Live at Project Syndicate: The Truth Behind Today’s US Inflation Numbers https://www.project-syndicate.org/commentary/fed-low-inflation-more-stimulus-by-j–bradford-delong-2017-06: BERKELEY – In December 2015, the US Federal Reserve embarked on a monetary-tightening cycle, by raising the target range for the short-term nominal federal funds rate by 25 basis points (one-quarter of a percentage point). At the time, the Federal Open Market Committee (FOMC)–the Fed body that sets monetary policy–issued a median forecast predicting three things… Read MOAR at Project Syndicate
Tag: Monetary Policy
Why Is the FOMC So Certain the U.S. Is “Essentially at Full Employment”?
Suppose you had, back in 1992 or 2004 or indeed any other time since 1990 and before 2013, asked a question of Charlie Evans—or, indeed, any of the other non-Neanderthal participants in the Federal Reserve’s Federal Open Market Committee meetings. Suppose you had asked whether a 25-54 employment-to-population ratio in the United States of today’s 78.5% was anywhere near “full employment”. What would they have said?
They would have said “of course not!”
They would have observed that the post-baby boom decline in fertility, wage stagnation among male earners, and the coming of feminism had greatly increased the share of 25-54 year old women who wanted paying jobs outside the home.
They would have pointed out that upward pressure on core inflation at an 80% 25-54 employment-to-population ratio in 1990 was small, that upward pressure on core inflation at an 82.5% 25-54 employment-to-population ratio in 2000 was minimal, and that upward pressure on core inflation at an 80% 25-54 employment-to-population ratio in 2007 was minimal.
They would have pointed out that today’s 78.5% was between between the 78.1% 1992 recession trough and the 78.6% 2003 recession trough.
They would have concluded that, by the standards of the post-feminist revolution era, a labor market with a 25-54 employment-to-population ratio of 78.5% was a labor market as bad from a business cycle perspective as the labor market got during the Great Moderation.
So why is Charlie Evans now saying that today the United States has “essentially returned to full employment”? Why no qualifiers? Why no “if you look only at the unemployment rate, and put the shockingly-low labor force participation statistics to one side…? Why no “it may well be the case that the U.S. has essentially returned to full employment? Why this certainty on the part of even the non-Neanderthal members of the FOMC—in public, at least—that the unemployment rate is the sole guide?
And why the puzzlement at the failure of core inflation to rise to 2%? That is a puzzle only if you assume that you know with certainty that the unemployment rate is the right variable to put on the right hand side of the Phillips Curve. If you say that the right variable is equal to some combination with weight λ on prime-age employment-to-population and weight 1-λ on the unemployment rate, then there is no puzzle—there is simply information about what the current value of λ is:
Charles Evans: Lessons Learned and Challenges Ahead: “These policies… produced results. Unemployment began to fall… https://www.chicagofed.org/publications/speeches/2017/05-25-lessons-learned-and-challenges-ahead-bank-of-japan
…more quickly than anticipated in 2013…. We were able to scale back the QE3 purchases…. Today, we have essentially returned to full employment in the U.S.
Unfortunately, low inflation has been more stubborn, being slower to return to our objective. From 2009 to the present, core PCE inflation, which strips out the volatile food and energy components, has underrun 2% and often by substantial amounts. This is eight full years below target. This is a serious policy outcome miss…
Charlie says a lot of good things in his talk. His discussions of “outcome-based policies… symmetric inflation target[s]… [and] risk management” are wise. But wisdom can be usefully applied only if you know where you start from. And we start from a position in which we really do not know how close the U.S. economy is right now to “full employment”—how much headroom for catch-up growth and catch-up employment remains, and how powerful and useful more aggressive policies to stimulate spending would be right now.
In 25 years my students are likely to ask me why the FOMC was so certain the U.S. was “essentially at full employment” today. What will I tell them?
Sluggish Future: No Longer Fresh Over at Finance and Development
Over at Finance and Development: Sluggish Future: You are reading this because of the long, steady decline in nominal and real interest rates on all kinds of safe investments, such as US Treasury securities. The decline has created a world in which, as economist Alvin Hansen put it when he saw a similar situation in 1938, we see “sick recoveries… die in their infancy and depressions… feed on themselves and leave a hard and seemingly immovable core of unemployment…” In other words, a world of secular stagnation. Harvard Professor Kenneth Rogoff thinks this is a passing phase—that nobody will talk about secular stagnation in nine years. Perhaps. But the balance of probabilities is the other way. Financial markets do not expect this problem to go away for at least a generation… Read MOAR at Finance and Development
My Draft: You are reading this right now because of the long, steady decline in safe interest rates at all maturities since 1990.(1)
In the United States, we have seen declines in short-term safe interest rates from 4% to -1.2% on the real side and from 8% to 0.5% on the nominal side. And we have seen the decline in long-term safe interest rates from 5% to 1% on the real side, and from 9% to 3% on the nominal side. The elusive Wicksellian “neutral” rate of interest—that rate at which planned investment equals desired full-employment savings—has fallen by more: the economy in 1990 had no pronounced tendency to fall short of full employment; the economy today has.
