Tag: Secular Stagnation

Should We Use Expansionary Fiscal Policy Now Even If the Economy Is at Full Employment? Yes!

Posted on by Brad DeLong

When should you use fiscal policy to expand demand even if the economy is at full employment?

First, when you can see the next recession coming: that would be a moment to try to see if you could push the next recession further off.

Second, if it would help you prepare you to better fight the next recession whenever it comes.

The second applies now whether we are near full employment or not. Under any sensible interpretation of where we are now, using some of our fiscal space would put upward pressure on interest rates and so open up enormous amounts of potential monetary space to fight the next recession. It would do so whether or not it raised output and employment today as long as it succeeded in raising the neutral interest rate–and if a large enough fiscal expansion does not raise the neutral interest rate, we do not understand the macroeconomy and should simply go home.

Fiscal Policy in the New Normal: IMF Panel

Note to Self: I Still Fail to Understand Ken Rogoff’s Medium-Long Term Macroeconomic Optimism…

Posted on by Brad DeLong

Ken Rogoff: “In nine years, nobody will be talking about ‘secular stagnation’. I’ve been debating Larry on this for a year, and I started saying ‘in ten years…, and so for consistency I now say ‘in nine years…”.

10 Year Treasury Constant Maturity Rate FRED St Louis Fed

This is a wager that the full-employment long-run in which money and its associates are a veil that does not affect or disturb the Say’s Law operation of the economy will come not more than 18 years after the shock of 2017–or at least that whatever remnants of the effects of that shock on the business cycle come 2025 will be dwarfed the effects of other business cycle shocks subsequent to now.

I do know from experience that one disagrees with Ken Rogoff at one’s grave intellectual peril. But is he correct here? I really cannot follow him to the conclusion he wants me to reach…

Things to reread and chew over:

  • Paul Krugman (2015): The Inflationista Puzzle: “Traditional IS-LM analysis said that the Fed’s [expansionary QE] policies would have little effect on inflation; so did the translation of that analysis into a stripped-down New Keynesian framework that I did back in 1998, starting the modern liquidity-trap literature. We even had solid recent empirical evidence: Japan’s attempt at quantitative easing in the naughties…. I’m still not sure why relatively moderate conservatives like Feldstein didn’t find all this convincing back in 2009…”

  • J. Bradford DeLong (2015): New Economic Thinking, Hicks-Hansen-Wicksell Macro, and Blocking the Back Propagation Induction-Unraveling from the Long Run Omega Point

  • Paul Krugman (2015): Backward Induction and Brad DeLong: “Brad DeLong is, unusually, unhappy with my analysis in a discussion of the inflationista puzzle–the mystery of why so many economists failed to grasp the implications of a liquidity trap, and still fail to grasp those implications despite 6 years of being wrong. Brad sorta-kinda defends the inflationistas on the basis of backward induction; I find myself somewhat baffled by that defense…”

  • Paul Krugman (2015): Rethinking Japan: “Secular stagnation and self-fulfilling prophecies: Back in 1998… I used a strategic simplification… [assumed] the Wicksellian natural rate… would return to a normal, positive level at some future date. This… provided a neat way to deal with the intuition that increasing the money supply must eventually raise prices by the same proportional amount; it was easy to show that this proposition applied only if the money increase was perceived as permanent, so that the liquidity trap became an expectations problem… [so] that if the central bank could “credibly promise to be irresponsible,” it could gain traction even in a liquidity trap. But what is this future period of Wicksellian normality of which we speak?… Japan looks like a country in which a negative Wicksellian rate is a more or less permanent condition. If that’s the reality, even a credible promise to be irresponsible might do nothing…. The only way to be at all sure of raising inflation is to accompany a changed monetary regime with a burst of fiscal stimulus…. While the goal of raising inflation is, in large part, to make space for fiscal consolidation, the first part of that strategy needs to involve fiscal expansion. This isn’t at all a paradox, but it’s unconventional enough that one despairs of turning the argument into policy…”

  • Paul Krugman (2015): St. Augustine and Secular Stagnation: “The assumption here is that the neutral rate will eventually rise so that monetary policy can take over the job of achieving full employment. What if we have doubts about whether that will ever happen? Well, that’s the secular stagnation question… a situation in which the neutral interest rate is normally, persistently below zero. And this raises a puzzle: If we worry about secular stagnation, should we then say that St. Augustine no longer applies, because better days are never coming? No. The way to deal with secular stagnation, if we believe in our models, is to raise the long-run neutral interest rate…. If we can do this via structural reform and/or self-financing infrastructure investment, fine. If not, raise the inflation target. And how do we get to the higher target inflation rate, when monetary policy is having trouble getting traction? Fiscal policy! If you’re really worried about secular stagnation, you should advocate a combination of a raised inflation target and a burst of fiscal stimulus to help the central bank get there. So the St. Augustine approach is right either way, with secular stagnation suggesting the need to be even less chaste in the short run.”

  • J. Bradford DeLong (2015): Must-Read: Paul Krugman: Rethinking Japan: “Paul Krugman’s original argument assumed that the economy would eventually head towards a long-run equilibrium in which flexible wages and prices would make Say’s Law hold… [with] the price level would be proportional to the money stock. That now looks up for grabs. It is the fact that that is up for grabs that currently disturbs Paul. Without a full-employment Say’s Law equilibrium out there in the transversality condition to which the present day is anchored by intertemporal financial-market and intertemporal consumer-utility arbitrage, all the neat little mathematical tricks that Paul and Olivier Blanchard built up at the end of the 1970s to solve for the current equilibrium break in their hands…. There is… more. Paul Krugman’s original argument also assumed back-propagation into the present via financial-market… and consumer-satisfaction intertemporal… arbitrage of the effects of that future well-behaved full-employment equilibrium. The equilibrium has to be there. And the intertemporal arbitrage mechanisms have to work. Both have to do their thing…”

  • J. Bradford DeLong (2015): The Scary Debate Over Secular Stagnation: Hiccup… or Endgame?

