Archive for April 2015


The WSJ Editorial Board, Paul Krugman and Simon Wren-Lewis

What do these strange bedfellows have in common?  Confusing employment shortfalls with productivity slowdowns. Here’s Ben Bernanke:

It’s generous of the WSJ writers to note, as they do, that “economic forecasting isn’t easy.” They should know, since the Journal has been forecasting a breakout in inflation and a collapse in the dollar at least since 2006, when the FOMC decided not to raise the federal funds rate above 5-1/4 percent.

[Memo to myself:  If I get into a debate with Bernanke, I need to expect to come out bloodied.  He’s been taking notes.]

Bernanke continues:

However, the WSJ editorialists draw some incorrect inferences from the FOMC’s recent over-predictions of growth. Importantly, they fail to note that, while the FOMC (and virtually all private-sector economists) have been too optimistic about growth, they have also been consistently too pessimistic about unemployment, which has fallen more quickly than anticipated. The unemployment rate is a better indicator of cyclical conditions than the economic growth rate, and the relatively rapid decline in unemployment in recent years shows that the critical objective of putting people back to work is being met. Growth in output has been slow, despite solid job creation, because productivity gains have been slow””perhaps as the result of the financial crisis, which hammered new business formation and investment in research and development, perhaps for other reasons. But nobody claims that monetary policy can do much about productivity growth. Where it can be helpful is in supporting the return to full employment, and there the record has been reasonably good. Indeed, it seems clear that the Fed’s aggressive actions are an important reason that job creation in the United States has outstripped that of other industrial countries by a wide margin.

Here’s where Krugman and Wren-Lewis come in.  Britain has done a very good job of creating jobs in recent years, much better than the US.  Unfortunately their RGDP growth rate has been poor, due to abysmal productivity growth (much worse than the US.)  Bernanke and I would say that this reflects supply-side problems.  Now in fairness Bernanke later mentions that infrastructure investments can boost growth in the long run (something I’m more skeptical about, at least if done by government.)  But of course when you look at how long it takes to do projects like Heathrow expansion of HR2 lines to Birmingham, it’s obvious these investments wouldn’t have effected productivity until many years in the future.  Yet somehow Krugman and Wren-Lewis seemed to think an AD shortfall in Britain caused by Conservative “austerity” killed output without killing jobs, sort of an economic reverse neutron bomb.  That doesn’t even make sense in the Keynesian model.  But then neither does the idea that fiscal stimulus can reduce the deficit by dramatically boosting growth.  We’ve now reached the point where Keynesian economics has “jumped the shark.”  Anything is possible, and one need not even be constrained by the (already rather heroic) assumptions of textbook Keynesianism.

OK, I’m letting my right wing tribalism get the better of me.  Rather than bashing two distinguished Keynesian economists, I ought to highlight the far more absurd arguments of the WSJ editorial page.  Here’s Bernanke:

For the second year in a row, the first-quarter Gross Domestic Product figures were disappointing. TheWall Street Journal, in an editorial entitled “The Slow-Growth Fed,” uses the opportunity to argue (again) for tighter monetary policy. The editorialists point out that the Federal Open Market Committee’s projections of economic growth have been too high since the financial crisis, which is true. Therefore (the WSJ concludes), monetary policy is not working and efforts to use it to support the recovery should be discontinued.

So since 2008 the Fed has mostly fallen short on both sides of its dual mandate, and hence the solution to the problem is tighter money—so that . . . . so that what?  So that we fall even further short of the inflation target?  What problem does tighter money solve?  I don’t get it.

And it’s not just on the right.  Today I got a newsletter from the Levy Institute, highlighting a paper suggesting that higher interest rates might boost growth.  OK, I could just barely envision a scenario where that is true. It’s very difficult, but not impossible.  Say the BOJ established a 100% credible forex regime where the yen depreciated 5%/year against the dollar, forever.  The interest parity effect would raise Japanese rates immediately and the yen depreciation would boost AD.  If that doesn’t work do 5%/month.  Yes, it’s possible.  But you read their explanations and they write as if central banks just moves rates around with a magic wand.  As if it doesn’t matter whether the higher rates are caused by easier money or tighter money. People write as if they didn’t notice what happened when Japan, the ECB and the Riksbank tried to exit the zero bound by raising rates.


Dean Baker reasons from a quantity change

I criticized Dean Baker for claiming that “all economists” believed you had to reduce the trade deficit to boost jobs.  In the comment section he responded as follows:

Glad to see that I seem to have got your juices flowing with this one. Let’s see if we can figure out the source of the misunderstanding.

