Misdiagnosis of 2008 and the Fed: Inflation Targeting Was Not the Problem. An Unwillingness to Vaporize Asset Values Was Not the Problem…

This, from the very sharp Martin Wolf, seems to me to go substantially awry when Martin writes the word “convincingly”. Targeting inflation is not easy: you don’t see what the effects of today’s policies are on inflation until two years or more have passed. Targeting asset prices, by contrast, is very easy indeed: you buy and sell assets until their prices are what you want them to be.

As I have said before, as of that date January 28, 2004, at which Mallaby claims that Greenspan knew that he ought to “vaporise citizens’ savings by forcing down [housing] asset prices” but had “a reluctance to act forcefully”, that was not Greenspan’s thinking at all. Greenspan’s thinking, in increasing order of importance, was:

  1. Least important: that he would take political heat if the Fed tried to get in the way of or even warned about willing borrowers and willing lenders contracting to buy houses and to take out and issue mortgages.

  2. Less important: a Randite belief that it was not the Federal Reserve’s business to protect rich investors from the consequences of their own imprudent folly.

  3. Somewhat important: a lack of confidence that housing prices were, in fact, about fundamentals except in small and isolated markets.

  4. Of overwhelming importance: a belief that the Federal Reserve had the power and the tools to build firewalls to keep whatever disorder finance threw up from having serious consequences for the real economy of demand, production, and employment.

(1) would not have kept Greenspan from acting had the other more important considerations weighed in the other direction: Greenspan was no coward. William McChesney Martin had laid down the marker that: “If the System should lose its independence in the process of fighting for sound money, that would indeed be a great feather in its cap and ultimately its success would be great…” Preserving your independence by preemptively sacrificing it when it needed to be exercised was not Greenspan’s business. (2) was, I think, an error–but not a major one. And on (3), Greenspan was not wrong:

S P Case Shiller 20 City Composite Home Price Index© FRED St Louis Fed

Nationwide, housing prices today are 25% higher than they were at the start of 2004. There is no fundamental yardstick according to which housing values then needed to be “vaporized”. The housing bubble was an issue for 2005-6, not as of the start of 2004.

It was (4) that was the misjudgment. And the misjudgment was not that the economy could not handle the adjustment that would follow from the return of housing values from a stratospheric bubble to fundamentals. The economy handled that return fine: from late 2005 into 2008 housing construction slackened, but exports and business investment picked up the slack, and full employment was maintained:

Macroeconomic Overview Talk for UMKC MBA Students April 1 2013 DeLong Long Form

The problem was not that the economy could not climb down from a situation of irrationally exuberant and elevated asset prices without a major recession. The problem lay in the fact that the major money center banks were using derivatives not to lay subprime mortgage risk off onto the broad risk bearing capacity of the market, but rather to concentrate it in their own highly leveraged balance sheets. The fatal misjudgment on Greenspan’s part was his belief that because the high executives at money center banks had every financial incentive to understand their derivatives books that they in fact understood their derivatives books.

As Axel Weber remarked, afterwards:

I asked the typical macro question: who are the twenty biggest suppliers of securitization products, and who are the twenty biggest buyers. I got a paper, and they were both the same set of institutions…. The industry was not aware at the time that while its treasury department was reporting that it bought all these products its credit department was reporting that it had sold off all the risk because they had securitized them…

That elite money center financial vulnerability and the 2008 collapse of that Wall Street house of cards, not the unwinding of the housing bubble, was what produced the late 2008-2009 catastrophe:

Macroeconomic Overview Talk for UMKC MBA Students April 1 2013 DeLong Long Form

Greenspan’s error was not in targeting inflation (except at what in retrospect appears to be too low a level). Greenspan’s error was not in failing to anticipatorily vaporize asset values (though more talk warning potentially overleveraged homeowners of risks would have been a great mitzvah for them). Greenspan’s error was in failing to regulate and supervise.

Martin Wolf: Man in the Dock:

Of his time as Fed chairman, Mr Mallaby argues convincingly that:

The tragedy of Greenspan’s tenure is that he did not pursue his fear of finance far enough: he decided that targeting inflation was seductively easy, whereas targeting asset prices was hard; he did not like to confront the climate of opinion, which was willing to grant that central banks had a duty to fight inflation, but not that they should vaporise citizens’ savings by forcing down asset prices. It was a tragedy that grew out of the mix of qualities that had defined Greenspan throughout his public life—intellectual honesty on the one hand, a reluctance to act forcefully on the other.

