Now That John Williams Is President of the New York Fed, He Really Should Convene a Blue Ribbon Commission on What the Inflation Target Should Be

From June 2017: Fed Up Rethink 2% Inflation Target Blue-Ribbon Commission Conference Call: I hear four arguments for not changing the 2%/year inflation target, even though pursuing that target found us in a situation where monetary policy was greatly hobbled in its ability to manage the economy for a solid decade. And, as best as I can evaluate them, all four of these arguments seem to me to be wrong. They are:

  1. The Federal Reserve, even at the zero lower bound, has powerful tools sufficient to carry out its stabilization policy tasks….

  2. The problem is not the 2%/year target but rather pressure on the Federal Reserve… from substantial numbers of economists and politicians practicing bad economics and motivated partisan reasoning….

  3. A higher inflation rate would bring shifting expectations of inflation back into the mix, distract people and firms from their proper task of calculating real costs and benefits to worry about monetary policy, and make monetary policy management more complicated….

  4. The Federal Reserve needs to maintain its credibility, and if it were to even once change the target inflation rate, its commitment to any target inflation rate would have no credibility….

Monday DeLong Smackdown: Trying and Failing to Get in Touch with My Inner Austrian Back in 2004…

That I never figured out how to write this paper is deserving of a smackdown. Why did I never figure out how to write it? Because I never figured out what to say, or what the answer was:

Hoisted from 2004: Getting in Touch with My Inner Austrian: A Still-Unwritten Paper: Fragment of an Unfinished Ms.: Part II of an unfinished paper, “After the Bubble.” The paper currently lacks Parts I, III, IV, V, and VI:

II. Aggressively Expansionary Monetary Policy and Macroeconomic Vulnerabilities:

Let us begin with a passage from Mussa (2004), “Global Economic Prospects: Bright for 2004 but with Questions Thereafter” (Washington: Institute for International Economics: April 1), in which Michael Mussa writes about global financial imbalances:

Michael Mussa: Policy interest rates are exceptionally low in most industrial countries: zero in Japan and Switzerland, 1 percent in the United States, 2 percent in the euro area, and at or near historic lows in the United Kingdom and Canada…. The very low level of policy interest rates is an imbalance (relative to normal conditions) that reflects exceptionally easy monetary policies to combat economic weakness.

This policy imbalance poses an important challenge for the future conduct of monetary policy. Situations of low policy interest rates and low inflation tend to be associated with unusual inertia in the processes of general price inflation, which makes traditional indicators of rising inflationary pressures less reliable as measures of the need to begin to tighten monetary conditions. Also, these situations tend to be associated with high valuations of equities, real estate, and long-term bonds, which can become fertile ground for large, unsustainable increases in asset prices. In this situation, if monetary policy is tightened too much too soon (perhaps because of worries about unsustainable increases in asset prices), the result can be an unnecessary asset market crunch and economic slowdown, and monetary policy may have relatively little room to ease in order to counteract this outcome.

On the other hand, if monetary policy remains too easy for too long (perhaps because subdued general price inflation gives no clear signal of the need for monetary tightening), then large asset price anomalies may develop before corrective action is taken. The monetary authority would then confront the grim choice of trying to keep an unsustainable asset price bubble alive or trying to combat the collapse of such a bubble without a great deal of room for monetary easing.

A further concern related to the general monetary policy imbalance in the industrial countries is its effect on emerging market economies. Interest rate spreads for emerging market borrowers have contracted substantially and flows of new credit have increased. The boom in emerging market credit has not yet reached the frenzy of the first half of 1997, but it is headed in that direction. Another major series of emerging market financial crises (such as 1997-99) does not seem likely in the near term in view of the very low level of industrial country interest rates and the favorable global economic environment for emerging market countries. By 2005 or 2006, however, either upward movements in industrial country interest rates or deterioration of market perceptions of the economic and financial stability of some emerging market countries could trigger another round of crises.

