Tag: Liquidity Trap

My Sections: As Delivered: Fed Up Rethink 2% Inflation Target Blue-Ribbon Commission Conference Call

Posted on by Brad DeLong

Opening Statement (as Delivered): I digress from my job here to say that I agree with everything that Jason and Josh have said. They do not speak just for themselves. They speak for me as well.

And let me also digress by trumping both Jason and Josh.

They both said “if you thought a 2% inflation target was appropriate a decade ago”. A decade ago I did not think a 2% inflation target was appropriate.

It was twenty-five years ago this summer that Larry Summers and I went to the Federal Reserve’s conference at Jackson Hole to say, among other things, that we thought it would be extremely risky and inappropriate to drop the Fed’s informal inflation target from its then-five percent to two percent. The 1990 savings and loan crisis was a small macroeconomic shock. Yet the Federal Reserve cut short-term interest rates by 600 basis points to respond to it. If there were ever a big shock, we said, the Fed would want all that much room to maneuver and more. It would not have that room to maneuver with a two percent inflation target.

So I’ve been beating this drum for twenty-five years off and on, and feeling very Cassandra-like for the past decade.

Now on to my job here. It is to get all medieval, in the sense of Thomas Aquinas, on you. It is to deal with the objections to our position, and then to provide what we believe are sufficient answers to those objections.

I hear four arguments for not changing the 2%/year inflation target, even though pursuing that target found us in a situation where monetary policy was greatly hobbled in its ability to manage the economy for a solid decade. And, as best as I can evaluate them, all four of these arguments seem to me to be wrong. They are:

The Federal Reserve, even at the zero lower bound, has powerful tools sufficient to carry out its stabilization policy tasks (Cf.: Mankiw and Weinzierl (2011) https://scholar.harvard.edu/files/mankiw/files/exploration_of_optimal.pdf), so moving away from 2%/year as a target is not necessary. This leaves begging the questions of why, then, employment has been so low over the past decade and why production is still so low relative to our circa-2007 expectations.

The problem is not the 2%/year target but rather pressure on the Federal Reserve: pressure from substantial numbers of economists and politicians practicing bad economics and motivated partisan reasoning. (As an example, somebody sent me a video clip this week of the very smart Marvin Goodfriend half a decade ago, arguing that faster recovery required the Fed to hit the economy on the head with a brick to make people more confident in its willingness to fight inflation http://www.bradford-delong.com/2017/06/on-the-negative-information-revealed-by-marvin-goodfriends-i-dont-teach-is-lm.html.) This ignores the Fed’s long institutional history of being willing to ignore outside pressure as it performs its standard monetary policy task of judging what appropriate interest rates are. Pressure only mattered when we got into “non-standard” monetary policies, which we needed to do only because the low inflation target had caused us to hit the zero lower bound.

At 2%/year, inflation is non-salient: nobody worries about it. A higher inflation rate would bring shifting expectations of inflation back into the mix, distract people and firms from their proper task of calculating real costs and benefits to worry about monetary policy, and make monetary policy management more complicated. But right now people and firms are “distracted” by the high likelihood of depressions that last longer than five years. That is a much bigger distraction than worrying about whether inflation will be 4%/year of 5%/year. And right now the zero lower bound makes monetary policy management much more complicated than it was back in the 1990s when the impact of Fed policy on inflation expectations was in the mix.

The Federal Reserve needs to maintain its credibility, and if it were to even once change the target inflation rate, its commitment to any target inflation rate would have no credibility. But the credibility you want to have is credibility that you will follow appropriate policies to successfully stabilize the economy—not credibility that you will mindlessly pursue a destructive policy because you think it somehow wrong to acknowledge that the considerations that led you to adopt it in the first place were wrong or have changed. As my friend Daniel Davies puts it in his One-Minute MBA Course: “Is a credible reputation as an idiot a kind of credibility really worth having?” http://crookedtimber.org/2006/11/29/reputations-are-made-of/

Over to you, Joe…

* * * *

Answers to Questions: There is no unemployment rate target right now.