Many will contrast Mr Greenspan’s malleability with the obduracy of his predecessor, Paul Volcker, who crushed inflation in the 1980s. Mr Greenspan lacked Mr Volcker’s moral courage. Yet one of the reasons why Mr Greenspan became Fed chairman was that the Reagan administration wanted to get rid of Mr Volcker, who “continued to believe that the alleged advantages of financial modernisation paled next to the risks of financial hubris.”

Mr Volcker was right. But Mr Greenspan survived so long because he knew which battles he could not win. Without this flexibility, he would not have kept his position. The independence of central bankers is always qualified. Nevertheless, Mr Greenspan had the intellectual and moral authority to do more. He admitted to Congress in 2008 that: “I made a mistake in presuming that the self-interests of organisations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms.” This “flaw” in his reasoning had long been evident. He knew the government and the Fed had put a safety net under the financial system. He could not assume financiers would be prudent.

Yet Mr Greenspan also held a fear and a hope. His fear was that participants in the financial game would always be too far ahead of the government’s referees and that the regulators would always fail. His hope was that “when risk management did fail, the Fed would clean up afterwards.” Unfortunately, after the big crisis, in 2007-08, this no longer proved true.

If Mr Mallaby faults Mr Greenspan for inertia on regulation, he is no less critical of the inflation-targeting that Mr Greenspan ultimately adopted, albeit without proclaiming this objective at all clearly. The advantage of inflation-targeting was that it provided an anchor for monetary policy, which had been lost with the collapse of the dollar’s link to gold in 1971 followed by that of monetary targeting. Yet experience has since shown that monetary policy is as likely to lead to instability with such an anchor as without one. Stable inflation does not guarantee economic stability and, quite possibly, the opposite.

Perhaps the biggest lesson of Mr Greenspan’s slide from being the “maestro” of the 1990s to the scapegoat of today is that the forces generating monetary and financial instability are immensely powerful. That is partly because we do not really know how to control them. It is also because we do not really want to control them. Readers of this book will surely conclude that it is only a matter of time before similar mistakes occur.

The root problem of 2008 was not that inflation targeting generates instability (even though a higher inflation target then and now would have been very helpful). The root problem of 2008 was not that the Federal Reserve was unwilling to vaporize asset values–the Federal Reserve vaporized asset values in 1982, and stood willing to do so again *if it were to seem appropriate*. The root problem of 2008 was a failure to recognize that the highly leveraged money center banks had used derivatives not to distribute subprime mortgage risk to the broad risk bearing capacity of the market as a whole but, rather, to concentrate it in themselves.

At least as I read Mallaby, he does not criticize Greenspan for “inertia on regulation” nearly as much as he does for Greenspan’s failure to “vaporise citizens’ savings by forcing down asset prices…” even when there is no evidence of rising inflation expectations or excess demand in the goods and labor markets as a whole.


Axel Weber’s full comment:

I think one of the things that really struck me was that, in Davos, I was invited to a group of banks–now Deutsche Bundesbank is frequently mixed up in invitations with Deutsche Bank.

I was the only central banker sitting on the panel. It was all banks. It was about securitizations. I asked my people to prepare. I asked the typical macro question: who are the twenty biggest suppliers of securitization products, and who are the twenty biggest buyers. I got a paper, and they were both the same set of institutions.

When I was at this meeting–and I really should have been at these meetings earlier–I was talking to the banks, and I said: “It looks to me that since the buyers and the sellers are the same institutions, as a system they have not diversified”. That was one of the things that struck me: that the industry was not aware at the time that while its treasury department was reporting that it bought all these products its credit department was reporting that it had sold off all the risk because they had securitized them.

What was missing–and I think that is important for the view of what could be learned in economics–is that finance and banking was too-much viewed as a microeconomic issue that could be analyzed by writing a lot of books about the details of microeconomic banking. And there was too little systemic views of banking and what the system as a whole would develop like.

The whole view of a systemic crisis was just basically locked out of the discussions and textbooks. I think that that is the one big lesson we have learned: that I now when I am on the board of a bank, I bring to that bank a view, don’t let us try to optimize the quarterly results and talk too much about our own idiosyncratic risk, let’s look at the system and try to get a better understanding of where the system is going, where the macroeconomy is going. In a way I take a central banker’s more systemic view to the institution-specific deliberations. I try to bring back the systemic view. And by and large I think that helps me understand where we should go in terms of how we manage risks and how we look at risks of the bank compared to risks of the system.