Mussa is warning that the high asset prices produced by very low interest rates pose dangers that may turn out to be substantial. One way to read Mussa’s warning is as a polite–a very polite–criticism of Alan Greenspan’s self-praise of his own low interest-rate policy contained in Greenspan (2004), “Risk and Uncertainty in Monetary Policy” (Washington: Federal Reserve Board: January 3):

Alan Greenspan: Perhaps the greatest irony of the past decade is that… success against inflation… contributed to the stock price bubble …. Fed policymakers were confronted with forces that none of us had previously encountered. Aside from the then-recent experience of Japan, only remote historical episodes gave us clues to the appropriate stance for policy under such conditions. The sharp rise in stock prices and their subsequent fall were, thus, an especial challenge to the Federal Reserve. It is far from obvious that bubbles, even if identified early, can be preempted at lower cost than a substantial economic contraction and possible financial destabilization–the very outcomes we would be seeking to avoid…. The notion that a well-timed incremental tightening could have been calibrated to prevent the late 1990s bubble while preserving economic stability is almost surely an illusion.

Instead of trying to contain a putative bubble by drastic actions with largely unpredictable consequences, we chose, as we noted in our mid-1999 congressional testimony, to focus on policies “to mitigate the fallout when it occurs and, hopefully, ease the transition to the next expansion.”

During 2001, in the aftermath of the bursting of the bubble and the acts of terrorism in September 2001, the federal funds rate was lowered 4-3/4 percentage points. Subsequently, another 75 basis points were pared, bringing the rate by June 2003 to its current 1 percent, the lowest level in 45 years. We were able to be unusually aggressive in the initial stages of the recession of 2001 because both inflation and inflation expectations were low and stable. We thought we needed to be, and could be, forceful in 2002 and 2003 as well because, with demand weak, inflation risks had become two-sided for the first time in forty years.

There appears to be enough evidence, at least tentatively, to conclude that our strategy of addressing the bubble’s consequences rather than the bubble itself has been successful. Despite the stock market plunge, terrorist attacks, corporate scandals, and wars in Afghanistan and Iraq, we experienced an exceptionally mild recession–even milder than that of a decade earlier. As I discuss later, much of the ability of the U.S. economy to absorb these sequences of shocks resulted from notably improved structural flexibility. But highly aggressive monetary ease was doubtless also a significant contributor to stability…

Greenspan is confident that raising interest rates and thus raising the unemployment rate during the bubble of the late 1990s would have been the wrong policy, and that aggressively lowering interest rates after the bubble was the right policy. Lowering interest rates cushioned falls in bond prices. Lowering interest rates made use of bond financing for investment more attractive. Lowering interest rates boosted bond and real estate prices, induced households to refinance, and so provided a powerful spur to consumption spending that largely offset the post-bubble fall in investment spending. In Greenspan’s view, the aggressive lowering ofinterest rates was exactly the right thing to do in the aftermath of the bubble to shift spending from investment to consumption and so to keep the economy not far from full employment.

Mussa says: not so fast. Very low interest rates, coupled with assurances from high Federal Reserve officials that interest rates will stay very low for substantial periods of time, produce a situation in which the prices of long-duration assets—long-term bonds, growth stocks, and real estate—climb very high. What goes up may come down, and may come down rapidly. And should some class of asset prices come down rapidly and should it turn out that many debtors in the economy go bankrupt because their assets have lost value, serious financial crisis will result. The price of using exceptionally easy money to keep the collapse of the dot-com bubble from turning into a depression has been the creation of a three-fold vulnerability:

  1. If the assets the prices of which collapse when interest rates start to rise are emerging-market debt, then the memories of the 1990s and increasing risk will induce large-scale capital flight from the periphery to the core—an echo of the East Asian financial crises of 1997-1998.

  2. If the assets the prices of which threaten collapse when interest rates start to rise are domestic bond and real estate holdings that have been pushed to unsustainable levels by positive-feedback “bubble” buying, then the “monetary authority would… confront the grim choice of trying to keep an unsustainable asset price bubble alive or trying to combat the collapse of such a bubble without a great deal of room for monetary easing” to keep real estate and bond prices from falling far and fast.