  • Paul Krugman (2015): On Being Against Secular Stagnation Before You Were for It

  • Duncan Weldon (2016): Negative Yields, the Euthanasia of the Rentier, and Political Economy: “I understand the mechanics of engine that took us here but not what the driver was thinking…”

  • J. Bradford DeLong (2015): Just What Are the Risks That Alarm Ken Rogoff?: “This part of Ken Rogoff’s piece appears to me to be very much on the wrong track: ‘Ken Rogoff: Debt Supercycle, Not Secular Stagnation: Robert Barro… has shown that in canonical equilibrium macroeconomic models small changes in the market perception of tail risks can lead both to significantly lower real risk-free interest rates and a higher equity premium…. Obstfeld (2013) has argued cogently that governments in countries with large financial sectors need to have an ample cushion, as otherwise government borrowing might become very expensive in precisely the states of nature where the private sector has problems…’ We need to be clear about what the relevant tail-risk states that Ken Rogoff is talking about are…. [They are that] even though it was sold at a high price and carries a low interest rate, the issuing of government debt is very expensive to the government [because] when the time comes in the bad state of the world for it to raise the money to amortize the debt, it finds that it really would very much rather not do so. It is clear if you are Argentina or Greece what the risk is: it is of a large national-level terms-of-trade or political shock, something that you can insure against by investing in the ultimate reserves of the global monetary system. If you are the United States or Germany or Japan or Britain, what is the risk? What is the risk that cannot be handled at low real resource cost by a not-injudicious amount of inflation, or of financial repression?”

  • J. Bradford DeLong (2015): Watching a Discussion: The Omega Point

Note to Self: Inadequate Musings on Elements of Rogoff’s Debt Supercycle Hypothesis

Posted on by Brad DeLong
Real Gross Domestic Product for European Union 28 countries © FRED St Louis Fed

It is, once again, time for me to think about Ken Rogoff’s hypothesis: his claim that right now the world economy as a whole is depressed because we are in the down phase of a debt supercycle–dealing with a debt overhang.

I have never been able to make enough sense of Rogoff’s perspective here to find it convincing.

I should, however, warn people that when I fail to see the point of something that Ken Rogoff has written, the odds are only one in four that I am right. The odds are three in four that he is right, and I have missed something important:

One way to view the situation is that there have been four serious diagnoses of the ills of the Global North. They are:

  • A Bernanke global savings-glut.
  • A Krugman-Blanchard return to “depression economics”.
  • A Rogoffian-Minskyite crisis of overleverage and debt overhang
  • A Summers secular-stagnation chronic crisis.

The policies recommended by the different diagnoses do differ.

  • A Bernanke global savings-glut chronic crisis requires shifts in global governance that reduce incentives to run large trade surpluses and a redistribution of world income to those with lower marginal propensities to save.
  • A Krugman-Blanchard return to “depression economics” requires larger automatic stabilizers, a higher inflation target, and perhaps a return of fiscal policy to preeminence
  • A Rogoffian-Minskyite temporary crisis of overleverage and of excessive underwater debt requires debt writedowns and financial-intermediary recapitalizations.
  • A Summers secular-stagnation chronic crisis of insufficiently-profitable risk-adjusted investment opportunities requires a shift in responsibility for long-run expenditure from private to government–” a more-or-less comprehensive socialization of investment”, as some guy once wrote.

Let me put the other three to the side, and focus on Rogoff here…

A principal implication of Rogoff’s hypothesis is that, if it is true, that there is no complete and quick fix : recovery is inevitably a lengthy process–although good policies can accelerate and bad policies retard full recovery.

As I understand it, the down phase of what Ken Rogoff calls a debt supercycle can be generated by some or all of:

  • a collapse of market risk tolerance, or of trust in the credit channel, itself generated by one or more of:
    • a failure to mobilize society’s risk bearing capacity,
    • inadequate capitalization of financial intermediaries,
    • a collapse in the reputation of financial intermediaries: either trust that they are long-term greedy, or confidence in their competence, or both.
  • a rise in fundamental riskiness.
  • the past issue of too much risky debt.
  • the past issue of too much risky debt that has become or is now perceived to be risky.
  • a decline in expectations of how much future cash flow there will be available for potential debt servicing.

How long it takes to work off a debt supercycle and rebalance the economy depends on the speed of the processes of:

  • economic growth, which raises cash flow for potential debt servicing.
  • capital depreciation, which by raising the profit rate also raises cash flow for potential debt servicing.
  • debt write-offs.
  • the normal pace of debt amortization.
  • unexpected inflation writing down nominal debts.
  • other forms of financial repression.

As long as we remain in the down-phase of the debt supercycle, even low interest rates do little to encourage the investment spending needed to drive the economy to full employment. Why? Because investment spending requires not just positive expected value given the interest rate, but also the commitment of risk bearing capacity, which is absent because of the debt overhang.

My first reaction is that the right way to deal with this is to rebalance the economy by undertaking economic activities that do not require the deployment of risk bearing capacity to set them in motion. Governments with exorbitant privilege that have ample fiscal space should borrow and spend–most desirably on things that raise potential output in the future, but other worthwhile activities that create utility are also fine.

As I wrote: We have underemployment. We have interest rates on government debt and thus the debt amortization costs of the government far below any plausible rate of return on productive public investments (or, indeed, any plausible social rate of time discount geared to a sensible degree of risk aversion and the trend rate of technological progress). Under such circustances, at least reserve currency-issuing governments with exorbitant privilege should certainly be spending more, taxing less, and borrowing.

But Rogoff seems to disagree:

Kenneth Rogoff (2011): The Second Great Contraction: “Many commentators have argued that fiscal stimulus has largely failed… because it was not large enough…

…But, in a “Great Contraction,” problem number one is too much debt. If governments that retain strong credit ratings are to spend scarce resources effectively, the most effective approach is to catalyze debt workouts and reductions…. Governments could facilitate the write-down of mortgages in exchange for a share of any future home-price appreciation…. Europe could perhaps be persuaded to engage in a much larger bailout for Greece (one that is actually big enough to work), in exchange for higher payments in ten to fifteen years if Greek growth outperforms…

And:

Kenneth Rogoff (2015): world’s economic slowdown is a hangover not a coma: “Vastly increased quality infrastructure investment… a great idea. But… not… a permanently sustained blind spending binge…

…What if a diagnosis of secular stagnation is wrong? Then an ill-designed permanent rise in government spending might create the very disease it was intended to cure…. There can be little doubt that a debt super cycle lies behind a significant part of what the world has experienced over the past seven years. This resulted first in the US subprime crisis, then the eurozone periphery crisis, and now the troubles of China and emerging markets. The whole affair has strong precedent…. America’s experience–whether one looks at the trajectory of housing and equity prices, unemployment and output, or public debt–has uncannily tracked benchmarks from past systemic financial crises. This is not to say that secular factors are unimportant. Most financial crises have their roots in a slowing economy that can no longer sustain excessive debt burdens…

Rogoff seems to have a counter. He seems to think that borrow-and-spend by governments with fiscal space will, or perhaps may, lead, ultimately, to disaster. Why? Because the fiscal space was never really there. The increase in debt issue will transform even the government’s old safe debt into risky debt. And the overhang of risky debt will be increased, worsening the problem.

