Tag: Olivier Blanchard

Must-read: Olivier Blanchard: “The US Phillips Curve: Back to the 60s?”

Posted on by Brad DeLong

Must-Read: Olivier Blanchard says that he and Paul Krugman differ not at all on the analytics but, rather, substantially on “tone”. When I read Olivier, I find his tone so measured and reasonable that casual and even more-attentive-than-casual readers are likely to completely miss the point.

When Olivier believes that the Federal Reserve did right to raise interest rates last month. But when he says “each of the last three conclusions presents challenges for the conduct of monetary policy”, what he means the conclusion I draw is: The Federal Reserve has made and is making three mistakes in its assessment of the relationship between inflation and unemployment:

  1. It believes that the relationship is tight, so that you can make policy by simply looking at the forecast without looking at asymmetric consequences in the tails of the distribution of future outcomes. But the relationship is not tight, but loose. It has always been loose.
  2. It believes that the gearing between unemployment and inflation is strong, so that minor falls of unemployment below the natural rate produce substantial increases in inflation even in the short run. But that gearing has not been strong since the early 1980s. It is weak.
  3. It believes that increases in inflation substantially and rapidly affect expectations of future inflation, so that we are never far from a wage-price spiral. But that gearing has not been strong since the late 1980s, if then. Inflation expectations are anchored.

Why the Federal Reserve is working today as if the Phillips-Curve relationship is still what it was in the years around 1980 is a great mystery. But it is, I think–and I think Olivier thinks, though with his reasonable tone it is hard to tell–leading the Federal Reserve to place bad monetary-policy bets right now:

Olivier Blanchard: The US Phillips Curve: Back to the 60s?: “The US Phillips curve is alive…

…(I wish I could say “alive and well,” but it would be an overstatement: the relation has never been very tight.) Inflation expectations, however, have become steadily more anchored, leading to a relation between the unemployment rate and the level… rather than the change in in inflation… [that] resembles more the Phillips curve of the 1960s than the accelerationist Phillips curve of the later period. The slope of the Phillips curve… has substantially declined…. The standard error of the residual… is large…. Each of the last three conclusions presents challenges for the conduct of monetary policy…

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Must-read: Olivier Blanchard: “The Price of Oil, China, and Stock Market Herding”

Posted on by Brad DeLong

Must-Read: Olivier Blanchard: The Price of Oil, China, and Stock Market Herding: “The main effect of a slowdown in China would be, through lower commodity prices…

…help rather than hurt the United States…. The oil price explanation… is even more puzzling…. It was taken for granted that a decrease in the price of oil was good news for oil-importing countries…. We learned in the last year that, in the short run, the adverse effect on investment on energy producing firms could come quickly and temporarily slow down the effect, but this surely does not undo the general conclusion. Yet the headlines are now about low oil prices leading to low stock prices…. [Not] convincing… [is] that very low prices lead to such serious problems for oil producers that this will end up… dominating the scene… [or] that the low prices reflect a yet unmeasured decrease in world growth…. Maybe we should not believe the market commentaries. Maybe it was neither oil nor China….

I believe that to a large extent, herding is at play. If other investors sell, it must be because they know something you do not know. Thus, you should sell…. So how much should we worry? This is where economics… gives the dreaded two-handed answer. If it becomes clear… that fundamentals are in fact not so bad, stock prices will recover…. [But] the stock market slump… can become self-fulfilling…. Hope for the first… worry about the second.

Must-read: Olivier Blanchard: “Ten Take Aways from the ‘Rethinking Macro Policy: Progress or Confusion?'”

Posted on by Brad DeLong

Must-Read: I think the extremely-sharp Olivier Blanchard misses an important part of my argument here. If g the rate of growth of a government’s taxing capacity > r its cost of funds via borrowing and if the government is risk-neutral then obviously the government should issue more debt: the economy is then dynamically inefficient with respect to the investments taxpayers have made in their “ownership” of the government and its assets. Any argument that such a government should not be frantically running up its debt must hinge on aversion to interest-rate risk caused by fear of the consequences in the event of an interest-rate spike. But in the case of a reserve currency-issuing sovereign, what are those consequences? The consequences are merely that one must then balance the government’s budget constraint, via some combination of higher taxes, inflation, and financial repression. And there is no reason to think that, for reserve currency-issuing sovereigns, the costs of such a balancing are unduly large.

Other policies to get rid of the distortions that produce g > r for government debt may well be better than running up the debt. But in the absence of those other policies, running up the debt is certainly better than the status quo unless the government is near the edge of its financial repression and taxing capacities and the costs of inflation are very large. And for reserve currency-issuing sovereigns those are none of them the case.

