Archive for October 2015


Is it time to blow up the New Keynesian model?

This is from a paper by Gauti Eggertsson, a very distinguished New Keynesian economist:

Tax cuts can deepen a recession if the short-term nominal interest rate is zero, according to a standard New Keynesian business cycle model. An example of a contractionary tax cut is a reduction in taxes on wages. This tax cut deepens a recession because it increases deflationary pressures. Another example is a cut in capital taxes. This tax cut deepens a recession because it encourages people to save instead of spend at a time when more spending is needed.

Elsewhere he showed that in a deep depression, the NK model suggested that artificial attempts to raise wages, such as FDR’s NIRA, could be expansionary.

Several economists have recently suggested that the NK model has NeoFisherian implications. If the Fed were to raise its fed funds target, the policy shift would be inflationary.

Nick Rowe shows that the NK model implies that a slowdown in the rate of government spending growth is expansionary.

To summarize:

1.  The NK model implies that higher taxes on wages can be expansionary.

2.  The NK model implies that higher capital gains taxes can be expansionary

3.  The NK model implies that raising the aggregate wage level by government fiat can be expansionary.

4.  The NK model implies that an increase in the fed funds target can be expansionary.

5.  The NK model implies that fiscal austerity can be expansionary, if done by slowing the growth in government spending.

These are claims made by NK supporters, NK opponents, and people in the middle. And what they all have in common is that they suggest that the NK model has preposterous implications.  These claims about the world aren’t just wrong, they are borderline absurd.  I’ve studied macroeconomics all my life, both the Great Depression and the post-1970 period.  I’ve seen hundreds of natural (policy) experiments, and watched how both markets and the broader economy reacted to those natural experiments.  And if these claims are true then I might as well stop being an economist, because it would mean I understand nothing about the world, absolutely nothing.

Perhaps merely to keep my sanity, I prefer to find another model, which doesn’t yield one preposterous result after another.  Here’s the best I can do:

The Musical Chairs model:

1.  In the short run, employment fluctuations are driven by variations in the NGDP/Wage ratio.

2.  Monetary policy drives NGDP, by influencing the supply and demand for base money.

3.  Nominal wages are sticky in the short run, and hence NGDP shocks cause variations in employment in the same direction.

4.  In the long run, wages are flexible and adjust to changes in NGDP. Unemployment returns to the natural rate (currently about 5% in the US.)

This models seems to fit the stylized facts quite well:

In my model, artificial attempts to raise wages are contractionary, because they reduce NGDP/W.

In my model, higher wage taxes are contractionary, because they reduce NGDP/W (“W” is actually hourly labor costs for firms, including employer-side taxes and benefits.)

In my model, capital gains taxes have little impact on employment.

In my model, increases in the fed funds target are achieved via decreases in the base. This reduces NGDP, and thus NGDP/W, and therefore is contractionary.

In my model, a decrease in the growth rate of government spending doesn’t effect employment.

So in all five cases where the NK model has loony implications, my model has implications that are more consistent with what we know about how the world actually works.

Oh, and one other thing, the NK model has enormous academic prestige, whereas my model is ignored, or dismissed as non-rigorous.

I am quite certain that my model will not win out in the long run; it’s too crude. (Even I could do better.)  But I’m equally certain that the NK model can’t survive in its current form.  It’s time to blow it up, and start over with a completely different framework. Preferably a model that doesn’t focus on inflation, interest rates and output, but rather NGDP, nominal wages, and employment.

PS.  I have a new post at Econlog; metaphors run wild.

The best news of 2015

Eleven days ago I predicted:

I predict that the Chinese government will eliminate the one child policy within 2 years””that will help.

If only I had said “two weeks”.  Here’s the FT:

China has decided to scrap its one-child policy, one of the most draconian social experiments in modern history which has caused criticism overseas and resentment at home for decades.

Xinhua, the state news agency, sent a one-line tweet on Thursday night saying that all couples would be allowed to have two children, more than three decades after Beijing adopted a policy limiting most of the country to only one child.

Now if only they’d allow all couples to have 20 children.  Still, this is great news.

In 2013 the policy had been relaxed somewhat:

Beijing had said it expected about 1m babies to be born as a result of the 2013 policy relaxation, but recent figures showed that only less than half that number had so far been born.

Less than 1/2 of a million is still a lot of precious human beings.

In recent years the policy was not as draconian as before, but it was still pretty awful:

Enforcement of the one-child policy has remained harsh in many rural areas, even in recent years, with many Chinese women undergoing mandatory pregnancy tests, forced sterilisations after pregnancies, and even forced abortions.

