Tag: Macroeconomics

Must-read: Adair Turner: “Are Central Banks Really Out of Ammunition?”

Posted on by Brad DeLong

Must-Read: Adair Turner: Are Central Banks Really Out of Ammunition?: “The global economy faces a chronic problem of deficient nominal demand…

…But the debate about which policies could boost demand remains inadequate, evasive, and confused. In Shanghai, the G-20 foreign ministers committed to use all available tools – structural, monetary, and fiscal – to boost growth rates and prevent deflation. But many of the key players are keener to point out what they can’t do than what they can….

Central banks frequently stress the limits of their powers, and bemoan lack of government progress toward ‘structural reform’…. But while some [SR measures] might increase potential growth over the long term, almost none can make any difference in growth or inflation rates over the next 1-3 years…. Vague references to ‘structural reform’ should ideally be banned, with everyone forced to specify which particular reforms they are talking about and the timetable for any benefits that are achieved…. Central bankers are right to stress the limits of what monetary policy alone can achieve…. Negative interest rates, and… yet more quantitative easing… can make little difference to real economic consumption and investment. Negative interest rates… [may have the] the actual and perverse consequence… [of] higher lending rates….

Nominal demand will rise only if governments deploy fiscal policy to reduce taxes or increase public expenditure – thereby, in Milton Friedman’s phrase, putting new demand directly ‘into the income stream.’ But the world is full of governments that feel unable to do this. Japan’s finance ministry is convinced that it must reduce its large fiscal deficit…. Eurozone rules mean that many member countries are committed to reducing their deficits. British Chancellor of the Exchequer George Osborne is also determined to reduce, not increase, his country’s deficit. The standard official mantra has therefore become that countries that still have ‘fiscal space’ should use it. But there are no grounds for believing the most obvious candidates – such as Germany – will actually do anything….

These impasses have fueled growing fear that we are ‘out of ammunition’…. But if our problem is inadequate nominal demand, there is one policy that will always work. If governments run larger fiscal deficits and finance this not with interest-bearing debt but with central-bank money…. The option of so-called ‘helicopter money’ is therefore increasingly discussed. But the debate about it is riddled with confusions.

It is often claimed that monetizing fiscal deficits would commit central banks to keeping interest rates low forever, an approach that is bound to produce excessive inflation. It is simultaneously argued (sometimes even by the same people) that monetary financing would not stimulate demand because people will fear a future ‘inflation tax.’
Both assertions cannot be true; in reality, neither is. Very small money-financed deficits would produce only a minimal impact on nominal demand: very large ones would produce harmfully high inflation. Somewhere in the middle there is an optimal policy…. The one really important political issue is ignored: whether we can design rules and allocate institutional responsibilities to ensure that monetary financing is used only in an appropriately moderate and disciplined fashion, or whether the temptation to use it to excess will prove irresistible. If political irresponsibility is inevitable, we really are out of ammunition that we can use without blowing ourselves up. But if, as I believe, the discipline problem can be solved, we need to start formulating the right rules and distribution of responsibilities…

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

Posted on by Brad DeLong

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

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

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

Must-read: Olivier Blanchard et al.: “Reality Check for the Global Economy”

Posted on by Brad DeLong

Olivier Blanchard et al.: Reality Check for the Global Economy: “After five years of disappointing recovery throughout the major economies…

…almost everyone is ready to believe the worst. The widespread large declines in global asset prices indicate a significant divergence between what financial markets fear and what most mainstream macroeconomic forecasts are showing for the world economy. Having some clarity to distinguish between the more solid underlying economic outlook and the shadows thrown by financial puppetry is critical to avoid an unnecessary recession.

In this Briefing, a group of PIIE scholars came together to provide a reality check for the global economy. They set out what is known, both about macroeconomic dynamics and policy capabilities, in a context where distrust of both mainstream economic analysis and policymakers’ credibility has become excessive. Global economic fundamentals today are not so grim, though there is room for improvement in key areas including China, the United States, European banks, Brazil and Latin America, oil markets, global trade, and monetary policy options.