The counter to that, of course is helicopter money: money printing- and financial repression-financed expansionary fiscal policy rebalances the economy at full employment without any risk of incurring a larger overhang of risky debt further down the road.

And Rogoff’s response to that is… what?

Relevant:

Paul Krugman: Airbrushing Austerity: “Ken Rogoff weighs in on the secular stagnation debate, arguing basically that it’s Minsky, not Hansen…

…that we”re suffering from a painful but temporary era of deleveraging, and that normal policy will resume in a few years…. Rogoff doesn”t address the key point that Larry Summers and others, myself included, have made–that even during the era of rapid credit expansion, the economy wasn’t in an inflationary boom and real interest rates were low and trending downward–suggesting that we”re turning into an economy that “needs” bubbles to achieve anything like full employment. But what I really want to do right now is note… people who predicted soaring interest rates from crowding out right away now claim that they were only talking about long-term solvency… people who issued dire warnings about runaway inflation say that they were only suggesting a risk, or maybe talking about financial stability; and so on down the line…. In Rogoff’s version of austerity fever all that was really going on was that policymakers were excessively optimistic, counting on a V-shaped recovery; all would have been well if they had read their Reinhart-Rogoff on slow recoveries following financial crises. Sorry, but no….

David Cameron didn’t say “Hey, we think recovery is well in hand, so it’s time to start a modest program of fiscal consolidation.” He said “Greece stands as a warning of what happens to countries that lose their credibility.” Jean-Claude Trichet didn’t say “Yes, we understand that fiscal consolidation is negative, but we believe that by the time it bites economies will be nearing full employment”. He said: “As regards the economy, the idea that austerity measures could trigger stagnation is incorrect … confidence-inspiring policies will foster and not hamper economic recovery, because confidence is the key factor today.” I can understand why a lot of people would like to pretend, perhaps even to themselves, that they didn’t think and say the things they thought and said. But they did.

And this part of Ken Rogoff’s piece appears to me to be on the wrong track:

Ken Rogoff: Debt Supercycle, Not Secular Stagnation: “Robert Barro… has shown that in canonical equilibrium macroeconomic models…

…small changes in the market perception of tail risks can lead both to significantly lower real risk-free interest rates and a higher equity premium…. Martin Weitzman has espoused a different variant of the same idea based on how people form Bayesian assessments of the risk of extreme events…. Those who would argue that even a very mediocre project is worth doing when interest rates are low have a much tougher case to make. It is highly superficial and dangerous to argue that debt is basically free. To the extent that low interest rates result from fear of tail risks a la Barro-Weitzman, one has to assume that the government is not itself exposed to the kinds of risks the market is worried about, especially if overall economy-wide debt and pension obligations are near or at historic highs already. Obstfeld (2013) has argued cogently that governments in countries with large financial sectors need to have an ample cushion, as otherwise government borrowing might become very expensive in precisely the states of nature where the private sector has problems…

Has Macro Policy Been Different since 2008?

Posted on by Brad DeLong
3 Month Treasury Bill Secondary Market Rate FRED St Louis Fed

Was macro policy different after 2008? I interpret that to be the question: “Did macro policy follow the same rule after 2008 that people had presumed before 2008 it would follow in a true tail event?” To answer that question requires determining just what policy rule people back before 2008 thought that the U.S. government was following. Let me propose four candidates for our (implicit) pre-2008 macroeconomic policy rule:

  1. Limit fiscal policy to automatic stabilizers, and follow a Taylor rule with John Taylor’s coefficients (Taylor).
  2. Follow Milton Friedman’s advice and target velocity-adjusted money: if nominal GDP is below trend, print more money and buy bonds; if that does not restore nominal GDP to either the trend level or the trend growth rate (depending on whether your favorite flavor has or does not have base-drift sprinkles), repeat (Friedman).
  3. Use open market operations to manipulate the short-term safe nominal interest rate to stabilize inflation and unemployment as long as you are not at the zero lower bound. At the zero lower bound credibly promise to be irresponsible in the future in order to raise inflation expectations by enough to push the real interest rate down to its negative Wicksellian neutral rate value, and so restore real macroeconomic balance (Krugman).
  4. Use open market operations to manipulate the short-term safe nominal interest rate to stabilize inflation and unemployment as long as you are not at the zero lower bound. At the zero lower bound resort to expansionary fiscal policy and do as much of it as needed, at least as long as interest rates on long-term government debt remain low (Blinder).

Were there any other live candidates for “the policy rule” back before 2008?

Pyrrhus at Jackson Hole: A Monetary Policy “Victory” That Leaves the Central Bank in a Very Weak Position Blogging

Posted on by Brad DeLong
Real Potential Gross Domestic Product FRED St Louis Fed

Larry Summers says that he is disappointed along three dimensions at what came out of the Federal Reserve’s Jackson Hole Conference. I think Summers is right to be disappointed. Indeed, from my perspective, it was disturbing that there was not more connection between the academic papers on how the monetary policy toolkit might be expanded and the policy discussion.

Summers’s view is that the policy discussion is seriously awry: “near-term policy signals… on the tightening side… will end up hurting both the Fed’s credibility and the economy…. The longer-term discussion revealed… dangerous complacency about the… existing tool box…. [And] failure to seriously consider major changes in the current monetary policy framework…” I think that gets it right:

  • The Fed appears to me to be dangerously complacent,
  • Both with respect to the short-term macroeconomic situation,
  • And with respect to its ability to stabilize the economy over the longer term;
  • Hence its current policies appear to me to be dangerously blind to current realities,
  • And it is not seriously engaged in setting the stage so that the successors of current policymakers can have a chance at a quiet life.