Financial penalties for excess children could range from three to 10 times annual family income, and varied widely by area.

Villagers in two provinces visited by the Financial Times this month said family planning enforcement had become stricter despite the announcements of loosening on a national level.

Whoever that commenter was who asked me for examples of how China continues to reform, here it is (and it’s hard to think of a more important reform.)

Contradictions? (Plus a dose of moral outrage)

Bob Murphy (AKA Inspector Javert) is taking time off from his search for Krugman Kontradictions, to look for some over at this blog.  Here’s one example:

In any event, Scott used to lecture people when they thought about central bank policy in terms of interest rates. Nowadays, all Scott talks about is how it would be a mistake for central banks to raise rates.

Bob’s made this claim before, many times.  And each time I patiently point out that:

1.  The level of interest rates is not a reliable indicator of the stance of monetary policy.

2.  The Fed uses the fed funds target as a tool to implement monetary policy.  On any given day a Fed decision to raises rates is a tighter policy that a Fed decision to not raise rates.  As long as the Fed uses the fed funds rate as a policy tool, I have to talk about interest rates.  I wish they’d use NGDP futures, so I could stop talking about interest rates.

Contrary to the implication of the term “Nowadays”, I’ve been doing both of these things since day one.  In 2009, my first year of blogging, you can find me talking about the Fed’s foolish decision not to cut rates in September 2008, ad nauseum. So Bob’s flat out wrong, “nowadays” my views are exactly the same as before.

When looking for contradictions, it’s important not to be mesmerized by words, but rather consider underlying meaning.

It used to be that Scott said “there is no such thing as wait and see” when it comes to evaluating monetary policy. For example, here and here. If you read those links, you’ll see that this was a principle he used to try to ram into people’s heads; I don’t just mean he adhered to it the way, say, he might like vanilla ice cream. No, to say “there is no such thing as ‘wait and see’ when it comes to monetary policy” was a tenet of Scott Sumner, blogger.

But now things have totally flipped. Not only does Scott think the last six years have amply proven that the hawks were wrong, but he in fact is aghast that some people might deny that you could look at several years of experience and then determine whether the hawks in 2009 had been right or wrong:

At least this is a new accusation.  But again, let’s look at the context of my “wait and see” argument.

1.  Sometimes I say, “there is no wait and see, the markets tell us immediately how much impact the policy will have, and whether it is adequate.”  There’s some hyperbole here.  For the current stance of policy, you’d need market indicators that correlate perfectly with the Fed policy goals (i.e. NGDP futures markets under NGDP targeting). We don’t have that.  But in the Great Recession I argued that we had good enough indicators (such as TIPS spreads) to know the Fed had done too little—so I thought the hyperbole was justified.  Especially given that unemployment was really high at the same time that inflation was expected to run below target.

2.  In the recent post that Bob mentions, I was making a very different point. Obviously the Fed thinks the market is wrong about inflation, and about the future path of interest rates.  So from an EMH perspective there is no wait and see, policy should be expected to be on target (using market expectations) and it isn’t.  That’s obvious. But it’s just as obvious that the Fed doesn’t buy the EMH—why else would it disagree with market forecasts?  So my EMH argument won’t convince anyone. But even in that case (I argued), there ought to eventually be some sort of day of reckoning, where we can all say that the hawks were right (ex post), or the hawks were wrong.

Here’s an analogy.  Suppose Bob claims to be able to predict the future.  He tells me that when I toss a die the number will end up being 1.  I’d say that’s a bad forecast, as there is only a 1 in 6 chance that 1 shows up on the die.  There’s no “wait and see”, Bob simply made a bad forecast, based on probability theory.  On the other hand Bob continues to insist that he can beat the odds, because he can see the future.  So I say, OK, but surely we can agree that if the die is tossed and 3 dots appear on the top of the die, then Bob was wrong and his claim to see the future is dubious.

When considering contradictions, context is everything.

PS.  I’ve also disagreed with the Fed on the issue of trend NGDP, which they think is about 4% (2% inflation and 2% RGDP growth.)  I say 3%.  With today’s announcement NGDP growth is running at 2.9% over the past 4 quarters, and this was a period of rapidly falling unemployment.  Just wait until the unemployment rate stops falling!

(Yes, inflation will pick up slightly, but RGDP growth will slow further.  I’m sticking with 3%.)

PPS.  I have a new post on Bernanke’s memoir, at Econlog.

