Ten Current-Situation Questions for Brad DeLong

(1) Recession Chances?: The chances of recession are smmall, but not very small. Robert Solow likes to quote Damon Runyon that nothing between humans is more than 3 to 1. We have a very hard time imagining how fat the tails are–and so even when things look clear there are always dangers surprisingly close

That said, expansions do not die of natural causes. It is true that the unwinding of malinvestment balances is a fraught moment. But we climbed down from the dot-com bubble successfully. And we almost climbed down from the housing bubble successfully—I confess that even in July 2008 I thought we were going to make it. And so I think, today, that we are going to make it without a recession in our near future. (Britain and Texas, on the other hand…)

(2) Secular Stagnation?: If what we call “secular stagnation” were predominantly on the supply side, we would be seeing many more signs of demand exceeding supply and of upward pressure on prices in individual sectors with bottlenecks than we are. As it is, we see only one bottleneck and one sector of significant pressure: housing prices in world cities where NIMBYism rules.

(3) The Equilibrium Level of the Interest Rate?: The case for a lower equilibrium safe real interest rate is the market’s: that is what the market is telling us. The big remaining question his whether this Is because of a shortage of profitable investment opportunities—that we have had a breakdown in that those investments that would promote societal utility cannot be also jiggered to create private profits—or whether it is because it is a shortage of global risk-bearing capacity. And both theories have evidence supporting them.

(4) Should the Fed Have Increased Rates in December?: No. There was no upside I could see. There was some downside that I could see. Now the downside has come to roost and is sitting on the telephone wire. With no possible upside and possible downsides, how could it not have been a mistake ex ante? And with the downside as it has materialized, it does look like a moderate mistake ex post.

(5) A Higher Inflation Target?: Put yourself back in the mid-1990s. There is no way that anybody who foresaw any reasonable possibility of 2008-2016 would have thought that a 2.5%/year CPI-inflation target was a reasonable thing. It would have been 4%/year. And in the long run there is nothing to be gained by desperately trying to hold onto a policy that was and remains unwise. For getting a credible reputation for unwisdom is not the kind of credibility you want.

(6) Fed Performance?: Both Bernanke and Yellen were world-class in their preparation for the job, are world-class in their intelligence and competence, and have done better then any of the other first-world central bankers since 1995. We are lucky. They have avoided repeating previous mistakes. They are making and will continue to make their own mistakes. But what we think we identify in real-time and will identify in retrospect as their policy failures speaks not that they should not have had their jobs but rather of the difficulty of the dive. We are very lucky that GWB and Obama made those appointments, and Senators who did not advise and consent should be deeply ashamed of themselves.

(7) Trump?: The hoped-for scenario if Trump wins is Trump = Schwarzenegger—a Hollywood celebrity who would try to make Hollywood-style deals in politics and, like Schwarzenegger, fail. The feared scenario if Trump wins is Trump = Berlusconi–or, worse, Mussolini. More broadly, if Trump wins and turns out to be less abnormal than his campaign persona–or if Clinton wins–there are then three other scenarios:

  1. There is the total gridlock scenario.
  2. There is the people-realize-that-they-are-“Washington”-and-that-making-“Washington”-disfunctional-is-bad-for-their-long-run-careers scenario, in which case what we used to think of as normal—pre-1993 dealmaking rather than rigid ideological posturing—resumes.
  3. There is the Trump has negative coattails that destroy Republican congressional power scenario.

(8) China?: We do not know if Xi Jinping’s desire to return to “democratic centralism” is at all compatible with a prosperous modern economy. The experience of 19th and 20th Century Europe says no—that authoritarian rule by a caste without a plausible economic role is unstable in the industrial and even more so in the post-industrial age. But maybe Europe is a bad guide. We do not know why the Middle Income Trap is a Thing, or even whether it is really a Thing. But maybe that is a Latin American phenomenon only. China’s long history tells us that the way to bet is that China’s natural condition is to be at the lead as one of the world’s most prosperous and most peaceful regions containing about one-fifth of humanity. If we can take a 200-year perspective, that is probably right. But in a 50-year perspective? Be afraid. Be very afraid.

But it is not a thing I would worry about if either the Federal Reserve or the rest of the U.S. government had both the will and the tools to stabilize aggregate demand in response to what can be, at most, only a moderate adverse shock from China. Unfortunately, the Federal Reserve has the will but may not have the tools. And the rest of the government has the tools but not the will…

(9) Brexit?: Brexit may well not happen. Buyer’s remorse may be very high, and none of the Brexiteers seem to have read the legal documents to figure out which parliaments have to approve Brexit for it to happen or if indeed there can be an Engxit if Scotland, Wales, and Northern Ireland wish their people to retain their EU passports. It is a disaster: investment in England is right now dropping like a stone as everyone decides to wait and see.

Whatever happens–Engxit, Brexit, Morexit, or nothing–Europe will continue to be a very rich part of the world. Profits from investing and producing in Europe will continue to be high. The political economy of Europe will continue to make Germany an export powerhouse. And that means that as long as the world as a whole has slack demand—which looks like a long time—being in a currency union with Germany and being subject to German demands for fiscal policy will inflict considerable drag on the rest of Europe. But it is the strangling of rapid growth and the fumbling of opportunities for economic convergence that is at issue here, not a meltdown or any harder landing then we have already had.

(10) Risks to Emerging Markets?: The conventional economic models that I was taught told me that monetary tightening in the United States was expansionary for emerging markets as long as they allowed the market to value their currencies. That seems to be wrong. But we are confused about why that is wrong. Some say that it is because emerging markets must borrow inflation-fighting credibility from abroad and so cannot afford to let their currencies undergo a clean float. Others say that international capital flows carry not just financing capacity but risk-bearing and entrepreneurship along with them. Therefore: be afraid, be very afraid of the current Fed tightening cycle, although our models of why we should be afraid are pretty-much crap.

As to why growth keeps disappointing, it has always been thus. We tend to focus on the Western European convergence during the 30 glorious years, on the Asian Tigers, on Japan’s Meiji and Showa eras, on China today, and, earlier, on Wilhelmine Germany. But those are the exceptions. The rule is that this is very hard.

Now on some level it makes no sense that this is very hard.

Both Karl Marx and John Stuart Mill around 1850 were certain that the next 50 years would see industrial structure and productivity levels in India converge to the British standard. Mill expected it to be because of world trade, the inculcation of British market-friendly institutions, and good government by himself and all his friends in the India Office. Marx expected it to be because the British Millocracy were throwing a net of railroads across India for their own profit that would, unintentionally, allow the global markets and the world bourgeoisie to do their wonderful, horrible thing that would make the communist revolution to create a free society of associated producers possible, necessary, and very desirable. Both were wrong.

Right now we can ship anything non-spoilable across the world for pennies, talk to anyone, and access any piece of engineering knowledge less than a generation old for free. Yet the world has very steep valleys and peaks. And one billion of our fellow human beings who could do just as well as we do in our pitch and our board meetings if they were properly briefed still live lives barely distinguishable from those of our pre-industrial agrarian age ancestors.

June 26, 2016


Brad DeLong
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