In particular, we argue: The relative forecasting ability of financial markets for the real economy has probably gone down postcrisis (Adam S. Posen). The US economy remains at a relatively low, though slightly elevated, risk of recession (David Stockton). The positive effects of the decline in the price of oil on the US economy have taken longer to materialize than was expected, but they will strengthen looking forward (Olivier Blanchard and Julien Acalin). Chinese economic growth is, at a minimum, well above current fear-driven estimates, and that growth is predominantly service sector–based and therefore sustainable (Nicholas Lardy). The slowdown in growth of global trade reflects weak global investment and a medium-term adjustment to the past creation of global supply chains and is not a harbinger of further contraction (Caroline Freund). The European banking system is in transition to a stronger state, and the problems evident in Italy are not enough to throw Europe’s economy off course (Nicolas Véron). Brazil’s economy while dysfunctional is far more likely to experience years of higher inflation than any overt fiscal or balance of payments crisis (Monica de Bolle). Latin America more generally has run into problems of slow productivity growth but is not doomed by the commodity cycle (José De Gregorio). Monetary policy remains potent, with multiple possible avenues for additional stimulus if needed, starting with effective quantitative easing on private assets (Joseph Gagnon).

Must-read: John Plender: Uncertainty Principles: ‘The End of Alchemy’, by Mervyn King

Posted on by Brad DeLong

Must-Read: John Plender: : “King’s hugely ambitious aim in his book is to put an end to the alchemy…

…that has made financial crises a permanent feature of the landscape and allowed money — a public good — to become the byproduct of credit creation by private-sector banks. Above all, he argues that the crisis of 2007-09 reflected not just a failure of individuals or institutions, but a failure of the ideas that underpin current economic policymaking…. King argues that in a world of what economists now call ‘radical uncertainty’… there is simply no way of identifying the probabilities of all future events and no set of economist’s equations that describe people’s attempts to cope with that uncertainty…. In King’s terms, the coping strategy of households, businesses and investors involved adopting a narrative of stability while the level of spending ran at unsustainably high levels….

Western consumers’ urge to spend was not strong enough to offset the greater urge of northern Europeans and Asians to save, [so] global interest rates fell. Banks then satisfied investors’ desperate search for income by creating increasingly complex and risky financial products…. Bank balance sheets grew explosively…. The financial crisis changed the narrative. In King’s estimation, policymakers were right to adopt a Keynesian stimulatory response in 2008-9…. They averted a repetition of the Great Depression but, in doing so, created what King calls a paradox of policy. Interest rates today, he says, are too high to permit rapid growth of demand in the short run but too low to be consistent with a proper balance between spending and saving in the long run….

King argues that Bagehot’s famous dictum on central bank crisis management — lend freely on good collateral at penalty rates — is out of date because bank balance sheets today are much larger and have fewer liquid assets than in the 19th century. Central banks are thus condemned in a crisis to take bad collateral in the shape of risky, illiquid assets on which they will lend only a proportion of the value, known as a haircut…. King suggests this lender of last resort role should be replaced by what he calls, with a pleasing irreverence towards central banking mystique, a pawnbroker for all seasons…. Banks would decide how much of their asset base to lodge in advance at the central bank to be available for use as collateral. For each asset, the central bank would calculate a haircut…. The system would displace what King regards as a flawed risk-weighted capital regime ill-suited to addressing radical uncertainty…

Must-read: Simon Wren-Lewis: “The ‘Strong Case’ Critically Examined”

Posted on by Brad DeLong

Simon Wren-Lewis: The ‘Strong Case’ Critically Examined: “The deficit obsession that governments have shown since 2010…

… has helped produce a recovery that has been far too slow, even in the US. It would be nice if we could treat that obsession as some kind of aberration… but unfortunately that looks way too optimistic. The Zero Lower Bound (ZLB) raises an acute problem for… the consensus assignment… [of] leaving macroeconomic stabilisation to an independent, inflation targeting central bank) [and when you] add in [fiscal] austerity… you get major macroeconomic costs. ICBs appear to rule out the one policy (money financed fiscal expansion) that could combat both the ZLB and deficit obsession….

Many macroeconomists do see the problem, but the solutions they propose are often just workarounds… [q]uantitative Easing… NGDP targets… a higher inflation target… mean that in response to a sharp enough recession, we would still regret no longer having the possibility of undertaking a money-financed fiscal stimulus.

I also think there is a grain of truth in the argument that ICBs created an environment where deficit obsession became easier…. Ask the following question: in the absence of ICBs, would our deficit obsessed governments actually have undertaken a money financed fiscal stimulus? To answer that you have to ask why they are deficit obsessed. If it is out of ignorance (my Swabian syndrome), then another piece of macro nonsense that ranks alongside deficit obsession is the evil of printing money in any circumstances. I suspect a patient suffering Swabian syndrome would also be subject to this fallacy. If the reason is strategic (the desire for a smaller state) the answer is obviously no. We would simply be told it could not be done because it would open the inflation floodgates.