Must-Read: Martin Wolf: David Cameron, the Ex-Prime Minister, Took a Huge Gamble and Lost

Must-Read: The very sharp Martin Wolf sees structural recession in Britain’s near future.

People minimizing risk are going to leave Britain. People who would otherwise locate in Britain and are risk-shy are going to pause and wait and see. The Bank of England needs to drop the value of the pound by enough to try to maintain full employment in Britain–but not by so much as to make investors feel that investments in Britain are unsafe and so lose the pound its exorbitant privilege.

As Keynes wrote at the beginning of his Tract on Monetary Reform back in 1923:

I dedicate this book, humbly and without permission, to the Governors and Court of the Bank of England, who now and for the future has a much more difficult and anxious task entrusted to them than in former days…

Martin Wolf: Brexit: David Cameron, the Ex-Prime Minister, Took a Huge Gamble and Lost: “The fearmongering of Boris Johnson, Michael Gove, Nigel Farage, The Sun and the Daily Mail has won…

…The UK, Europe, the west and the world are, this morning, damaged. The UK is diminished and will, quite possibly, end up divided. Europe has lost its second-biggest and most outward-looking power. The hinge between the EU and the English-speaking powers has been snapped…. It is, above all, a victory of the disappointed and fearful…. The geography of the outcome reveals that this has also been a revolt of the provinces against a prosperous and globalised London. It is also a revolt against the establishment…. The UK might not be the last country to suffer such an earthquake….

The UK is now at the beginning of an extended period of uncertainty that, in overwhelming probability, foreshadows a diminished future. The Conservatives… will have to do what the Brexiters failed so egregiously to do during their mendacious campaign, namely, map out a strategy and tactics for unravelling the UK’s connections with the EU. This will probably consume the energies of that government and its successors over many years. It will also involve making some huge decisions… [abandon] membership of the single market. At best, the UK might participate in a free trade area in goods. Meanwhile, the rest of the EU, already burdened with so many difficulties, will have to work out its own negotiating positions. I expect them to be tough ones….

The UK economy is going to be reconfigured. Those businesses that have set up in the UK to serve the entire EU market from within must reconsider their position…. Manufacturers… will have to consider how to readjust…. Many will ultimately wish to relocate. Businesses who depend on their ability to employ European nationals must also reshape their operations…. In the short term, however, it will be difficult for businesses to make such decisions sensibly…. This uncertainty has always been the most obvious result of a vote to leave….

The UK’s decision to join the EU was taken for sound reasons. Its decision to leave was not. It is likely to be welcomed by Ms Le Pen, Mr Trump and Vladimir Putin. It is a decision by the UK to turn its back on the great European effort to heal its divisions. It is, for me, among the saddest of hours.

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

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?

We Are so S—ed. Econ 1-Level Edition

As I told my undergraduates yesterday:

Y = μ[co + Io + NX] + μG – μIrr

where:

  • Y is real GDP
  • μ = 1/(1-cy) is the Keynesian multiplier
  • co is consumer confidence
  • cy is the marginal propensity to consume
  • C = co + cyY is the consumption function–how households’ spending on consumption goods and services varies with consumer confidence, with their income which is equal to real GDP Y, and with the marginal propensity to consume
  • Io is businesses’ and banks’ “animal spirits”–their confidence in enterprise
  • r is “the” long-term risky real interest rate r
  • Ir is the sensitivity of business investment to r
  • NX is foreigners’ net demand for our exports
  • And G is government purchases.

And as I am going to tell them next Monday, real GDP Y will be equal to potential output Y* whenever “the” interest rate r is equal to the Wicksellian neutral rate r*, which by simple algebra is:

r* = [co + Io + NX]/Ir + G/Ir – Y*/μIr

If interest rates are low and inflation is not rising it is not because monetary policy is too easy, but because r* is low–and r* can be low because:

  • consumers are terrified (co low)
  • investors’ animal spirits are depressed (Io low)
  • foreigners’ demand for our exports inadequate (NX low)
  • or fiscal policy too contractionary (G low)

for the economy’s productive potential Y*.