Olivier Blanchard: Ten Take Aways from the “Rethinking Macro Policy: Progress or Confusion?: “On the latter, perhaps the most provocative conclusion of the conference…

…was offered by Brad DeLong:  If the rate at which the government can borrow (r) is less than the growth rate (g), then, he argued, governments should increase, not decrease, current debt levels. If people value safety so much (and thus the safe rate is so low), then it makes sense for the state to issue safe debt, and possibly use it for productive investment.  And if the interest rate is less than the growth rate, debt is safe: the debt- to-GDP ratio will decrease, even if the government never repays the debt.
One senses that the argument has strong limits, from the likelihood that r remains less than g (the two letters appear to have become part of the general vocabulary), to the issue of what determines the demand for safe assets, to whether r less than g is an indication of dynamic inefficiency or some distortion, to whether, even if this world, high levels of debt increase the probability of multiple equilibria, rollover crises and sudden stops.

Must-read: Martin Sandbu: “Free Lunch: On Models and Making Policy”

Posted on by Brad DeLong

Must-Read: Superb from the extremely sharp Martin Sandbu! Only three quibbles:

  1. There are indeed “three great economists” in the mix here, but their names are Summers, Krugman, and Blanchard…
  2. This isn’t really a conversation that would have taken place even in an academic setting. If I have ever been in the same room at the same time with Larry, Paul, and Olivier–let alone all of Olivier’s coauthors, Michael Woodford, Danny Vinit, and Lukasz Rachel and Thomas Smith–I cannot remember it. And discussions and exchanges in scholarly journal articles are formal and rigid in an unhelpful way.
  3. Do note that Keynes was on Summers’s side with respect to the importance of maintaining business confidence: cf.: General Theory, ch. 12, “The State of Long-Term Expectation”

Martin Sandbu: Free Lunch: On Models and Making Policy: “The internet has… open[ed] up to the public…

…discussions… that previously took place mostly in face-to-face gatherings or scholarly journal articles. Neither medium was particularly accessible….

Summers posted a characteristically succinct statement on why he disagreed with the Federal Reserve’s decision to begin tightening… His analysis is well worth reading in full, but the trigger of the ensuing debate was his explanation for why the Fed thinks differently: ‘I suspect it is because of an excessive commitment to existing models and modes of thought. Usually it takes disaster to shatter orthodoxy.’… DeLong expressed doubts that the Fed’s analysis was indeed compatible with existing models; Krugman asserted that conventional models straightforwardly showed the Fed to be in the wrong, and that… policy was driven… by… ‘a conviction that you and your colleagues know more than is in the textbooks’….

Summers then responded… showed a fascinating divergence…. DeLong and Krugman think the Fed erred by ignoring… models…. Summers thinks the Fed erred by ignoring things that such models do not capture…. Summers is also much more comfortable with the notion that policymakers should aim to underpin market confidence. That notion has often been derided by Krugman…. Two quotes rather nicely capture the methodological disagreement here. Summers writes: ‘I think maintaining confidence is an important part of the art of policy…. Paul is certainly correct in his model but I doubt that he is in fact.’ DeLong responds: ‘Larry, however, says: We know things that are not in the model. Those things make Paul’s claim wrong. My problem with Larry is that I am not sure what those things are.’…

What is a policymaker to do if she thinks this is the case in reality, even if no extant model captures it? Surely not wait for 30 years in the hope that new mathematical techniques enable economists to model that reality. In his willingness to listen to those who may have an untheoretical ‘feel’ for the market, and in his intellectual respect for the limits of his own knowledge, Summers comes across as the most Keynesian of these three…

A semi-platonic dialogue about secular stagnation, asymmetric risks, Federal Reserve policy, and the role of model-building in guiding economic policy

Posted on by Brad DeLong
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Sokrates: You remember how I used to say that only active dialogue–questions-and-answers, objections-and-replies–could convey true knowledge? That a flat wax tablet covered by written words could only convey an inadequate and pale simulacrum of education?

Aristoteles: Yes. And you remember how I showed you that you were wrong? That conversation is ephemeral, and very quickly becomes too confused to be a proper educational tool? That only something like an organized and coherent lecture can teach? And only something like the textbooks compiled by my lecture notes can make that teaching durable?

Aristokles: But, my Aristoteles, you never mastered my “dialogue” form. My “dialogue” form has all the advantages of permanence and organization of your textbooks, and all the advantages of real dialectic of Sokrates’s conversation.

Sokrates: How very true, wise Aristokles!