Must-read: Simon-Wren Lewis: “The Strong Case Against Independent Central Banks”

Posted on by Brad DeLong

Must-Read: Simon Wren-Lewis: The Strong Case Against Independent Central Banks: “In the post war decades there was a consensus…

…that achieving an adequate level of aggregate demand and controlling inflation were key priorities for governments. That meant governments had to be familiar with Keynesian economics…. A story some people tell is that this all fell apart in the 1970s with stagflation. In the sense I have defined it, that is wrong. The Keynesian framework had to be modified… but it was modified successfully. Attempts by New Classical economists to supplant Keynesian thinking in policy circles failed…. The more important change was the end of Bretton Woods and the move to floating exchange rates. That was critical… allowed the creation of what I have called the consensus assignment. Demand management should be exclusively assigned to monetary policy, operated by ICBs pursuing inflation targets, and fiscal policy should focus on avoiding deficit bias. The Great Moderation appeared to vindicate this consensus.

However the consensus assignment had an Achilles Heel… the Zero Lower Bound…. Although many macroeconomists were concerned about this, their concern was muted because fiscal action always remained as a backup. To most of them, the idea that governments would not use that backup was inconceivable…. That turned out to be naive. What governments and the media remembered was that they had delegated the job of looking after the economy to the central bank, and that instead the focus of governments should be on the deficit….

Macroeconomists were also naive about central banks. They might have assumed that once interest rates hit the ZLB, these institutions would immediately and very publicly turn to governments and say we have done all we can and now it is your turn. But for various reasons they did not. Central banks had helped create the consensus assignment, and had become too attached to it to admit it had an Achilles Heel….

Economists knew that the government could always get the economy out of a demand deficient recession, even if it had a short term concern about debt. The fail safe tool to do this was a money financed fiscal expansion. This fiscal stimulus paid for by the creation of money was why the Great Depression could never happen again. But the existence of ICBs made money financed fiscal expansions impossible when you had debt-obsessed governments, because neither the government nor the central bank could create money for governments to spend or give away…

Must-read: David M. Byrne et al.: “Does the United States Have a Productivity Slowdown or a Measurement Problem?”

Posted on by Brad DeLong

Must-Read: Is it really credible that the rapid growth in potential output over 1995-2004 was 90+% an “anomaly… upward shift in the level of productivity rather than… thanks to the Internet, the reorganization of distribution sectors, and the like…” and 10-% a supply-side consequence of a high-pressure economy? Surely the coincidence of sustained high demand relative to current potential in this one single decade of the past four and rapid potential output growth create a strong and unrebutted presumption that the split is 50%-50% or 70%-30% and not 95%-5%?

David M. Byrne et al.: Does the United States Have a Productivity Slowdown or a Measurement Problem?: “After 2004, measured growth in labor productivity and total-factor productivity (TFP) slowed…

…We find little evidence that the slowdown arises from growing mismeasurement of the gains from innovation in IT-related goods and services…. Underlying macroeconomic trends–not mismeasurement of IT-related innovations — are responsible for the slowdown in U.S. labor productivity and total factor productivity (TFP) since the early 2000s…. Because the slowdown predated the Great Recession, and growth was similar in the 1970s and 1980s to what it’s been since 2004, it was the fast-growth of 1995-2004 period that was the anomaly — a one-time upward shift in the level of productivity rather than a permanent increase in its growth rate – thanks to the Internet, the reorganization of distribution sectors, and the like. ‘Looking forward, we could get another wave of the IT revolution. Indeed, it is difficult to say with certainty what gains may yet come from cloud computing, the internet of things and the radical increase in mobility represented by smartphones,’ they write. Still, those hypothetical benefits have not appeared yet.

I also confess to being annoyed by:

Second, many of the tremendous consumer benefits from smartphones, Google searches, and Facebook are, conceptually, non-market: Consumers are more productive in using their nonmarket time to produce services they value. These benefits do not mean that market-sector production functions are shifting out more rapidly than measured, even if consumer welfare is rising…

Isn’t “measuring consumer welfare” the point? We (a) arrange atoms (b) in forms we find pleasing and convenient, and then use them in combination with (c) information and (d) communication to accomplish our purposes. That our measures of economic growth are overwhelmingly “market” measures that capture the value of (a), much of the value of (b), and little of the value of (c) and (d) is an indictment of those measures, and not an excuse for laziness by shrugging them off as “non-market” and claiming that measuring the shifting-out of market-sector production functions is our proper business.