PPPS.  A few weeks ago I did a post pointing to the absurdity of prosecuting Dennis Hastert for withdrawing money from his own bank account, and using the funds for a completely legal activity (paying blackmail.)

Now Brett Arends has a column that makes some similar arguments, but much more effectively:

Hastert is not facing jail time for the sexual conduct, if any. No charges have been brought or answered.

He is facing jail because he took his own money out of his own bank accounts in order to pay what amounts to blackmail.

His accuser does not appear to have hired a lawyer or sought damages. He sought hush money.

When did we start supporting blackmailers in this country? When did that become OK? Did I miss the memo?

What if Hastert were a more sympathetic case? What if he hadn’t been paying hush money to cover up alleged sexual misconduct with a student? What if he had been blackmailed for having a love child, or having had an affair, or for being gay? Would he still go to jail for paying?

And what if this weren’t a former politician but, say, a popular figure on TV “” like a personality that everybody liked? Would she still be “disgraced”? Would we be piling on?

Hastert admitted to the court that he knew what he did was “wrong.” Bah. He only “broke the law” because the law is an outrage. Your bank has to report it to the Feds if you withdraw more than $10,000 of your own money. Heaven forbid you should handle your own cash.

Is it wrong for me to point out that so far not one Wall Street crook has faced a day of jail time for stealing the country’s money, but someone faces jail time for handling his own cash?

The $10,000 limit hasn’t been changed in decades. Once it was a lot of money. Now it’s not. Oh, and to make the law even more ridiculous, it’s actually also illegal for you to get around it by acting legally. No, I’m not kidding. If you avoid the $10,000 limits by withdrawing, say, lots of $5,000 installments, they can still send you to jail.

It’s like getting a ticket for “evading the speed limits” by driving at 54 miles per hour.

Or being thrown in jail for “evading the statutory rape laws” by having sex with someone who is over the age of consent.

It simply defies belief.

Hastert withdrew the money as cash because he wanted to keep the payments anonymous.

The law is there to use against really bad crooks, such as terrorists and drug dealers and so on. But old men paying blackmailers?

Perhaps the prosecutors only used this law to go after Hastert because they couldn’t go after him for the alleged sexual misconduct. The response to that is: Really? I thought we had courts, juries, presumption of innocence and rules of evidence? Instead it’s all being decided by prosecutors based on what they want?

Giving prosecutors a blank check to jail whomever they like: Hmm, that’ll end well. Thomas Jefferson and James Madison must be so proud of us.

One of the ironies is that Hastert could have avoided all of this if he’d simply paid his blackmailer in gold coins instead of greenbacks.

Gold is just as anonymous as cash. But it is essentially exempt from these financial regulations. Hastert could have called up any reputable gold dealer and purchased $50,000 worth of gold Eagles or Buffaloes or Krugerrands at a time, and no one would have asked any questions. All he then had to do was give the coins to his blackmailer, who could then call up a gold dealer and sell them.

Or he could have paid by check.  Here’s my prediction.  People will say, “Yes, the law’s unfair but it’s OK in this one case because Hastert’s a sleaze bag.”  And then later someone else will be prosecuted for withdrawing cash from his own bank account and giving it to charity, and people will say, “But Hastert was punished, so why shouldn’t Mr. X also go to jail for the same crime.”  Don’t believe me? Then perhaps you’ ve forgotten about the shameful treatment of Kimba Wood:

In January 1993, Clinton’s nomination of corporate lawyer Zoë Baird for the position came under attack after it became known that she and her husband had broken the law by employing two illegal aliens from Peru as a nanny and chauffeur for their young child. They had also failed to pay Social Security taxes for the workers until shortly before the disclosures. While the Clinton administration thought the matter was relatively unimportant, the news elicited a firestorm of public opinion, most of it against Baird. Within eight days, her nomination lost political support in the U.S. Congress and was withdrawn.

The following month, Clinton’s choice of federal judge Kimba Wood for the job was leaked to the press, but within a day it became known that she too had employed an undocumented immigrants to look after her child. Although Wood had done so at a time when this was legal, and had paid Social Security taxes for the worker, the disclosures were enough to cause the immediate withdrawal of Wood from consideration. The Clinton administration then said that the hiring practices for household help would be examined for all of the more than thousand presidential appointments under consideration, causing the whole process to slow down significantly. Determined to choose a woman for the Attorney General post, Clinton finally selected state prosecutor Janet Reno, who was confirmed and served through all eight years of the administration.

