Tag: Macroeconomics

Notes on the global economy as of early April 2016

Posted on by Brad DeLong

A Note on the Likelihood of Recession: With global inflation currently more than quiescent, there is no chance that global recovery will be—as Rudi Dornbusch used to say—assassinated by inflation-fighting central banks raising interest rates.

As for recovery being assassinated by financial chaos, we face a paradox here: Financial risks that policymakers and economists can see are those that bankers can see and hedge against as well. It is only the financial risks that policymakers and economists do not see that are truly dangerous. Many back in 2005 saw the global imbalance of China’s export surplus and feared disaster from a fall in the dollar coupled with the discovery of money-center institutions having sold massive amounts of unhedged dollar puts. Very few, if any–even among those who believed US housing was a massive bubble likely to pop—feared that any problems created thereby would not be rapidly handled and neutralized by the Federal Reserve.

The most likely danger of recession is thus absent, and the second most likely danger is unknowable.

That leaves the third: a global economy that drifts into a downturn because both fiscal and monetary policymakers sit on their hands and refuse to use the stimulative demand management tools they have.

Here there is, I think, some reason to fear. A passage from a recent speech by the nearly-godlike Stan Fischer was flagged to me by Tim Duy:

If the recent financial market developments lead to a sustained tightening of financial conditions, they could signal a slowing in the global economy that could affect growth and inflation in the United States. But we have seen similar periods of volatility in recent years–including in the second half of 2011–that have left little visible imprint on the economy, and it is still early to judge the ramifications of the increased market volatility of the first seven weeks of 2016. As Chair Yellen said in her testimony to the Congress two weeks ago, while “global financial developments could produce a slowing in the economy, I think we want to be careful not to jump to a premature conclusion about what is in store for the U.S. economy”…

And Tim commented:

This… again misses the Fed’s response to financial turmoil…. I really do not understand how Fed officials can continue to dismiss market turmoil using comparisons to past episodes when those episodes triggered a monetary policy response. They don’t quite seem to understand the endogeneity in the system…

However, anything that could be called a “global recession” in the near term still looks like a less than 20% chance to me. But that is up from a 5% chance nine months ago.

A Note on China: I do not understand China. And I know I do not understand China. Perhaps that gives me an advantage in analyzing China, perhaps not. The relevant long-run fundamentals of China seem to me to be two:

  1. Your typical wealthy Chinese plutocrat-political clan seeks in the long run to have perhaps 1/3 of its wealth outside of China as insurance against political risks, and thus seeks an opportunity to export capital from China.
  2. Your typical North Atlantic business or investment group sees returns from further massive investments in China as uncertain and sees political risks as large but as capable of resolution over the next decade, and so will delay investing in China.

That means renminbi weakness as a background trend behind shorter-term financial- and political-business cycles. And that has to shape what the real risks are (large) and opportunities (smaller).

A Note on the Non-Need for a New Plaza Accord: I would say that international monetary affairs in the Global North high now need not an accord but, rather, the right kind of discord.

At my Berkeley office I dwell in the zone of influence of the truly formidable Barry Eichengreen. His strongly, and I believe correctly, argued view is essentially that he set out in Eichengreen and Sachs (1986): that what we need is not an accord but a currency war. Global North blocs—the U.S., Britain, the Eurozone, Japan—leapfrogging each other with aggressive competitive devaluations every four months or so are likely to produce positive monetary spillovers as large as anything that monetary policy could now produce.

But what could monetary policy now produce?

My career analytical nadir was my memo to my Treasury bosses in 1993 that NAFTA was likely to put upward pressure on the peso. My second-worst was my confident prediction at the end of 2008 that within three years North Atlantic nominal demand would be back to its pre-2008 trend. My third has been my prediction that Abenomics would be an obvious and substantial success. That third prediction was based on my reading of the 1930s, in which four aggressive reflationary régime changes—that of Neville Chamberlain as Chancellor of the Exchequer in 1931, that of Takahashi Korekiyo as Finance Minister in 1932, that of Hjalmar Horace Greeley Schacht as Reichsbank President in 1933, and that of Franklin Delano Roosevelt as President in 1933—had been substantial successes. The mixed success of Abenomics thus tells me that my views of what monetary policy tools would work and how well they would work are almost surely wrong, and that I need to rethink.