The Federal Reserve thinks about what the non-accelerating inflation rate of unemployment might be. But they claim not to have any strong view. They claim to be guided by the data, in terms of assessing how much pressure the economy can take. By contrast, the Federal Reserve had an informal inflation target of four to five percent per year in the late 1980s and early 1990s. And it then shifted down first, in the mid-1990s, to an informal target of two percent per year for the core PCE index under Alan Greenspan. It then formalized that under Bernanke in the late 2000. If they did have an unemployment rate target to talk about, we would be talking about that as well. But they don’t.

The question is a very good one. When I come write the economic history of the 2010s, I think that both Ben Bernanke and Janet Yellen are likely to be judged quite harshly. Once the recession of 2008-2009 had reached its end, the Federal Reserve had one overwhelming first priority: to create a strong enough economy that it could sustain short-term safe nominal interest rates of 400 to 500 basis points, and still grow at potential, in order that the Federal Reserve would have room to deal with the next recessionary shock when it came by conventional interest rate policy. The Federal Reserve did not prioritize that objective. Now here we are, late in a recovery, with short-term safe interest rates at 80 basis points or so, and with substantial fear that the economy is not robust enough to support any substantial rise over the time before the next severe recessionary shock hits. Indeed, an attempt to push short-term rates higher in the near future might well be such a recessionary shock.

The Federal Reserve has wedged itself into a position where it has almost no conventional monetary policy ammunition to deploy.

Let me say that the housing bubble did not blow up the economy. Let me say that the deflation of the housing bubble did not blow up the economy. As of the start of 2008, the housing bubble had collapsed, and all of the excess workers who had
been employed in construction had moved out and overwhelmingly found jobs in other sectors without even a small recession or more than a trivial rise in the unemployment rate.

But there was left in the bowels of the financial system the fact that the big money center banks had been playing regulatory arbitrage—claiming that the mortgage-backed securities they were holding were true AAA assets when they were nothing of the sort. It was this concentration of overvalued and mischaracterized assets in the highly leveraged money center banks that got us into big trouble, not the collapse of the housing bubble.

You can see this if you recall that the collapse of the dot-com bubble in 2000-1 took down about five times as much in the way of investors’ wealth as the collapse of the housing bubble took down the wealth of subprime lenders. And yet the 2000-1 bubble collapse did not cause a big recession. Why not? Because the people who took the hit were the rich equity investors in Silicon Valley, rather than the highly overleveraged money center banks that had decided to get a little bit too clever with how they characterized the assets they were holding.

Note that there are people like Larry Summers and Olivier Blanchard who are right now much more on now on Team Expansionary Fiscal Policy than on Team Raise the Inflation Target, in substantial part because of a desire to keep inflation non-salient and because our understanding of how bubbles are generated and what role ultra-low interest rates and quantitative easing play in generating them is very poor.

Let me underscore Jason’s point: Marvin Goodfriend is a potential future nominee to the Federal Reserve Board. Marvin Goodfriend has a remarkable aversion to and suspicion of quantitative easing. But has been very comfortable with the Federal Reserve’s interest rate management role.

When I have pitched this idea of a blue-ribbon examination of the proper inflation target in the past, what I have believed was my cleverest thought was to make Ben Bernanke and Larry Summers co-chairs, and make them in charge of figuring out where the rough consensus of—once again getting Thomas Aquinas on you—the greater and wiser part of the informed community of thinkers about this is.

I have to run to two pointless bureaucratic meetings. If you have any more questions, please email me at delong@econ.berkeley.edu, and if I can hide my phone keyboard and use my thumbs I will answer during the meetings, and if not I will answer as soon as I can afterwards.

And one thing I did not say: We have had four pieces of bad news in the past decade, all of which strongly argue against preserving the two percent per year core PCE inflation target. They are:

  1. bad news about the value of the Wicksellian neutral interest rate.
  2. bad news about the public sphere’s understanding of what the non-interest rate macroeconomic policy tools are and how to deploy them.
  3. bad news about partisanship—the solid opposition of the Republican Party to the policies of South Carolina Republican Ben Bernanke because it was thought they might redound to the benefit of Obama.
  4. bad news about the strength of non-standard stimulative monetary policies.

