Tag: Macroeconomics

Must-Read: Paul Krugman: Germany Austerity Policy

Posted on by Brad DeLong

Must-Read: Paul Krugman: Germany Austerity Policy: “Once the bubble burst, there was going to be a difficult time for the Euro, regardless…

…But it’s been far worse than it needed to be and Germany bears some of the responsibility because of turning what should have been viewed as essentially a technical economic problem into a morality play. That has been a very unfortunate story…. Austerity policies have taken what was fundamentally a story about excessive private capital flows and housing bubbles and turned it into lectures of fiscal responsibility that have ended up doing a lot of damage….

Greece was going to have to do a fair amount of austerity but not this much. In the end it would still have been ugly, but not on this level. What could have mitigated the damage? The thing is that what has actually happened has not worked. Greece is still in the Euro. There’s a little bit of economic growth but at the cost of an incredible slump. The ratio of debt to GDP is higher than ever. All of this austerity has not only not resolved the fiscal problem, it hasn’t even moved it in the right direction…

Must-Read: Paul Krugman: Friedman and the Austrians

Posted on by Brad DeLong

Must-Read: Paul Krugman (2013): Friedman and the Austrians: “Still thinking about the Bloomberg Businessweek interview with Rand Paul…

…in which he nominated Milton Friedman’s corpse for Fed chairman. Before learning that Friedman was dead, Paul did concede that he wasn’t an Austrian. But I’ll bet he had no idea about the extent to which Friedman really, really wasn’t an Austrian. In his ‘Comments on the critics’ (of his Monetary Framework) Friedman described the ‘London School (really Austrian) view’

that the depression was an inevitable result of the prior boom, that it was deepened by the attempts to prevent prices and wages from falling and firms from going bankrupt, that the monetary authorities had brought on the depression by inflationary policies before the crash and had prolonged it by ‘easy money’ policies thereafter; that the only sound policy was to let the depression run its course, bring down money costs, and eliminate weak and unsound firms.

and dubbed this view an ‘atrophied and rigid caricature’ of the quantity theory. [His version of the] Chicago School, he claimed, never believed in such nonsense. I have, incidentally, seen attempts [by Larry White and company] to claim that nobody believed this, or at any rate that Hayek never believed this, and that characterizing Hayek as a liquidationist is some kind of liberal libel. This is really a case of who are you gonna believe, me or your lying eyes. Let’s go to the text (pdf), p. 275:

And, if we pass from the moment of actual crisis to the situation in the following depression, it is still more difficult to see what lasting good effects can come from credit expansion. The thing which is needed to secure healthy conditions is the most speedy and complete adaptation possible of the structure of production to the proportion between the demand for consumers’ goods and the demand for producers’ goods as determined by voluntary saving and spending.

If the proportion as determined by the voluntary decisions of individuals is distorted by the creation of artificial demand, it must mean that part of the available resources is again led into a wrong direction and a definite and lasting adjustment is again postponed. And, even if the absorption of the unemployed resources were to be quickened in this way, it would only mean that the seed would already be sown for new disturbances and new crises. The only way permanently to ‘mobilize’ all available resources is, therefore, not to use artificial stimulants—whether during a crisis or thereafter—but to leave it to time to effect a permanent cure by the slow process of adapting the structure of production to the means available for capital purposes.

And so, at the end of our analysis, we arrive at results which only confirm the old truth that we may perhaps prevent a crisis by checking expansion in time, but that we can do nothing to get out of it before its natural end, once it has come…

If that’s not liquidationism, I’ll eat my structure of production…

http://krugman.blogs.nytimes.com/2013/08/11/friedman-and-the-austrians/?_r=0

Must-Read: Steve Goldstein: Fed’s Lael Brainard Calls for ‘Waiting’ as Labor Market Has Slowed

Posted on by Brad DeLong
Https www federalreserve gov monetarypolicy files fomcprojtabl20151216 pdf

Must-Read: If people on the FOMC had known late last November that the first half of 2016 would be as bad as it is shaping up to be–a GDP growth rate that looks to be 1.7%/year rather than 2.4%/year, and a PCE-chain inflation rate of not 1.6%/year but 0.8%/year–how many of them would have pulled the trigger and gone for an interest rate increase last December?