Thus as far as monetary policy is concerned I am at sea.

With respect to fiscal policy, however, I am much more confident: Blanchard and Leigh (2013) is convincing. DeLong and Summers (2012) is correct. Coordinated North Atlantic fiscal expansion—unless the money is spent in a truly perverse fashion—is highly likely to boost production with North Atlantic-wide multipliers of around 3 and to reduce debt-to-GDP ratios. Whether it will generate enough inflation to be unwelcome hinges on the state of aggregate supply in the North Atlantic. And there we are so far outside the bounds of previous experience that I do not think anyone can or should speak with confidence.

A Note on Negative Interest Rates: Cash should be a very attractive asset vis-a-vis Treasury bonds at any negative or, indeed, slightly positive interest rate. Containers full of durable, storable commodities should be a very attractive asset vis-a-vis cash—and more so vis-a-vis Treasury bonds and even cash at a wider range of interest rates up to nearly the long-term expected rate of inflation. The only way I can understand current strong demand for the interest-bearing securities and, indeed, the cash of reserve currency-issuing sovereigns possessing exorbitant privilege is that 2008-9 and the political reaction thereto has cast the existence of the Bagehot lender-of-last-resort into grave doubt. Thus we not only have East Asian and other sovereigns desperate for reserves to avoid another 1998, we have every major financial institution desperate to avoid another fall of 2008. These economic agents seem to me to be no longer pursuing sensible risk-return optimization strategies. Instead, they seem to seek enough reserves to surmount any possible future crisis so that they can stay in the game and then earn profits whenever normalization and the future come.

As to dysfunctionalities—so far I see no signs of massive malinvestments in physical or organizational capital that will pay large negative societal returns, and I see no taking of extraordinarily risky large positions by too-big-to-fail entities. I feel that dysfunctional asset prices that produce dysfunctional investments and dysfunctional portfolios. But I cannot see what they are…

Must-read: Barry Eichengreen: “The Case for a Grand Bargain”

Posted on by Brad DeLong

Must-Read: Barry Eichengreen: The Case for a Grand Bargain: “What would it take for all this to happen?…

…First, there would have to be a reassertion of non-ideological economic common sense in U.S. and German policy making circles. One doesn’t have to be a Keynesian to believe that record low interest rates in both countries create a once-in-a-lifetime opportunity for infrastructure spending or to acknowledge that there are aspects of public infrastructure in both countries desperately in need of repair.

Second, central banks in countries lacking fiscal space would have to do more. This means not just talking down the exchange rate as a way of enhancing competitiveness but taking steps to encourage domestic spending, for example ramping up domestic [financial] security purchases still further, and ignoring domestic opposition.

Third, emerging markets and Southern European countries would have to make a credible commitment to structural reform. The need is there, quite independent of international coordination. But without this commitment, international coordination is off the table.

Skeptics will say that I am a dreamer for imagining this grand bargain. But the alternative to this dream is an ongoing economic nightmare.

Historical Nonfarm Unemployment Statistics

Posted on by Brad DeLong

An updated graph that Claudia Goldin had me make two and a half decades ago. The nonfarm unemployment rate since 1890:

2016 04 05 Historical Nonfarm Unemployment Estimates numbers

Then it was 1890-1990, now it is 1869-2015, thanks to:

The assumption–debateable–is that “unemployment” is not a farm thing–that in the rural south or in the midwest or on the prairie you can always find a place of some sort as a hired hand, and that “unemployment” is a town- and city-based nonfarm phenomenon.

