Tag: Larry Summers

What Is the Eccles Building Thinking Today? II: The Reasonable People Are Very Unreasonable Indeed

Posted on by Brad DeLong

Larry Summers: What Should the Fed Do and Have Done?: “The Federal Reserve… has strongly signaled that it will raise rates…

…Given the strength of the signals that have been sent it would be credibility-destroying not to carry through with the rate increase, so there is no interesting discussion to be had about what should be done on Wednesday…

This seems to me to be wrong: credibility that one will stubbornly pursue bad policies is not worth gaining, or preserving.

If the FOMC were to end today’s discussion convinced that on balance it would be a mistake to raise interest rates right now, the right communique would be: “While we entered this meeting believing that raising interest rates was appropriate, we find–to our surprise–that today’s discussion has changed our minds.”

If–as is more likely than not–they will in the future wish that they had backed off their policy and surprised markets with lower interest rates, better to have the smaller surprise sooner than the bigger surprise later.

Larry continues:

But was it right to move at this juncture? This requires weighing relative risks. A decision to keep rates at zero would have…risk[ed] an overheating economy and an acceleration of inflation, possibly necessitating a sharp and destabilizing hike in rates later… encourag[ed] financial instability, particularly if there became a perception that the Fed would never raise rates… [left] the Fed with less room to lower rates in response to problems than it would have if it increased rates. Finally, perhaps… economic actors take… zero rates as evidence that the Fed is worried and so they should be…. Some believe that… we no longer have a pathological economy and so no longer should have zero rates…. Perhaps there is a fear that when rates go up something catastrophic will happen and this source of uncertainty can only be removed by raising rates.

These arguments do not seem hugely compelling to me.

Indeed not.

Summers concludes:

An excessive delay in raising rates can be remedied eight weeks later at the next FOMC meeting by raising them then. On the other hand, if rates are raised and it proves to be a mistake… inflation expectations move down, financial turbulence… the economy… tips towards recession.  Reversing the rate increase would be unlikely to eliminate these consequences.  Moreover, reversing the direction of policy would hardly be helpful for central bank credibility…

And then comes a sentence I really do not understand:

Reasonable people can come to different judgements on all of this…

How can reasonable people come to different judgments? If the FOMC concludes that it is behind the curve on raising interest rates, it can immediately catch up. As Larry says: “An excessive delay in raising rates can be remedied eight weeks later…” If the FOMC concludes that it is ahead of the curve on raising interest rates, it cannot then recover by dropping them below zero. The asymmetry of the zero lower bound makes it unwise to start liftoff as long as there remains a material chance that the short-run neutral rate will again kiss zero in the near future. And there does remain such a material chance.

What is the reasonable person’s argument here?

What Is the Eccles Building Thinking Today? I: The Failure to Think Through the Consequences of “Secular Stagnation”

Posted on by Brad DeLong

Olivier Blanchard, at least, has said that the secular decline in global real interest rates and increased macro instability means that the 2%/year inflation target was greatly ill-advised and needs to be raised to 4%/year. But, among the great and good who staff the finance ministries, central banks, and international organizations these days, he is nearly alone. And the other pieces of the policy puzzle that might get us out of our zero-lower-bound-secular-stagnation pickle–aggressive redistribution via taxes and transfers, higher debt levels for reserve currency-issuing sovereigns with exorbitant privilege to boost the supply of safe assets, reducing risk premia by governments’ assumption of the role of entrepreneurial risk-bearer of last resort, international organizations that emerging markets regard as friends rather than enemies–are nowheresville.

The prevailing view among the great and good who staff governments and organizations is that the interest rate-capacity utilization configuration is going to normalize “soon”. As Larry writes: “the ‘headwinds’ orthodoxy prevailing in the official community… has been consistently far behind the curve…. The ‘temporary headwinds’ interpretation of low neutral real rates has been wrong for the last few years and is not hugely plausible as a basis for predicting the next few…”

And with U.S. 30-year Treasury bonds at 3.0%/year nominal and German at 1.4%/year nominal, financial markets provide no warrant for believing what are now called “headwinds” will ease any time over the next generation.