More References:

Rethink 2%

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

Rethink 2% http://populardemocracy.org/sites/default/files/Rethink%202%25%20letter.pdf:

Federal Reserve Board of Governors
Constitution Ave NW & 20th Street Northwest
Washington, D.C. 20551

Dear Chair Yellen and the Board of Governors:

The end of this year will mark ten years since the beginning of the Great Recession. This recession and the slow recovery that followed was extraordinarily damaging to the livelihoods and financial security of tens of millions of American households. Accordingly, it should provoke a serious reappraisal of the key parameters governing macroeconomic policy.

One of these key parameters is the rate of inflation targeted by the Federal Reserve. In years past, a 2 percent inflation target seemed to give ample leverage with which the Fed could lower real interest rates. But given the evidence that the equilibrium interest rate had fallen substantially even prior to the financial crisis, and that the Fed’s short-term policy rate remained at zero for seven years without sparking any large acceleration of aggregate demand growth, a reassessment of this target seems warranted. Such a reassessment is particularly appropriate when the lack of evidence that moderately higher inflation would harm Americans’ standard of living is juxtaposed with the tremendous evidence that a tighter labor market would improve Americans’ standards of living.

Some Federal Reserve policymakers have acknowledged these shifting realities and indicated their willingness to reconsider the appropriate target level. For example, San Francisco Federal Reserve President John Williams noted the need for central banks to “adapt policy to changing economic circumstances,” in suggesting a higher inflation target, and Boston Federal Reserve President Eric Rosengren cited the different context in which the inflation target was set in emphasizing the need for debate about the right target.[1] [2]

In May, Vice Chair Stanley Fischer highlighted the Canadian system of reconsidering the inflation target every five years, saying, “I can envisage–say, in the case of inflation targeting–a procedure in which you change the target or you change the other variables that are involved on some regular basis and through some regular participation.”[3]

The comments made by Fischer, Rosengren, and Williams all underscore the ample evidence that the long-term neutral rate of interest may have fallen. Even if a 2 percent inflation target set an appropriate balance a decade ago, it is increasingly clear that the underlying changes in the economy would mean that, whatever the correct rate was
then, it would be higher today. To ensure the future effectiveness of monetary policy in stabilizing the economy after negative shocks–specifically, to avoid the zero lower bound on the funds rate–this fall in the neutral rate may well need to be met with an increase in the long-run inflation target set by the Fed.

More immediately, new, post-crisis economic conditions suggest that a reiteration of the meaning of the Fed’s current target is in order. In its 2016 statement of long-run goals and strategy, the Federal Open Market Committee wrote: “The Committee would be concerned if inflation were running persistently above or below this objective.” Some FOMC participants, however, appear to instead consider 2 percent a hard ceiling that should never be breached, and justify their decision-making on that basis. It is important that the Federal Reserve makes clear–and operates policy based on–its stated goal that it aims to avoid inflation being either below or above its target.

Economies change over time. Recent decades have seen growing evidence that developed economies have harder times generating faster growth in aggregate demand than in decades past. Policymakers must be willing to rigorously assess the costs and benefits of previously-accepted policy parameters in response to economic changes.

One of these key parameters that should be rigorously reassessed is the very low inflation targets that have guided monetary policy in recent decades. We believe that the Fed should appoint a diverse and representative blue ribbon commission with expertise, integrity, and transparency to evaluate and expeditiously recommend a path forward on these questions. We believe such a process will strengthen the Fed as an institution and its conduct of monetary policy, and help ensure wise policymaking for the years and decades to come.