So if these issues were not, in my view, properly discussed at Jackson Hole, where should people go to learn about them?

First, Summers. This morning Summers argues about the near-term policy and economic outlook:

Larry Summers: Disappointed by What Came Out of Jackson Hole:

I had high hopes… billed as a forum that would look at new approaches to the conduct of monetary policy…. The Federal Reserve system and its Chair are to be applauded for welcoming challengers and critics… meet[ing] with the “Fed Up” group…. The fact that the Fed has now recognized that the decline in the neutral rate is something that is much more than a temporary reflection of the financial crisis is a very positive sign. On balance though, I am disappointed….

The near-term policy signals were on the tightening side which I think will end up hurting both the Fed’s credibility and the economy…. The Fed has not earned the right to be intellectually complacent or to expect that others will have faith in its current policy framework…. The Fed has been too serene about the economic outlook…. When the Fed predicted last December that it would raise rates four times in 2016, market participants saw a disconnect from reality. It has been that way for a long time….

Disappointed by what came out of Jackson Hole Larry Summers

Disappointed by what came out of Jackson Hole Larry Summers 

Chair Yellen… basically repeated the existing Fed position that rates would be raised at some point when the data were clear that the economy was strong and inflation reaching two percent. Markets took the remarks as mildly dovish until Vice Chair Fischer was seen on CNBC as interpreting the Chair as implying that two rates increases by the end of the year were possible…. I [had] hoped that the Fed would make clear that it would tighten only when there appeared a real risk of inflation expectations rising above two percent. At a time when market forecasts of inflation on Fed’s preferred price index are in the range of 1.2 percent, this is very likely some time off. Some are skeptical of market measures of inflation expectations. Note that survey measures of long term inflation expectations for both professionals and consumers are near historical lows and if anything have declined over the last year…

Second, people should go read Paul Krugman. Basically, since at least 1998 Paul has been way ahead of the curve on many issues, one of which is the return of “depression economics” and the need for abandoning the belief that stabilization policy can successfully be conducted by independent central banks with a narrow monetary policy operations toolkit:

Paul Krugman: On Twitter:

Paul is citing himself from four years ago:

Paul Krugman (2012): Monetary Versus Fiscal Policy, Revisited:

One recurring complaint… is that [people] can’t figure out where I stand on monetary versus fiscal policy as a response to a deeply depressed economy…. Mike Woodford’s latest paper, especially taken in tandem with his paper last year at the Cambridge Keynes conference, actually explains it all…. Current monetary policy is indeed ineffective in a liquidity trap… there is still scope for central bank action in… credible commitments to keep monetary policy easy in the future…. The trouble is how to make those credible commitments… to convince the central bank itself that it’s a good idea… to convince the private sector that the central bank will not, in fact, just revert to type once the crisis is past. My judgment back in late 2008/early 2009 was that it would take a long time to get through those two stages….

What about fiscal policy? As Mike pointed out in his earlier paper, fiscal stimulus in a liquidity trap doesn’t require that you convince the market that you’re going to behave differently once the crisis is past. It doesn’t depend on expectations at all; the government just goes out and creates jobs. So it made a lot of sense to argue for stimulus as the main immediate response to the slump. But isn’t fiscal stimulus also a hard sell politically? Yes, indeed….

So what should well-meaning economists do now, with both fiscal and monetary policy falling short? The answer is, campaign on both fronts, trying to convince influential players both that austerity is wrong and that the Fed needs to start signaling its willingness to see more inflation before it raises rates. And that’s more or less where I am.

That was true back in the fall of 2012. And that is still true. The Federal Reserve can, if it wants declare victory by pretending that the economy is at full employment (it might be; but it probably is not) and that inflation is effectively at its 2%/year core PCE target (yes, Stan Fischer, we are looking at you: there is a very small chance that it might be; but the odds are overwhelmingly that it is not), but it cannot pretend that it has set up the game board properly for today’s policymakers and their successors to deal with the next business cycle when it comes. For this, you need to read Jared Bernstein:

Jared Bernstein: Will the Federal Reserve Really Have What It Takes to Fight Off the Next Recession?:

No one knows when the next recession is going to hit… we just can’t accurately call these things…. There is, of course, a recession out there somewhere. The problem isn’t that we don’t know where; it’s that we’re not ready for it…. You simply cannot trust our Congress to act quickly and forcefully on countercyclical, discretionary fiscal policy (“discretionary” meaning the stuff aside from the automatic stabilizers)…. The Federal Reserve… likely [has a] limited-firepower problem…. The federal funds rate (FFR)… is sitting at less than half-a-percent, which gives them very little room to cut….Reifschneider… argues that this concern may be overblown, at least under certain conditions. His reasoning is threefold:

  1. If the recovery keeps going the Fed may have time to get rates back up to a needed perch.
  2. For reasons I’ve discussed in other posts, that perch is lower than it used to be.
  3. The FFR is not their only tool. There’s also quantitative easing (buying longer-term bonds to lower longer-term rates) and forward guidance (resetting people’s expectations by telling us that they’re going to keep rates low for a long time)….

I am not much comforted. There are a lot of “ifs” in Reifschneider’s story (all of which he is totally straight up about)…. Sure, I hope Reifschneider’s optimistic scenarios are correct. But I fear they’re not and we’d be crazy not to have a Plan B.

And Paul Krugman again:

Paul Krugman: On Fed Complacency:

Is the Fed really repeating its big mistake of the pre-crisis era, dismissing concerns about its ability to respond to recession? Jared Bernstein thinks so, and so do I…. The current state of thinking seems to be… Reifschneider, which argues… that by the time the next recession arrives, the Fed funds rate will have returned to a level that still leaves sufficient room to cut….

I can’t help but recall a 1999 paper by Reifschneider and John Williams about inflation targets and the risk of hitting the zero lower bound. They concluded that a 2 percent target should be enough to make this a minor concern… binding only 5 percent of the time, and ZLB episodes would last on average only 4 quarters…. We have just gone through an 8-year–32 quarter–ZLB episode, which accounts for more a quarter of the time that has passed since the beginning of the Great Moderation. Basically, that optimistic take was off by an order of magnitude. Shouldn’t that miss give the Fed pause now?

