Must-Read: : Gordon and Varian Approaches to Understanding the Ill-Named “Secular Stagnation”: Tren Griffin and Friends…
Tag: Secular Stagnation
Must-Read: Ryan Avent: Expect the Worst
Must-Read: the sharp Ryan Avent, I think, nails it:
: Expect the Worst: “It wouldn’t make sense for the Fed to target real GDP growth, but then, the Fed is not really in that business…
…The Fed is also unable to control the long-run real interest rate, which is a function of global saving and investment. What’s more, it does seem clear that the global real interest rate has settled down to a level of approximately zero. But does it follow that the Fed should then either 1) set a high nominal interest rate in order to achieve higher inflation, or 2) keep its interest rate low and accept low inflation? I don’t believe so…. It is not the case that the Fed is choosing low rates and inflation expectations are therefore converging toward a low level…. The Fed has been targeting very low inflation, and falling inflation expectations imply much lower interest rates in future. This dynamic is there back in 2013. In its projections the Fed indicates that rates will rise steadily, even as it projects that inflation will be extraordinarily low, just over 1% in 2013, converging, finally, toward 2% by the end of 2015. Essentially every set of Fed projections since then has shown the same thing. It allowed its QE programmes to end despite too-low inflation, and it raise its interest rate in December despite too-low inflation. The Fed has signalled very strongly that markets should expect inflation to remain at very low levels, indeed, below target. It would be shocking if inflation expectations hadn’t trended inevitably downward….
Is there a route out?… Where in the past the Fed has promised to raise rates even as inflation stays low, it could instead promise to keep them low no matter what, even if, and indeed until, inflation rises above the target. If the Fed wants higher nominal rates in a world of low real rates, it must cultivate higher inflation…. The Fed can choose whether nominal rates get stuck near zero or rise to a higher, safer level. Right now, unfortunately, it is steering the American economy firmly into a low-rate rut.
Must-Read: Paul Krugman: A Question For the Fed
Must-Read: As I was just saying yesterday: Take the rate of profit–typically 6% to 7% per year–on the operating companies that make up the stock market. Subtract the risk premium–typically 4%. Add on the expected inflation rate–2.5% on the CPI basis. Get 4.5% to 5.5%. That is what the nominal interest rate on Treasury bills is likely to be in normal times toward the end of a healthy expansion. That provides a healthy amount of room for the Federal Reserve to cut interest rates to encourage spending and support the economy when a recession comes. But note that 5% of sea-room to cut interest rates when necessary was not nearly enough back in 2007-2010.
Now suppose that we are entering an age of secular stagnation. It will have a higher risk premium–say 5-6%. Slower growth will have an impact on the rate of profit for operating companies–knock, say, 1-2% off their typical value. Go through the math, and we get a likely nominal interest rate on Treasury in normal times toward the end of a healthy expansion of roughly 1-3%, not 5%.
The dot-plots tell us that the FOMC now thinks that it is headed for a 3% Treasury Bill rate–at the upper end of this range, but still very far from a 5% rate. And if we do live in a semi-permanent age of secular stagnation, this will not be a temporary inconvenience but, rather, a permanent structural fact.
That means that if the FOMC keeps its current inflation target then it will have only 3% of sea-room when the next big recession comes, whether next year, next decade, or a quarter century from now.
That means that if the FOMC keeps attempting to raise interest rates back to a 5% normal–or even, unless it is lucky, to a 3% normal–it will find itself continually undershooting its inflation target, and continually promising that rates will go up more real soon now as soon as the current idiosyncratic fit of sub-2% inflation passes.
I do not know anybody seriously thinking about all this who thinks that 3% of sea-room is sufficient in a world in which shocks as big as 2007-2010 are a thing. And I do not know anybody seriously thinking about all this who thinks that pressing for a premature “normalization” of interest rates is a good idea: It will deanchor inflationary expectations on the downside, and with rational market inflation expectations 1-2% below the “target” that means an equilibrium late-expansion Treasury Bill rate of not 1 to 3% but rather -1 to 2%.
Therefore either (a) the Federal Reserve really should raise its inflation target, or (b) the Federal Reserve should right now be screaming to high heaven about how it is the necessary and proper task of the rest of the government to do something, something big, something now to resolve our secular stagnation problem. And under no circumstances should the Fed be (c) pushing for probably premature “normalization” of interest rates.