Aristokles How am I to take that?

Xanthippe: You now very well: as snark, pure snark. That’s his specialty.

Hypatia: This is all complicated by the fact that in the age of the internet real, written, permanent dialogues can spring up at a moment’s notice:

Sokrates: And with that, let’s roll the tape:

Other things linked to that are highly relevant and worth reading:

Things I did not find and place outbound links to, but should have:

  • Polya
  • Dennis Robertson
  • Donald Patinkin

Looking at the whole thing, I wince at how lazy people–especially me–have been with their weblog post titles. I should find time to go back and retitle everything, perhaps adding an explanatory sentence to each link…

MOAR musings on whether we consciously know more or less than what is in our models…

Posted on by Brad DeLong

Larry Summers presents as an example of his contention that we know more than is in our models–that our models are more a filing system, and more a way of efficiently conveying part of what we know, than they are an idea-generating mechanism–Paul Krugman’s Mundell-Fleming lecture, and its contention that floating exchange-rate countries that can borrow in their own currency should not fear capital flight in a utility trap. He points to Olivier Blanchard et al.’s empirical finding that capital outflows do indeed appear to be not expansionary but contractionary:

Olivier Blanchard et al.: Macro Effects of Capital Inflows: Capital Type Matters: “Some scholars view capital inflows as contractionary…

…but many policymakers view them as expansionary. Evidence supports the policymakers…. Bond inflows lead to currency appreciation and are contractionary, while non-bond inflows lead to an appreciation but also to a decrease in the cost of borrowing, and thus may be expansionary…. How can we reconcile the models and reality? … Capital inflows may… reduce the cost of financial intermediation… be expansionary even for a given policy rate. In emerging markets, with a relatively underdeveloped financial system, the effect of a reduction in the cost of financial intermediation may dominate, leading to a credit boom and an output increase despite the appreciation….

The appropriate policies vis-à-vis capital inflows depend very much on the nature of the inflows. Sterilised foreign exchange (FX) market intervention… used in response to non-bond inflows… increases capital inflows, and thus increases the effects of inflows on credit and the financial system…. If the central bank is worried about both appreciation and unhealthy or excessive credit growth, FX intervention or capital controls are preferable to the use of the policy rate in response to an increase in bond inflows…. In response to non-bond inflows, our framework suggests that if the goal is to maintain exchange rate stability with minimum impact on the return to non-bonds, capital controls do the job best, followed by FX intervention, followed by a move in the policy rate…

If you asked me for a precis of what is going on in Blanchard et al., I would start drawing a graph in which we had:

  1. An IS (“Investment-Savings”) curve, for which the level of production (a) increases when government purchases increase; (b) falls when the long-term risky real interest rate rises, discouraging investment and consumption directly and discouraging exports indirectly by raising the value of the currency; and (c) falls when desired capital inflows rise and thus raise the value of the currency.
  2. An LM (“Liquidity-Money) curve, relating demand for money and thus the short-term safe nominal interest rate as a function of the level of output given the money stock.
  3. A CC (“Credit-Channel) wedge between the two, consisting of (a) the term premium on interest rates, that is how much long-term rates exceed short-term rates; (b) the risk premium on investments; and (c) the expected inflation rate:
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I would point out that, in Blanchard et al.‘s setup, what they call “bond inflows” move the IS curve to the left by raising the value of the currency for any given short-term safe nominal policy interest rate. Thus they are contractionary–for a constant policy interest rate on the LM curve, and a constant double-arrow CC credit-channel wedge.

I would point out that what they call “nonbond inflows” both move the IS curve to the left and shrink the double-arrow CC credit-channel wedge. So–for a constant policy rate–are contractionary if the first and expansionary if the second effect dominates.

And I would point out that Krugman’s Mundell-Fleming lecture deals with this case under the heading of “banking crisis”:

Banking crisis: Several commentators – for example, Rogoff (2013) — have suggested that a sudden stop of capital inflows provoked by concerns over sovereign debt would inevitably lead to a banking crisis, and that this crisis would dominate any positive effects from currency depreciation. If correct, this would certainly undermine the optimism I have expressed about how such a scenario would play out. The question we need to ask here is why, exactly, we should believe that a sudden stop leads to a banking crisis. The argument seems to be that banks would take large losses on their holdings of government bonds. But why, exactly? A country that borrows in its own currency can’t be forced into default, and we’ve just seen that it can’t even be forced to raise interest rates. So there is no reason the domestic-currency value of the country’s bonds should plunge. The foreign-currency value of those bonds may indeed fall sharply thanks to currency depreciation, but this is only a problem for the banks if they have large liabilities denominated in foreign currency…

Krugman is working in a framework in which the risk-premium part of the credit channel–the risk-premium part of the double-headed orange CC arrow–is small in normal times but can discontinuously shift to large in the event of a “banking crisis”. For Blanchard et al. and Summers, the size of the risk-premium part of the CC arrow is not discontinuously 0-1, but rather moves gradually with “confidence”: low when confidence is high and desired capital inflows are large, high when confidence is low and there is a sudden stop. Krugman says that since, in the absence of large foreign currency-denominated debt, there is no reason for there to be fears of a banking crisis in the event of a sudden stop.