I confess I do not know why Lael Brainard is saying “there is uncertainty that future data will resolve in the near-term and so we should wait” rather than “if we knew then what we know now we wouldn’t have raised rates in December, and so we should cut”:

Steve Goldstein: Fed’s Lael Brainard Calls for ‘Waiting’ as Labor Market Has Slowed: “Brainard, who’s the first Fed official to speak since the Labor Department…

…reported just 38,000 jobs were added in May, said the central bank should wait for more data on how the economy is performing in the second quarter, as well as a key vote by Britain on whether to leave the European Union. ‘Recognizing the data we have on hand for the second quarter is quite mixed and still limited, and there is important near-term uncertainty, there would appear to be an advantage to waiting until developments provide greater confidence,’ Brainard said at the Council on Foreign Relations. She said she wanted to have a greater confidence in domestic activity, and specifically mentioned the uncertainty around the Brexit vote, as reasons to pause at the next Federal Open Market Committee meeting, which is due to end June 15…

Lack of Demand Creates Lack of Supply; Lack of Proper Knowledge of Past Disasters Creates Present and Future Ones

Posted on by Brad DeLong
FRED Graph FRED St Louis Fed

“We have lost 5 percent of capacity… $800 billion[/year]…. A soft economy casts a substantial shadow forward onto the economy’s future output and potential.” It is now three years later than when Summers and the rest of us did these calculations. If you believe Janet Yellen and Stan Fischer’s claims that we are now effectively at full employment, the permanent loss of productive capacity as a result of the 2007-9 financial crisis, the resulting Lesser Depression, and the subsequent bobbling of the recovery is not 5% now. It is much closer to 10%. And it is quite possibly aiming for 15% before it is over:

Lawrence Summers et al. (2014): Lack of Demand Creates Lack of Supply: “Jean-Baptiste Say, the patron saint of Chicago economists…

…enunciated the doctrine in the 19th century that supply creates its own demand…. If you produce things… you would have to create income… and then the people who got the income would spend the income and so how could you really have a problem[?]… Keynes… explain[ed] that [Say’s Law] was wrong, that in a world where the demand could be for money and for financial assets, there could be a systematic shortfall in demand.

Here’s Inverse Say’s Law: Lack of demand creates, over time, lack of supply…. We are now in the United States in round numbers 10 percent below what we thought the economy’s capacity would be today in 2007. Of that 10 percent, we regard approximately half as being a continuing shortfall relative to the economy’s potential and we regard half as being lost potential…. We have lost 5 percent of capacity… we otherwise would have had…. $800 billion[/year]. It is more than $2,500[/year] for every American…. A soft economy casts a substantial shadow forward onto the economy’s future output and potential. This might have been a theoretical notion some years ago, it is an empirical fact today…

What are we going to do?

Well, we are going to do nothing–or, rather, next to nothing. Life would be convenient for the Federal Reserve if right now (a) the U.S. economy were at full employment, (b) a rapid normalization of interest rates were necessary to avoid inflation rising significantly above the Federal Reserve’s 2%/year PCE chain index inflation target, and (c) U.S. tightening were more likely to stimulate economies abroad via greater opportunities to sell to the U.S. than contract economies abroad by withdrawing risk-bearing capacity. And the Federal Reserve appears to have decided to believe what makes life convenient. Thus nothing additional in the way of action to boost the economy can be expected from monetary policy. And on fiscal policy a dominant or at least a blocking position is held by those who, as the very sharp Olivier Blanchard put it recently, even though:

[1] In the short run, the demand for goods determines the level of output. A desire by people to save more leads to a decrease in demand and, in turn, a decrease in output. Except in exceptional circumstances, the same is true of fiscal consolidation [by governments]…

nevertheless Olivier Blanchard:

was struck by how many times… [he] had to explain the “paradox of saving” and fight the Hoover-German line, [2] “Reduce your budget deficit, keep your house in order, and don’t worry, the economy will be in good shape”…