Of course, the Fed could and should be doing both (a) and (b). But it seems to be doing neither–it seems to be doing (c).
Perhaps Janet’s thoughts on secular stagnation are part of process of trying to assemble an FOMC coalition to… do something… or at least beg others to do something…
But this intellect, at least, is pretty pessimistc.
: A Question For the Fed: “There is a near-consensus at the FOMC that rates must eventually move up…
….But… exactly?… Which component of aggregate demand do we believe will continue to strengthen in a way that will require monetary tightening to avoid an overheating economy? Here’s a look at two obvious candidates… as shares of potential GDP… deviations from the 1990-2007…. Nonresidential investment has basically recovered from the recession-induced slump. Residential investment is still a bit low by historical standards, but not as much as you might think…. So I don’t see an obvious reason to believe that current rates are too low. Yes, they’re near zero–but that in itself doesn’t mean too low. Like others, notably Larry Summers, I think the Fed is trying to return to a normality that is no longer normal.
Must-Read: FOMC: Press Release–June 15, 2016
Must-Read: Somebody really should have dissented from this press release: if 0.5% is the forecast of the appropriate Fed Funds rate in 2018, zero is the appropriate Fed Funds rate now.
But who? Charlie Evans or Lael Brainard? I would bet Lael, based solely on the Fed convention that a Governor’s dissent is a much bigger deal than a Regional Bank President’s dissent. But that is only a guess: I do not know…
: Press Release–June 15, 2016: “The pace of improvement in the labor market has slowed while growth in economic activity appears to have picked up…
…Inflation has continued to run below the Committee’s 2 percent longer-run objective, partly reflecting earlier declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation declined; most survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months…. The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market indicators will strengthen. Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term…. Against this backdrop, the Committee decided to maintain the target range for the federal funds rate…. In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation…. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data…
Must-Read: Gauti B. Eggertsson, Neil R. Mehrotra, Sanjay R. Singh, and Lawrence H. Summers: A Contagious Malady? Open Economy Dimensions of Secular Stagnation
Must-Read: : A Contagious Malady? Open Economy Dimensions of Secular Stagnation: “We consider an overlapping generations, open economy model of secular stagnation…
…and examine the effect of capital flows on the transmission of stagnation. In a world with a low natural rate of interest, greater capital integration transmits recessions across countries…. In a global secular stagnation, expansionary fiscal policy carries positive spillovers implying gains from coordination, and fiscal policy is self-financing. Expansionary monetary policy, by contrast, is beggar-thy-neighbor…. Competitiveness policies, including structural labor market reforms or neomercantilist trade policies, are also beggar-thy-neighbor in a global secular stagnation…
Must-Read: Larry Summers: Fed’s Current Strategy Ill Adapted to the Realities
Must-Read: Larry Summers is right.
If the Phillips Curve today still had the short-run slope in the gearing of expected inflation to recent past inflation that it appeared to have at the start of the 1980s, there might–but only might–be a case for the Federal Reserve’s current policy.
There is no reason for internal comity between the Board of Governors and the regional bank presidents to be a concern: Bernanke and Yellen have now had three full regional bank-appointment cycles to get bank presidents who are on the same page as the Board of Governors. The Federal Reserve always has and is understood to have the freedom to raise interest rates to maintain price stability when incoming data suggests that it is threatened: there is no need for talk to highball the chances of future rate increases when the current data flow does not suggest it will be needed. Thus I see no reasons at all to support a Fed policy posture other than that one that Larry Summers recommends: “signal[ling] its commitment to accelerating growth and avoiding a return to recession, even at some cost in terms of other risks…”
: Fed’s Current Strategy Ill Adapted to the Realities: “The current hawkish inclination of the Fed, with its chronic hope and belief that conditions will soon permit interest rate increases, is misguided…
…The greater danger is of too little rather than too much demand. A new Fed paradigm is therefore in order…. I would guess that from here the annual probability of recession is 25-30 percent. This seems to me the only way to interpret the yield curve. Markets anticipate only about 65 basis point of increase in short rates over the next 3 years. Whereas the Fed dots suggest that rates will normalize at 3.3 points, the market thinks that even 5 years from now they will be about 1.25 percent. Markets are thinking that recession will come at some point and when it does rates will go to near zero…. This implies that if the Fed is serious… about having a symmetric 2 percent inflation target then its near-term target should be in excess of 2 percent. Prior to the next recession–which will presumably be deflationary–the Fed should want inflation to be above its long term target…. The Fed’s dots forecasts refer to a modal scenario of continued recovery… [with] inflation rising to 2 percent only in 2018. Why shouldn’t they prefer a path with more demand, inflation at target sooner, more stimulus as recession insurance, and a small margin of extra inflation as a buffer against the next recession?….