I confess I do not understand how anyone can look at this series and think that calculating stable and unchanging autocorrelations and innovation variances is a reasonable first-cut thing to do…

Monday Smackdown: Robert Waldmann Marks Brad DeLong’s Beliefs about “The Return of Depression Economics” to Market

Posted on by Brad DeLong

Robert Waldmann: Brad DeLong Marks His Beliefs about “The Return of Depression Economics” to Market: “Brad DeLong…reposted his review of Krugman’s ‘The Return of Depression Economics’ from 1999…

…’Just in case I get a swelled-head and think I am right more often than I am …’ Way back in the last century, Brad thought he had a valid criticism of Paul Krugman’s argument that Japan (and more generally countries in a liquidity trap) need higher expected inflation. I think the re-post is not just admirable as a self criticism session, but also shows us something about the power of Macroeconomic orthodoxy. Brad is just about as unorthodox as an economist can be without being banished from the profession, but even he was more influenced by Milton Friedman and Robert Lucas than he should have been…. Japan had slack aggregate demand at a safe nominal interest rate of 0–that i,s it was in the liquidity trap. Krugman argued that higher expected inflation would cause negative expected real interest rates and higher aggregate demand and solve the problem. Brad was unconvinced (way back then):

But at this point Krugman doesn’t have all the answers. For while the fact of regular, moderate inflation would certainly boost aggregate demand for products made in Japan, the expectation of inflation would cause an adverse shift in aggregate supply: firms and workers would demand higher prices and wages in anticipation of the inflation they expected would occur, and this increase in costs would diminish how much real production and employment would be generated by any particular level of aggregate demand.

Would the benefits on the demand side from the fact of regular moderate inflation outweigh the costs on the supply side of a general expectation that Japan is about to resort to deliberate inflationary finance? Probably. I’m with Krugman on this one. But it is just a guess–it is not my field of expertise–I would want to spend a year examining the macroeconomic structure of the Japanese economy in detail before I would be willing to claim even that my guess was an informed guess.

And there is another problem. Suppose that investors do not see the fact of inflation–suppose that Japan does not adopt inflationary finance–but that a drumbeat of advocates claiming that inflation is necessary causes firms and workers to mark up prices and wages. Then we have the supply-side costs but not the demand-side benefits, and so we are worse off than before.

As Brad now notes, this argument makes no sense. I think it might be hard for people who learned about macro in the age of the liquidity trap to understand what he had in mind. I also think the passage might risk being convincing to people who haven’t read enough Krugman or Keynes. The key problems in the first paragraphs are ‘adverse’ and ‘any particular level of aggregate demand’. Brad assumed that an increase in wage and price demands is an adverse shift. The argument that it is depends on the assumption that he can consider a fixed level of nominal aggregate demand (and yet he didn’t feel the need to put in the word ‘nominal’). The butchered sentence ‘would diminish how much real production and employment would be generated by any particular level of [real] aggregate demand.’ clearly makes no sense.

During the 80s, new Keynesian macroeconomists got into the habit of considering a fixed level of nominal aggregate demand when focusing on aggregate supply. Because it wasn’t the focus, they used the simplest existing model of aggregate demand the rigid quantity theory of money in which nominal aggregate demand is a constant times the money supply (which is assumed to be set by the monetary authority). This means that the aggregate demand curve (price level on the y axis and real gdp on the x axis) slopes down. This in turn means that an upward shift in the aggregate supply curve is an adverse shift.

More generally, the way in which a higher price level causes lower real aggregate demand is by reducing the real value of the money supply, but if the economy is in the liquidity trap the reduction in the real money supply has no effect on aggregate demand. In the case considered by Krugman, the aggregate demand curve is vertical. This means that he can discuss the effect of policy on real GDP without considering the aggregate supply curve. The second paragraph just repeats the assumption that higher expected inflation causes ‘costs’. There are no such costs (at least according to current and then existing theory) if the economy is in a liquidity trap. The third paragraph shows confusion about the cause of the ‘demand side benefits’. They are caused by higher expected inflation not by higher actual inflation. If there were higher expected inflation not followed by higher actual inflation, Japan would enjoy the benefits anyway. Those benefits would outweigh the non-existent costs.