Yours,

Dean Baker
Laurence Ball
Jared Bernstein
Heather Boushey
Josh Bivens
David Blanchflower
J. Bradford DeLong
Tim Duy
Jason Furman
Joseph Gagnon
Marc Jarsulic
Narayana Kocherlakota
Mike Konczal
Michael Madowitz
Lawrence Mishel
Manuel Pastor
Gene Sperling
William Spriggs
Mark Thoma
Joseph Stiglitz
Valerie Wilson
Justin Wolfers

[1] John Williams, “Monetary Policy in a Low R-Star World,” August 15, 2016

[2] Sam Fleming, “Inflation Goal May Be Too Low, says Fed’s Rosengren,” Financial Times, April 21, 2015

[3] Greg Robb, “Fed’s Williams Backs Changing Central Bank’s Strategy to Price-Level Targeting,” Market Watch, May 5, 2017

Why the Fed Should Rethink Its 2%/Year No-Lookback Inflation Target

Posted on by Brad DeLong

Conference call today at 9:00 PDT/noon EDT on why the Federal Reserve would be very smart to abandon its 2%/year no-lookback inflation target for a less destructive policy framework. The call is to be moderated Shawn Sebastian. Then Josh Bivens will summarize his short whitepaper: “Is 2% Too Low? Rethinking the Fed’s Arbitrary Inflation Target to Avoid Another Great Recession” http://www.epi.org/publication/is-2-percent-too-low/. Jason Furman will talk about the evidence for the fall in the equilibrium Wicksellian neutral rate of interest and the implications of that for optimal monetary policy. I come next. Joe Stiglitz wraps up. And then questions from reporters.

My task is to set out what the arguments on the other side are—and why we do not find them convincing:

I hear four arguments for not changing the 2%/year inflation target, even though pursuing that target found us in a situation where monetary policy was greatly hobbled in its ability to manage the economy for a solid decade. And, as best as I can evaluate them, all four of these arguments seem to me to be wrong. They are:

  1. The Federal Reserve, even at the zero lower bound, has powerful tools sufficient to carry out its stabilization policy tasks (Cf.: Mankiw and Weinzierl (2011) https://scholar.harvard.edu/files/mankiw/files/exploration_of_optimal.pdf), so moving away from 2%/year as a target is not necessary. The response is: This leaves begging the questions of why, then, employment has been so low over the past decade, and why production is still so low relative to our circa-2007 expectations.

  2. The problem is not the 2%/year target but rather pressure on the Federal Reserve: pressure from substantial numbers of economists and politicians practicing bad economics and motivated partisan reasoning. (As an example, somebody sent me a video clip this week of the very smart Marvin Goodfriend half a decade ago, arguing that faster recovery required the Fed to hit the economy on the head with a brick to make people more confident in its willingness to fight inflation http://www.bradford-delong.com/2017/06/on-the-negative-information-revealed-by-marvin-goodfriends-i-dont-teach-is-lm.html.) The response is: This ignores the Fed’s long institutional history of being willing to ignore outside pressure as it performs its standard monetary policy task of judging what appropriate interest rates are. Pressure only mattered when we got into “non-standard” monetary policies, which we needed to do only because the low inflation target had caused us to hit the zero lower bound.

  3. At 2%/year, inflation is non-salient: nobody worries about it. A higher inflation rate would bring shifting expectations of inflation back into the mix, distract people and firms from their proper task of calculating real costs and benefits to worry about monetary policy, and make monetary policy management more complicated. The response is: But right now people and firms are “distracted” by the high likelihood of depressions that last longer than five years. That is a much bigger distraction than worrying about whether inflation will be 4%/year of 5%/year. And right now the zero lower bound makes monetary policy management much more complicated than it was back in the 1990s when the impact of Fed policy on inflation expectations was in the mix.

  4. The Federal Reserve needs to maintain its credibility, and if it were to even once change the target inflation rate, its commitment to any target inflation rate would have no credibility. The response is: But the credibility you want to have is credibility that you will follow appropriate policies to successfully stabilize the economy—not credibility that you will mindlessly pursue a destructive policy because you think it somehow wrong to acknowledge that the considerations that led you to adopt it in the first place were wrong or have changed. As my friend Daniel Davies puts it in his One-Minute MBA Course: “Is a credible reputation as an idiot a kind of credible reputation one really wants to have?” http://crookedtimber.org/2006/11/29/reputations-are-made-of/