The central bank’s task in the long run is to try to do what it can to stabilize psychology and so reduce fluctuations in r. the central bank’s task in the short run is to adjust the short-term safe nominal interest rate it controls i in such a way as to match the market rate of interest r to r. For only then will Say’s Law, false in theory, be true in practice:

Martin Wolf: Negative Rates Not Central Banks’ Fault: “It is hard to understand the obsession with limiting public debt when it is as cheap as it is today…

…Almost nine years after the west’s financial crisis started, interest rates remain ultra-low. Indeed, a quarter of the world economy now suffers negative interest rates. This condition is as worrying as the policies themselves are unpopular. Larry Fink, chief executive of BlackRock, the asset manager, argues that low rates prevent savers from getting the returns they need for retirement. As a result, they are forced to divert money from current spending into savings. Wolfgang Schäuble, Germany’s finance minister, has even put much of the blame for the rise of Alternative für Deutschland, a nationalist party, and on policies introduced by the European Central Bank. ‘Save the savers’ is an understandable complaint by an asset manager or finance minister of a creditor nation. But this does not mean the objection makes sense. The world economy is suffering from a glut of savings relative to investment opportunities. The monetary authorities are helping to ensure that interest rates are consistent with this fact….

The savings glut (or investment dearth, if one prefers) is the result of developments both before and after the crisis…. Some will object that the decline in real interest rates is solely the result of monetary policy, not real forces. This is wrong. Monetary policy does indeed determine short-term nominal rates and influences longer-term ones. But the objective of price stability means that policy is aimed at balancing aggregate demand with potential supply. The central banks have merely discovered that ultra-low rates are needed to achieve this objective…. We must regard ultra-low rates as symptoms of our disease, not its cause….

[But is] the monetary treatment employed… the best one[?]…. Given the nature of banking institutions, negative rates are unlikely to be passed on to depositors and… so are likely to damage the banks…. There is a limit to how negative rates can go without limiting the convertibility of deposits into cash…. And this policy might do more damage than good. Even supporters agree there are limits…. [Does] this mean monetary policy is exhausted? Not at all. Monetary policy’s ability to raise inflation is essentially unlimited. The danger is rather that calibrating monetary policy is more difficult the more extreme it becomes. For this reason, fiscal policy should have come into play more aggressively….

The best policies would be a combination of raising potential supply and sustaining aggregate demand. Important elements would be structural reforms and aggressive monetary and fiscal expansion…. Monetary policy cannot be for the benefit of creditors alone. A policy that stabilises the eurozone must help the debtors, too. Furthermore, the overreliance on monetary policy is a result of choices, particularly over fiscal policy, on which Germany has strongly insisted. It is also the result of excess savings, to which Germany has substantially contributed…

One way of looking at it is that two things went wrong in 2008-9:

  • Asset prices collapsed.
  • And so spending collapsed and unemployment rose.

The collapse in asset prices impoverished the plutocracy. The collapse in spending and the rise in unemployment impoverished the working class. Central banks responded by reducing interest rates. That restored asset prices, so making the plutocracy whole. But while that helped, that did not do enough to restore the working class.

Then the plutocracy had a complaint: although their asset values and their wealth had been restored, the return on their assets and so their incomes had not be. And so they called for austerity: cut government spending so that governments can then cut our taxes and so restore our incomes as well as our wealth.

But, of course, cutting government spending further impoverished the working class, and put still more downward pressure on the Wicksellian neutral interest rate r* consistent with full employment and potential output.

And here we sit.

Must-Read: Martin Wolf: Why Fossil Fuel Power Plants Will Be Left Stranded

Must-Read: Martin Wolf: Why Fossil Fuel Power Plants Will Be Left Stranded: “Virtually all new fossil fuel-burning power-generation capacity will end up ‘stranded’…

…This is the argument of a paper by academics at Oxford university…. February was the warmest month on record. The current El Niño–the warming of the global climate triggered by the Pacific Ocean–has boosted temperatures, just as it did in 1997-98…. Two forms of inertia govern climate policy…. Infrastructure in power generation… is long-lived…. Carbon dioxide remains in the atmosphere for centuries. Thus it is necessary to think not of annual flows but of cumulative emissions or of a global carbon budget…. Within power generation itself, there are four options. The first would be a more or less immediate shift to zero-emissions technologies. The second would be retrofitting of conventional capacity with carbon capture and storage. The third would be to replace new capital stock with zero-emissions capacity early in its life. The last would be early introduction of technologies to remove atmospheric stocks of carbon….