Krugman actually did consider a model of aggregate supply, but it is so simple it is easy to miss. As usual (well as became usual as Krugman did this again and again) the model has two periods–the present and the long run. In the present, it is assumed that wages and prices are fixed. In the long run it is assumed that there is full employment and constant inflation. Krugman’s point is that all of the important differences between old Keynesian models and models with rational forward looking agents can be understood with just two periods and very simple math. The problem is that the math is so simple that it is easy to not notice it is there and to assume that he ignored the supply side.

I am going to be dumb (I am not playing dumb–I just worked through each step) and consider different less elegant models of aggregate supply. The following will be extremely boring and pointless:

  1. Fixed nominal wages, flexible prices and profit maximization (this is Keynes’s implicit model of aggregate supply). In this case, the supply curve gives increasing real output as a function of the price level. An ‘adverse’ shift of this curve would be a shift up. It would not affect real output in the liquidity trap since the aggregate demand curve is vertical. it would not impose any costs as the increased price level would reduce the real money supply from plenty of liquidity to still plenty of liquidity. This model of aggregate supply is no good (it doesn’t fit the facts). It is easy to fear that Krugman implicitly assumed it was valid when in a rush (at least this is easy if one hasn’t been reading Krugman every day for years–he doesn’t do things like that).

  2. A fixed expectations-unaugmented Phillips curve which gives inflation as an increasing function of output. An ‘adverse’ shift of he Phillips curve would imply higher inflation. This would have no costs.

  3. An expectations-augmented Phillips curve in which expected inflation is equal to lagged inflation–output becomes a function of the change in inflation. In a liquidity trap, there would be either accelerating inflation or accelerating deflation. For a fixed money supply accelerating inflation would reduce real balances until the economy would no longer be in a liquidity trap. The simple model would imply the possibility of accelerating deflation and ever decreasing output. This model is no good, because such a catastrophe has never occurred, Japan had constant mild deflation which did not accelerate, even during the great depression the periods of deflation ended.

  4. An expectations augmented Phillips curve with rational expectations–oh hell I’ll just assume perfect foresight. Here both the aggregate demand and aggregate supply curves are vertical. If they are at different levels of output, there is no solution. The result is that a liquidity trap is impossible. This is basically a flexible price model. If there were aggregate demand greater than the fixed aggregate supply, the price level would jump up until the real value of money wasn’t enough to satiate liquidity preference. Krugman assumed that, in the long run, people don’t make systematic forecasting mistakes. So he assumed that the economy can’t stay in the liquidity trap for the long run. Ah yes, his model had everything new classical in the long run (this is the point on which Krugman has marked his beliefs to market).

The argument that Krugman would not have reached his conclusions about the economics of economies in liquidity traps if he had considered the supply side only makes sense if it includes the intermediate step that, if one considers the supply side, one must conclude that economies can never be in liquidity traps. This is no good as Japan was in the liquidity trap as are all developed countries at present.

I think the only promising effort here was (3)–a Phillips curve with autoregressive expectations. The problem is: why hasn’t accelerating deflation ever occurred? Way back in 1999, Krugman clearly thought that the answer was just that we had been lucky so far. He warned of the risk of accelerating deflation. Now he thinks he was wrong. Like Krugman, I think the reason is that there is downward nominal rigidity — that it is very hard to get people to accept a lower nominal wage or sell for a lower price. This depends on the change in the wage or price and not in that change minus expected inflation.

Clearly this rigidity isn’t absolute (Japan has had deflation and there were episodes of deflation in the 30s). But it is possible to get write a model in which unemployment is above the non accelerating inflation rate, but nominal wages aren’t cut. In this case expected inflation remains constant–actual deflation doesn’t occur so expected deflation doesn’t occur. The math can work. See here.

Must-read: Tim Duy: “Yellen Pivots Toward Saving Her Legacy”

Posted on by Brad DeLong

Must-Read: Ever since the Taper Tantrum, it has seemed to me that the center of gravity of the FOMC has not had a… realistic picture of the true forward fan of possible scenarios.