The logic that led to the adoption of the 2 percent inflation target years ago suggests that it is too low now…. The case for a positive inflation target balances the benefits of stable money with the output cost of lowering inflation and two ways that positive inflation is helpful—the periodic need to have negative real rates, and inflation’s role in facilitating downward adjustment in real wages given nominal rigidities. All of the factors pointing towards a higher inflation target have gained force in recent years…. Experience has proven that Yellen was correct to be skeptical of the idea very low inflation rates would improve productivity. And it is plausible that the error in price indices has increased with the introduction of new categories of innovative and often free products…. If a two percent inflation target reflected a proper balance when it first came into vogue decades ago, a higher target is probably appropriate today….
Long term inflation expectations are depressed and declining…. The Fed has in the past counterbalanced declines in market inflation expectation measures by pointing to the relative stability in surveys-based measures. This argument is much harder to make now that consumer expectations of inflation have broken decisively below their all-time lows even as gas prices have been rising…. The Fed’s summary employment conditions index has been flashing yellow since the beginning of the year. Declines in this measure have presaged recession half of the time and uniformly been followed by rate reductions rather than rate increases….
The right concern for the Fed now should be to signal its commitment to accelerating growth and avoiding a return to recession, even at some cost in terms of other risks. This is not the Fed’s policy posture. Watching the Fed over the last year there is a Groundhog Day aspect. One senses they really want to raise rates and achieve a more ‘normal’ stance. But at the same time they do not want to tighten when the economy may be slowing or create financial turmoil. So they keep holding out the prospect of future rate increases and then find themselves unable to deliver. But they always revert to holding out the prospect of rate increases soon, partly for internal comity and partly to preserve optionality. Over the last 12 months nominal GDP has risen at a rate of only 3.3 percent. We hardly seem in danger of demand running away. Today we learned that Germany has followed Japan into negative 10 year rates. We are only one recession away from joining the club…
Must-read: Tim Duy: Fed Watch: Fed Speak, Claims
Must-Read: I confess I could understand FOMC participants wanting to raise interest rates right now if projected growth over 2016 was 3.5% or higher. But we have a first quarter of 0.8% and a second quarter of 2.3%: we may well not even get to 2.0% this year.
I confess I understand FOMC participants worrying about “imbalances” created by extremely-low interest rates, but:
- If they are worried about extremely-low real interest rates, they need to be all-in pressuring the Congress for more expansionary fiscal policy.
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If they are worried about extremely-low nominal interest rates, they need to be all-in pressuring their colleagues for a higher inflation target.
It’s the absence of either of those two from the Fed hawks–and the Fed moderates–that has me greatly concerned:
: Fed Watch: Fed Speak, Claims: “The Fed is not likely to raise rates in June…
…But not everyone at the Fed is on board with the plan. Serial dissenter Kansas City Federal Reserve President Esther George repeated her warnings that interest rates are too low…. Boston Federal Reserve President Eric Rosengren… reiterated his warning that financial markets just don’t get it….
I would suggest that the failure of policymakers to better manage the economy at turning points is not because it is impossible, but because they have overtightened in the latter stage of the cycle, forgetting to pay attention to the lags in policy they think are so important during the early stages of the cycle….
Bottom Line: Ultimately, I suspect the FOMC will not find sufficient reason in the data before June to convince the Fed that growth is sufficiently strong to justify a hike. Hence I anticipate that they will pass on that opportunity to raise rates. Look for an opportunity in September…. I doubt, however, that most on the Fed are pleased that market participants have already priced out a June hike on the basis of the April employment report…. They do not see the outcome as already preordained.