And you should also read Steve Matthews’s report on the conference, with reports of some policymakers understanding how dire the situation is:

Steve Matthews: Central Bankers Spurn Call for Radical Approach at Jackson Hole:

Yellen and three regional Fed bank presidents — Robert Kaplan of Dallas, Eric Rosengren of Boston and Loretta Mester of Cleveland — all urged fiscal policy makers to step up. “Central bankers, we are increasingly talking about this, about the need for fiscal policy and other economic tools beyond monetary policy,” Kaplan said during a luncheon Friday, although he cautioned it could be “many years” for there to be action…. “You can’t expect us to do the whole job,” Christopher Sims, Nobel Prize-winning economist from Princeton University, told Fed leaders on Friday. “So long as the legislature has no clue of its role in these problems, nothing is going to get done. Of course, convincing them that they have a role and there is something they should be doing, especially in the U.S., may be a major task”…

But they were not willing to call for institutional and policy reforms that will be needed in the highly-likely eventuality that fiscal policymakers do not recover their sanity:

Federal Reserve Chair Janet Yellen and her peers… re-affirmed their belief in power of monetary policy to stop economies from slipping into deflation. They were less keen on academic proposals that included the abolition of cash, raising their inflation targets, or keeping permanently large balance sheets…. Yellen, in her keynote address at the Kansas City Fed’s annual mountain retreat, said that additional tools remain “subjects for research” and were not being actively considered. Policy makers from Europe and Japan echoed her caution…. In stressing that monetary policy is adequate, Yellen and three other Fed officials at Jackson Hole urged structural reforms or a greater reliance on fiscal action…

Bank of Japan Governor Haruhiko Kuroda and Benoit Coeure, European Central Bank Executive Board member, both rejected the idea of a higher inflation target. Kuroda promised “ample space for additional easing” as needed, while Coeure said “we may need to dive deeper into our operational framework”…

Why Do We Talk About “Helicopter Money”?

Posted on by Brad DeLong

Why do we talk about “helicopter money”? We talk about helicopter money because we seek a tool for managing aggregate demand–for nudging the level of spending in an economy up to but not above the economy’s current sustainable productive potential–that is all of:

  1. Effective and successful–even in the very low interest rate world we appear to be in.
  2. Does not excite fears of an outsized central bank balance sheet–with its vague but truly-feared risks.
  3. Does not excite fears of an outsized government interest-bearing debt–with its very real and costly amortization burdens should interest rates rise.
  4. Keeps what ought to be a technocratic problem of public administration out of the mishegas that is modern partisan politics.

Right now the modal projection by participants in the Federal Reserve’s Open Market Committee meetings is that the U.S. Treasury Bill rate will top out at 3% this business cycle. It would be a brave meeting participant who would be confident that we would get there–if we would get there–with high probability before 2020. That does not provide enough room for the Federal Reserve to loosen policy by even the average amount of loosening seen in post-World War II recessions. Odds are standard open market operation-based interest rate tools will not be able to do the macroeconomic policy stabilization job when the next adverse shock hits the economy.

The last decade has taught us that quantitative easing on a scale large enough to rapidly return economies to full employment is one bridge if not more too far for central banks as they are currently constituted–if, that is, it is possible at all. The last decade has taught us that bond-funded expansionary fiscal policy on a scale large enough to rapidly return economies to full employment is at least several bridges too far for our political systems, at least as they are currently constituted.

If we do not now start planning for how to implement helicopter money when the next adverse shock comes, what will our plan be? As a candidate for a tool capable of doing all four of these things, helicopter money–giving the central bank the additional policy tool of printing up extra money and either mailing it out to households as checks or getting it into the hands of the public by buying extra useful stuff–is our last hope, and, if it is not our best hope, then I do not know what our best hope might be.

I Do Not Understand the View from the Financial Markets…

Posted on by Brad DeLong

I want to say that people like Global Head of Credit Products Strategy at Citigroup Matt King are simply not thinking clearly. The macroeconomic regularities that seem obvious to me simply are not there to him. What he ought to be saying is:

  1. Mammoth safe asset shortage–in large part because since 2007 nobody trusts any of his peers’ issuing departments to create a AAA asset.
  2. Hence destructively low yields.
  3. Hence those that can need to bend every policy nerve toward creating large amounts of safe assets–which means borrow-and-spend on the part of governments: expansionary fiscal policy.

But that is rarely what he or his peers are saying. Thus I hesitate. Could they possibly be misreading the situation in such an obvious way? What are they seeing and thinking about that I am missing?

Thus I never know what to do with pieces like this:

Alexandra Scaggs: There’s No Yield, and Citi Isn’t Going to Take It Anymore:

Citi’s Matt King has some harsh words for central bankers… echoes a group of fund managers who say central banks’ stimulus efforts are distorting the way global markets function…. With negative yields on $13 trillion of safe assets, investment managers are crowding into the shrinking group of investments with yield–or into securities they may be able to sell to central banks. This has been frustrating for those fund managers, to say the least…. Here are some of the reasons he thinks markets are broken:

(1) A greater share of global equity-market variance is explained by macro factors…. (2) Credit spreads aren’t responding to climbing leverage and defaults…. (3) Normal market relationships are breaking down…. (4) Cross-asset correlations are high, even though volatility is low….

It’s clear that global central banks have had a big effect on markets. A bigger challenge is answering the following question: so what? Lower borrowing costs should be a benefit of central bank stimulus, you’d think. But King says corporate borrowing isn’t helping the economy as much as policy makers would like, and raises the risk that the leverage will make any economic downturn worse. He continues:

Most doctors–and even patients–know that when a course of drugs seems not to be working, you don’t simply keep on doubling the dosage. This applies particularly when the patient, if no longer as sprightly as they used to be, is nevertheless doing more or less fine. The side effects of such a course are more likely to kill than to cure. Yet this is what central banks now seem intent on doing. They have too much invested in their models to consider changing them in our view…

I look at graphs like this:

FRED Graph FRED St Louis Fed

And I think:

  • If the Fed had followed policies to put short-term safe nominal interest rates at 3%/year right now, then you add on the impact of that on inflation–pushing inflation down from just below 2%/year to just negative–and you have a real value of the dollar in all likelihood 30% more than it is today. Would exports be as high in such a world?