Now Tim Duy sees signs that the center of the FOMC’s distribution is moving closer to mine. Of course, I still do not see the FOMC taking proper account of the asymmetries, but at least their forecast of central tendencies no longer seems as far awry to me as it had between the Taper Tantrum and, well, last month:

Tim Duy: Yellen Pivots Toward Saving Her Legacy: “Janet Yellen… [would] her legacy… amount to being just another central banker…

…who failed miserably in their efforts to raise interest rates back into positive territory[?] The Federal Reserve was set to follow in the footsteps of the Bank of Japan and the Riksbank, seemingly oblivious to their errors. In September… a confident Yellen declared the Fed would be different…. ANN SAPHIR…. “Are you worried… that you may never escape from this zero lower bound situation?” CHAIR YELLEN…. “I would be very surprised if that’s the case. That is not the way I see the outlook or the way the Committee sees the outlook…. That’s an extreme downside risk that in no way is near the center of my outlook.”…

Bottom Line: Rising risks to the outlook placed Yellen’s legacy in danger. If the first rate hike wasn’t a mistake, certainly follow up hikes would be. And there is no room to run; if you want to ‘normalize’ policy, Yellen needs to ensure that rates rise well above zero before the next recession hits. The incoming data suggests that means the economy needs to run hotter for longer if the Fed wants to leave the zero bound behind. Yellen is getting that message. But perhaps more than anything, the risk of deteriorating inflation expectations – the basis for the Fed’s credibility on its inflation target – signaled to Yellen that rates hike need to be put on hold. Continue to watch those survey-based measures; they could be key for the timing of the next rate hike.

Must-read: Narayana Kocherlakota: “Information in Inflation Breakevens about Fed Credibility”

Posted on by Brad DeLong

Must-Read: Whenever I look at a graph like this, I think: “Doesn’t this graph tell me that the last two years were the wrong time to give up sniffing glue the zero interest-rate policy”? Anyone? Anyone? Bueller?

Graph 3 Month Treasury Bill Secondary Market Rate FRED St Louis Fed

And Narayana Kocherlakota agrees, and makes the case:

Narayana Kocherlakota: Information in Inflation Breakevens about Fed Credibility: “The Federal Open Market Committee has been gradually tightening monetary policy since mid-2013…

…Concurrent with the Fed’s actions, five year-five year forward  inflation breakevens have declined by almost a full percentage point since mid-2014.  I’ve been concerned about this decline for some time (as an FOMC member, I dissented from Committee actions in October and December 2014 exactly because of this concern).  In this post, I explain why I see a decline in inflation breakevens as being a very worrisome signal about the FOMC’s credibility (which I define to be investor/public confidence in the Fed’s ability and/or willingness to achieve its mandated objectives over an extended period of time).

First, terminology.   The ten-year breakeven refers to the difference in yields between a standard (nominal) 10-year Treasury and an inflation-protected 10-year Treasury (called TIPS).  Intuitively, this difference in yields is shaped by investors’ beliefs about inflation over the next ten years.  The five-year breakeven is the same thing, except that it’s over five years, rather than 10.  

Then, the five-year five-year forward breakeven is defined to be the difference between the 10-year breakeven and the five-year breakeven.   Intuitively, this difference in yields is shaped by beliefs about inflation over a five year horizon that starts five years from now.   In particular, there is no reason for beliefs about inflation over, say, the next couple years to affect the five-year five-year forward breakeven. 

Conceptually, the five-year five-year forward breakeven can be thought of as the sum of two components:
 
1. investors’ best forecast about what inflation will average 5 to 10 years from now

  1. the inflation risk premium over a horizon five to ten years from now – that is, the extra yield over that horizon that investors demand for bearing the inflation risk embedded in standard Treasuries.
     
    (There’s also a liquidity-premium component, but movements in this component have not been all that important in the past two years.) 

There is often a lot of discussion about how to divide a given change in breakevens in these two components.  My own assessment is that both components have declined.  But my main point will be a decline in either component is a troubling signal about FOMC credibility.  