  3. “If monetary policy is tightened too much too soon” (presumably because of fears of positive-feedback “bubble” buying), the result may be a credit crunch and a recession—with no guarantee that a reversal of the monetary policy tightening will undue the effects of the credit crunch. I do not believe that many economists would say that Mussa’s fears about the potential macroeconomic vulnerabilities created by the low interest-rate policy the Federal Reserve has pursued since the end of the dot-com bubble are unreasonable. (Few, however, carry their alarm to the degree that Stephen Roach of Morgan Stanley does.)

And Mussa expresses them in a coherent language—one in which sustained rises in asset prices induce positive-feedback trading that “bubbles” prices above fundamentals, one in which what goes up comes down rapidly, one in which large sudden falls in asset prices produce chains of bankruptcy and raise risk and default premia enough to threaten to cause deep recessions. The language has echoes of the great Charles P. Kindleberger’s (1978) Manias, Panics, and Crashes (New York: Basic Books), and of earlier writings about the consequences of excessive money-printing: “inflation, revulsion, and discredit.”

But what Mussa’s assessment of risks lacks is a model. And without a model, we have a hard time assessing his argument. Alan Greenspan frightened away the Evil Depression Fairy in 2000-2002 by promising not that he would let the Evil Fairy marry his daughter but by promising high asset prices—unsustainably high asset prices—for a while. Whether this was a good trade or not depends on the relative values of the risks avoided and the risks accepted. And to evaluate this requires a model of some sort…


Alan Greenspan (2004), “Risk and Uncertainty in Monetary Policy” (Washington: Federal Reserve Board: January 3).

Michael Mussa (2004), “Global Economic Prospects: Bright for 2004 but with Questions Thereafter” (Washington: Institute for International Economics: April 1)…”

Shiller CAPE Is Currently Pricing in One Great Recession Every Decade

Note to Self: Spent the Berkeley Econ faculty lunch talking to Yuriy Gorodnichenko, Pierre-Olivier Gourinchas, St. Matthew the Greater, Dmitriy Sergeyev, and a couple of others about a very wide range of topics, ending with r-star (which Yuriy has to discuss Saturday at the Clausen Center Conference). I left the conversation desperate to figure out how Shiller’s stock-market CAPE index which currently suggests substantial stock market valuation even with a low fundamental safe real interest rate r-star is affected by the low earnings of the crisis years 2008-2011…

Yes, it makes a significant difference:

2017 11 15 Shiller Alternative CAPE

Replacing actual earnings from 2007 on with just flat real earnings until actual earnings catch up knocks the Alternative CAPE index down by 5, from higher than any time save during the High Dot-Com Bubble to lower than during the 1995-2007 part of the Great Moderation era. Taking Shiller CAPE at face value means that your idea of stock market fundamentals is currently pricing in one Great Recession every decade. If you do not believe that, you should not take Shiller CAPE at face value…

2017 11 15 Long Run Shiller Alternative CAPE


# set up function to import data as a pandas time series dataframe object 

import pandas as pd
import os
from urllib.request import urlretrieve

URL = ""
FILENAME = "2017-11-15_shiller_cape_alternative.csv"

def get_stocks_data(filename, url, force_download = False):
    if force_download or not os.path.exists(filename):
        urlretrieve(url, filename)
    data = pd.read_csv(filename, index_col = 0)
    return data

# import shiller data as a pandas time series dataframe object
# read it in from web if necessary

stocks_data = get_stocks_data(URL, FILENAME)
stocks_data.rename(columns = {'CAPE’':'Alternative CAPE'}, inplace = True)

stocks_data['Alternative CAPE'].plot()

plt.title("Stock Market Value as a Multiple of a 10-Year 

Lagged Moving Average of Earnings”,
plt.ylabel(“Multiple of 10-Yr Average of Lagged Earnings”)
plt.xlim(1970, )

stocks_data['Alternative CAPE'].plot()
plt.title("Stock Market Value as a Multiple of a 10-Year 

Lagged Moving Average of Earnings”,
plt.ylabel(“Multiple of 10-Yr Average of Lagged Earnings”)

(Late) Monday Smackdown: In Which I Am Annoyed at Being Paired with John Taylor

Clowns (ICP)

The IMF’s Finance and Development has paired me on “secular stagnation” with John Taylor.