Blanchard et al. appear to think that Krugman is largely right about developed economies. In them risk premiums are, they think, relatively small: financial markets work relatively well, and are not all that sensitive to amounts of new investment money flowing in. But, they say, they believe that in developing economies things are different. There, they believe, the risk premium component of the credit channel wedge is sensitive to international market conditions and thus the size the desired capital inflow.

In brief, Blanchard et al appear to think that only developing economies are “Minskyite” in the sense of a strong vulnerability of the CC risk premium to “confidence” even in the absence of fundamental shocks. Summers’s judgment appears to be that all economies are “Minskyite”. If I understand Paul’s thinking, it is more that “confidence” is only likely to matter as an equilibrium-selection device in a model with multiple equilibria like that of Krugman’s (1999b) third-generation financial-crisis model in “Balance Sheets, the Transfer Problem, and Financial Crises”. No multiple equilibrium, no possibility of suddenly jumping to a bad equilibrium, and so little possibility of any sort of pure “confidence” shock causing large amounts of trouble.

Paul here is more on the “financial markets work like they ought to” side of the argument. Olivier and company are more on the side of “developing economies have financial-market vulnerabilities North Atlantic economies do not” side. And Summers is more on the side of Keynes here:

Enterprise only pretends to itself to be mainly actuated by the statements in its own prospectus…. Only a little more than an expedition to the South Pole, is it based on an exact calculation of benefits to come. Thus if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die…. This means, unfortunately, not only that slumps and depressions are exaggerated in degree, but that economic prosperity is excessively dependent on a political and social atmosphere which is congenial to the average business man. If the fear of a Labour Government or a New Deal depresses enterprise, this need not be the result either of a reasonable calculation or of a plot with political intent;–it is the mere consequence of upsetting the delicate balance of spontaneous optimism. In estimating the prospects of investment, we must have regard, therefore, to the nerves and hysteria and even the digestions and reactions to the weather of those upon whose spontaneous activity it largely depends…

Must-read: Olivier Blanchard et al.: “Macro Effects of Capital Inflows: Capital Type Matters”

Posted on by Brad DeLong

Olivier Blanchard et al.: Macro Effects of Capital Inflows: Capital Type Matters: “Some scholars view capital inflows as contractionary…

…but many policymakers view them as expansionary. Evidence supports the policymakers. This column introduces an analytic framework that knits together the two views. For a given policy rate, bond inflows lead to currency appreciation and are contractionary, while non-bond inflows lead to an appreciation but also to a decrease in the cost of borrowing, and thus may be expansionary….

How can we reconcile the models and reality? [Our] answer… relies on… allowing for both ‘bonds’ (the rate on which can be thought of as the policy rate) and ‘non-bonds’… which are imperfect substitutes…. Capital inflows may decrease the rate on non-bonds and reduce the cost of financial intermediation…. Capital inflows may in this case be expansionary even for a given policy rate. In emerging markets, with a relatively underdeveloped financial system, the effect of a reduction in the cost of financial intermediation may dominate, leading to a credit boom and an output increase despite the appreciation. In more advanced economies, the appreciation may dominate, and capital inflows (even into non-bonds) may be contractionary (e.g. the Swiss case)….

The appropriate policies vis-à-vis capital inflows depend very much on the nature of the inflows.

Sterilised foreign exchange (FX) market intervention, if done through bonds (as is usually the case), can fully offset the effects of bond inflows…. When, however, sterilised foreign exchange intervention is used in response to non-bond inflows… FX intervention… by reducing upward pressure on the currency… increases capital inflows, and thus increases the effects of inflows on credit and the financial system….