Far from having years to work out how to curb the risks of climate change, we face an imminent moment of truth…. After last year’s Paris climate conference, the world congratulated itself on having agreed a new process, even though real action was postponed. Yet, given the longevity of a large part of the capital stock, the time for decisive change is right now, not decades in future. But the world is not really serious about climate, is it? It prefers fiddling while the planet burns.

Must-read: Martin Wolf: “Helicopter drops might not be far away”

Must-Read: The central banks of the North Atlantic seem to be rapidly digging themselves into a hole in which, if there is an adverse demand shock, their only options will be (a) dither, and (b) seize the power to do a degree of fiscal policy via helicopter money by some expedient or other…

Martin Wolf: Helicopter drops might not be far away: “The world economy is slowing, both structurally and cyclically…

…How might policy respond? With desperate improvisations, no doubt. Negative interest rates… fiscal expansion. Indeed, this is what the OECD, long an enthusiast for fiscal austerity, recommends…. With fiscal expansion might go direct monetary support, including the most radical policy of all: the ‘helicopter drops’ of money recommended by the late Milton Friedman… the policy foreseen by Ray Dalio, founder of Bridgewater, a hedge fund….

Why might the world be driven to such expedients? The short answer is that the global economy is slowing durably…. Behind this is a simple reality: the global savings glut — the tendency for desired savings to rise more than desired investment — is growing and so the ‘chronic demand deficiency syndrome’ is worsening…. The long-term real interest rate on safe securities has been declining for at least two decades….

It is this background — slowing growth of supply, rising imbalances between desired savings and investment, the end of unsustainable credit booms and, not least, a legacy of huge debt overhangs and weakened financial systems — that explains the current predicament. It explains, too, why economies that cannot generate adequate demand at home are compelled towards beggar-my-neighbour, export-led growth via weakening exchange rates….

The OECD argues, persuasively, that co-ordinated expansion of public investment, combined with appropriate structural reforms, could expand output and even lower the ratio of public debt to gross domestic product. This is particularly plausible nowadays, because the major governments are able to borrow at zero or even negative real interest rates, long term. The austerity obsession, even when borrowing costs are so low, is lunatic (see chart). If the fiscal authorities are unwilling to behave so sensibly — and the signs, alas, are that they are not — central banks are the only players… send money… to every adult citizen. Would this add to demand? Absolutely….

The easy way to contain any long-term monetary effects would be to raise reserve requirements. These could then become a desirable feature of our unstable banking systems…. The economic forces that have brought the world economy to zero real interest rates and, increasingly, negative central bank rates are, if anything, now strengthening…. Policymakers must prepare for a new ‘new normal’ in which policy becomes more uncomfortable, more unconventional, or both…

Must-read: Martin Wolf: “China’s Struggle for a New Normal”

Must-Read: Martin Wolf: China’s Struggle for a New Normal: “Beijing must be decisive and yet responsive to the needs of the people…

…At present, it seems strangely indecisive on the economy and yet increasingly authoritarian on the politics. Only a fool would consider political instability anything but a disaster for China and the world. Equally, the desire of President Xi Jinping to attack corruption and so strengthen the legitimacy of the Communist party is understandable…. [But] its political institutions must surely move beyond the ‘democratic centralism’ invented by Vladimir Lenin a century ago. The challenges are daunting. It is only the successes of the recent past that provide confidence in those of the future.

Must-read: Paul Krugman (2014): “Why Weren’t Alarm Bells Ringing?”

Paul Krugman (2014): Why Weren’t Alarm Bells Ringing?: “Almost nobody predicted the immense economic crisis…

…If someone claims that he did, ask how many other crises he predicted that didn’t end up happening. Stopped clocks are right twice a day, and chronic doomsayers sometimes find themselves living through doomsday. But while prediction is hard, especially about the future, this doesn’t let our economic policy elite off the hook. On the eve of crisis in 2007 the officials, analysts, and pundits who shape economic policy were deeply, wrongly complacent. They didn’t see 2008 coming; but what is more important is the fact that they even didn’t believe in the possibility of such a catastrophe. As Martin Wolf says in The Shifts and the Shocks, academics and policymakers displayed ‘ignorance and arrogance’ in the runup to crisis, and ‘the crisis became so severe largely because so many people thought it impossible.’…

Focusing, as Martin Wolf does, on the measurable factors—the ‘shifts’—that increased our vulnerability to crisis is incomplete…. Intellectual shifts—the way economists and policymakers unlearned the hard-won lessons of the Great Depression, the return to pre-Keynesian fallacies and prejudices—arguably played an equally large part in the tragedy of the past six years. Say’s Law… liquidationism… conventional economic analysis fell short…. But when policymakers rejected orthodox economics, what they did by and large was to reject it in favor of doctrines like ‘expansionary austerity’—the unsupported claim that slashing government spending actually creates jobs—that made the situation worse rather than better. And this makes me a bit skeptical about Wolf’s proposals to avert ‘the fire next time.’ The Shifts and the Shocks… Wolf’s substantive proposals… are all worthy and laudable. But the gods themselves contend in vain against stupidity. What are the odds that financial reformers can do better?