Since World War II, central bankers and governments have at least believed that they had the tools to successfully manage the macroeconomy. Now I do not believe that they think they do have tools adequate to the likely macroeconomic environment over the next generation. Yet this lack of tools does not seem to bother the great and good very much today…

Must-Read: Larry Summers: Breaking New Ground on Neutral Rates: “Lukasz Rachel and Thomas Smith have a terrific new paper…

…document[ing]… the length and breadth of the decline… in real rates… over 25 years… shows the inadequacy of shorter-term explanations of low neutral real rates such as those of Ken Rogoff that focus on the financial crisis and its aftermath…. They present thoughtful calculations assigning roles to rising inequality and growing reserve accumulation on the saving side and lower priced capital goods and slower labor force growth on the investment side. They also note the importance of rising risk premia… [an] first important word on decomposing the causal factors behind declining real rates….

They reach the important conclusion that there is little basis for assuming a significant increase in neutral real rates going forward. This conclusion differs sharply from the ‘headwinds’ orthodoxy prevailing in the official community…. There will be much less scope to raise rates in the industrial world over the next few years than the world’s central banks suppose…. The zero lower bound is likely to be a major issue….

Rachel and Smith also share my concern that a world of chronic very low real rates is going to be a world of high volatility, imprudent risk taking, excessive leverage and frequent financial accident…. It is fashionable to invoke the brave new world of macro-prudential policy…. As best I can tell, US macroprudential policy as currently practiced has meaningfully impaired liquidity in some key markets and damaged the credit availability for small and medium sized businesses while not touching excessive flows to emerging markets and high yield corporate issuance…. I doubt that actual regulators who, after all, were proclaiming the health of the banking system in mid 2008 are capable of pulling it off consistently given the pressures they face.

Must-Read: Adam Posen: Some Big Changes in Macroeconomic Thinking from Lawrence Summers

Posted on by Brad DeLong

Must-Read: Adam Posen: Some Big Changes in Macroeconomic Thinking from Lawrence Summers: “In the United States, since 1965, there has been a tripling of the non-employment rate…

…for men… 24 and 54… similar trends… elsewhere…. It is a real puzzle to observe simultaneously multi-year trends of rising non-employment of low-skilled workers and declining measured productivity growth. Either we need a new understanding, or one of these observed patterns is ill-founded or misleading…. Unless we can somehow transform that sustained lower demand for workers into the widespread leisure of the sort imagined by Keynes and some science fiction writers, with the income redistribution to support it, I would think this is very bad news for social stability and technological progress….

Unmeasured quality improvement… [the] fraction of the economy… [susceptible] has been rising, so the amount of mismeasurement (and therefore productivity understatement) would be rising…. [Thus] inflation is lower than even its currently low level–and that has the consequence that real interest rates are higher, so monetary policy at present is tighter… [and] farther away from its mandated inflation target…

Recessions in the OECD… in most cases the level of GDP is lower five to ten years afterward than any prerecession forecast or trend…. “The classic model of cyclical fluctuations… around the given trend is not the right model…. The preoccupation of macroeconomics should be on lower frequency fluctuations that have consequences over long periods of time….

Discussing… Abenomics’ results… I asked whether a message we should take from the Japanese experience is to avoid bad states of the economy at almost any cost…. [And] the very language we use to speak of business cycles, of trend growth rates, of recoveries of to those perhaps non-stationary trends, and so on–which reflects the underlying mental framework of most macroeconomists–would have to be rethought.

New thinking: Larry Summers puts in his 2 cents on “hysteresis” and “superhysteresis”

Posted on by Brad DeLong

Let me point out that, to the extent one recognizes even the possibility of hysteresis or superhystesis, obvious optimal control policy when you approach the zero lower bound is to dial up current monetary expansion to the max and call for more fiscal expansion as well. The long-run damage from not generating a V-shaped recovery in the short-run is then immense, and you always dial policy down to be less expansionary should it look like you were about to overshoot. Yet such arguments had no purchase in the Bernanke Fed or the Geithner Treasury, and little inside the Obama White House.

I must confess that I have never understood why people ever thought it reasonable to believe that the pace of potential output growth was the same in a low pressure as an high-pressure economy. And, indeed, it is not:

Larry Summers: Advanced Economies Are so Sick We Need a New Way to Think About Them: “There appear to be more cases where recessions reduce the subsequent growth of output…

…than where output returns to trend. In other words ‘super hysteresis,’ to use Larry Ball’s term, is more frequent than ‘no hysteresis.’… We look at… recessions with different precursors. We find that even recessions that are associated with disinflationary monetary policies or the drying up of credit have substantial long-run output effects–suggesting the presence of hysteresis effects…. [Moreover,] fiscal policy changes have large continuing effects on levels of output suggesting the importance of hysteresis…

But we knew all this back in 1936, no? John Maynard Keynes:

John Maynard Keynes (1936): The General Theory of Employment, Interest and Money, chapter 24: “The enlargement of the functions of government…