When they told me that I would be paired with John Taylor, I protested: As I see it, sometime in the early 2000s John Taylor ceased being an economist and became a politician. Hence, I thought, he was likely to have very little of value to say to professional economists–to those of us who are trying to use the tools of economics to understand the world.

And I see that I was right: I do not think Taylor’s piece has any value at all to professional economists.

Let me take especial note of five passages in Taylor’s piece: passages that, in my view, a professional economist simply could not write:

The fact that central banks have chosen low policy rates since the crisis casts doubt on the notion that the equilibrium real interest rate just happened to be low. Indeed, in recent months, long-term interest rates have increased with expectations of normalization of monetary policy…

People did not just change their expectations with respect to the chances of “normalization” of interest rates. To say that they did is a politician’s and not a professional economist’s statement. Long-term interest rates increased with the shifting expectations of Trump deficits and the belief that an inflation targeting Fed to respond.

And claiming that central banks feely “chose” low policy rates… Central banks were impelled and compelled by what they saw and see as very strong evidence of a low equilibrium real interest rate. A professional economist would not say that their “choice” of such low rates casts doubt on the notion of a low equilibrium real rate. A professional economist would say that low policy rates reflect central banks’ judgment that the equilibrium real rate was low–and that the failure of inflation to accelerate with low policy rates affirms the correctness of that judgment.

As bad is:

Low policy interest rates set by monetary authorities, such as the US Federal Reserve, before the financial crisis were associated with a boom characterized by rising inflation and declining unemployment—not by the slack economic conditions and high unemployment of secular stagnation…

Again, this is not something that a professional economist would say. Core inflation was 2.8% on the eve of the 2001 recession and 2.4% on the eve of the 2008 recession. A professional economist simply cannot say that the course of inflation over that business cycle is in any way evidence that policy interest rates over the cycle were in any Wicksellian sense “too low”. A professional economist simply can not say that the course of employment over that business cycle is in any way evidence of an unsustainable boom:


This third is, I think, worst of all:

The evidence runs contrary to the view that the equilibrium real interest rate—that is, the real rate of return required to keep the economy’s output equal to potential output—was low prior to the crisis…

If inflation stable over the cycle and subpar employment performance with very low real policy rates is not “evidence… [for] the view that the equilibrium real interest rate… was low prior to the crisis”, what could possibly be evidence for that view?

Professional economists like John Williams who estimate r* find a 1.25%-point decline in it from the late 1980s to 2007–and then another 1.25%-point decline in the crisis.

Cursor and Whatever happened to secular stagnation

But perhaps Taylor’s most political statement of all is:

During the 1980s and 1990s, tax reform, regulatory reform, monetary reform, and budget reform proved successful at boosting productivity growth in the United States…

“Tax reform”–for the Republicans who are Taylor’s main audience, “tax reform” means the 1981 Reagan tax cut. But productivity growth did not rise until after 1995. That is a very long fuse indeed to run a claim from policy cause to economic effect.

“Regulatory reform”–Anne Gorsuch’s actions as EPA head giving a pass to lead polluters in 1981-2 was particularly unfortunate given what we have learned since about lead and human cognition. Again, the timing does not work, and is hidden by Taylor’s artful reference “during the 1980s and the 1990s”. Again, productivity growth did not rise until after 1995. That is a very long fuse indeed to run a claim from policy cause to economic effect.

“Monetary reform”–that was Paul Volcker’s accession to the Fed Chairship in 1979. But, once again, productivity growth did not rise until after 1995. And, once again, is a very long fuse indeed to run a claim from policy cause to economic effect.

Tax “reform”, regulatory “reform”, and monetary “reform” were not obviously helpful “during the 1980s and 1990s”. The big pushes come at the start of the 1980s. The productivity boom comes more than a decade and a half later.

Only with “budget reform” is there a case that a professional economist might make. “Budget Reform” is, in this context, the 1993 Clinton administration Reconciliation Bill—the bill that undid a lot of what Taylor’s employers and allies had done in the previous fifteen years. There are possible and plausibly strong links for a professional economist to draw between the adoption of not-insane and sustainable U.S. fiscal policies in 1993 and the post-1995 productivity boom propelled by the leading high-tech sector. How strong are these links? That is uncertain.