Translation:  No highly successful moms need apply.  Oh, and Tim Geithner was a tax cheat, and Geithner also employed an illegal alien housekeeper. But he’s a man so there’s no problem making him Secretary of the Treasury. He’s a hero in Bernanke’s memoir.  Meanwhile Kimba Wood has her reputation destroyed.  For engaging in an entirely legal activity and even withholding payroll taxes (which most people don’t do). “But wasn’t her case kinda like Zoe Baird?”  Once you start down these slopes, the ball just keeps rolling.

When do the Dems believe in trickle-down?

Here’s my hypothesis:  When it comes to microeconomics the Dems are the “stupid party”.  When it comes to monetary policy, and just about all non-economic areas of public policy, the GOP is the “stupid party”.

How could we tell if I’m right about the Dems?  We know that economics is really, really counterintuitive.  It doesn’t seem logical that imports would be good for the economy, or that price gouging in a natural disaster would be good for consumers, or that regulations banning banks from charging fees on ATMS would be bad for bank consumers.  But they are.

So let’s suppose that Dems are like most people; they are not very good at economics. And we also know that they claim to favor the “little guy” and have contempt for “trickle-down economics”, which is the idea that sound economic policies will also benefit people at the bottom.

If my theory is correct, then you’d expect the Dems to favor trickle down policies whenever there were easily discernible “concrete steps” linking the subsidies for big business with the welfare of the common man.

Thus Dems would oppose a cut in the corporate tax rate, unless competition from overseas started to raise fears of jobs losses.  And even then they’d demand that any cuts in the top rate be offset by the closing of loopholes.  And that’s exactly what we observe.

Most importantly, Dems would favor subsidies for big business that seemed likely to directly create jobs, such as the Ex-Im Bank.  And guess what, there is far more support for the Ex-Im Bank (an almost perfect example of crony capitalism) among Dems than among the GOP.  Even when not at the zero bound, and hence not at a time where there might conceivably be a net gain in employment.  Stupid.

Another example is the GSEs, Fannie and Freddie.  These companies have traditionally been strongly supported by the Dems, despite their outrageous business model and obscene profits, because they were seen as helping the common man buy a house.  (As an aside, a portion of the GOP agrees with the Dems, but that’s because big business owns a portion of the GOP, not for ideological reasons. The GOP ideologues tend to oppose crony capitalism.)

What about the vast range of issues where the Dems oppose sound economic policies? My claim is that those are areas where the “concrete steps” helping the average guy are harder to see.  More counterintuitive.

I conclude that the Dems actually do favor trickle-down economics, when they understand it, they simply don’t have the imagination required to see the vast array of areas where deregulation, privatization, and tax reform would help the average guy. They can’t envision anything beyond concrete steps.

The current Ex-Im dispute is the “tell” that lets us see into the mind of Dems, to understand what’s actually motivating their supposed “anti-business” worldview.

Update:  A few additional points, based on some of the comments.  Some seemed to think this post was in some way defending the GOP.  It’s far more critical of the GOP than the Dems.  Take another look.  People are also confused about “trickle down economics”.  AFAIK no one ever advocated trickle down economics.  I assumed everyone knew that.  The title of the post was a joke.  “Trickle down” was a term of derision used against some of the early neoliberal policy reform advocates such as Art Laffer and Jack Kemp, who claimed that deregulation, privatization and cuts in high marginal tax rates would help everyone, including the poor.  Again, no one actually advocated trickle down, it was a term of derision by those who didn’t understand neoliberalism, who could not fathom how conservatives could actually believe that supply-side policies would help the poor.  So they simply imagined that conservatives must believe in “trickle down”, which (AFAIK) no one believes. Why else would they favor tax cuts for the rich?

One criticism I do agree with is that this post is stupid.  All my posts on politics are stupid.  Indeed all articles on politics not written by Scott Alexander are stupid. Talking about politics immediately lowers your IQ by 25 points.  That’s why Tyler rarely writes on politics, he’s too smart to write stupid things.

And yes, the previous paragraph is also stupid, sort of.

