Tag: Macroeconomics

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

Posted on by Brad DeLong

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

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

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

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

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

Larry continues:

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

These arguments do not seem hugely compelling to me.

Indeed not.

Summers concludes:

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

And then comes a sentence I really do not understand:

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

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

What is the reasonable person’s argument here?

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

Posted on by Brad DeLong

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

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

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

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

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

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

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

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

Must-Read Pre-Liftoff Lollapalooza: Lukasz Rachel and Thomas D Smith: Secular Drivers of the Global Real Interest Rate

Posted on by Brad DeLong

Must-Read Pre-Liftoff Lollapalooza: As Larry Summers says, this fits neither Ben Bernanke’s ascription of low real interest rates to a transitory global savings glut caused by the political-insurance preferences of non-return maximizing market actors, nor Ken Rogoff’s belief that it is overwhelmingly the result of overleverage and the need for the unwinding phase of a debt supercycle. The cures proposed are then (i) higher target inflation rates, (ii) higher public debt levels, (iii) more mobilization of risk-bearing capacity in private-sector financial markets, (iv) redistribution, and (v) an international lender of last resort that emerging markets trust.

Lukasz Rachel and Thomas D Smith: Secular Drivers of the Global Real Interest Rate: “Long-term real interest rates across the world have fallen by about 450 basis points over the past 30 years…

…We think we can account for around 400 basis points of the 450 basis points fall… slowing global growth [is] one force… but shifts in saving and investment preferences appear more important… demographic forces, higher inequality and to a lesser extent the glut of precautionary saving by emerging markets. Meanwhile, desired levels of investment have fallen as a result of the falling relative price of capital, lower public investment, and… an increase in the spread between risk-free and actual interest rates. Moreover, most of these forces look set to persist and some may even build further. This suggests that the global neutral rate may remain low and perhaps settle at (or slightly below) 1% in the medium to long run. If true, this will have widespread implications for policymakers — not least in how to manage the business cycle if monetary policy is frequently constrained by the zero lower bound.

Must-Read Pre-Liftoff Lollapalooza: Peter Newcomb (2013): Fed Hawks Worry about Threat of Inflation

Posted on by Brad DeLong

Must-Read Pre-Liftoff Lollapalooza: Peter Newcomb (2013): Fed Hawks Worry about Threat of Inflation: “Two top Federal Reserve policymakers expressed discomfort on Thursday with the U.S. central bank’s easy monetary policy…

…That stance is hardly representative of other influential officials…. Their view was more closely captured by comments from Narayana Kocherlakota, who noted inflation was forecast to remain below the central bank’s 2 percent target for the foreseeable future, even by the Fed’s own estimates. ‘This forecast suggests that, if anything, monetary policy is currently too tight, not too easy,’ he said in remarks in Minneapolis…

Must-Read Pre-Liftoff Lollapalooza: Jeff Spross: Don’t do it, Fed! It’s a trap!

Posted on by Brad DeLong

Must-Read Pre-Liftoff Lollapalooza: How much of the current diversion between the views of Yellen and Summers is due to the drip-drip-drip of banking-sector opinions that have excessive voice in the Eccles Building?

Jeff Spross: Don’t do it, Fed! It’s a trap!: “The first thing is for voters, activists, and politicians to treat monetary policy with the seriousness it deserves…

…One of the greatest failures of Obama’s presidency was failing to staff the Fed, allowing positions on its decision-making board to run vacant for long periods. Had Obama made this a political priority, he could have given doves like Bernanke and Yellen far more clout in the Fed’s internal politics…. Perhaps we should also reform how the Fed does business. Of the 17 members at the top of the Fed, 12 vote on monetary policy. But only seven of them are appointed by the president and the legislature. The rest are drawn from the banks. This should change: All 12 voting members should be answerable to the democratic process.

Must-Read Pre-Liftoff Lollapalooza: Matthew Yglesias: This week, the US government will take action to slow the economy and prevent wage growth

Posted on by Brad DeLong

Must-Read Pre-Liftoff Lollapalooza: Matthew Yglesias: This week, the US government will take action to slow the economy and prevent wage growth: “Imagine President Barack Obama announced a… new tax… [to] raise the price of borrowing money…

…Republicans would, of course, denounce him. Why would the president impose a new job-killing tax at a time when the American people have been suffering from an agonizingly slow labor market recovery and years of flat wages? And then imagine the Democratic reaction when Obama explained that… his only goal with the new tax was precisely to reduce the pace of job growth. To make sure that unemployment didn’t get too low. That workers’ bargaining power didn’t become excessive…. ‘When it comes to inflation,’ the president might say, ‘it’s better safe than sorry. So here’s your new job-killing tax!’…