  • If the Fed had followed policies to put short-term safe nominal interest rates at 3%/year right now, then you add on the impact of that on inflation–pushing inflation down from just below 2%/year to just negative–and you have real hurdle rates on business investment on the order of 5%-points/year higher than they are now. Would business investment–which is, in spite of the weak overall economy and sluggish growth, normal– be as high in such a world?

  • If the Fed had followed policies to put short-term safe nominal interest rates at 3%/year right now, then you add on the impact of that on inflation–pushing inflation down from just below 2%/year to just negative–and you have potential homebuyers facing greatly accelerated amortization burdens. Would residential investment–pathetic as it is–be as high in such a world?

If King has a magic wand that can boost government purchases massively, then yes–higher interest rates might well be appropriate. But he doesn’t. So what is the magic wand that would boost what component of spending to offset downward pressure on exports, business investment, residential investment, and consumer durables spending that would come from higher interest rates and lower inflation right now? Or what is the magic wand that would make buyers of exports, planners of business investment, and buyers of new houses from reacting to the signals prices are sending them?

I just do not get it. King seems to envision a world in which interest rates are higher and he is happier because he can clip coupons on his portfolio, and all without anybody changing any of their spending decisions. I do not see how that world can possibly be.

Indeed, I don’t think even King would like the world he says he wants to see: business corporation and real estate equity cushions are ample on average, but in the anti-Panglossian world of bond finance that your counterparties have ample equity cushions on average isn’t worth very much in terms of guaranteeing the quality of the assets you are long, is it?

Macroeconomic Policy Reform: A Tentative Agenda

Posted on by Brad DeLong

It was 24 years ago this week that Larry Summers and I warned that if we were to push the target inflation rate much below roughly 5%/year, then, in the immortal words of Dr Suess’s the Fish in the Pot:

“Do I like this? Oh, no, I do not. This is not a good game”, said our fish as he lit. “No, I do not like it, not one little bit!”

As I see it, if we want good macroeconomic business-cycle stabilization policy over the next generation, we need to do one or more of four things. I think the more of them we do, the better. And I want Summers and Bernanke to chair a commission this fall and winter to establish the order in which we should attempt to do these four things, and to start building the political and technocratic coalition to get them accomplished:

  1. Raise the inflation target when the economy has any chance of hitting the zero lower bound on short-term safe nominal interest rates–either by nominal GDP or price-level catchup targeting, or by raising the inflation target to 4%/year or so. The way to sell this is to say that the Fed has a dual mandate, that dual mandate requires tradeoffs, and that those tradeoffs are best accomplished via targeting recovery too and growth along a 6%/year nominal GDP growth path.

  2. Give the Federal Reserve the tools that it needs in order to properly manage aggregate demand. That means such things as:

    • Deciding by itself how it is going to use its seigniorage revenue, rather than returning its profits to the Treasury as a matter of course. (Yes, this is helicopter money.)
    • Funding mechanisms to support what ought to be state-level automatic stabilizers in a downturn–states should not be cutting construction and education and public safety spending when the economy as a whole is in recession, and thus when there is plenty of slack in the labor market.
    • More aggressive use of regulatory asset-quality and reserve-requirement tools as countercyclical policy instruments.
  3. Act to substantially reduce the risk premium on safe highly-collateralizable assets, both to repair a significant microeconomic financial market failure and to raise the medium-run equilibrium short-term safe real interest rate–the r*–in order to provide the central bank with more sea room on the lee shore it finds itself on. This requires operating both on the side of boosting market risk tolerance and expanding the supply of safe assets. This means moving beyond “government debt and deficits are always bad!” to “under certain conditions, the national debt of those sovereigns with exorbitant privilege that create safe assets when they issue debt can be a global blessing.”

  4. Reintegrate macroeconomic policy. Return forecasting from three separate exercises–the White House’s Troika (CEA-Treasury-OMB), Congress’s OMB, and the Federal Reserve–back to the Quadriad (Federal Reserve-CEA-Treasury-OMB) or on to a Pentiad (Federal Reserve-CEA-Treasury-OMB-CBO), with the principals to whom it reports being not just the President and the FOMC, but also the Majority and Minority Leaders of the Senate and the Speaker and Minority Leader of the House.

The argument against (4) is, of course, that the Fed needs to be insulated from the broader policy-political world because (a) the Fed can do the job by itself, and (b) having its elbow joggled by the policy-political world would only bolix things up. Well, the past decade has proven to us that (a) the Fed cannot do the job by itself, and (b) Fed “independence” does not keep the policy-political world from bolixing things up. The moment the Republican Party decided in January 2009 to go all-in in root-and-branch opposition to Obama, it necessarily also decided to go all-in in root-and-branch to policies pursued by Obama–which meant root-and-branch opposition to the Federal Reserve as well.

And certainly if we are not going to do (2), we definitely need to do (4).

Some very recent background reading:

Larry Summers: A Thought Provoking Essay from Fed President Williams:

John Williams has written the most thoughtful piece on monetary policy that has come out of the Fed in a long time…. He stresses the desirability of raising r* by pursuing structural policies to raise growth and affirms the importance of fiscal policy. I yield to no one in my enthusiasm for improved education and educational opportunity, but I do not think it is plausible that it will change the neutral rate appreciably in the next decade given that the vast majority of the 2030 labor force will be unaffected.

If Williams is overenthusiastic on education, he is under enthusiastic on fiscal stimulus.  He fails to emphasize the supply side benefits of infrastructure investment that likely enable debt financed infrastructure investments to pay for themselves as suggested by DeLong and Summers and the IMF.  Nor does he note at current interest rates an increase in pay as you go social security could provide households with higher safe returns than private investments…. Nor does Williams address the possibility of tax measures such as incremental investment credits or expansions in the EITC financed by tax increases on those with a high propensity to save.  The case for fiscal policy changes in the current low r* environment seems to me overwhelming….

Williams’s comments on monetary policy have generated more interest…. If the Fed believed that a 2 percent inflation target was appropriate at the beginning of 2012 when it believed the neutral real rate was above 2 percent, I cannot see any argument for not adjusting the target or altering the framework when the neutral real rate is very plausibly close to zero.  The benefits of a higher target have increased and so far as I can see nothing has happened to change the cost of a higher target. I am disappointed therefore that Williams is so tentative in his recommendations on monetary policy…. Moreover even accepting the current framework, I find the current policy framework hard to comprehend.  If as it asserts, the Fed is serious about the 2 percent inflation target being symmetric there is an anomaly in its forecasts….