It is well-understood why a decline in the first component should be seen as problematic for FOMC credibility.  The FOMC has pledged to deliver 2% inflation over the long run.  If investors see this pledge as credible, their best forecast of inflation over five to ten year horizon should also be 2%.   A decline in the first component of breakevens signals a decline in this form of credibility.  

Let me turn then to the inflation-risk premium (which is generally thought to move around a lot more than inflation forecasts). A decline in the inflation risk premium means that investors are demanding less compensation (in terms of yield) for bearing inflation risk. In other words, they increasingly see standard Treasuries as being a better hedge against macroeconomic risks than TIPs.  

But Treasuries are only a better hedge than TIPs against macroeconomic risk if inflation turns out to be low when economic activity turns out to be low.  This observation is why a decline in the inflation risk premium has information about FOMC credibility.  The decline reflects investors’ assigning increasing probability to a scenario in which inflation is low over an extended period at the same time that employment is low – that is, increasing probability to a scenario in which both employment and prices are too low relative to the FOMC’s goals. 

Should we see such a change in investor beliefs since mid-2014 as being ‘crazy’ or ‘irrational’? The FOMC is continuing to tighten monetary policy in the face of marked disinflationary pressures, including those from commodity price declines.  Through these actions, the Committee is communicating an aversion to the use of its primary monetary policy tools: extraordinarily low interest rates and large assetholdings. Isn’t it natural, given this communication, that investors would increasingly put weight on the possibility of an extended period in which prices and employment are too low relative to the FOMC’s goals?

To sum up: we’ve seen a marked decline in the five year-five year forward inflation breakevens since mid-2014.  This decline is likely attributable to a simultaneous fall in investors’ forecasts of future inflation and to a fall in the inflation risk premium.   My main point is that both of these changes suggest that there has been a decline in the FOMC’s credibility.   

To be clear: as I well know, in the world of policymaking, no signal comes without noise.  But the risks for monetary policymakers associated with a slippage in the inflation anchor are considerable.   Given these risks, I do believe that it would be wise for the Committee to be responsive to the ongoing decline in inflation breakevens by reversing course on its current tightening path.

Watching as the Federal Reserve juggles priceless eggs in variable gravity…

Posted on by Brad DeLong

Is it necessary to say that we hold Ben Bernanke, Mervyn King, Mark Carney, Janet Yellen, Stan Fischer, Lael Brainard, and company to the highest of high standards–demand from them constant triple aerial somersaults on the trapeze–because we have the greatest respect for and confidence in them? It probably is…

Back in 1992 Larry Summers and I wrote that pushing the target inflation rate from 5% down to 2% was a very dubious and hazardous enterprise because the zero-lower bound was potentially a big deal: “The relaxation of monetary policy seen over the past three years in the United States would have been arithmetically impossible had inflation and nominal interest rates both been three percentage points lower in 1989. Thus a more vigorous policy of reducing inflation to zero in the mid-1980s might have led to a recent recession much more severe than we have in fact seen…”

This does seem, in retrospect, to have been quite possibly the smartest and most foresightful thing I have ever written. Future historians will, I think, have a very difficult time explaining how the cult of 2%/year inflation targeting got itself established in the 1990s. And they will, I think, have an even harder time explaining why the first monetary policymaker reaction to 2008-2012 was not to endorse Olivier Blanchard et al.’s call for a higher, 4%/year, inflation target in the coded terms of IMF speak:

The great moderation (Gali and Gambetti 2009) lulled macroeconomists and policymakers alike in the belief that we knew how to conduct macroeconomic policy. The crisis clearly forces us to question that assessment….

The crisis has shown that large adverse shocks do happen. Should policymakers aim for a higher target inflation rate in normal times, in order to increase the room for monetary policy to react to such shocks? Are the net costs of inflation much higher at, say, 4% than at 2%, the current target range? Is it more difficult to anchor expectations at 4% than at 2%? Achieving low inflation through central bank independence has been a historic accomplishment. Thus, answering these questions implies carefully revisiting the benefits and costs of inflation.