Over to you, Joe…

Sluggish Future: No Longer Fresh Over at Finance and Development

Posted on by Brad DeLong
Secular Stagnation

Over at Finance and Development: Sluggish Future: You are reading this because of the long, steady decline in nominal and real interest rates on all kinds of safe investments, such as US Treasury securities. The decline has created a world in which, as economist Alvin Hansen put it when he saw a similar situation in 1938, we see “sick recoveries… die in their infancy and depressions… feed on themselves and leave a hard and seemingly immovable core of unemployment…” In other words, a world of secular stagnation. Harvard Professor Kenneth Rogoff thinks this is a passing phase—that nobody will talk about secular stagnation in nine years. Perhaps. But the balance of probabilities is the other way. Financial markets do not expect this problem to go away for at least a generation… Read MOAR at Finance and Development

My Draft: You are reading this right now because of the long, steady decline in safe interest rates at all maturities since 1990.(1)

In the United States, we have seen declines in short-term safe interest rates from 4% to -1.2% on the real side and from 8% to 0.5% on the nominal side. And we have seen the decline in long-term safe interest rates from 5% to 1% on the real side, and from 9% to 3% on the nominal side. The elusive Wicksellian “neutral” rate of interest—that rate at which planned investment equals desired full-employment savings—has fallen by more: the economy in 1990 had no pronounced tendency to fall short of full employment; the economy today has.

An economy suffers from “secular stagnation” when the average level of safe nominal interest rates is low and so crashes the economy into the zero lower bound with frequency. Thus, in the words of Alvin Hansen (1939): “sick recoveries… die in their infancy and depressions… feed on themselves and leave a hard and seemingly immovable core of unemployment…”(2)

Financial markets, at least, do not expect this problem to go away for at least as generation. That makes, as I have written, this current policy debate “the most important policy-relevant debate in economics since John Maynard Keynes’s debate with himself in the 1930s…”

I have heard eight different possible causes advanced for this secular fall in safe interest rates:

  1. High income inequality, which boosts savings too much because the rich can’t think of other things they’d rather do with their money.
  2. Technological and demographic stagnation that lowers the return on investment and pushes desired investment spending down too far.
  3. Non-market actors whose strong demand for safe, liquid assets is driven not by assessments of market risk and return but rather by political factors or by political risk.
  4. A collapse or risk-bearing capacity as a broken financial sector finds itself overleveraged and failing to mobilize savings, thus driving a large wedge between the returns on risky investments and the returns on safe government debt.
  5. Very low actual and expected inflation, which means that even a zero safe nominal rate of interest is too high to balance desired investment and planned savings at full employment.
  6. Limits on the demand for investment goods coupled with rapid declines in the prices of those goods, which together put too much downward pressure on the potential profitability of the investment-goods sector.
  7. Technological inappropriateness, in which markets cannot figure out how to properly reward those who invest in new technologies even when the technologies have enormous social returns—which in turn lowers the private rate of return on investment and pushes desired investment spending down too far.
  8. Increased technology- and rent seeking-driven obstacles to competition which make investment unprofitable for entrants and market-cannibalizing for incumbents.

The first of these was John A. Hobson’s explanation a century ago for the economic distress that had led to the rise of imperialism.(3) The second was, of course, Hansen’s, echoed today by Robert Gordon.(4) The third is Ben Bernanke’s global savings glut.(5) The fourth is Ken Rogoff’s debt-supercycle.(6)

The fifth notes that, while safe real interest rates are higher than they were in the 1980s and 1990s, that is not the case for the 1960s and 1970s. It thus attributes the problem to central banks’ inability to generate the boost from expected and actual inflation a full-employment flex-price economy would generate naturally.(7)

(6), (7), and (8) have always seemed to me to be equally plausible as potential additional factors. But the lack of communication between industrial organization and monetary economics has deprived them of scrutiny. While Gordon, Bernanke, Rogoff, Krugman, and many others have covered (1) through (5), (6), (7), and (8) remain undertheorized.