…[is] the only practicable means of avoiding the destruction of existing economic forms in their entirety and as the condition of the successful functioning of individual initiative…. If effective demand is deficient, not only is [there] the public scandal of wasted resources… but the individual enterpriser… is operating with the odds loaded against him… many zeros, so that the players as a whole will lose if they have the energy and hope to deal all the cards. Hitherto the increment of the world’s wealth has fallen short of the aggregate of positive individual savings; and the difference has been made up by the losses of those whose courage and initiative have not been supplemented by exceptional skill or unusual good fortune. But if effective demand is adequate, average skill and average good fortune will be enough…

Only in a high-pressure economy, Keynes says, will the “increment of wealth”–the value of productive capital and organizations created–match “the aggregate of positive individual savings”–the amount of resources devoted to trying to boost productive capacity. In a low-pressure economy, a lot of investments that could pay off from a tastes-and-technologies standpoint won’t because of slack demand, and so perfectly-productive factories and organizations will be scrapped and shut down.

And we have to add on to this the perspective, derived from Granovetter, that a great deal of the societal resource-allocation capital of the labor market is the social network of loose ties generated that nobody gets paid for, and is thus a spillover; the perspective, derived from Saxenian, that a great deal of the societal resource-allocation capital of the value chain is the social network of overlapping communities of engineering practice generated that nobody gets paid for, and is thus a spillover; and the perspective derived from Hayek that a great deal of the societal resource-allocation capital of the price system is the revelation by market prices of societal scarcities and values that nobody could calculate on their own, and that nobody gets paid for generating, and is thus a spillover. Externalities all over the place here!

The question is: why did people ever assume otherwise? Yes, a linear Phillips Curve is simple to work with. Yes, the assumption that the rate of inflation expected next year is simply actual inflation last year seems like a not unreasonable rule-of-thumb. But you have to put very great weight on both–weight that the past decade has conclusively proven they cannot bear–to even conclude the business cycles are fluctuations around rather than falls below sustainable levels of production. And you are still absolutely nowheresville with respect to the invariance of potential growth to cyclical conditions.

Must-Read: Larry Summers: Advanced Economies Are so Sick We Need a New Way to Think About Them

Posted on by Brad DeLong

Must-Read: Larry Summers: Advanced Economies Are so Sick We Need a New Way to Think About Them: “Standard new Keynesian macroeconomics… [and] to an even greater extent… dynamic stochastic general equilibrium (DSGE) models…

…imply that… the only effect policy can have is on the amplitude of economic fluctuations, not on the [average] level of output. This assumption is problematic…. The assumption is close to absurd. It is surely reasonable to assume that better policy could have avoided the Depression or the huge output losses associated with the financial crisis without having shaved off some previous or subsequent peak…. Contrary to the now common view that macroeconomics is best understood by studying the stochastic properties of stationary time series, the most important macroeconomic events are in some sense one off. Think of the Depression or the Great Recession or the high inflation of the 1970s. The problem has always been that it is difficult to beat something with nothing. This may be changing as topics like hysteresis, secular stagnation, and multiple equilibrium are getting more and more attention…

Intellectual Broker: (Trying to) Make Sense of Current (Small) Analytical Disagreements Between Paul Krugman and Larry Summers: Where Is the Can Opener?

Posted on by Brad DeLong

Larry Summers tweets:

David Wessel picks it up:

And I attempt to Twittersplain, with how much success I do not know:

Larry Summers: Where Paul Krugman and I differ on secular stagnation and demand: “Paul Krugman suggests that I have had some kind of change of heart on secular stagnation…

…and converged towards his point of view…. I certainly appreciate the gravity of the secular stagnation issue more than I did…. But I think Paul exaggerates the change in my views considerably. The topic… was: ‘North America faces a Japan-style era of high unemployment and low growth.’ Paul argued in favor. I opposed the motion–not on the grounds that the US economy was in good shape, but on the grounds that our demand deficiency problems should be easier to solve than Japan’s… [because] it is dimensionally much less than the problems that Japan faced in four respects. Japan’s problems were different in magnitude, different in the depth of their structural roots, different in the… perspective… relative to the rest of the world… different in the degree of resilience [of] their system…. Paul responded in part by saying:

The question is, are we going to be stuck in a state of depressed demand of the kind that Larry has talked about. Larry and I agree that that is what has been happening… I think Larry and I agree almost entirely on the economics, on what needs to be done….