Fed meeting today.  Daniel Reeves sent me the following movie posters:

Screen Shot 2015-10-28 at 10.56.15 AMScreen Shot 2015-10-28 at 10.55.58 AM

The Musical Chairs model in Ireland

Tyler Cowen links to a recent paper by Aedín Doris, Donal O’Neill, and Olive Sweetman, studying wage flexibility in Ireland.  This is from the paper:

The Irish case is particularly interesting because it has been one of the countries most affected by the crisis. We find a substantial degree of downward wage flexibility in Ireland in the pre-crisis period. Furthermore, we observe a significant change in wage dynamics since the crisis began; the proportion of workers receiving wage cuts more than trebled, rising from 17% in 2006 to 56% at the height of the crisis. Given the large number of workers receiving pay cuts it seems unlikely that wage rigidity played an important role in unemployment dynamics in Ireland over this period.

Tyler comments:

One question is what then caused so much Irish unemployment.

That one is easy—sticky nominal hourly wages combined with falling NGDP.  The authors of the study could have saved themselves a lot of time by simply looking at the aggregate wage data (nominal hourly wages).  Here are the 12-month rates of change, and also the change in NGDP over the same period:

Period ending   Wage Growth   NGDP Growth

2008:2                +3.6%             -5.7%

2009:2                +2.3%             -7.9%

2010:2                 -2.4%             -2.7%

2011:2                 -0.9%              +5.3%

2012:2                +1.0%              +2.9%

2013:2                +0.5%              -2.7%

2014:2                -0.6%              +4.7%

2015:2                +0.9%             +12.3%

[Warning:  Eurostat is a nightmare to use, and I am a bit doubtful about the second quarter 2015 data–can anyone confirm?]

This fits the sticky wage model very well.  Notice that NGDP plunged by 15.5% between 2007 and 2010.  Wages actually rose over that three-year period.  Unemployment soared, and indeed I’m surprised it didn’t soar even more, given the stickiness of wages.  (Perhaps output fell the most sharply in capital-intensive manufacturing and construction?)  Also notice there was a double dip in NGDP in 2012-13.  And finally, notice that in both the original deep recession, and the later smaller double dip, the very small wage declines occurred with a long lag—just what the sticky wage model predicts.

Tyler continues:

A second question is why Ireland seems to have higher than normal nominal wage flexibility.

Could it be a greater than average willingness to endure living standard cuts without complaining?  The Irish after all didn’t protest austerity as much as did most of the other Europeans in a comparable position.  Maybe that means their wages can be cut without incurring the same morale costs.

Or could it have something to do with the “dual” nature of the Irish economy, namely that you either work for a multinational or you don’t?  If you work for a multinational, maybe they can lower your wages and still you will work hard to keep that job.

Any takers on these questions?

There sure is a taker!  This one is also easy to answer; Ireland doesn’t have higher than normal wage flexibility. If you look at any other country with big NGDP plunges (Portugal, Greece, Spain, Estonia, etc.), you’d also observe declining wages occurring with a lag after the big NGDP plunge.

And indeed this also occurs in the US.  We saw huge falls in NGDP in 1920-21 and 1929-33, and 1937-38, and in all three cases we saw lots of wage reductions.  Indeed in the case of 1920-21 the wage cuts were far steeper and more rapid than in Ireland, and hence the subsequent fall in unemployment was also much more rapid.  Wage flexibility helps to stabilize an economy (contra Keynes/Krugman.)

But what about the recent recession in the US?  OK, but NGDP fell by only 3% vs. 15.5% in Ireland.  So naturally the slowdown in wage growth in the US was far smaller than in Ireland.  Not enough to make it slightly negative, just less positive. If our NGDP had fallen by 15.5%, then nominal wages would certainly have also declined here.  But just as certainly they would not have declined enough to prevent a big rise in unemployment.

The more I look at the data from different times and places, the more I like the sticky wage/NGDP shock model (AKA musical chairs model.)  I think Tyler focuses too much on the fact that wages do eventually respond, and that when there are big NGDP shocks wages do fall in absolute terms.  But the term “sticky wages” was created for the express purpose of distinguishing the model from “rigid wages.”  Wages are not rigid.  They change over time.  But they adjust far to slowly to prevent big swings in unemployment. Indeed even in 1920-21, the poster child of wage flexibility, beloved by Austrians everywhere, the unemployment rate soared over a period of about a year, before falling rapidly as wages adjusted.  Even then wages weren’t instantaneously flexible, and hence wage stickiness plus a huge NGDP decline caused a severe recession in 1921.

BTW, the authors finding that 56% of workers took pay cuts at the height of the crisis is exactly what you’d expect from the aggregate data, showing that aggregate hourly wages declined slightly in 2010. Looking at disaggregated wage data doesn’t really tell us anything important that we didn’t already know about Ireland.  It’s represents another success of the sticky wage/NGDP shock model.