In general, economists have focused on a single individual one of these causes, and either advocated policies to cure it at its roots or waiting until the evolution of the market and the polity removes it. By contrast, Lawrence Summers(8) has focused on the common outcome. And if one seeks not to cure a single root cause but rather to neutralize and palliate the deleterious macroeconomic effects of a number of causes working together, one is driven—as Larry has been—back to John Maynard Keynes (1936)(9):

A somewhat comprehensive socialisation of investment… [seems] the only means of securing an approximation to full employment… not exclud[ing] all manner of compromises and of devices by which public authority will cooperate with private initiative…

Summers has, I think, a very strong case here. Ken Rogoff likes to say that nine years from now nobody will be talking about secular stagnation.

Perhaps.

But if that is so, it will most likely be so because we will have done something about it.

 

Notes:

(1) For considerably overlapping and much extended versions of this argument, see J. Bradford DeLong (2016): Three, Four… Many Secular Stagnations! http://www.bradford-delong.com/2017/01/three-four-many-secular-stagnations.html; (2015): The Scary Debate Over Secular Stagnation: Hiccup… or Endgame? Milken Review http://tinyurl.com/dl20170106m

(2) Alvin Hansen (1939): Economic Progress and Declining Population Growth American Economic Review https://www.jstor.org/stable/1806983

(3) John A. Hobson (1902): Imperialism: A Study (New York: James Pott) http://files.libertyfund.org/files/127/0052_Bk.pdf

(4) Robert Gordon (2016): The Rise and Fall of American Growth http://amzn.to/2iVbYKm

(5) Ben Bernanke (2005): The Global Saving Glut and the U.S. Current Account Deficit http://www.federalreserve.gov/boarddocs/speeches/2005/200503102/

(6) Kenneth Rogoff (2015): Debt Supercycle, Not Secular Stagnation http://www.voxeu.org/article/debt-supercycle-not-secular-stagnation

(7) Paul Krugman (1998): The Return of Depression Economics http://tinyurl.com/dl20170106r

(8) Lawrence Summers (2013): Secular Stagnation http://larrysummers.com/imf-fourteenth-annual-research-conference-in-honor-of-stanley-fischer/ ; https://www.youtube.com/watch?v=KYpVzBbQIX0&ab_channel=JamesDecker; (2014): U.S. Economic Prospects: Secular Stagnation, Hysteresis, and the Zero Lower Bound http://link.springer.com/article/10.1057%2Fbe.2014.13; (2015): Rethinking Secular Stagnation After Seventeen Months http://larrysummers.com/wp-content/uploads/2015/07/IMF_Rethinking-Macro_Down-in-the-Trenches-April-20151.pdf;(2016): The Age of Secular Stagnation http://larrysummers.com/2016/02/17/the-age-of-secular-stagnation/

(9) John Maynard Keynes (1936): The General Theory of Employment, Interest and Money https://www.marxists.org/reference/subject/economics/keynes/general-theory/ch24.htm

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Will Somebody Please Tell Me Again Why the Federal Reserve Has Embarked on a Tightening Cycle?

Posted on by Brad DeLong
Real Gross Domestic Product Growth Personal Consumption Expenditures Excluding Food and Energy Chain Type Price Index FRED St Louis Fed

With 2017Q1 real GDP growth currently forecast at a 1.2% annual rate—down from 2.7% expected last December—it is worth pausing to remember that if that number comes true:

  • 4Q real GDP growth is: 2.0%/year
  • 8Q real GDP growth is: 1.9%/year

Maybe this is an economy in which slow productivity growth is constraining expansion. But if that is the case, where is the inflation? More likely this is the case in which overly-tight fiscal and monetary policy are constraining an economy that still has some significant amount of macroeconomic slack in it…

Plus: this is what you would expect from a central bank that regards 2.0%/year core PCE inflation as a ceiling not to be crossed, rather than as a central-tendency target…