An economy suffers from “secular stagnation” when the average level of safe nominal interest rates is low and so crashes the economy into the zero lower bound with frequency. Thus, in the words of Alvin Hansen (1939): “sick recoveries… die in their infancy and depressions… feed on themselves and leave a hard and seemingly immovable core of unemployment…”(2)
Financial markets, at least, do not expect this problem to go away for at least as generation. That makes, as I have written, this current policy debate “the most important policy-relevant debate in economics since John Maynard Keynes’s debate with himself in the 1930s…”
I have heard eight different possible causes advanced for this secular fall in safe interest rates:
- High income inequality, which boosts savings too much because the rich can’t think of other things they’d rather do with their money.
- Technological and demographic stagnation that lowers the return on investment and pushes desired investment spending down too far.
- Non-market actors whose strong demand for safe, liquid assets is driven not by assessments of market risk and return but rather by political factors or by political risk.
- A collapse or risk-bearing capacity as a broken financial sector finds itself overleveraged and failing to mobilize savings, thus driving a large wedge between the returns on risky investments and the returns on safe government debt.
- Very low actual and expected inflation, which means that even a zero safe nominal rate of interest is too high to balance desired investment and planned savings at full employment.
- Limits on the demand for investment goods coupled with rapid declines in the prices of those goods, which together put too much downward pressure on the potential profitability of the investment-goods sector.
- Technological inappropriateness, in which markets cannot figure out how to properly reward those who invest in new technologies even when the technologies have enormous social returns—which in turn lowers the private rate of return on investment and pushes desired investment spending down too far.
- Increased technology- and rent seeking-driven obstacles to competition which make investment unprofitable for entrants and market-cannibalizing for incumbents.
The first of these was John A. Hobson’s explanation a century ago for the economic distress that had led to the rise of imperialism.(3) The second was, of course, Hansen’s, echoed today by Robert Gordon.(4) The third is Ben Bernanke’s global savings glut.(5) The fourth is Ken Rogoff’s debt-supercycle.(6)
The fifth notes that, while safe real interest rates are higher than they were in the 1980s and 1990s, that is not the case for the 1960s and 1970s. It thus attributes the problem to central banks’ inability to generate the boost from expected and actual inflation a full-employment flex-price economy would generate naturally.(7)
(6), (7), and (8) have always seemed to me to be equally plausible as potential additional factors. But the lack of communication between industrial organization and monetary economics has deprived them of scrutiny. While Gordon, Bernanke, Rogoff, Krugman, and many others have covered (1) through (5), (6), (7), and (8) remain undertheorized.
In general, economists have focused on a single individual one of these causes, and either advocated policies to cure it at its roots or waiting until the evolution of the market and the polity removes it. By contrast, Lawrence Summers(8) has focused on the common outcome. And if one seeks not to cure a single root cause but rather to neutralize and palliate the deleterious macroeconomic effects of a number of causes working together, one is driven—as Larry has been—back to John Maynard Keynes (1936)(9):
A somewhat comprehensive socialisation of investment… [seems] the only means of securing an approximation to full employment… not exclud[ing] all manner of compromises and of devices by which public authority will cooperate with private initiative…
Summers has, I think, a very strong case here. Ken Rogoff likes to say that nine years from now nobody will be talking about secular stagnation.
Perhaps.
But if that is so, it will most likely be so because we will have done something about it.