What is the economy’s speed limit?

Posted on by Brad DeLong

More on the very-sharp Ryan Cooper’s gotten one mostly wrong…

The two questions are (a) how much higher could expansionary fiscal and cooperative monetary policy permanently push annual GDP up above its current trend without triggering massive inflation, and (b) how large would the expansionary policies have to be to push the economy up that far? My guesses are 5% to (a)–that we could permanently raise annual GDP $800 billion relative to our current trajectory without triggering an upward spiral in inflation–and that we would need $300 billion more of annual government purchases. to get us there to (b).

Ryan Cooper:

Ryan Cooper: Who’s Afraid of John Maynard Keynes?: “Does the economy have room to grow?…

…Could we create many more jobs and wealth if we really tried, or have we reached the limits of what we can produce? This… is at the heart of a recent dispute among academic economists… nominally centered on Bernie Sanders’ economic plan, but also illustrates a major fault line in the practice of theoretical economics today…. [Gerald] Friedman… assumed a model in which Sanders’ huge stimulus would push the economy up to full capacity (meaning full employment and maximum output), after which it would stay permanently at a higher level…. However, the key assumption behind the mainstream model is that an economy always tends towards full employment…. [But] even by conservative assumptions we are still something like $500 billion under total economic capacity, productivity has been consistently very weak, and there is absolutely nothing on the horizon that looks like it will return us to the level of employment we had in 2007, let alone 1999…. What’s more, a Friedman-style model in which a stimulus delivered to a depressed economy returns it to full capacity, after which it stays there, is not ridiculous…

Let’s start with one of my favorite workhorse graphs:

Playfair equitable graphs

Starting in 2006 residential construction fell to the very bottom of the chart, and it has stayed there: more than 1.5%-points of GDP below its 2007-peak share of potential GDP. Starting in 2008 business investment fell to the very bottom of the chart, and then took a long tine to recover from its nadir of 2.5%-points below its 2007-peak share of potential GDP. Between 2007 and, say, the end of this year the cumulative shortfall has been some 18%-point years of residential construction not undertaken, and some 8%-point years of business investment not undertaken.

In a world with a capital-output ratio of 3 and a capital share of income of 30%, that shortfall would generate (under somewhat heroic analytical assumptions) a reduction of some 2.6%-points of GDP in the cumulative growth of potential output relative to what it would otherwise have been. That is the damage done to growth in America’s long-run economic potential from the investment shortfall since 2007. And then there is the equal or larger reduction in the growth in America’s long-run economic potential from the labor shortfall–workers not trained, workers not gaining experience, the breaking of ties to people who might hire you or might know of people who might higher you. Add up those two, and I get a 6%-point reduction in what our productive potential is relative to the pre-2008 trend. Thus 6%-points of the current gap between production now and the pre-2008 trend has been lost to the years that the locust hath eaten. And 5%-points remains as a gap that could quickly be closed by expansionary fiscal policy.

And we should close that gap. But a mere $140 billion or so of increased government spending is very unlikely to get us there. That would require a multiplier of nearly six–that only 17.5% of dollars earned as income from higher government spending leak out of the flow of spending on domestically-produced commodities either as savings or as spending on imports. And we know that it’s more like 33%-40% of dollars that so leak. That gives us a multiplier of 2.5-3. And that gives me my desire to see $300 billion more of government purchases.

What if we don’t get that extra spending? Well, perhaps we will get a residential construction boom to return us to economic potential. But don’t bet on it. Perhaps we will get an export boom to return us to economic potential. But don’t bet on it. Perhaps businesses will become wildly more optimistic about the future and a business investment boom will return us to economic potential. But don’t bet on it. Perhaps consumers will decide–after just living through 2007-2016–that they have not borrowed enough, and go on a spending spree to run their debts up further. But don’t bet on it.

No, if we don’t take active steps to boost spending, what will happen is not that economic growth will accelerate to return us to an economic potential that is itself growing at 2+%/year. What will happen is that low investment and underemployment will continue to do damage to the growth of potential and our economic potential will grow at 2-%/year until actual output is once again at potential output. But that will not be because actual has sped up its growth to catch up to potential. It will be because potential has slowed down to fall back to actual.