Sluggish Future: Over at Finance and Development

Posted on by Brad DeLong

Over at Finance and Development: Sluggish Future: You are reading this because of the long, steady decline in nominal and real interest rates on all kinds of safe investments, such as US Treasury securities. The decline has created a world in which, as economist Alvin Hansen put it when he saw a similar situation in 1938, we see “sick recoveries… die in their infancy and depressions… feed on themselves and leave a hard and seemingly immovable core of unemployment…” In other words, a world of secular stagnation. Harvard Professor Kenneth Rogoff thinks this is a passing phase—that nobody will talk about secular stagnation in nine years. Perhaps. But the balance of probabilities is the other way. Financial markets do not expect this problem to go away for at least a generation… Read MOAR at Finance and Development

Helicopter Money: When Zero Just Isn’t Low Enough: Milken Review

Posted on by Brad DeLong

At Milken Review: Helicopter Money: When Zero Just Isn’t Low Enough: If you pay much attention to the chattering classes — those who chatter about economics, anyway — you’ve probably run across the colorful term “helicopter money.” At root, the concept is disarmingly simple. It’s money created at the discretion of the Federal Reserve (or any central bank) that could be used to increase purchasing power in times of recession. But the controversy over helicopter money (formally, money-financed fiscal policy) is hardly straightforward… Read MOAR at Milken Review

More Expansionary FIscal Policy Is Needed: The Only Question Is Whether for a Short-Term Full Employment Attainment or a Medium-Term Full-Employment Maintenance Purpose

Posted on by Brad DeLong

J. Bradford DeLong: On Twitter:

If the Federal Reserve wants to have the ammunition to fight the next recession when it happens, it needs the short-term safe nominal interest rate to be 5% or more when the recession hits. I believe that is very unlikely to happen without substantial fiscal expansion. No, at least in the world that Janet Yellen sees, “fiscal policy is not needed to provide stimulus to get us back to full employment.” But fiscal policy stimulus is needed to create a situation in which full employment can be maintained. It would be a rash economist indeed who would forecast a short-term safe nominal interest rate above 3% when the time for the next loosening cycle arrives:

3 Month Treasury Bill Secondary Market Rate FRED St Louis Fed

Thus if we do not shift to a more expansionary fiscal policy–and the higher neutral rate of interest that it brings–now, what do we envision will happen when the next recession arrives? Do we trust that congress and the president will then understand and react appropriately in a timely fashion and at the right scale to deal with the slump in aggregate demand?

Once again, it would be a very rash economist who would forecast that. An FOMC that does not press strongly for more expansionary fiscal policy now is an FOMC that is adopting a policy that threatens to make life very difficult indeed for their successors between two and six years from now.

And, of course, there is the chance–I see it as a substantial chance–that full employment is attained at a prime-age employment-to-population ratio of not 78% but 80%–or 81.5%. In that case, Janet Yellen is wrong to say that “fiscal policy is not needed to provide stimulus to get us back to full employment.”

Employment Population Ratio 25 54 years FRED St Louis Fed

Central Banks, Neutral Policy, and Economic Structure

Posted on by Brad DeLong

Since 2009 the Federal Reserve and other global north central banks have, first hesitantly and enthusiastically, been trying to sacrifice the health of the commercial banking sector in order to keep the life support machines that are keeping the rest of the economy alive going.

Your average commercial bank needs a 2.5% margin on its liabilities in order to cover the cost of its branches and its ATM network. Commercial banks are used to taking their deposits, sticking them in long term Treasuries and similar assets, and relying on time, diversification, the slope of the yield curve ,and the normal level of interest rates to generate the revenue so that they can earn profits if they manage their branches and ATM networks efficiently. Since 2008 that has not been a profitable strategy for commercial banks. Thus commercial banks have been under enormous pressure for a near-decade now.

It is there, I think, that central banks have been inflicting significant pain. It is not the case that extremely low interest rates on extremely safe assets has been keeping alive businesses that ought to shut down. For small businesses, credit is tight. Equity earnings yields are about normal–a company that is trying to think about whether to expand or payout its earnings is not facing any sort of environment in which there is a cost of capital that is in any sense “artificially low”.

So I do not see the Fed as having given any sort of pass to industry as a whole at all. It has kept the rest of the economy functioning while imposing very heavy pressures on the commercial banking sector. This is not normal. But it is not a bubble…

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

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

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

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

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