Apparently he was flabbergasted by the number of people who would agree with [1] in theory and yet also demand that policies be made according to [2], and he plaintively asks for:

anybody who argues along these lines must explain how it is consistent with the IS relation…

Remember: the United States is not that different. As Barry Eichengreen wrote:

It is disturbing to see the refusal of [fiscal] policymakers, particularly in the US and Germany, to even contemplate… action, despite available fiscal space (as record-low treasury-bond yields and virtually every other economic indicator show). In Germany, ideological aversion to budget deficits runs deep… rooted in the post-World War II doctrine of “ordoliberalism”…. Ultimately, hostility to the use of fiscal policy, as with many things German, can be traced to the 1920s, when budget deficits led to hyperinflation. The circumstances today may be entirely different from those in the 1920s, but there is still guilt by association, as every German schoolboy and girl learns at an early age.

The US[‘s]… citizens have been suspicious of federal government power, including the power to run deficits…. From independence through the Civil War, that suspicion was strongest in the American South, where it was rooted in the fear that the federal government might abolish slavery. In the mid-twentieth century… Democratic President Lyndon Baines Johnson’s “Great Society”… threatened to withhold federal funding for health, education, and other state and local programs from jurisdictions that resisted legislative and judicial desegregation orders. The result was to render the South a solid Republican bloc and leave its leaders antagonistic to all exercise of federal power… a hostility that notably included countercyclical macroeconomic policy. Welcome to ordoliberalism, Dixie-style. Wolfgang Schäuble, meet Ted Cruz…

The world very badly needs an article–a long article, 20,000 words or so. It would teach us how we got into this mess, why we failed to get out, and how the situation might still be rectified–so that the Longer Depression of the early 21st century does not dwarf the Great Depression of the 20th century in future historians’ annals of macroeconomic disasters. Such a book would have to assimilate and transmit the lessons of what I think of as the six greatest books on our current ongoing disaster:

Plus it would have to summarize and evaluate Larry Summers’s musings on secular stagnation.

We were lucky that John Maynard Keynes started writing his General Theory summarizing the lessons we needed to learn from the Great Depression even before that depression reached its nadir. But we were not lucky enough. As Eichengreen stresses, only half the lessons of Keynes were assimilated–enough to keep us from repeating the disaster, but not enough to enable us to get out of it. (Although, to be fair, the world of the 1940s emerged from it only at the cost of imbibing the even more poisonous and deadly elixir called World War II.)

Paul? (Krugman, that is.) Are you up to the task?

Must-Read: Timothy B. Lee: The Economy Just Got Its Worst Job Report in Years

Posted on by Brad DeLong

Must-Read: The way to bet is that two-thirds of the surprising component of this month’s employment report will be reversed over the next quarter or so.

Nevertheless: does anybody want to say that the Federal Reserve’s increase in interest rates last December and its subsequent champing-at-the-bit chatter about raising interest rates was prudent in retrospect? Anyone? Anyone? Bueller?

And does anybody want to say–given that the downside risks we are now seeing were in the fan of possibilities as of last December, and given that the Federal Reserve could have quickly reacted to neutralize any inflationary pressures generated by the upside possibilities in the fan last December–that the Federal Reserve’s increase in interest rates last December and its subsequent champing-at-the-bit chatter about raising interest rates was sensible as any form of an optimal-control exercise?

And we haven’t even gotten to the impact of the withdrawal of risk-bearing capacity from the rest of the world that happens in a Federal Reserve tightening cycle…

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Timothy B. Lee: The Economy Just Got Its Worst Job Report in Years: “The US economy created 38,000 jobs in May, the slowest pace of job growth in five years…

…Not only did job growth fall well short of economists’ expectations in May, the Labor Department also revised its estimates for March and April job growth downward by a total of 59,000…. One factor is the strike among Verizon workers, which cost the economy about 34,000 jobs. Those jobs should reappear in future reports…. There’s other bad news…. Over the last six months, the economy had started to reverse a years-long decline in the labor force participation rate…. But the latest report shows the economy has given most of those gains back, with the labor force participation rate falling from 63 percent in March to 62.6 percent in May…

Must-Read: Olivier Blanchard: How to Teach Intermediate Macroeconomics after the Crisis?