And the claim that in the long run (in which we are all dead) the economy’s actual level of output converges to potential? Four things can cause this to happen:

  1. Potential can slow.
  2. Something–a spending boom by somebody–can boost actual.
  3. Deflation can lead to lower interest rates as deflation carries with it a decline in the intensity of demand for a stable nominal stock of money. But in the modern world we certainly do not have inflation. We double-certainly do not have central banks that keep the nominal stock of money stable. And we triple-certainly have no room for interest rates to fall further
  4. The gap between potential and actual production can lead the central bank to lower interest rates. That cannot happen. It could lead the central bank to resort to additional extraordinary stimulative measures. But that is not going to happen either.

You may ask: Why can’t we recover more than 5%-points of the 11%-point gap between current production and what we thought back in 2007 was our trend growth destiny? If a low-pressure economy can reduce potential, why won’t a high-pressure economy increase potential? The key is easily recover. Easily. When a lack of markets or a lack of financing keeps investments that had obvious payoffs from being made, the costs are large. When a boom encourages investments to be made that look profitable only as long as the boom and the exuberance that accompanies it lasts, the long-run benefits are smaller. We as a country did benefit from MCI-WorldCom’s investments in the fiber-optic backbone in 1998-2000. But we did not benefit by nearly as much as MCI-WorldCom was calculating in its irrational exuberance bordering on fraud.

I would love to be wrong. I would love to discover that a high-pressure economy with spending more than halfway back to the pre-2008 trend would be consistent with relatively-stable inflation and with rapid-enough growth of economic potential to quickly catch us back up to that trend. But I don’t expect that that would be the case.

Must-read: Ryan Cooper: “Who’s Afraid of John Maynard Keynes?”

Posted on by Brad DeLong

Must-Read: I think the very-sharp Ryan Cooper has gotten this mostly wrong. The two questions are (a) how much higher could expansionary fiscal and cooperative monetary policy permanently push annual GDP up above its current trend without triggering massive inflation, and (b) how large would the expansionary policies have to be to push the economy up that far? My guesses are 5% to (a)–that we could permanently raise annual GDP $800B relative to our current trajectory without triggering an upward spiral in inflation–and that we would need $300B more of annual government spending to get us there:

Ryan Cooper: Who’s Afraid of John Maynard Keynes?: “Does the economy have room to grow?…

…Could we create many more jobs and wealth if we really tried, or have we reached the limits of what we can produce? This… is at the heart of a recent dispute among academic economists… nominally centered on Bernie Sanders’ economic plan, but also illustrates a major fault line in the practice of theoretical economics today…. [Gerald] Friedman… assumed a model in which Sanders’ huge stimulus would push the economy up to full capacity (meaning full employment and maximum output), after which it would stay permanently at a higher level…. However, the key assumption behind the mainstream model is that an economy always tends towards full employment…. [But] even by conservative assumptions we are still something like $500 billion under total economic capacity, productivity has been consistently very weak, and there is absolutely nothing on the horizon that looks like it will return us to the level of employment we had in 2007, let alone 1999…. What’s more, a Friedman-style model in which a stimulus delivered to a depressed economy returns it to full capacity, after which it stays there, is not ridiculous…

Must-read: Simon Wren-Lewis: “Understanding the Austerity Obsession”

Posted on by Brad DeLong

Must-Read: Simon Wren-Lewis: Understanding the Austerity Obsession: “The diagnosis in the case of the Republican party in the US is reasonably clear…

…The main economic goal is to cut taxes, particularly for the very rich. That requires, sooner or later, less public spending. What about evidence that more public investment would help everyone?… This group suffers from the delusion that the only way to help the economy is to tax the rich less and starve the beast that is the state… infect[ion] by the neoliberal ideology virus….

Germany… is much more difficult to diagnose… Swabian syndrome: a belief that the economy is just like a household, and the imperative is to balance the books. This seems like a case of labelling rather than explaining a disease. There may be an allergy involved: an aversion to Keynesian economics, and anything that sounds vaguely Keynesian. But the microeconomic case for additional public investment in Germany is also strong… the German public capital stock has been shrinking for over a decade…. The nature of the illness in Germany is therefore more of a mystery….

The Conservative Party in the UK also seem to have the symptoms associated with Swabian syndrome…. Some… argue that in reality the party are feigning the symptoms as a means of winning elections, while still others claim that tests have revealed clear traces of the ideology virus. What has become clear is that the traditional way of treating the austerity obsession, which involves occasional counselling with well trained economists, is having little effect. We also now know that the financial crisis shock treatment only makes the neoliberal virus more virulent. Extended therapy is the only known cure for this virus. As for Swabian syndrome, our best hope may be that the public gradually develop an immunity to the disease as its consequences become clear.