The Federal Reserve is going to do exactly this by raising interest rates at its meeting next week…. The Federal Reserve is structured as an independent agency precisely on the theory that for the long-term good of the economy we sometimes want the central bank to slow the pace of job creation in order to avoid inflation…. But the weird thing about this week’s push for higher interest rates is that there’s no inflation problem to solve…. There has been literally no inflation at all throughout 2015. If you ignore food and energy prices… inflation… has still been below the Fed’s 2 percent target for all of 2015. And… 2014. And… 2013. And… for about half of 2012….

The reason the Fed is now comfortable with the idea of a rate hike is that the labor market has improved considerably from where it was a few years ago…. But even though the labor market is in much better shape than it was a year or two ago, it’s honestly still not in such great shape. A broad gauge of the labor market–the share of 25- to 54-year-olds who have a job–shows that something between 2 and 5 percent of the prime age population has vanished from the workforce…. At a congressional hearing earlier this year, Fed Chair Janet Yellen was asked about the black-white unemployment gap and said basically that there’s nothing she can do about it…. It’s easy enough to see… [that] the African-American unemployment rate and the white unemployment rate move in tandem at a 2-to-1 ratio…. But as Jared Bernstein points out, this semi-fixed ratio actually means that monetary policy matters a great deal for the racial gap….

With the United States currently enjoying a lowish 5 percent unemployment rate, it’s easy for relatively privileged people to neglect the benefits of further small reductions. But for an African-American population that will enjoy a double-scale version of any drop in the unemployment rate, the stakes remain quite high. The same is true of other kinds of vulnerable populations….

Most economists think I am wrong and the Fed should raise rates. But the thinking behind this, as measured in things like the IGM Survey of prominent economists, is awfully fuzzy. Anil Kashyap of the University of Chicago says he strongly agrees with a rate hike because, ‘As Mike Mussa once famously said, ‘If not now, when?” Darrell Duffie of Standard says ‘the macro vital signs look healthy enough now.’… Many supporters haven’t articulated a rationale at all…. The relevant question is whether, under the circumstances, the risks of a little bit of inflation are really worse than the risks of sluggish job growth. This is a subject that deserves to be debated squarely…

Must-Read Pre-Liftoff Lollapalooza: Neil Irwin: Yellen Blinks on Interest Rates

Posted on by Brad DeLong

Must-Read Pre-Liftoff Lollapalooza: From last September: the very sharp Neil Irwin on Yellen’s blinking:

Neil Irwin: Yellen Blinks on Interest Rates: “The cost of waiting… to ensure that the economy continues to perform the way… models predict…

… [is] low…. The challenge… is that we could well get through the end of 2015 without the open questions that triggered the September delay being resolved…. There is no assurance that these key questions… whether inflation is finally… poised to rise, and whether economic softness in… emerging markets will crimp… growth… will be resolved by December or even by the spring…. Inflation continues coming in less than forecast, and the global economy looks perilous….

As… Stanley Fischer said… if the Fed waits until it is absolutely certain it is time to raise rates, it will probably be too late…. The decision to hold off on rate increases this week suggests Ms. Yellen and the Fed want a little more evidence that the economy is on the mend, but they may find themselves back in the same spot before they know it.

But, as Stanley Fischer did not say, if the Fed raises interest rates when the odds are still only 60-40 that it should, it is not probably but definitely raising them too early.

Must-Read Pre-Liftoff Lollapalooza: Tim Duy: Makes You Wonder What The Fed Is Thinking

Posted on by Brad DeLong

Must-Read Pre-Liftoff Lollapalooza: The extremely-thoughtful Tim Duy is… genuinely frightened…

Tim Duy: Makes You Wonder What The Fed Is Thinking: “My interest tonight is a pair of Wall Street Journal articles that together call into question…

…the wisdom of the Fed’s expected decision… inflation, or lack thereof, by Josh  Zumbrun… the growing consensus among economists that the Fed faces the zero bound again in less than five years…. Fed officials expect the terminal fed funds rate in the 3.3-3.8 percent range (central tendency) while the 2001-03 easing was 5.5 percentage points and the 1990-92 easing was 5.0 percentage points. You see of course how the math works….