Must-Read: Martin Wolf: America’s Labour Market Is Not Working

Must-Read: Martin Wolf: America’s Labour Market Is Not Working: “In 2014… close to one in eight…

…of US men between the ages of 25 and 54 were neither in work nor looking for it… far higher than in other members of the group of seven leading high-income countries: in the UK, it was 8 per cent; in Germany and France 7 per cent; and in Japan a mere 4 per cent…. The proportion of US prime-age women neither in work nor looking for it was 26 per cent, much the same as in Japan and less only than Italy’s…. Participation rates for those over 16. These fell from 65.7% at the start of 2009 to 62.8% in July 2015… 1.6 percentage points of this decline was due to ageing and 0.3 percentage points due to (diminishing) cyclical effects…. Yet… the UK experienced no decline in labour-force participation after the Great Recession, despite similar ageing trends…. Back in 1991, the proportion of US prime-age men who were neither in work nor looking for it was just 7 per cent. Thus the proportion of vanished would-be workers has risen by 5 percentage points since then…. What has been happening to participation of prime-aged women is no less striking….

The comforts of idleness cannot be a plausible explanation since the US has the least generous welfare state among high-income countries. High minimum wages cannot be blocking job creation…. In the case of prime-aged women, the absence of affordable childcare would seem a plausible explanation…. The numbers with criminal records created by mass incarceration might also help explain the difficulty in finding jobs…. The relentless decline in the proportion of prime-aged US adults in the labour market indicates a significant dysfunction. It deserves attention and analysis. But it also merits action.

Must-Read: Martin Wolf: Lunch with the FT: Ben Bernanke

Must-Read: Martin Wolf: Lunch with the FT: Ben Bernanke: “‘The notion that the Fed has somehow enriched the rich…

…through increasing asset prices doesn’t really hold up…. The Fed basically has returned asset prices… to trend… [and] stock prices are high… because returns are low…. The same people who criticise the Fed for helping the rich also criticise the Fed for hurting savers…. Those two… are inconsistent….

‘Should the Fed not try to support a recovery?… If people are unhappy with the effects of low interest rates, they should pressure Congress… and so have a less unbalanced monetary-fiscal policy mix. This is the fourth or fifth argument against quantitative easing after all the other ones have been proven to be wrong….’ Other critics argue, I note, that the Fed’s intervention prevented the cathartic effects of a proper depression. He… respond[s]… that I have a remarkable ability to keep a straight face while recounting… crazy opinions…. ‘We were quite confident from the beginning there would be no inflation problem…. As for… the Andrew Mellon [US Treasury secretary] argument from the 1930s… certainly among mainstream economists, it has no credibility. A Great Depression is not going to promote innovation, growth and prosperity.’ I cannot disagree, since I also consider such arguments mad….

Does… blame… lie in pre-crisis monetary policy… interest rates… too low… in the early 2000s?… ‘Serious studies that look at it don’t find that to be the case…. Shiller… has a lot of credibility…. The Fed had some complicity… in not constraining the bad mortgage lending… [and] the structural vulnerabilities in the funding markets….’ Thus, lax regulation…. Has the problem been fixed?… ‘It’s an ongoing project…. You can’t hope to identify all the vulnerabilities in advance. And so anything you can do to make the system more resilient is going to be helpful.’… I push a little harder on the costs of financial liberalisation. He agrees that, in light of the economic performance in the 1950s and 1960s, ‘I don’t think you could rule out the possibility that a more repressed financial system would give you a better trade-off of safety and dynamism.’ What about the idea that if the central banks are going to expand their balance sheets so much, it would be more effective just to hand the money directly over to the people rather than operate via asset markets?… A combination of tax cuts and quantitative easing is very close to being the same thing.’ This is theoretically correct, provided the QE is deemed permanent…