: Josh Bivens: Larry Summers, the Congressional Progressive Caucus Budget, and the Abandonment of Fiscal Policy

Posted on by Brad DeLong

Must-Read: Josh Bivens: Larry Summers, the Congressional Progressive Caucus Budget, and the Abandonment of Fiscal Policy: “Federal budget season came and went this year without any budget proposal hitting the floor of the U.S. House of Representatives…

…This was an odd (and ironic) bit of incompetence by the GOP leadership, who couldn’t even wrangle a majority to support their own budget proposal. But it was especially damaging to U.S. economic policy debates because it limited attention paid to the budget of the Congressional Progressive Caucus (CPC)…. The need to resuscitate fiscal policy was usefully underscored in a widely-discussed speech by former Treasury Secretary and National Economic Council Chair Larry Summers earlier this week….

I am here to tell you that the most important determinant of our long term fiscal picture is how successful we are at accelerating the economy’s growth rate in the next three to five years, not the austerity measures that we implement…. What are the crucial elements of changing the fiscal monetary mix I would highlight?

One, the only one I have a slide on, is a substantial increase in public investment. It is insane that [net] federal and infrastructure [investment] is now negative at a moment when interest rates have never been lower and ten-year real interest rates are essentially zero and precious little good is happening at the state and local level either….

Second, strong support for social insurance. When Keynes came to the United States in 1942, he pointed out that an important virtue of Social Security was that it could absorb the excess savings that would potentially hold back U. S. economic growth after the Second World War. Those considerations were not relevant in the succeeding 60 years but they potentially are relevant in our current period of secular stagnation….

The Summers speech has been widely commented-upon, and rightly so—it contains a lot of wisdom. People should know, however, that the ideas in his remarks are embodied in real-world legislation proposed earlier this year, and which sadly disappeared without much attention, all because the Republican-led House could not even organize themselves to have the annual debate on budget proposals.

Must-Read: Larry Summers: Four Common-Sense Ideas for Economic Growth

Posted on by Brad DeLong

Must-Read: Larry Summers: Four Common-Sense Ideas for Economic Growth: “Since the summer of 2009, the US economy has grown at about 2 percent…

…The 10-year interest rate at the end of trading today [February 18, 2016] was just a bit below 1.8 percent…. We are having trouble achieving… a 2 percent inflation…. This is the judgment of a market that thinks that the Fed is not going to do anything like what it says it’s going to do…. The real interest rate is at least a kind of measure of the certainty equivalent of the productivity of capital. If the market is saying that’s below 1 percent, that has to be of concern as well. [And] the Fed has been substantially too optimistic in its one-year-ahead forecast every year for the last six….

What should be done?… First, there is an overwhelming case in the United States for expanded public infrastructure investment…. Yt the rate of infrastructure investment is lower now than it’s been anytime since 1947. If you take depreciation out, federal infrastructure investment is negative…. Second, we should increase support for private investment in infrastructure…. With respect to private investment, tax reform is critical…. Third, we should grow our effective labor force…. What we do to educate our workforce matters. What we do to incentivize our workforce—through the design of our social safety net, and through disability insurance—matters. What we do to change our immigration policies—particularly our immigration policies on highly skilled workers—matters….

Fourth, our financial system requires continuing attention… the 1987 crash, the 1990 real-estate bubble, the S&L crash, the Mexican financial crisis, the Asian financial crisis, the internet bubble, Enron, and then the Great Recession of 2008. On average, a crisis every three years for the last 30 years. That surely has taken a toll on growth. At the same time, because pendulums swing, at a time of substantial unemployment, a large number of middle-class Americans are not able to get mortgages today with reasonable down payments. It appears, though the matter is in some dispute, that there are significant impediments in the flow of capital to small businesses as well. Financial reform, labor-force support, stimulus to private investment, increases in public investment—this stuff is not rocket science. Most of it operates on both the demand side and the supply side….

If all you care about is that we’ve got an excessive federal debt, the most important determinant of the debt-to-GDP ratio in 2030 is how rapidly the economy grows between now and then. If what you care about is American national security, the most important determinant of how much we are respected and how much influence we have in the world is how well our economy performs. If what you care about is inequality and poverty, the most important determinant of the employment prospects of the poor is how rapidly the economy is growing…

Must-read: Larry Summers: “Corporate Profits Near Record Highs Is a Problem”

Posted on by Brad DeLong

Must-Read: Larry Summers: Corporate Profits Near Record Highs Is a Problem: “The rate of profitability in the US is at a near-record-high level…

…All this might be taken as evidence that this is a time when the return on new capital investment is unusually high…. A high market value of corporations implies that ‘old capital’ is highly valued and suggests a high payoff to investment in new capital…. Yet matters are more complex. For some years now, real interest rates on safe financial instruments have been low and, for the most part, declining. And business investment is either in line with cyclical conditions or a little weaker than would be predicted…. This is anomalous…. An unusually high rate of investment would be expected to go along with a high rate of return on existing capital.

How can this anomaly be resolved? There are a number of logical possibilities…. [But] it could be that higher profits do not reflect increased productivity of capital but instead reflect an increase in monopoly power…. Is the increased monopoly power theory plausible?… (i) Many industries have become more concentrated; (ii) we are coming off a major merger wave; (iii) there is some evidence of greater profit persistence among major companies; (iv) new business formation has declined; (v) overlapping ownership of companies that compete has become more common with the rise of institutional investors; (vi) leading technology companies such as Google and Apple may be benefiting from increasing returns to scale and network effects…. Only the monopoly power story can convincingly account for the divergence between the profit rate and the behavior of real interest rates and investment…

Must-read: Larry Summers: “A World Stumped by Stubbornly Low Inflation”

Posted on by Brad DeLong

Must-Read: Larry Summers: A World Stumped by Stubbornly Low Inflation: “[The 1970s taught us that] allowing not just a temporary increase in inflation but a shift to above-target inflation expectations could be very costly…

…At present we are… in a world that is the mirror image…. Market measures of inflation expectations have been collapsing and on the Fed’s preferred inflation measure are now in the range of 1-1.25 per cent over the next decade. Inflation expectations are even lower in Europe and Japan…. The Fed’s most recent forecasts call for interest rates to rise almost 2 per cent in the next two years, while the market foresees an increase of only about 0.5 per cent. Consensus forecasts are for US growth of only about 1.5 per cent for the six months from last October to March. And the Fed is forecasting a return to its 2 per cent inflation target on the basis of models that are not convincing to most outside observers….

In a world that is one major adverse shock away from a global recession, little if anything directed at spurring demand was agreed. Central bankers communicated a sense that there was relatively little left that they can do to strengthen growth or even to raise inflation. This message was reinforced by the highly negative market reaction to Japan’s move to negative interest rates. No significant announcements regarding non-monetary measures to stimulate growth or a return to target inflation were forthcoming, either…. Today’s risks of embedded low inflation tilting towards deflation and of secular stagnation… will require shifts in policy paradigms if they are to be resolved. In all likelihood the important elements will be a combination of fiscal expansion drawing on the opportunity created by super low rates and, in extremis, further experimentation with unconventional monetary policies.