Finally there is this:  Everything we know about business cycle history suggests an overwhelming likelihood that there will be downturns in the industrial world sometime in the next several years. Nowhere is there room to cut rates by anything like the normal 400 basis points in response to potential recession.  This is the primary monetary and indeed macroeconomic policy challenge of our generation. I hope it will be very much in focus at Jackson Hole.

Greg Ip: The Case for Raising the Fed’s Inflation Target:

Six years ago, Olivier Blanchard, then chief economist at theInternational Monetary Fund, floated the idea that central banks should target 4% inflation instead of 2%. I remember giving a colleague countless reasons why he was wrong. It was I who was wrong….

Last week John Williams, president of the Federal Reserve Bank of San Francisco, made the case for a higher inflation target in a bank newsletter. The subject will almost certainly be in the air when Fed officials and their foreign counterparts meet next week at the annual Jackson Hole symposium…. The historical case for low inflation rested on the assumption that high inflation created damaging distortions and more frequent recessions. Low inflation or deflation was a trivial risk because central banks could easily drive inflation higher by promising to print more money. But in 2008, central banks around the world cut interest rates to nearly zero and printed copious amounts of money, and only lackluster growth followed….

Here are my original objections and how they have changed.

  1. Central banks have invested their credibility in a 2% target. If they raise it, the public will assume they’ll raise it again, and expectations will rapidly become unanchored…. If anything, central banks are too credible: Investors seem to believe 2% is a ceiling, not a midpoint.

  2. As inflation rises, individual prices become more volatile, which makes the economy less efficient and more prone to booms and busts. This is still true, but against that we can see the harm from not being able to lower real (inflation-adjusted) rates further is much larger than anticipated. Meanwhile, the microeconomic harm of higher inflation is elusive….

  3. Since inflation is below 2% now and there are no new tools to get it higher, it will undermine central banks’ credibility to raise the target. Japan’s success in getting inflation back above zero, albeit not to 2%, suggests adopting a higher inflation target can bring a shift in expectations, and actions, that help make it happen.

  4. A higher inflation target makes real interest rates more negative, which would spur reach-for-yield and other speculative excesses. This is true but the alternative may be worse….

  5. What happened in 2008 was unique. Why change the target for something that happens maybe twice per century? Interest rates have been near zero now for more than seven years, and there is every reason to think similar episodes are going to happen again…. Williams sees ample evidence that deep-seated structural forces have dragged down the real natural interest rate—which keeps the economy at full employment without stoking inflation—from around 2.5% before the recession to 1% now. It may be lower….

John Williams: Monetary Policy in a Low R-Star World:

The inflation wars of the 1970s and 1980s led to a broad consensus on two fronts among academics and policymakers….

[Larry Summers and I warned]:

First, central banks are responsible and accountable for price stability… often acknowledged through… formal adoption of… inflation targeting…. Second, monetary policy should play the lead role in stabilizing inflation and employment, while fiscal policy plays a supporting role through… automatic stabilizers…. Fiscal policy should focus primarily on longer-run goals such as economic efficiency and equity….

In the post-financial crisis world, however, new realities pose significant challenges…. A variety of economic factors have pushed natural interest rates very low and they appear poised to stay that way…. Interest rates are going to stay lower than we’ve come to expect in the past…. Juxtaposed with pre-recession normal short-term interest rates of, say, 4 to 4½%, it may be jarring to see the underlying r-star guiding us towards a new normal of 3 to 3½%—or even lower…. Conventional monetary policy has less room to stimulate the economy during an economic downturn, owing to a lower bound on how low interest rates can go…. In this new normal, recessions will tend to be longer and deeper, recoveries slower, and the risks of unacceptably low inflation and the ultimate loss of the nominal anchor will be higher…. If the status quo endures, the future is likely to hold more of the same—with the possibility of even more severe challenges to maintaining price and economic stability.

To avoid this fate, central banks and governments should critically reassess the efficacy of their current approaches and carefully consider redesigning economic policy strategies to better cope with a low r-star environment…. Greater long-term investments in education, public and private capital, and research and development…. Countercyclical fiscal policy should be our equivalent of a first responder to recessions, working hand-in-hand with monetary policy…. Stronger, more predictable, systematic adjustments of fiscal policy that support the economy during recessions and recoveries…. Monetary policy frameworks should be critically reevaluated to identify potential improvements in the context of a low r-star…. A low inflation rate… is not as well-suited for a low r-star era…. The most direct attack on low r-star would be for central banks to pursue a somewhat higher inflation target…. Second, inflation targeting could be replaced by a flexible price-level or nominal GDP targeting framework….

We’ve come to the point on the path where central banks must share responsibilities. There are limits to what monetary policy can and, indeed, should do. The burden must also fall on fiscal and other policies to do their part to help create conditions conducive to economic stability…

Simon Wren-Lewis: Helicopter Money: Missing the Point:

I am tired of reading discussions of helicopter money (HM) that have the following structure:

  1. HM is like a money financed fiscal stimulus
  2. HM would threaten central bank independence
  3. So HM is a bad idea….

These discussions never seem to ask… why we have independent central banks (ICB) in the first place. And what they never seem to note, even in establishing (1), is that ICBs deny the possibility of a money financed fiscal stimulus (MFFS)…. Creating an ICB means that a MFFS is no longer possible… [because] it could only happen through ICB/government cooperation, which would negate independence…. Proponents of ICBs say… macro stabilisation can be done entirely by using changes in interest rates, so a MFFS is never going to be needed. Then we hit the Zero Lower Bound….

To then say no problem, governments can do a bond financed fiscal expansion is to completely forget why ICBs were favoured in the first place. Politicians are not good at macroeconomic stabilisation…. Demonstrating (1) does not, I repeat not, imply that ICBs do not need to do HM. Implying that it does is a bit like saying governments could set interest rates, so why do we need ICBs. Most macroeconomists would never dream of doing that, so why are they happy to use this argument with HM?