Posted on by Brad DeLong

Must-Read: Am I allowed to say that nearly all of this is in Paul Krugman’s 1998 The Return of Depression Economics?

Olivier Blanchard: How to Teach Intermediate Macroeconomics after the Crisis?: “The IS relation remains the key to understanding short-run movements in output…

…In the short run, the demand for goods determines the level of output. A desire by people to save more leads to a decrease in demand and, in turn, a decrease in output. Except in exceptional circumstances, the same is true of fiscal consolidation. I was struck by how many times during the crisis I had to explain the ‘paradox of saving’ and fight the Hoover-German line, ‘Reduce your budget deficit, keep your house in order, and don’t worry, the economy will be in good shape.’ Anybody who argues along these lines must explain how it is consistent with the IS relation. The demand for goods, in turn, depends on the rate at which people and firms can borrow (not the policy rate set by the central bank, more on this below) and on expectations… animal spirits… largely self-fulfilling. Worries about future prospects feed back to decisions today….

The LM relation… is the relic of a time when central banks focused on the money supply…. The LM equation must be replaced, quite simply, by the choice of the policy rate by the central bank, subject to the zero lower bound. How the central bank achieves it… can stay in the background…. Traditionally, the financial system was given short shrift in undergraduate macro texts. The same interest rate appeared in the IS and LM equations…. This is not the case and that things go very wrong. The teaching solution, in my view, is to… discuss how the financial system determines the spread between the two….

Turning to the supply side, the contraption known as the aggregate demand–aggregate supply model should be eliminated…. One simply uses a Phillips Curve…. Output above potential, or unemployment below the natural rate, puts upward pressure on inflation. The nature of the pressure depends on the formation of expectations…. If people expect inflation to be the same as in the recent past, pressure takes the form of an increase in the inflation rate. If people expect inflation to be roughly constant… pressure takes the form of higher—rather than increasing—inflation. What happens to the economy, whether it returns to its historical trend, then depends on how the central bank adjusts the policy rate in response to this inflation pressure…. This… is already standard in more advanced presentations and the new Keynesian model (although the Calvo specification used in that model, as elegant as it is, is arbitrarily constraining and does not do justice to the facts). It is time to integrate it into the undergraduate model…. These modified IS, LM, and PC relations can do a good job….

I consider two extensions… expectations… openness. Here, also, there are important lessons from the crisis…. The long interest rate… as the average of future expected short rates, with a fixed term premium. Quantitative easing… can affect this premium…. Deriv[ing]… exchange rates from the uncovered interest rate parity condition… assumes infinitely elastic capital flows. The crisis has shown… capital flows have finite elasticity and are subject to large shocks beyond movements in domestic and foreign interest rates. Periods of ‘risk on-risk off’ and large movements in capital flows have been an essential characteristic of the crisis and its aftermath…

Must-Read: Olivier Blanchard: Rethinking Macro Policy: Progress or Confusion?: Fiscal Policy

Posted on by Brad DeLong

Must-Read: On this one–views of fiscal policy–put me down not for progress but for “confusion for $2000”, Alex, for on this one I think the very sharp Olivier Blanchard has got it wrong.

Graph 10 Year Treasury Constant Maturity Rate FRED St Louis Fed

The world cannot simultaneously be short of safe assets and yet there also be a correct “large consensus that [government debt] is too large today.” That just does not compute. You can say that the IMF and the exorbitant privilege-possessing reserve-currency issuers are not properly backstopping other governments (quite possibly because other governments are unwilling to allow the conditionality that would make such backstopping prudent). You can say that some countries have too much debt and other countries have too little. But you cannot say that government debt in general is too high when markets are screaming as loud as they can that the liabilities of exorbitant privilege-possessing reserve-currency issuers are the scarcest and most valuable things in the world:

Olivier Blanchard: Rethinking Macro Policy: Progress or Confusion?: Fiscal Policy: “Let me move to a brief discussion of the third pillar, fiscal policy…

…We have learned many things. Fiscal stimulus can help. Public debt can increase very quickly when the economy tanks, but even more so when contingent—explicit or implicit—liabilities become actual liabilities. The effects of fiscal consolidation have led to a flurry of research on multipliers, on whether and when the direct effects of fiscal consolidation can be partly offset by confidence effects, through decreasing worries about debt sustainability. (There has been surprisingly little work or action where I was hoping to see it, namely, on a better design of automatic stabilizers.)… Navigation by sight may be fine for the time being. The issue of what debt ratio to aim for in the long run is not of the essence when there is a large consensus that it is too large today and the adjustment will be slow in any case—although even here, Brad DeLong has provocatively argued that current debt ratios are perhaps too low….

There is no magic debt-to-GDP number. Depending on the distribution of future growth rates and interest rates, on the extent of implicit and explicit contingent liabilities, one country’s high debt may well be sustainable, while another’s low debt may not. Conceptually and analytically, the right tool is a stochastic debt sustainability analysis (something we already use at the IMF when designing programs). The task of translating this into simple, understandable goals remains to be done…

Must-Read: Narayana Kocherlakota: There Goes the Fed’s Credibility

Posted on by Brad DeLong

Must-Read: By now we can no longer understand the Federal Reserve Chair as needing to maintain harmony on a committee that has on it many regional reserve bank presidents who have failed to process the lessons of 2005-2015. By now all the regional bank presidents are people whom the Federal Reserve Board has had an opportunity to veto:

There Goes the Fed s Credibility Bloomberg View

Narayana Kocherlakota: There Goes the Fed’s Credibility: “The Federal Reserve promised to keep its preferred measure of inflation…

…close to 2 percent over the longer run…. Some would say that central banks are out of ammunition…. Actually, though, the Fed has been deliberately tightening monetary policy over the past three years. Just last week, Chair Janet Yellen made a point of saying that the Fed intends to keep raising interest rates in the coming months….

Would it have started pulling back on stimulus in May 2013 if its short-term interest-rate target had been at 5 percent instead of near zero, and if it hadn’t been holding trillions of dollars in bonds? I strongly suspect that the Fed would instead have added stimulus by lowering interest rates…. The Fed’s current course is driven not by the state of the economy, but by a desire to get interest rates and its balance sheet back to what is considered ‘normal.’ Savers, bankers and many politicians agree with this objective…. The Fed, however, promised to focus on actual economic outcomes….

Investors’ doubts [about the Fed] aren’t surprising, given the Fed’s focus on ‘normalizing’ interest rates rather than on hitting its inflation target. Such concerns will create an extra drag on the economy if and when bad times do come. In other words, the Fed’s willingness to renege on its promises seems likely to make the next recession worse than it otherwise would be.

Must-Read: Michael Woodford: Quantitative Easing and Financial Stability

Posted on by Brad DeLong

Must-Read: The extremely sharp Michael Woodford makes the obvious point about quantitative easing and financial stability: by increasing the supply and thus reducing the premium on safe liquid assets, it should–if demand and supply curves slope the normal way–not increase but reduce the risks of the banking sector.

It is very, very nice indeed to see Mike doing the work to demonstrate that I was not stupid when I made this argument in partial equilibrium:

J. Bradford DeLong (January 17, 2014): “Beer Goggles”, Forward Guidance, Quantitative Easing, and the Risks from Expansionary Monetary Policy: When the Federal Reserve undertakes quantitative easing, it enters the market and takes some risk off the table, buying up some of the risky assets issued by the U.S. government and its tame mortgage GSEs and selling safe assets in exchange. The demand curve for risk-bearing capacity seen by the private market thus shifts inward, to the left: a bunch of risky Treasuries and GSEs are no longer out there, as the government is no longer in the business of soaking-up as much of the private-sector’s risk-bearing capacity:

NewImage

And this leftward shift in the net demand to the rest of the market for risk-bearing capacity causes the price of risk to fall, and the quantity of risk-bearing capacity supplied to fall as well. Yes, financial intermediaries that had held Treasuries and thus carried duration risk take some of the cash they received by selling their risky long-term Treasuries to the Fed and go out and buy other risky stuff. But the net effect of quantitative easing is to leave investors and financial intermediaries holding less risky portfolios because they are supplying less risk-bearing capacity…

It is reassuring that I was not stupid–that there is nothing important in general equilibrium that I had missed:

Michael Woodford: Quantitative Easing and Financial Stability: “Conventional interest-rate policy, increases in the central bank’s supply of safe (monetary) liabilities, and macroprudential policy…

…are logically independent dimensions of variation in policy… [that] jointly determine financial conditions, aggregate demand, and the severity of the risks associated with a funding crisis in the banking sector…. If one thinks that the [risk] premia that exist when market pricing is not “distorted” by the central bank’s intervention provide an important signal of the degree of risk that exists in the marketplace, one might fear that central-bank actions that suppress this signal–not by actually reducing the underlying risks, but only by preventing them from being reflected so fully in market prices–run the danger of distorting perceptions of risk in a way that will encourage excessive risk-taking. The present paper… argues… that the concerns just raised are of little merit….

Quantitative easing policies can indeed effectively relax financial conditions…. Risks to financial stability are an appropriate concern of monetary policy deliberations…. Nonetheless… quantitative easing policies should not increase risks to financial stability, and should instead tend to reduce them…. Investors are attracted to the short-term safe liabilities created by banks or other financial intermediaries because assets with a value that is completely certain are more widely accepted as a means of payment. If an insufficient quantity of such safe assets are supplied by the government (through means that we discuss further below), investors will pay a “money premium” for privately-issued short-term safe instruments with this feature, as documented by Greenwood et al. (2010), Krishnamurthy and Vissing-Jorgensen (2012), and Carlson et al. (2014). This provides banks with an incentive to obtain a larger fraction of their financing in this way… choose an excessive amount of this kind of financing… because each individual bank fails to internalize the effects of their collective financing decisions on the degree to which asset prices will be depressed in the event of a “fire sale.” This gives rise to a pecuniary externality, as a result of which excessive risk is taken in equilibrium (Lorenzoni, 2008; Jeanne and Korinek, 2010; Stein, 2012)….

Cut[ting] short-term nominal interest rates in response to an aggregate demand shortfall can arguably exacerbate this problem, as low market yields on short-term safe instruments will further increase the incentive for private issuance of liabilities of this kind (Adrian and Shin, 2010; Giavazzi and Giovannini, 2012)…. Quantitative easing policies lower the equilibrium real yield on longer-term and risky government liabilities, just as a cut in the central bank’s target for the short-term riskless rate will, and this relaxation of financial conditions has a similar expansionary effect on aggregate demand in both cases. Nonetheless, the consequences for financial stability are not the same…. Conventional monetary policy[‘s] reduction in the riskless rate lowers the equilibrium yield on risky assets… [by] provid[ing] an increased incentive for maturity and liquidity transformation on the part of banks…. In the case of quantitative easing, instead, the equilibrium return on risky assets is reduced… through a reduction rather than an increase in the spread…. The idea that quantitative easing policies, when pursued as an additional means of stimulus when the risk-free rate is at the zero lower bound, should increase risks to financial stability because they are analogous to an expansionary policy that relaxes reserve requirements on private issuers of money-like liabilities is also based on a flawed analogy…. In the model presented here, quantitative easing is effective at the zero lower bound… because an increase in the supply of safe assets… reduces the equilibrium “money premium”… [which reduces] banks’ issuance of short-term safe liabilities… so that financial stability risk should if anything be reduced….

[This] paper develops these points in the context of an explicit intertemporal monetary equilibrium model, in which it is possible to clearly trace the general-equilibrium determinants of risk premia, the way in which they are affected by both interest-rate policy and the central bank’s balance sheet, and the consequences for the endogenous capital structure decisions of banks…