The policy risks are asymmetric. They can always raise rates, but the room to lower is limited by the zero bound. But that understates the asymmetry. You should also include the asymmetry of risks around the inflation forecast. The Fed has repeated under over-forecasted inflation. It seems like they should also see an asymmetry in the inflation forecast that compounds the policy response asymmetry. Asymmetries squared. Given all of these asymmetries, I would think the Fed should continue to stand pat until they understand better the inflation dynamics. The Fed thinks otherwise. Why would Federal Reserve Chair Janet Yellen allows the Fed to be pulled in such a direction? Partly to appease the Fed hawks. And then… Yellen is wedded to the theory that the sooner the Fed begins normalizing policy, the more likely the Fed can avoid a recession-inducing sharp rise in rates. She follows up this concern with: “Moreover, holding the federal funds rate at its current level for too long could also encourage excessive risk-taking and thus undermine financial stability.”

This is what Mark Dow calls ‘avalanche patrol’… becomes a story of a Fed caught between a world in which the policy necessary to meet their inflation target is inconsistent with financial stability…. And my sense is that Yellen feels the best way to slip through those cracks is early and gentle tightening….

The Fed likely only gets one chance to lift-off from the zero bound on a sustained basis…. They [sh]ould wait until they were absolutely sure inflation was coming. Even more so given the poor performance of their inflation forecasts. But the Fed thinks there is now more danger in waiting than moving. And so into the darkness we go.

Must-Read Pre-Liftoff Lollapalooza: Jared Bernstein: Will Inflation Really Snap Back Once “Temporary Factors” Abate?

Posted on by Brad DeLong

Must-Read Pre-Liftoff Lollapalooza: Even if there were no model uncertainty, the asymmetry of the situation would lead a rational optimizing policymaker to keep interest rates at zero until the need for liftoff was undeniable. With model uncertainty, a rational optimizing policymaker would keep interest rates at zero for considerably longer…

Jared Bernstein: Will Inflation Really Snap Back Once “Temporary Factors” Abate?: “I noted the Fed’s theory of the case as to why inflation isn’t accelerating…

…temporary factors, including low, low oil prices and the strong dollar, are blocking the usual signal…. [But] it’s not just that inflation isn’t picking up as output gaps close and unemployment falls. Inflation didn’t fall as much as expected when such activity gaps were much wider…. Blanchard, Cerutti, and Summers… a flat slope of the Phillips curve… ain’t exactly a new development…. The slope of the PC has been low for a decade… about 0.2, well below it’s historical levels in the 70s and 80s…. Larry Ball, in commenting on BCS, runs particularly transparent models and finds more stable, significant PC coefficients (though they are of the same magnitude as BCS)…. However, [he] do[es] not give much support to the view that the flat PC is temporarily low as a function of a few unique factors…. Inflation hawks, pull in your talons!

Must-Read Pre-Liftoff Lollapalooza: Jon Faust: Liftoff? And then…

Posted on by Brad DeLong

Must-Read Pre-Liftoff Lollapalooza: I find this from Jon Faust inadequate, mostly because if its failure to make even a bow in the direction of asymmetric risks. If the hawk scenario comes true, the Federal Reserve can then raise interest rates quickly to get to where it wants to be. If the dove scenario comes true, the Federal Reserve cannot lower interest rates far below zero and so cannot get to where it wants to be. Thus liftoff should wait until it is pretty damn clear that the hawk scenario is overwhelmingly more likely. And it is not overwhelmingly more likely now. The Fed is making a mistake. And Faust’s on-the-one-hand-on-the-other-hand without acknowledging the asymmetry in the situation…

Jon Faust: Liftoff? And then…: “The Fed’s policy projections going into the December FOMC last year showed a year-end 2015 median federal funds rate…

…of about 1.5 percent, with a range from zero to three percent. And the situation is almost the same this year: the funds rate is zero entering the December meeting, and the projections for year-end 2016 have a span of approximately zero to three percent, with a median just below 1.5 percent. More Groundhog Day than Christmas…. For the hawkish faction, the extraordinary accommodation that has long been in place is causing–or at least planting the seeds for–distortions and excesses, including inflation. In the main dovish scenario… any adverse development might be sufficient to push the economy into a pernicious deflation and require the Fed to dip deeper into the bag of unconventional tools…. By raising the federal funds rate now, the FOMC may counter some distortions and will make future rate increases less fraught should the hawk’s scenario come to pass. But raising rates inevitably entails some drag on Main Street…. What I’d most like for the holidays, of course, is for those projections of solid growth and accelerating inflation to come true, in which case we’ll all be toasting better times and more normal interest rates next holiday season.