Must-Read: Larry Summers: Four Common-Sense Ideas for Economic Growth
Must-Read: : Four Common-Sense Ideas for Economic Growth: “Since the summer of 2009, the US economy has grown at about 2 percent…
…The 10-year interest rate at the end of trading today [February 18, 2016] was just a bit below 1.8 percent…. We are having trouble achieving… a 2 percent inflation…. This is the judgment of a market that thinks that the Fed is not going to do anything like what it says it’s going to do…. The real interest rate is at least a kind of measure of the certainty equivalent of the productivity of capital. If the market is saying that’s below 1 percent, that has to be of concern as well. [And] the Fed has been substantially too optimistic in its one-year-ahead forecast every year for the last six….
What should be done?… First, there is an overwhelming case in the United States for expanded public infrastructure investment…. Yt the rate of infrastructure investment is lower now than it’s been anytime since 1947. If you take depreciation out, federal infrastructure investment is negative…. Second, we should increase support for private investment in infrastructure…. With respect to private investment, tax reform is critical…. Third, we should grow our effective labor force…. What we do to educate our workforce matters. What we do to incentivize our workforce—through the design of our social safety net, and through disability insurance—matters. What we do to change our immigration policies—particularly our immigration policies on highly skilled workers—matters….
Fourth, our financial system requires continuing attention… the 1987 crash, the 1990 real-estate bubble, the S&L crash, the Mexican financial crisis, the Asian financial crisis, the internet bubble, Enron, and then the Great Recession of 2008. On average, a crisis every three years for the last 30 years. That surely has taken a toll on growth. At the same time, because pendulums swing, at a time of substantial unemployment, a large number of middle-class Americans are not able to get mortgages today with reasonable down payments. It appears, though the matter is in some dispute, that there are significant impediments in the flow of capital to small businesses as well. Financial reform, labor-force support, stimulus to private investment, increases in public investment—this stuff is not rocket science. Most of it operates on both the demand side and the supply side….
If all you care about is that we’ve got an excessive federal debt, the most important determinant of the debt-to-GDP ratio in 2030 is how rapidly the economy grows between now and then. If what you care about is American national security, the most important determinant of how much we are respected and how much influence we have in the world is how well our economy performs. If what you care about is inequality and poverty, the most important determinant of the employment prospects of the poor is how rapidly the economy is growing…
We Are so S—ed. Econ 1-Level Edition
As I told my undergraduates yesterday:
Y = μ[co + Io + NX] + μG – μIrr
where:
- Y is real GDP
- μ = 1/(1-cy) is the Keynesian multiplier
- co is consumer confidence
- cy is the marginal propensity to consume
- C = co + cyY is the consumption function–how households’ spending on consumption goods and services varies with consumer confidence, with their income which is equal to real GDP Y, and with the marginal propensity to consume
- Io is businesses’ and banks’ “animal spirits”–their confidence in enterprise
- r is “the” long-term risky real interest rate r
- Ir is the sensitivity of business investment to r
- NX is foreigners’ net demand for our exports
- And G is government purchases.
And as I am going to tell them next Monday, real GDP Y will be equal to potential output Y* whenever “the” interest rate r is equal to the Wicksellian neutral rate r*, which by simple algebra is:
r* = [co + Io + NX]/Ir + G/Ir – Y*/μIr
If interest rates are low and inflation is not rising it is not because monetary policy is too easy, but because r* is low–and r* can be low because:
- consumers are terrified (co low)
- investors’ animal spirits are depressed (Io low)
- foreigners’ demand for our exports inadequate (NX low)
- or fiscal policy too contractionary (G low)
for the economy’s productive potential Y*.