Notes:
(1) For considerably overlapping and much extended versions of this argument, see J. Bradford DeLong (2016): Three, Four… Many Secular Stagnations! http://www.bradford-delong.com/2017/01/three-four-many-secular-stagnations.html; (2015): The Scary Debate Over Secular Stagnation: Hiccup… or Endgame? Milken Review http://tinyurl.com/dl20170106m
(2) Alvin Hansen (1939): Economic Progress and Declining Population Growth American Economic Review https://www.jstor.org/stable/1806983
(3) John A. Hobson (1902): Imperialism: A Study (New York: James Pott) http://files.libertyfund.org/files/127/0052_Bk.pdf
(4) Robert Gordon (2016): The Rise and Fall of American Growth http://amzn.to/2iVbYKm
(5) Ben Bernanke (2005): The Global Saving Glut and the U.S. Current Account Deficit http://www.federalreserve.gov/boarddocs/speeches/2005/200503102/
(6) Kenneth Rogoff (2015): Debt Supercycle, Not Secular Stagnation http://www.voxeu.org/article/debt-supercycle-not-secular-stagnation
(7) Paul Krugman (1998): The Return of Depression Economics http://tinyurl.com/dl20170106r
(8) Lawrence Summers (2013): Secular Stagnation http://larrysummers.com/imf-fourteenth-annual-research-conference-in-honor-of-stanley-fischer/ ; https://www.youtube.com/watch?v=KYpVzBbQIX0&ab_channel=JamesDecker; (2014): U.S. Economic Prospects: Secular Stagnation, Hysteresis, and the Zero Lower Bound http://link.springer.com/article/10.1057%2Fbe.2014.13; (2015): Rethinking Secular Stagnation After Seventeen Months http://larrysummers.com/wp-content/uploads/2015/07/IMF_Rethinking-Macro_Down-in-the-Trenches-April-20151.pdf;(2016): The Age of Secular Stagnation http://larrysummers.com/2016/02/17/the-age-of-secular-stagnation/
(9) John Maynard Keynes (1936): The General Theory of Employment, Interest and Money https://www.marxists.org/reference/subject/economics/keynes/general-theory/ch24.htm
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Will Somebody Please Tell Me Again Why the Federal Reserve Has Embarked on a Tightening Cycle?
With 2017Q1 real GDP growth currently forecast at a 1.2% annual rate—down from 2.7% expected last December—it is worth pausing to remember that if that number comes true:
- 4Q real GDP growth is: 2.0%/year
- 8Q real GDP growth is: 1.9%/year
Maybe this is an economy in which slow productivity growth is constraining expansion. But if that is the case, where is the inflation? More likely this is the case in which overly-tight fiscal and monetary policy are constraining an economy that still has some significant amount of macroeconomic slack in it…
Plus: this is what you would expect from a central bank that regards 2.0%/year core PCE inflation as a ceiling not to be crossed, rather than as a central-tendency target…
Helicopter Money: When Zero Just Isn’t Low Enough: Milken Review
At Milken Review: Helicopter Money: When Zero Just Isn’t Low Enough: If you pay much attention to the chattering classes — those who chatter about economics, anyway — you’ve probably run across the colorful term “helicopter money.” At root, the concept is disarmingly simple. It’s money created at the discretion of the Federal Reserve (or any central bank) that could be used to increase purchasing power in times of recession. But the controversy over helicopter money (formally, money-financed fiscal policy) is hardly straightforward… Read MOAR at Milken Review
Money Demand a Function of Private Consumption Spending, Not Income
Note to Self: I alway find it interesting that Friedman and the monetarists formulated money demand as a function of income rather than of private spending, or even of private consumption spending. You don’t need or want money when your income is high, unless you want to spend it.
And it seems highly likely that the ratio of desired money holdings to planned spending is much higher for consumption than investment. Money demand should therefore be a function of private sector consumption spending–and nominal interest rates–not a function of income. We thus have:
C = MV(i)/P
Y = C + I + G + (X-M)
And from this accounting framework it is very difficult indeed to make strong monetarist conclusions appear obvious facts of nature rather than weird and tendentious claims. Mankiw and Summers made this point back in 1982. And they were totally ignored—even though it was and is a very smart point…
More Expansionary FIscal Policy Is Needed: The Only Question Is Whether for a Short-Term Full Employment Attainment or a Medium-Term Full-Employment Maintenance Purpose
J. Bradford DeLong: On Twitter:
This strikes me as a bad mistake: fiscal needed to create space to normalize interest rates and give Fed room to fight next recession https://t.co/49djGBQRdS
— J. Bradford DeLong (@delong) December 14, 2016
Yellen: Fiscal policy is not needed to provide stimulus to get us back to full employment
— David Wessel (@davidmwessel) December 14, 2016
If the Federal Reserve wants to have the ammunition to fight the next recession when it happens, it needs the short-term safe nominal interest rate to be 5% or more when the recession hits. I believe that is very unlikely to happen without substantial fiscal expansion. No, at least in the world that Janet Yellen sees, “fiscal policy is not needed to provide stimulus to get us back to full employment.” But fiscal policy stimulus is needed to create a situation in which full employment can be maintained. It would be a rash economist indeed who would forecast a short-term safe nominal interest rate above 3% when the time for the next loosening cycle arrives:
Thus if we do not shift to a more expansionary fiscal policy–and the higher neutral rate of interest that it brings–now, what do we envision will happen when the next recession arrives? Do we trust that congress and the president will then understand and react appropriately in a timely fashion and at the right scale to deal with the slump in aggregate demand?