1) I assume the economy is below full employment in the standard Keynesian sense. Perhaps you don’t.
2) If it is below full employment then any increase in a component of demand (C,I,G, or [X-m]) will boost employment and output.
3) a main determinant of X-M is the price of goods and services in the United States relative to the price in other countries.
4) a lower valued dollar reduces the relative price of goods and services in the United States.
5) central banks can affect the relative price of currencies by buying or selling them.

Now perhaps you can tell me which one(s) of these propositions you disagree with. FWIW, you will find versions of all of them in Greg Mankiw’s textbook, as I said in my post on his column.

My juices always flow when I see someone reason from a price or quantity change. And Baker shouldn’t feel bad, I’ve seen worse from Nobel Prize winners.  But I’m afraid he’s not doing economics here, he’s doing accounting.  Yes, GDP equals C + I + G + (X – M), but it’s also true that:

GDP = C + S + T

Does Baker want to claim that this proves that more saving leads to more GDP? How about higher taxes?  As David Glasner likes to point out, accounting relationships tell us nothing about causation.

Intro textbooks often oversimplify macro at the beginning, saying things like more G increases GDP via a “multiplier,” even though the author knows that that relation assumes a fixed interest rate, not a 2% inflation target.  And no crowding out. And no Ricardian equivalence.  You are better off looking at Mankiw’s open economy macro chapters.  In chapter 19 of the 3rd edition, Mankiw points out that bigger budget deficits lead to larger trade deficits, citing the famous example of the Reagan “twin deficits,” where deficit spending by Reagan boosted our trade deficit. Does Baker want to claim that a smaller trade deficit is expansionary if caused by fiscal austerity?

In his reply he sensibly shifts the argument to monetary policy.  But Mankiw doesn’t even discuss monetary policy in the section on how shocks impact an open economy.  That may be because (contrary to the claim of Baker) after monetary stimulus, the substitution effect (lower exchange rate) is often overwhelmed the by the income effects (a booming economy sucks in imports.)  Yes, monetary stimulus boosts jobs in a depressed economy, but not because the trade deficit gets smaller. The most dramatic example of using monetary policy to devalue the dollar occurred in April 1933, and the trade deficit actually got “worse” over the next six months, as the resulting growth spurt sucked in imports.  (Things slowed later with FDR’s high wage policy.) Needless to say not all textbooks get into this level of complexity at the intro level.

In August 1971, Nixon dramatically devalued the dollar 10%, ending Bretton Woods.  The US trade deficit increased 4 fold in 1972 as compared to 1971, as very rapid GDP growth sucked in imports.  In fairness, fiscal policy was also expansionary.

So on trade deficit changes caused by fiscal policy, Baker is flat out wrong.  The theory on monetary induced changes is ambiguous, but there is lots of empirical evidence suggesting the income effect can often outweigh the substitution effect. And this isn’t just one of my crackpot theories, I’ve seen much more distinguished macroeconomists like Lars Svensson make the same point.

Of course Baker’s also wrong in claiming that any of this debate has any bearing on Mankiw’s discussion of the microeconomic efficiency gains from freer trade, which occur regardless of whether the economy is depressed.

No, trade deficits don’t cause unemployment

David Henderson directed me to an appalling post by Dean Baker:

There is one other big point which in Mankiw’s piece which needs correcting. Mankiw tells readers:

“Politicians and pundits often recoil at imports because they destroy domestic jobs, while they applaud exports because they create jobs.  Economists respond that full employment is possible with any pattern of trade.

“The main issue is not the number of jobs, but which jobs.”

Mankiw probably missed it, but we had a really bad recession when the housing bubble collapsed in 2007-2009 and the labor market still has not fully recovered. Millions of people are still unemployed or have given up looking for work. Tens of millions are unable to get wage gains because of the continuing weakness of the labor market.

In principle we could get back to full employment with large government budget deficits, but that is not going to happen for political reasons. Aggressive use of work sharing leading to shorter workweeks can also move us toward full employment, but this is also not something we are likely to see any time soon.

This means that if we want to get back to full employment, we have to reduce our $500 billion (@ 3 percent of GDP) trade deficit. (This is the intro econ on which all economists agree. It can even be found in Mankiw’s textbook.) Reducing the trade deficit means taking steps to lower the value of the dollar against other currencies. These trade agreements would be the obvious place to have currency rules. If we don’t address the currency issue here, where exactly are we going to do it?

Finally, Mankiw has been more than a little sloppy in his all economists agree proclamation. Among the opponents of these deals he would find Fred Bergsten, the former president of very pro-trade Peterson Institute for International Economics, Nobel Prize winning economist Joe Stiglitz and Nobel Prize winning economist Paul Krugman.

Where does one begin?  Baker insults Mankiw by suggesting that he doesn’t understand that America has an unemployment problem.  Baker doesn’t seem to recognize that this fact has no bearing on the Mankiw claim about trade.