But “during the 1980s and 1990s, tax reform, regulatory reform, monetary reform, and budget reform proved successful at boosting productivity growth in the United States” is not a statement a professional economist could or would make.


The recent US election has raised the chances for tax, regulatory, monetary, and perhaps even budget reform…

Are any words necessary?

Finance and Development, I think, made a bad mistake in choosing Taylor for this role. Taylor’s is a political document. It is written for political purposes. If fall the readers of Finance and Development understand that–and do not take it as an attempt to analyze the economy–no harm will be done. But not all readers will. Some will think they are supposed to learn something about the economy from it. They will be misled thereby.

Sluggish Future: 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

Three, Four… Many Secular Stagnations!

3 Month Treasury Bill Secondary Market Rate FRED St Louis Fed

I. The Third Coming of John A. Hobson

In my view, the current debate about “secular stagnation” started by Larry Summers is best thought of as the third coming of John A. Hobson.

The first coming of John A Hobson was, of course, Hobson (1902): Imperialism: A Study. In Hobson’s schema, unequal income distribution combined with the limited physical capacity to consume of the rich meant that anything like full employment could be maintained only with a growing share of output devoted to government purchases and investment. But where were there vents for additional investment? Abroad, in the growing empire:

Investors who have put their money in foreign lands, upon terms which take full account of risks connected with the political conditions of the country, desire to use the resources of their Government to minimize these risks, and so to enhance the capital value and the interest of their private investments. The investing and speculative classes in general also desire that Great Britain should take other foreign areas under her flag in order to secure new areas for profitable investment and speculation…

Moreover, the military apparatus necessary to conquer and to defend what had been conquered soaked up productive capacity that would otherwise have been idle. As Winston Churchill put it with respect to Great Britain’s naval construction plans for the year 1909: “The Admiralty had demanded six [Dreadnought-class] battleships: the economists offered four: and we finally compromised at eight.” Thus governments that embarked on imperialism and armaments found their domestic economies in relatively good shape with respect to employment, capacity utilization, and profits; while governments that minded their knitting did not. And even though imperialism and militarism were humanitarian and cost-benefit disasters, governments that pursued them tended to remain in office. And this pushed Europe toward World War I.

It is conventional among economists to not understand Hobson’s “underconsumptionist” argument. As Ben Bernanke commented in 2013:

As I pointed out… [when] Larry first raised the secular stagnation argument… it’s hard to imagine that there would be a permanent dearth of profitable investment projects. As Larry’s uncle Paul Samuelson taught me in graduate school at MIT, if the real interest rate were expected to be negative indefinitely, almost any investment is profitable. For example, at a negative (or even zero) interest rate, it would pay to level the Rocky Mountains to save even the small amount of fuel expended by trains and cars that currently must climb steep grades. It’s therefore questionable that the economy’s equilibrium real rate can really be negative for an extended period…

This, of course, misses the point that risk-bearing capacity is an essential factor of production needed for private-sector business investment, and risk bearing capacity must be mobilized and paid for—and paid for very handsomely given the adverse selection and moral hazard problems in financing private investment. A very healthy average risky rate of profit is perfectly consistent with a short-term safe real rate of interest less than the negative of the rate of inflation.

For Hobson, of course, the solution was progressive tax and transfer (and perhaps predistribution?) policies to end the Gilded Age and create a reasonable distribution of income, in which fortunes would not be in the hands of those whose stomachs were small and whose narrow eyes were not much bigger, and who would thus hoard rather than spend their incomes.

The second coming of John A. Hobson was, of course, Alvin Hansen (1939). Secular stagnation was “sick recoveries which die in their infancy and depressions which feed on themselves and leave a hard and seemingly immovable core of unemployment…” We were “rapidly entering a world in which we must fall back upon a more rapid advance of technology than in the past if we are to find private investment opportunities adequate to maintain full employment…” For Hansen, the solution was either (a) more investment in research and development to speed technological progress, or (b) public investment “in human and natural resources and in consumers’ capital goods of a collective character…”

In some sense Hobson’s fears became true and more than true: World War I, and what followed. And when the world economy reoriented itself after World War II we were no longer in a Gilded Age but, rather, in an Age of Social Democracy with a much more equal income distribution—and so Hobson’s unequal income distribution and resulting underconsumptionist worries were no longer relevant.