A related question is whether, when the inflation rate becomes very low, policymakers should err on the side of a more lax monetary policy, so as to minimize the likelihood of deflation, even if this means incurring the risk of higher inflation in the event of an unexpectedly strong pickup in demand. This issue, which was on the mind of the Fed in the early 2000s, is one we must return to…

But instead we got a very different reaction. Sudeep Reddy reported on it back in 2009:

Sudeep Reddy (2009): Sen. Vitter Presents End-of-Term Exam For Bernanke: “Earlier this month, Real Time Economics presented questions from several economists…

…for the confirmation hearing of Federal Reserve Chairman Ben Bernanke…. Sen. David Vitter (R., La.) submitted them in writing and received the responses from Bernanke….

D. Brad Delong, University of California at Berkeley and blogger: Why haven’t you adopted a 3% per year inflation target?

[Bernanke:] The public’s understanding of the Federal Reserve’s commitment to price stability helps to anchor inflation expectations and enhances the effectiveness of monetary policy, thereby contributing to stability in both prices and economic activity. Indeed, the longer-run inflation expectations of households and businesses have remained very stable over recent years. The Federal Reserve has not followed the suggestion of some that it pursue a monetary policy strategy aimed at pushing up longer-run inflation expectations.

In theory, such an approach could reduce real interest rates and so stimulate spending and output. However, that theoretical argument ignores the risk that such a policy could cause the public to lose confidence in the central bank’s willingness to resist further upward shifts in inflation, and so undermine the effectiveness of monetary policy going forward.

The anchoring of inflation expectations is a hard-won success that has been achieved over the course of three decades, and this stability cannot be taken for granted. Therefore, the Federal Reserve’s policy actions as well as its communications have been aimed at keeping inflation expectations firmly anchored.

This sounds like nothing so much as the explanations offered in the 1920s and 1930s for returning to and sticking with the gold standard at pre-WWI parities, and the explanations offered at the start of the 1990s by British Tories for sticking to the fixed parities of the then-Exchange Rate Mechanism. The short answer is that real useful positive credibility is not built by attempts to stick to policies that are in the long run destructive–and hence both incredible and stupid. As we learn more about the economy and as the structure of the economy changes, the optimal long-run policy strategy changes as well. Credibility arising from a commitment that the Federal Reserve will seek to follow an optimal long-run policy framework and to accurately convey its intentions but will revise that framework in light of knowledge and events is worth gaining and maintaining. Credibility arising from a commitment to stick, come hell or high water, to a number that Alan Greenspan essentially pulled out of the air with next to no substantive analytical backing in terms of optimal-control analysis is not.

Now, however, we have another answer from Janet Yellen: that the zero lower bound is not, in fact, such a big deal:

Janet Yellen: The Outlook, Uncertainty, and Monetary Policy: “One must be careful, however, not to overstate the asymmetries affecting monetary policy at the moment…

…Even if the federal funds rate were to return to near zero, the FOMC would still have considerable scope to provide additional accommodation. In particular, we could use the approaches that we and other central banks successfully employed in the wake of the financial crisis to put additional downward pressure on long-term interest rates and so support the economy–specifically, forward guidance about the future path of the federal funds rate and increases in the size or duration of our holdings of long-term securities.10 While these tools may entail some risks and costs that do not apply to the federal funds rate, we used them effectively to strengthen the recovery from the Great Recession, and we would do so again if needed.

Over on the Twitter Machine, the very-sharp Tim Duy–I take it from his picture that there is ample snowpack for the ski resorts in the Cascade Range–is impressed by how different the tone of this speech is with the get-ready-for-liftoff speeches of last fall:

And Dario Perkins and Mark Grady have chimed in in support: “suddenly she’s realised the rest of the world matters!…” and “lots of common messages, but emphasis v[ery] diff[erent] on the risks. And no mention of lags or falling behind the curve at all…”

I, by contrast, am still struck by the gap that remains between where she seems to be and where I am.

For there is a natural next set of questions to ask anyone who says that the zero lower bound and the liquidity trap are not big deals. That set is:

  • Then why isn’t nominal GDP on its pre-2008 trend growth path?