Which brings us to (2)… never… examined with the same rigour as (1)… just mentioning ‘fiscal dominance’ is enough to frighten the horses…. Imagine the set of all governments that would refuse a request from an ICB for recapitalisation during a boom when inflation was rising–governments of central bank nightmares. Now imagine the set of all governments that, in a boom with inflation rising, would happily take away the independence of the central bank to prevent it raising rates. I would suggest the two sets are identical…. HM does not seem to compromise independence at all. So please, no more elaborate demonstrations that HM is equivalent to a MFFS, as if that is an argument against HM…

Paul Krugman: Slow Learners:

Larry Summers has a very nice essay that takes off from a new paper by John Williams at the San Francisco Fed…. Williams is the highest-placed Fed official yet to suggest that maybe the inflation target should be higher. It’s not a new argument… but seeing it come from a senior official is news. Yet as Larry says, the paper is still weak and tentative even on monetary policy, to an extent that’s hard to understand…. Furthermore, there’s basically no break with orthodoxy on fiscal policy, despite the evident importance of the liquidity trap, evidence that multipliers are fairly large, and basically zero real borrowing costs. Yet Williams is at the cutting edge of policy rethinking at the Fed…. Mainstream thinking about macroeconomic policy has changed remarkably little, remarkably slowly.

You might say that it is always thus. But, you know, it isn’t…. Stagflation emerged as an issue in 1974, after the first oil shock, and pretty much ended with the Volcker double-dip recession of 1979-82–a recession whose end implication was that monetary policy continued to work in a fairly Keynesian way. So it was well under a decade of experience; yet it utterly transformed how everyone talked about macroeconomics.

Then came the 2008 crisis…. The sheer persistence both of depressed economies and of low inflation/interest rates should by now have led to a big rethinking. Depression economics redux has now gone on as long as stagflation did. Yet rethinking has been glacial at best. People who warned about the coming inflation in 2009 are warning about the coming inflation in 2016. Orthodox fears of budget deficits still dominate a lot of discourse. And the Fed still clings to an inflation target originally devised in the belief that the kind of thing that has happened to our economy would never happen.

I’m not entirely sure why learning has been so slow this time. Part of it, I suspect, is that the anti-Keynesian backlash of the 1970s had a lot of political power, and behind the scenes a lot of money, behind it–which influenced even academics, whether they realized it or not. And these days that same power and money is deployed against any rethinking. Whatever the explanation, however, it’s taking a painfully long time for serious policy discussion to arrive at a point that should have been obvious years ago.

Five Revisions of Its Model That the Fed Should Make or Test

Posted on by Brad DeLong

Must-Read: Five Revisions of Its Model That the Fed Should Make or Test: And I do not think that the Fed is handling the process of revising its thinking properly.

I say that the Fed should, right now, be rethinking its estimates of:

  1. the long-run real natural rate of interest,
  2. the natural rate of unemployment,
  3. the slope of the Phillips Curve, and
  4. the gearing between recent past deviations of inflation from its target and expectations of future inflation.

Ryan Avent says that the Fed is rethinking (1) and (2), but also rethinking a (5): its estimate of long-run potential output growth. I don’t think there is evidence to rethink (5). I think that the consilience of a low pressure economy and apparent sluggish potential output growth is just too large for people to be satisfied rejecting it as a mere coincidence. Ryan agrees with me, and asks why the Federal Reserve seems to want to jump to conclusions about (5) rather than testing it. I agree. But I also want to ask: why isn’t the Fed rethinking its views on (3) and (4) as well? There is powerful evidence that they are different from the implicit model Fed policy has been running off of for the past decade as well:

Ryan Avent: Absence of Evidence: The Fed Rethinking One Thing too Many:

OFFICIALS at the Federal Reserve, a few of them anyway, seem to be rethinking their views of the economy in some dramatic ways….

Ben Bernanke suggests… top policy-makers still have confidence in their mental model of the economy; they have just been tweaking a few of the parameters… long-run… GDP growth… unemployment… and their benchmark interest rate…. The latter two [what I call (1) and (2)]—a lower unemployment rate and a lower long-run interest rate—clearly imply that rates will rise more slowly to a lower overall level. The projection of a lower potential growth rate [what I call (5)], however… suggests, for instance, that the American economy is running closer to its “speed limit”… push[ing]… toward a more hawkish stance…. These three revisions are not created equal…. [(1) and (2)] are clearly justified…. [(5)] is different, however. Available evidence is consistent with a world in which long-run potential growth has fallen… but… also… with an economy… growing slowly because of too little demand… in which both strong employment growth and low productivity growth are side effects of the low level of wages.

The only way to resolve the question in a satisfying way is to test it: to push the economy beyond the estimated potential growth rate and see if inflation rises…. Bernanke argues that Fed officials are willing to be a little patient with the economy, to see whether running it a little hot brings more workers into the labour force and encourages productivity-enhancing investments. It certainly seems clear to me that overshooting is the right way for the Fed to err….

But I am less confident than Mr Bernanke in the Fed’s openness to overshooting. It did not exactly intend to run the unemployment rate experiment that demonstrated how run its previous projections had been…. Now, the Fed looks all too willing to revise down its GDP growth projections without ever really testing them…. There is far too little radicalism at the Fed. It risks making permanent a low-growth state of affairs which is largely a consequence of its own excessive caution.

I would say may be rather than is. But one thing we agree on is that it is definitely the Fed’s responsibility to find out. And on its current policy trajectory it will find out only by accident–only if the economy turns out to be stronger than the Fed currently projects.

Datawrapper LsH98 Visualize

The Federal Reserve: I Repeat Myself

Posted on by Brad DeLong
Real Gross Domestic Product FRED St Louis Fed

I repeat myself: to begin a tightening cycle and a process of interest-rate increases in December 2016–in fact, to announce in mid 2014 the end of further moves toward monetary expansion and a bias toward tightening as soon as it is not grossly imprudent–requires that one place only an infinitesimal weight on:

  1. Bond market very pessimistic long-run expectations.
  2. The asymmetry in policy responses and thus in risks created by the zero lower bound on short-term safe nominal interest rates.

I have been asking for quite a while now why any FOMC would choose to place such an infinitesimal weight not on just one but on both of these considerations. I have not gotten an answer from anywhere. I would like one. Very much…