Alvin Hansen’s worries were similarly obsolete as the post-World War II order formed itself. We got the greater public investment, both in research and development to spur more rapid technological progress—DARPA—and in the Cold War arms race.

The Wheel Has Turned Again

The Longer Depression: But now the wheel of history has turned once again. We have a Second Gilded Age. We have had what looks to have been either the second-largest or the largest adverse financial business-cycle shock in history. We have had an economic downturn followed by a very slow recovery that has produced and will produce a cumulative output gap vis-a-vis potential that will rival and may well exceed the Great Depression itself as a multiple of the economy’s productive potential.

But it is not just what people call “the Great Recession” and should call “the Longer Depression”. It is the long, steady decline in safe interest rates at all maturities since 1990: the decline in short-term safe real interest rates from 4% to -1.5%, and the decline in long-term safe real interest rates from 5% to 1%.

B. Larry’s Core Worry: And so now we have Larry Summers (2013), reacting to the collapse of the short-term safe nominal Wicksellian “neutral” rate of interest consistent with full employment and with central banks’ ability to hit their inflation targets.

We are handicapped because there is not one place in which Larry has developed his argument: it is evolving. But the debate Larry has started seems to me, as I wrote, “the most important policy-relevant debate in economics since John Maynard Keynes’s debate with himself in the 1930s.”

Summers’s core fear is that the global economy—or, at least, the North Atlantic chunk of it—will be stuck for a generation or more in a situation in which, if investors have realistically expectations, then even if central banks reduce interest rates to accommodate those expectations and even if governments follow sensible but not extravagant fiscal policies, private financial markets will still fail to support a level of investment demand compatible with full employment.

Thus economic policymakers will find themselves either hoping that investors form unrealistic expectations—prelude to a bubble—or coping with chronic ultralow interest rates and the associated risks of stubbornly elevated unemployment.

III. Causes of Secular Stagnation III

Such “badly behaved investment demand and savings supply functions,” as Martin Feldstein called them when he taught this stuff to me at Harvard back in 1980, could have seven underlying causes:

  1. High income inequality, which boosts savings too much because the rich can’t think of other things they’d rather do with their money. (Hobson)
  2. Technological and demographic stagnation that lowers the return on investment and pushes desired investment spending down too far. (Hansen)
  3. 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. (Bernanke)
  4. A broken financial sector that fails to mobilize the risk-bearing capacity of society and thus drives too large a wedge between the returns on risky investments and the returns on safe government debt. (Rogoff)
  5. 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. (Krugman, Blanchard)
  6. 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.
  7. 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.

A. Other Economists’ Views as Partial: The first thing to note is that other economists who have been worrying at related issues have views all of which appear to be a subset of Summers-style secular stagnation concerns. Hobson saw income inequality as the root—that’s number 1 on the list. Hansen saw demographic and technological stagnation—that’s number 2, and today this point of view is echoed by Gordon. Bernanke, the former Federal Reserve chairman, says we have entered an age of a “global savings glut” because of mercantilism and political risk in emerging markets—that’s number 3 on the list. Kenneth Rogoff of Harvard points to the emergence of global “debt supercycles” that have broken the ability of financial markets to do the risk transformation on a large enough scale—that’s number 4. CUNY’s Paul Krugman warns of the return of “Depression economics” and seeks central banks that will “credibly promise to be irresponsible”, while Olivier Blanchard called for a 4%/year inflation target—that’s number 5. And numbers 6 and 7 have not yet made their appearance in the policy-macroeconomic debate. But they should.

Larry Summers is all of the above: all seven.