  • Why is the five-year ahead five-year market inflation outlook so pessimistic?

  • Why hasn’t the Federal Reserve pushed interest rates low enough so that investment as a whole counterbalances the collapse in government purchases we have seen since 2010?

Gross Domestic Product FRED St Louis Fed Graph 5 Year 5 Year Forward Inflation Expectation Rate FRED St Louis Fed FRED Graph FRED St Louis Fed

I cannot help but be struck by the difference between what I see as the attitude of the current Federal Reserve, anxious not to do anything to endanger its “credibility”, and the Greenspan Fed of the late 1990s, which assumed that it had credibility and that because it had credibility it was free to experiment with policies that seemed likely to be optimal in the moment precisely because markets understood its long-term objective function and trusted it, and hence would not take short-run policy moves as indicative of long-run policy instability. There is a sense in which credibility is like a gold reserve: It is there to be drawn on and used in emergencies. The gold standard collapsed into the Great Depression in the 1930s in large part because both the Bank of France and the Federal Reserve believed that their gold reserves should never decline, but always either stay stable of increase.

It was Mark Twain who said that although history does not repeat itself, it does rhyme. The extent to which this is true was brought home to me recently by Barry Eichengreen’s excellent Hall of Mirrors…

I tell you, I have a brand new set of lectures to write for a large monetary-policy module in American Economic History…

Must-read: Janet Yellen: “The Outlook, Uncertainty, and Monetary Policy”

Posted on by Brad DeLong

Must-Read: Back in 1992 Larry Summers and I wrote that pushing the target inflation rate from 5% down to 2% was a very dubious and hazardous enterprise because the zero-lower bound was potentially a big deal: “The relaxation of monetary policy seen over the past three years in the United States would have been arithmetically impossible had inflation and nominal interest rates both been three percentage points lower in 1989. Thus a more vigorous policy of reducing inflation to zero in the mid-1980s might have led to a recent recession much more severe than we have in fact seen…”

Now we have an answer from Janet Yellen: that the zero lower bound is not, in fact, such a big deal:

Janet Yellen: The Outlook, Uncertainty, and Monetary Policy: “One must be careful, however, not to overstate the asymmetries affecting monetary policy at the moment…

…Even if the federal funds rate were to return to near zero, the FOMC would still have considerable scope to provide additional accommodation. In particular, we could use the approaches that we and other central banks successfully employed in the wake of the financial crisis to put additional downward pressure on long-term interest rates and so support the economy–specifically, forward guidance about the future path of the federal funds rate and increases in the size or duration of our holdings of long-term securities.10 While these tools may entail some risks and costs that do not apply to the federal funds rate, we used them effectively to strengthen the recovery from the Great Recession, and we would do so again if needed.

The natural next question to ask then is: Then why isn’t nominal GDP on its pre-2008 trend growth path? Why is the five-year ahead five-year market inflation outlook so pessimistic? Why hasn’t the Federal Reserve pushed interest rates low enough so that investment as a whole counterbalances the collapse in government purchases we have seen since 2010?

Gross Domestic Product FRED St Louis Fed Graph 5 Year 5 Year Forward Inflation Expectation Rate FRED St Louis Fed FRED Graph FRED St Louis Fed

Must-read: Macro Advisers: Now-Cast: Personal income and outlays way undershot expectations…

Posted on by Brad DeLong

Must-Read: Macro Advisers: Now-Cast: First-quarter real GDP growth at 1.0%/year:

Https macroadvisers bluematrix com sellside EmailDocViewer encrypt 07856b96 a505 4d8c 9910 fdea16842f37 mime pdf co macroadvisers id jbdelong uclink berkeley edu source mail

They will probably be angry at me for posting this, but it is genuine news: personal income and outlays way undershot expectations, and so they have marked down their estimate for first-quarter 2016 real GDP growth from the 1.9%/year it was five days ago to 1.0%/year now.

Certainly makes last December look like a bad time to stop sniffing glue the zero-interest-rate policy, doesn’t it?