The central bank’s task in the long run is to try to do what it can to stabilize psychology and so reduce fluctuations in r. the central bank’s task in the short run is to adjust the short-term safe nominal interest rate it controls i in such a way as to match the market rate of interest r to r. For only then will Say’s Law, false in theory, be true in practice:
: Negative Rates Not Central Banks’ Fault: “It is hard to understand the obsession with limiting public debt when it is as cheap as it is today…
…Almost nine years after the west’s financial crisis started, interest rates remain ultra-low. Indeed, a quarter of the world economy now suffers negative interest rates. This condition is as worrying as the policies themselves are unpopular. Larry Fink, chief executive of BlackRock, the asset manager, argues that low rates prevent savers from getting the returns they need for retirement. As a result, they are forced to divert money from current spending into savings. Wolfgang Schäuble, Germany’s finance minister, has even put much of the blame for the rise of Alternative für Deutschland, a nationalist party, and on policies introduced by the European Central Bank. ‘Save the savers’ is an understandable complaint by an asset manager or finance minister of a creditor nation. But this does not mean the objection makes sense. The world economy is suffering from a glut of savings relative to investment opportunities. The monetary authorities are helping to ensure that interest rates are consistent with this fact….
The savings glut (or investment dearth, if one prefers) is the result of developments both before and after the crisis…. Some will object that the decline in real interest rates is solely the result of monetary policy, not real forces. This is wrong. Monetary policy does indeed determine short-term nominal rates and influences longer-term ones. But the objective of price stability means that policy is aimed at balancing aggregate demand with potential supply. The central banks have merely discovered that ultra-low rates are needed to achieve this objective…. We must regard ultra-low rates as symptoms of our disease, not its cause….
[But is] the monetary treatment employed… the best one[?]…. Given the nature of banking institutions, negative rates are unlikely to be passed on to depositors and… so are likely to damage the banks…. There is a limit to how negative rates can go without limiting the convertibility of deposits into cash…. And this policy might do more damage than good. Even supporters agree there are limits…. [Does] this mean monetary policy is exhausted? Not at all. Monetary policy’s ability to raise inflation is essentially unlimited. The danger is rather that calibrating monetary policy is more difficult the more extreme it becomes. For this reason, fiscal policy should have come into play more aggressively….
The best policies would be a combination of raising potential supply and sustaining aggregate demand. Important elements would be structural reforms and aggressive monetary and fiscal expansion…. Monetary policy cannot be for the benefit of creditors alone. A policy that stabilises the eurozone must help the debtors, too. Furthermore, the overreliance on monetary policy is a result of choices, particularly over fiscal policy, on which Germany has strongly insisted. It is also the result of excess savings, to which Germany has substantially contributed…
One way of looking at it is that two things went wrong in 2008-9:
- Asset prices collapsed.
- And so spending collapsed and unemployment rose.
The collapse in asset prices impoverished the plutocracy. The collapse in spending and the rise in unemployment impoverished the working class. Central banks responded by reducing interest rates. That restored asset prices, so making the plutocracy whole. But while that helped, that did not do enough to restore the working class.
Then the plutocracy had a complaint: although their asset values and their wealth had been restored, the return on their assets and so their incomes had not be. And so they called for austerity: cut government spending so that governments can then cut our taxes and so restore our incomes as well as our wealth.
But, of course, cutting government spending further impoverished the working class, and put still more downward pressure on the Wicksellian neutral interest rate r* consistent with full employment and potential output.
And here we sit.
Must-read: Jon Faust: “Still Crazy After All These Years”
Must-Read: : Still Crazy After All These Years: “For the past several years, the Congressional Budget Office has been offering frightening forecasts…
…about government debt growing out of control unless strong action is taken. While these forecasts have played a prominent role in policy debates, the CFE’s Jonathan Wright and Bob Barbera have for several years been arguing that those forecasts are, well, crazy. Or as the headline on Bob’s 2014 FT piece put it: ‘Forecasts of U.S. Fiscal Armageddon are Wrong.’ The key… is that the CBOs economic growth and interest rate projections jointly make no sense…. Under the CBO’s projected tepid growth projection, interest rates were highly unlikely to rise to the assumed levels….
We were glad to read in Greg Ip’s recent column that Doug Elmendorf, the CBO director responsible for those forecasts until recently, now agrees. Elmendorf and Louise Scheiner of the Hutchins Institute make the argument that:
the fact that U.S. government borrowing rates are at historical lows and likely to stay low for some time, implies spending cuts and tax increases should be delayed and smaller in size than widely believed.
It was Elmendorf’s CBO that helped stoke those widely-believed views now labelled as misguided. And as noted above, the CBO is still stoking. For the sake of coherent public policy, we hope that the CBO will listen to Elmendorf and Scheiner.