B. Against Partial Explanations: And his major concern is to argue against those who think that it is just one of the seven that is the problem—that there is a quick fix, which will either come of itself relatively soon or could be brought forward in time via a simple, clever policy move. Thus Summers on Bernanke:

Ben… suggest[s]… the savings glut is a relatively transitory phenomenon that will be repaired. Perhaps in the fullness of time… [but] it is very difficult to read market judgments about real interest rates as suggesting that that is likely…. For the relevant medium‐term policy horizon (as I have no useful views about 2040 or 2050) the challenge of absorbing savings in productive investment will be the overriding challenge for macroeconomic policy…

And Summers on Rogoff:

Ken Rogoff argues… that the current weakness is the temporary result of over‐indebtedness…. The debt super‐cycle view does not have a ready explanation for the low level of real interest rates, nor does it have a ready explanation for the fact that real interest rates have fallen steadily…. Ken suggests an alternative hypothesis for explaining the low level of real interest rates… a generalized increase in the level of risk…. [But] you would… expect [that] to lead to a decline, rather than an increase, in asset values, given that it was those assets that had become more risky. You would expect it to manifest itself in a measurable and clear increase in implied volatilities, as reflected in options markets. You would expect it to reflect itself in a dramatic increase in the pricing of out‐of‐the‐money puts. But the opposite has occurred…. The length of time that markets are forecasting low real interest rates makes the stagnation fairly secular or the debt super‐cycle very long, at which point the distinction blurs.

And what is the temporary debt‐overhand induced headwind that is thought to be present in a major way today but that will be gone in three years? Corporate balance sheets are flush. The spread between LIBOR and other yields are low. Debt service ratios are at abnormally low levels. Whatever your indicator of repair from the financial crisis, it has mostly happened. And yet with interest rates of zero, the United States is still likely to grow at only two percent this year. I do not see a good reason to be confident that that situation will be significantly better three years from now….

Any debt overhang would itself be endogenous. Why did we have a vast erosion of credit standards by 2005? Why were interest rates in a place that enabled such bubbles? Because that was what was necessary to keep the economy going with adequate aggregate demand through that period. So even if a debt overhanging were occurring it would in a sense be a mechanism through which secular stagnation or over‐saving produces damage. It is not an alternative to the idea of secular stagnation…

Summers’s rejection of the Krugman-Blanchard higher-inflation-is-the-solution position as a sufficient and quick fix seems to me more subtle. I do not think he has set it out clearly. But what Summers is thinking—or at least what the Larry Summers emulation module I have running on my own wetware is thinking—is this:

There are worthy private risky investment projects and unworthy ones. Worthy risky projects have a relatively low elasticity with respect to the required real yield—that is, lowering interest rates to rock-bottom levels would not induce much more spending. In contrast, unworthy risky investment projects have a high elasticity. Thus, when safe interest rates get too low, savers who should not be bearing risk nonetheless reach for yield—they stop checking whether investment projects are worthy or unworthy.

Put it another way: there are people who should be holding risky assets and there are people who should be holding safe assets. The problem with boosting inflation so that the central bank can make the real return on holding safe assets negative is that it induces people who really should not be holding risky assets to buy them.

I would speculate that, deep down, Summers still believes in one tenet of inflation economics: that effective price stability—the expectation of stable 2 percent inflation—is a very valuable asset in a market economy. It should not be thrown away.

C. Seeking Not a Cure But Palliatives: For Summers, secular stagnation does not have one simple cause but is the concatenation of a number of different structural shocks un- or only loosely-connected with each other in their origin that have reinforced each other in their effects pushing the short-term safe nominal Wicksellian “neutral” rate down below zero. But even though there is no one root cause, there are two effective palliatives to neutralize or moderate the effects.

Thus Summers calls for two major policy initiatives:

  1. Larger and much more aggressive progressive tax and transfer (and predistribution?) policies to end the Second Gilded Age.

  2. A major shift to an investment-centered expansionary fiscal policy as the major component of what somebody or other once called “a somewhat comprehensive socialisation of investment… [as] 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…”

I think he has a very, very strong case here.

D. Achieving Potential: The standard diss of Larry was that even though his promise was immense—he was brilliant, provocative, creative, and so willing to think outside-the-box that you sometimes wondered whether he knew where the box was or even if there was a box—there was no great substantive contribution but only a bunch of footnotes to lines of inquiry that really “belonged” to others.

I think this is the contribution.