Then Baker suggests that reducing the trade deficit would magically create jobs, even though standard macro theory provides no support for that claim.  Then he talks about the government “taking steps” to lower the value of the dollar, without mentioning what those steps are.  In standard textbook economics, fiscal austerity lowers the value of the currency. Is that the policy “steps” Baker has in mind?  Or maybe he was thinking about monetary stimulus.  That’s actually slightly more plausible, at least in theory.  But in practice the income effect often outweighs the substitution effect, and hence easier money tends to make the trade deficit larger, not smaller.

I’m not sure what’s more appalling, the fact that Baker thinks reducing the trade deficit would create jobs, or that he thinks all economists agree with him.  The first is almost certainly wrong, the second claim is certainly wrong.

As far as adding “currency rules” to trade agreements, I don’t even know where to begin.  Does he contemplate Congress setting the value of the dollar via fiscal policy?  How about the Fed abandoning its dual mandate to target exchange rates? This isn’t even serious; I can’t believe that even Baker believes the US will start targeting the forex value of the dollar.

As for his appeal to authority, the Paul Krugman that won the Nobel Price was the guy who wrote Pop Internationalism, and who would have supported the current trade deal being negotiated, not the guy who’s moved so far to the left that he’s praising the loony Marxist government in Greece that almost everyone else seems to think is a bunch of crackpots.

[Also check out David’s excellent post, which I ripped off.]

Now that the GOP has gained control of the Senate . . .

I’m continually amazed at the naivete of many reporters, pundits, bloggers and other people who comment on public policy.  Again and again we are told that there is some sort of grand philosophical divide separating the two parties, with the GOP favoring “small government.”  And indeed the rhetoric often does fit that stereotype.  But in practice it rarely works out that way.  Sometimes I wonder how many times people have to get fooled before they wise up. Apparently the increase in government spending (as a share of GDP) under George Bush wasn’t enough.  Nor was the decline under Clinton.  Nor was the increase under Nixon.  The latest excuse is that Bush was the old GOP, and now the small government fanatics of the Tea Party have taken over.  “Yes, the GOP wasn’t really libertarian before, but now it is.”

So I guess any day now we’ll start to see some big cuts?  After all, the GOP just won a huge victory in the House, and gained control of the Senate.  And we all know that “elections have consequences.”  OK, here’s your consequence:

Whatever happened to the big, bad federal deficit? You know, the red ink menace that was supposed to devour America’s fiscal future?

We ask because the way Congress is acting the deficit must have gone into hiding. Look at how eager lawmakers were to whoop through the “doc fix,” the big bill averting (permanently) planned reductions in Medicare reimbursements for physicians. It passed the Senate today by a 92-to-8 vote, having squeaked through the House last month, 392-to-37.

Yes, the move is popular, obviously. It resolves an issue that’s been a problem for years. Yet the doc fix is expensive, and only about one-third of its cost is offset by budget cuts. It’ll add some $141 billion to the deficit over the next 10 years.

.  .  .

And that’s not the only up-spending in the works. Add in likely increases in military and domestic spending, and the deficit could go up $100 billion in the next year alone, calculates longtime federal budget expert Stan Collender.

That would be about a 21 percent increase.

Virtually every policy change that has already or soon will be considered seriously in the House and Senate will make the deficit higher rather than lower,” writes Mr. Collender in Forbes this week. (emphasis added)

Brace yourself for a lot of phony rhetoric in 2016, about how the election is fundamentally a decision between the small government GOP and the big government Dems.


The two parties are like high school cliques, with the GOP representing the military, business, people who work with their hands, and Christians.  The Dems represent the poor, minorities, people who work with their minds, and public employees.  Government is simply a tool to further the interests of whichever group is favored or disfavored by the party in power.

PS.  I have a post on VAR models over at Econlog.

PPS.  NGDP growth expectations just fell to 3.5%.  Who says I can’t move markets?

PPPS.  3.4%!!

PPPPS.  3.3%!!!!!!!

PPPPPS.  3.2%!!!!!!!!!!!



Surprise, the Fed again overestimates growth

The first quarter NGDP growth numbers are in, and they show about 0.1% annualized growth.  The Hypermind full year forecast fell from 3.8% to 3.6% on the news.  I doubt if we’ll even hit 3.6%, which would require nearly 4.8% annual growth for the final three quarters of the year.

The Fed seems anxious to raise interest rates this year, but I’m having trouble understanding what “problem” this is supposed to solve.

Overheating?  Expected future overheating?

Or is this urge a sort of atavistic gesture, like an arm or leg that suddenly jerks after being still for too long?  Are they planning to raise rates because . . . well because it’s the job of central banks to move interest rates to and fro?

The new and improved modern Fed says they will be “data driven.”  OK, what do they learn from the fact that the economy is once again underperforming their expectations?