Once again, it would be a very rash economist who would forecast that. An FOMC that does not press strongly for more expansionary fiscal policy now is an FOMC that is adopting a policy that threatens to make life very difficult indeed for their successors between two and six years from now.
And, of course, there is the chance–I see it as a substantial chance–that full employment is attained at a prime-age employment-to-population ratio of not 78% but 80%–or 81.5%. In that case, Janet Yellen is wrong to say that “fiscal policy is not needed to provide stimulus to get us back to full employment.”
Musings: Donald Trump Ought Not to Be a Hard-Money Gold-Standard Austerian Pain-Caucus President
When I was working in the Treasury in 1993, I was struck by how much it was the case that President Bill Clinton was still the ex-Governor of Arkansas, and that arguments that would have been powerful and important when directed at a Governor of Arkansas still resonated in his mind much more strongly than they perhaps should have if they were evaluated purely on technocratic grounds.
Arkansas, remember, was a small, poor state, heavily dependent on coupon-clipping from the Walton family and on the ability of Tyson Chicken to export to other states as its engines of economic growth. Those put constraints on Arkansas and make certain factors salient for Arkansas in ways that do not apply to the country as a whole.
Donald Trump has been a real estate developer–and a failed casino manager. The same where-he-comes-from-determine-which-arguments-resonate should apply here.
There thus ought to be an elective affinity between Donald Trump and proper technocratic fiscal policy: he ought to be very responsive to the very strong case for a real and substantial infrastructure construction-led fiscal expansion–and remember that investing in the human capital of twelve year olds is a very durable piece of infrastructure indeed. The math that shows that at current interest rates borrow-and-build is indeed a no-brainer for the economy is math that ought to be very familiar to Donald Trump.
And he ought to be very responsive to the Yellen caucus in the Federal Reserve. Very much like Reagan in 1980, Donald Trump has been told and from personal experience knows very different things about the Federal Reserve. by some that we need rigid Taylor Rules and has been told by others that we need a Gold Standard, but he also knows that high interest rates kill real estate values, real estate deals, and the solvency of real estate developers. Reagan’s goldbug and loose-money staffers fought each other to a standstill, and Volcker was left alone to manage the economy as best he could. There is a potential fight between the Donald Trump who develops real estate and the Donald Trump who wants to be a good Republican fighting for Republican causes he doesn’t really resonate with. My bet is that, if the issue can be properly framed, the valid technocratic arguments for loose money will prevail inside Donald Trump’s head, given the natural elective affinity with his past career.
And there is much to be done here…
One of my proudest moments was when, back in 1992, Larry Summers and I egged each other on to tell the Federal Reserve at Jackson Hole that, given the magnitude of recessionary shocks and the vulnerability of an economy to the zero lower bound, it was too hazardous to try to push the average inflation rate much below 5%/year. Great call. Completely correct. Totally ignored. One that I am very proud of.
But a 2%/year inflation target was set in stone for the U.S. by Alan Greenspan in the 1990s. Thereafter the Federal Reserve system fell in line and coalesced around finding reasons why that target was a good thing–not analyzing whether it was in fact a good thing.
It is now clear that it is not a good thing: shocks are too large. Perhaps the 2%/year target was appropriate if the Great Moderation was permanent. It wasn’t. We have radical uncertainty of many kinds, and a 2%/year target will have us slam into the zero lower bound appallingly often. The target inflation rate should be raised to 4%/year.
The only argument for keeping the 2%/year inflation target is that it helps build the Federal Reserve’s credibility. But the credibility that comes from doing stupid things consistently and persistently is not the kind of credibility you want to build or have, is it? It is important that people trust your promises. But the promises that you want to make and that you want credibility for are promises that you will do the right and smart thing–not the wrong and dumb thing–and thus that you will correct policies that turn out to have been clearly mistaken.
Note: Our Stabilization Policy Dilemma
Note to Self: If we want to have a better world, we either need to change the politics to restore the stabilization policy mission to fiscal authorities–and somehow provide them with the technocratic competence to carry out that mission–or give additional powers to central banks, powers that we classify or used to classify as being to a degree “fiscal”.
Why Does the Federal Reserve Take 2%/Year Inflation to Be a Ceiling Rather than a Target?
A Hypothesis: Some (many?) Federal Reserve policymakers seem to believe that if there is a recession, they lose.
And they also believe that if inflation gets above 2%/year they will be unable to reduce it to 2%/year without a recession.
Thus they do not take an “optimal control” view of the situation at all. Instead, they seek above all else to avoid getting into a situation in which they will have to take active steps to reduce the inflation rate, because they do not believe they can do so without generating something that will be called a recession.
This is a dangerous and a bad habit of thought for them to have…