Forthcoming Panel: The Nature of Capitalism and Secular Stagnation

Live from Chicago: American Economic Association: [The Nature of Capitalism and Secular Stagnation][]: Chair: Matias Vernengo…

…Panelist(s): Bradford DeLong, University of California-Berkeley; Han Despin, Nichols College; William Lazonick, University of Massachusetts-Lowell; Deirdre McCloskey, University of Illinois-Chicago; Anwar Shaikh, New School…

Has Academic Thinking About Countercyclical Fiscal Policy Changed?

Has academic thinking about countercyclical fiscal policy changed recently? I would not say that thinking has changed. I would say that there is a good chance that thinking is changing–that academia is swinging back to a recognition that monetary policy cannot do the stabilization policy by itself, at least not under current circumstances. But it may not be.

If things are swinging back, it is as a result of a whole bunch of extraordinary surprises.

Back in 2007 we thought we understood the macroeconomic world, at least in its broad outlines and essentials. It has become very clear to us since 2007 that that is not the case. Right now we have a large number of competing diagnoses about where we were most wrong. We clearly were very wrong about the abilities of major money center banks to manage their derivatives books, or even to understand to understand what their derivatives books were. We clearly did not fully understand how those markets should be properly regulated.

Right now, however:

  • We have people who think the key flaw in the world economy today is an extraordinary shortage of safe assets. Nobody trusts private sector enterprises to do the risk transformation properly. Probably people will not again trust private sector enterprises for at least a generation.

  • We have those who think the problem is an excessive debt load where–I think we should distinguish between debt for which there is nothing safer, the debt of sovereigns that possess exorbitant privilege, and all other debts.

  • We have those who think we are undergoing a necessary deleveraging.

  • We have those who look for causes in the demography.

  • And then there is Larry Summers, as the third coming of British turn-of-the 20th century economist John Hobson. (The second coming was Alvin Hansen in the 1930s.) And the question: just what is Larry talking about?

    • Is Larry talking about the inevitable consequences of the coming of the demographic transition and of the end of Robert Gordon’s long second Industrial Revolution of extremely rapid economic growth?

    • Or is he talking a collapse of the ability of financial markets to do the risk transformation–to actually shrink the equity risk premium from its current absurd level down to something more normal?

If you look at asset prices now, you confront the minus two percent real return on the debt of sovereigns that possess exorbitant privilege with what Justin Lahart of the Wall Street Journal tells me is now a 5.5% real earnings yield on the U.S. stock market as a whole. That 7.5% per year equity premium is a major derangement of asset prices. It makes it very difficult for us to use our standard tools to think about what good policy would be…

Fiscal Policy in the New Normal: IMF Panel

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:

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:

3 Month Treasury Bill Secondary Market Rate FRED St Louis Fed

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.”

Employment Population Ratio 25 54 years FRED St Louis Fed

Central Banks, Neutral Policy, and Economic Structure

Since 2009 the Federal Reserve and other global north central banks have, first hesitantly and enthusiastically, been trying to sacrifice the health of the commercial banking sector in order to keep the life support machines that are keeping the rest of the economy alive going.

Your average commercial bank needs a 2.5% margin on its liabilities in order to cover the cost of its branches and its ATM network. Commercial banks are used to taking their deposits, sticking them in long term Treasuries and similar assets, and relying on time, diversification, the slope of the yield curve ,and the normal level of interest rates to generate the revenue so that they can earn profits if they manage their branches and ATM networks efficiently. Since 2008 that has not been a profitable strategy for commercial banks. Thus commercial banks have been under enormous pressure for a near-decade now.

It is there, I think, that central banks have been inflicting significant pain. It is not the case that extremely low interest rates on extremely safe assets has been keeping alive businesses that ought to shut down. For small businesses, credit is tight. Equity earnings yields are about normal–a company that is trying to think about whether to expand or payout its earnings is not facing any sort of environment in which there is a cost of capital that is in any sense “artificially low”.

So I do not see the Fed as having given any sort of pass to industry as a whole at all. It has kept the rest of the economy functioning while imposing very heavy pressures on the commercial banking sector. This is not normal. But it is not a bubble…