I think we have both been focused on demand and the liquidity trap for a long time. There are, though, two areas where I have had somewhat different views from Paul. I believe that structural issues are often important for demand and growth…. Second, I have never related well to Paul’s celebrated liquidity trap analysis. It has always seemed to me be a classic example of economists’ tendency to ‘assume a can opener’. Paul studies an economy in liquidity trap that will, by deus ex machina, be lifted out at some point in the future. He makes the point that if you assume sufficiently inflationary policy after this point, you can drive ex ante real rates down enough to stimulate the economy even before the deus ex machina moment.

This is true and an important insight. But it seems to elide the main issue. Where is the deus ex machina? Where is the can opener? The essence of the secular stagnation and hysteresis ideas that I have been pushing is that there is no assurance that capitalist economies, when plunged into downturn, will over any interval revert to what had been normal. Understanding this phenomenon and responding to it seems the central challenge for macroeconomics in this era. Any analysis that assumes restoration of previous equilibrium is, from this perspective, missing the main issue. I was glad to see Paul recognize this point recently.  I suspect it will lead to more emphasis on fiscal rather than monetary actions in depressed economies.

Paul Krugman: Liquidity Traps, Temporary and Permanent: “Larry Summers reacts to an offhand post of mine, seeking to draw a distinction between our views…

…I actually don’t think our views differ significantly now, but he’s right that what he has been saying differs from the approach I took way back in 1998. And I’ve both acknowledged that and admitted that the approach I took then seems inadequate now…. Japan now looks like an economy in which a negative natural rate is a more or less permanent condition. So, increasingly, does Europe. And the US may be in the same boat, if only because persistent weakness abroad will lead to a strong dollar, and we will end up importing demand weakness. And if we are in a world of secular stagnation–of more or less permanent negative natural rates–policy becomes even harder.

And I commented on Paul’s webpage thus: But, as I was tweeting to David Wessel, you scorn the Confidence Fairy while having some hope for the Inflation-Expectations Imp, while he scorns the Inflation-Expectations Imp but has some hope for the Confidence Fairy, no? And he has more hope for pump-priming small fiscal expansion to trigger virtuous circles and give the economy escape velocity, no? Small differences relative to those of the two of you vis-a-vis Rogoff, Mankiw, Feldstein, Bernanke, and, I think, even Blanchard. But differences, no?…

A Reader’s Guide to the Secular Stagnation Debate: The Honest Broker for the Week of October 12, 2015

Posted on by Brad DeLong

The very sharp and energetic Peter Passell, who runs the Milken Institute Review these days, commissioned me to write a reader’s guide to the secular stagnation debate. I set it up as a four-corner cage match–Bernanke, Rogoff, Krugman, and Summers–and I am proud of it. (But I have to offer apologies to those–Koo, Blanchard, Feldstein come most immediately to mind, but there are others–who have their own serious positions that are not completely and satisfactorily understood as linear combinations of the four I chose to be my basis vectors.) It is out:

J. Bradford DeLong (2015): The Scary Debate Over Secular Stagnation, Milken Institute Review 2015:IV (October) pp. 34-51:

Bernanke… says we have entered an age of a “global savings glut.”… Rogoff… points to the emergence of global “debt supercycles.”… Krugman warns of the return of “Depression economics.” And… Summers calls for broad structural shifts in government policy to deal with “secular stagnation.” All… are expecting a future that will be very different than the second half of the 20th century, or even the so-far, not-so-good third millennium. But they… [differ on] optimism or pessimism… [and on whether] cautious repairs or an abrupt break with policy as usual [are needed. This] is, I believe, the most important policy-relevant debate in economics since John Maynard Keynes’s debate with himself… which transformed him from a monetarist to the apostle of active fiscal policy.

I think Summers is largely right, but then, I would, since I have been losing arguments with him since I was 20. What’s needed here, though, is not a referee’s decision, but a guide to the fight…

Briefly:

  • Bernanke sees anomalies in portfolio decisions by emerging-market central banks and plutocrats that have generated a global savings glut in the relatively short-run.
  • Rogoff sees overleverage as having created a medium-run period of stagnation that requires active debt-liquidation policies to shorten it.
  • Krugman sees the end of the era of moderate inflation as bringing about a return to “Keynesian” economic structures that require activist fiscal policy.
  • Summers sees deeper problems that call for more in the way of government’s acting as investment-spender, risk-bearer, safe asset-supplier, and bubble-preventer of last resort, and thus extend its proper role beyond that of Keynesian demand-management policies toward what Keynes called a “comprehensive socialization of investment”.

All are serious and live possibilities…