The policymaker may have several objectives in mind – with respect to credit growth (given the risk of financial crisis); the currency (given the risk of Dutch disease); and output (given nominal rigidities in the system). The issue is really one of matching the policy instrument (there are three) to deliver on the most important objectives, without too much cost in terms of the other objectives…. If the central bank is worried about both appreciation and unhealthy or excessive credit growth, FX intervention or capital controls are preferable to the use of the policy rate in response to an increase in bond inflows…. In response to non-bond inflows, our framework suggests that if the goal is to maintain exchange rate stability with minimum impact on the return to non-bonds, capital controls do the job best, followed by FX intervention, followed by a move in the policy rate….

[We] use global flows to all emerging market countries together with the VIX as instruments…. We find that, while bond inflows have a negative effect on economic activity, non-bond inflows have a significant and positive effect. We also find that non-bond inflows (excluding FDI) have a strong positive effect on credit…. FDI inflows, while they increase output, have a negative impact on credit, perhaps because some of the intermediation which would have taken place through banks is replaced by FDI financing…

Must-Read: Jan Mohlmann and Wim Suyker: Blanchard and Leigh’s Fiscal Multipliers Revisited

Posted on by Brad DeLong

Must-Read: Naughty, naughty!

Jan Mohlmann and Wim Suyker: Blanchard and Leigh’s Fiscal Multipliers Revisited: “[We] do not find convincing evidence for stronger-than-expected fiscal multipliers for EU countries…

…during the sovereign debt crisis (2012-2013) or during the tepid recovery thereafter…. As Blanchard and Leigh did, we find a negative and statistically significant coefficient for 2009-2010 and 2010-2011 but not for 2011-2012…. For 2012-2013 we find a larger estimate than Blanchard and Leigh, but due to the higher standard error the estimated coefficient is no longer significant at the 5% level…. In the two periods we added, our estimated coefficients are close to zero…. As Blanchard and Leigh did, we find a statistically significant negative coefficient in the panel forecast for 2009-2013. This result holds for the prolonged period 2009-2015. However, we do not find a statistically significant coefficient when we perform the panel analysis for the period 2011-2015.

Nowhere in their piece do Mohlmann and Suyker report their estimated coefficient and its standard error for the entire period 2009-2015.

Repeat: nowhere in their piece do they report estimates for their entire sample.

Trying to back out estimates from the information they do give, if they had reported it they would have reported a number like -0.60 with a standard error near 0.23. Compare that to the Blanchard-Leigh estimates for 2009-2013 of a number of -0.67 with a standard error of 0.16.

See that a good and true lead is not “[There is no] convincing evidence for stronger-than-expected fiscal multipliers… during… 2012-13 or thereafter…”

See that a good and true lead would be: “There is no statistical power at all over 2012-13, 2013-14, and 2014-15 to test whether excess fiscal multipliers in those years are different than the strong excess fiscal multipliers found by Blanchard and Leigh…”

Seizing the high ground of the null hypothesis for one’s favored position, and then running tests with no power, is undignified…

Blanchard leigh Google Search

Must-Read: Olivier Blanchard et al.: ion”>

Posted on by Brad DeLong

Must-Read: Olivier Blanchard et al., eds.: Progress and Confusion: The State of Macroeconomic Policy: “What will economic policy look like…

…once the global financial crisis is finally over? Will it resume the pre-crisis consensus, or will it be forced to contend with a post-crisis ‘new normal’? Have we made progress in addressing these issues, or does confusion remain?… Prominent figures—including Ben Bernanke, Lawrence Summers, and Paul Volcker—offer… essays that address topics that range from the measurement of systemic risk to foreign exchange intervention. The chapters address whether we have entered a ‘new normal’ of low growth, negative real rates, and deflationary pressures, with contributors taking opposing views; whether new financial regulation has stemmed systemic risk; the effectiveness of macro prudential tools; monetary policy, the choice of inflation targets, and the responsibilities of central banks; fiscal policy, stimulus, and debt stabilization; the volatility of capital flows; and the international monetary and financial system, including the role of international policy coordination…. Is there progress or confusion?… Both. Many lessons have been learned; but, as the chapters of the book reveal, there is no clear agreement on several key issues.

Secular Stagnation–That’s My Title, of the Longer Version at Least

Posted on by Brad DeLong

J. Bradford DeLong: The Tragedy of Ben Bernanke: Project Syndicate:

Ben Bernanke has published his memoir, The Courage to Act.

I am finding it hard to read. And I am finding it hard to read as anything other than a tragedy. It is the story of a man who may have been the best-prepared person in the world for the job he was given, but who soon found himself outmatched by its challenges, quickly falling behind the curve and never quite managing to catch up.

It is to Bernanke’s great credit that the shock of 2007-2008 did not trigger another Great Depression. But the aftermath was unexpectedly disappointing… READ MOAR AT PROJECT SYNDICATE