Archive for April 2016


Misremembering history

The Week has an article by Jeff Spross, which tries to rewrite the history of the early 1980s:

The story of how Volcker fulfilled his mission is complicated. But it boiled down to a massive hike in interest rates: The Fed’s primary target for those rates reached an astronomical 19 percent in 1981.

Actually, during 1979-82 the Fed switched from targeting interest rates to targeting the money supply.  (Although there is debate about whether they actually were targeting the money supply.)

The basic problem, as economist Dean Baker explained to The Week, is there’s no way to tame inflation that doesn’t involve inflicting damage on the economy. But using interest rate hikes to spark recessions is a methodology that loads the bulk of the pain onto everyday workers, and people who are marginalized in our society. The national unemployment rate (the blue line below) briefly reached 10.8 percent — higher than it got even in the Great Recession — and it didn’t get back to 5 percent until 1989. Which was bad enough. But the unemployment rate for lower class workers is always much higher than for upper class ones. Ditto racial minorities: The unemployment rate for African-Americans (the red line below) topped 20 percent by 1983.

And that’s not all:

The Volcker recession also roughly coincides with a remarkable inflection point in the American economy. Before the mid-1970s, labor markets were often tight and full employment was common. After the Volcker recession, full employment — when there are more jobs available than workers, so employers have to bargain up wages and work conditions — basically disappeared. Union membership had already fallen 5 percentage points from roughly 1960 to 1980. But after the Volcker recession, its decline accelerated, falling another 10 percentage points from 1980 to roughly 1995.

Most strikingly, the Volcker recession falls almost right atop the moment when inequality took off:

So what’s the alternative?

All of that raises the obvious question: Could we have done things differently?

The 1970s were actually a relatively straightforward version of standard Keynesian macroeconomic theory, in which an overheating economy drives up the inflation rate. The real economic growth rate was actually quite strong that decade, bouncing around near 5 percent.

This alternative doesn’t get off to a promising start.  Real growth was closer to 3%, not 5%.  And even that was mostly due to very fast labor force growth (boomers like me, plus women entering in large numbers).  In fact, the 1970s was the decade when the Keynesian model basically collapsed, and had to be replaced by New Keynesianism, which, as Brad DeLong later pointed out, was to a substantial extent monetarism.

Keynesianism says that hiking taxes and balancing the budget, or even driving it into surplus, will put a drag on economic growth and slow down inflation. So we could’ve raised taxes and returned to the mid-century model of lots of brackets and really high rates at the top. That would’ve inflicted most of the damage on richer Americans who can afford to absorb it, rather than the workers and the poor who can’t.

Where to start?  Even if this were true, the old Keynesian (Phillips curve) model says the slowdown in inflation would have produced mass unemployment, regardless of whether it was caused by fiscal austerity or tight money.  And of course the model is not true.  LBJ tried to control inflation with tax increases in 1968, and failed.  That was one of the key policy experiments (along with Volcker’s later success in controlling inflation, during a period of fiscal stimulus under Reagan) that led economists to abandon old Keynesianism. The theory simply does not work.  Even worse, the left-wing solution of high taxes was tried in Sweden during the 1970s and 1980s, and had to be abandoned in the early 1990s, as Sweden was rapidly losing ground relative to other developed countries.

On top of that, inflation was exacerbated by several historical flukes. The most obvious was the rise in oil prices over the 1970s, driven by OPEC’s oil embargo against the U.S., and then by the shutdown in Iranian oil exports brought on by the Iranian revolution.

This is a common myth, at least for the decade as a whole (perhaps true for 1974 and 1979).  During the period from 1972-81, NGDP growth averaged 11%, divided into 3% RGDP growth and 8% inflation.  Oil shocks may impact inflation, but they don’t impact NGDP.  Even if we had had no oil shocks during the 1970s, an 11% NGDP growth rate was enough to generate 8% inflation.  Even with 4% RGDP growth, inflation would have averaged 7%.

All these problems would’ve likely worked themselves out regardless of what Volcker did. The error in the CPI was corrected in 1982. The run-up in oil prices from the Middle East drove a massive surge in oil production in other parts of the world, and a big uptick in energy efficiency, all of which would’ve naturally pushed inflation back down. And as mentioned, unions were losing their clout, with membership already on a downslide.

“We could’ve expected inflation to fall in any case,” Baker continued. “Probably not as quickly and not as much.”

“But suppose it took us 6 years to get down to 4 percent inflation? What would’ve been the problem with that?”

The real problem was different; the short 1980 recession was a complete waste, accomplishing nothing.  Volcker got cold feet in the summer of 1980 and adopted an extremely expansionary monetary policy (the Fed was worried about Carter’s chances in the fall election).  For those who like “concrete steps”, the Fed drove real interest rates sharply negative in mid-1980.  This pushed NGDP growth up to an astounding 19.2% in 1980:4 and 1981:1.  Thus the Fed had to tighten again in mid-1981.  The recession from mid-1981 to the end of 1982 should have started at the beginning of 1980, in which case it would have been over by mid-1981.  And it would have been milder than the actual 1981-82 recession, because inflation expectations were even more deeply entrenched after the 19.2% spurt in NGDP after the brief 1980 recession.

Plus, Ronald Reagan would have looked far more heroic if the recession had ended in mid-1981.

My new article in Foreign Affairs

When I was young, I noticed that Foreign Affairs was the classiest looking publication on most newstands.  The kind of outlet where you’d read something by Henry Kissinger, or Zbigniew Brzezinski.  Thus I’m pleased that their new issue has an article by me, discussing the role of monetary policy in the Great Recession:

Here’s the intro, the only part not gated:

Today, there is essentially one accepted narrative of the economic crisis that began in late 2007. Overly optimistic homebuyers and reckless lenders in the United States created a housing price bubble. Regulators were asleep at the switch. When the bubble inevitably popped, the government had to bail out the banks, and the United States suffered its deepest and longest slump since the 1930s. For anyone who has seen or read The Big Short, this story will be familiar.

Yet it is also wrong. The real cause of the Great Recession lay not in the housing market but in the misguided monetary policy of the Federal Reserve. As the economy began to collapse in 2008, the Fed focused on solving the housing crisis. Yet the housing crisis was a distraction. On its own, it might have caused a weak recession, but little more. As the Fed bailed out the banks at risk from innumerable bad mortgages, it ignored the root cause of serious recessions: a fall in nominal GDP, or NGDP, which counts the total value of all goods and services produced in the United States, not adjusted for inflation. Such a fall began unimpeded in mid-2008, and once that happened, much of the damage had been done.

PS.  Sad to hear about Prince.  For me, he was the high point of 1980s pop, which I think of as the age of MTV.  Younger people might be surprised to know that during the golden age of rock music (mid-60s through early 1970s) the major rock bands rarely appeared on TV.  And of course there was no internet.  Unless you saw them live, you didn’t know what they looked like performing.  MTV changed music, made it more TV-oriented.  I can’t even imagine Led Zeppelin on TV.

Do New Yorkers like bad boys?

[Most people will want to skip this post]

New York has roughly 15 million adults.  It appears that 525,000 voted for Trump, a bit over 3%.  Congratulations.

It seems as though when you point out how bad Trump is, it makes voters like him even more:

The key distinction in what we do compared with focus groups and regular polls is that we do not ask what people think of a message; we observe the impact the message has on vote choice in the treatment group compared with the placebo-control group. Since the respondents are randomly assigned to each group, average support should be about the same in each. Any statistically significant difference between support in the two groups is because of the impact of the ad.

And we found that Cruz’s anti-Trump ad backfires. It doesn’t hurt Donald J. Trump. It helps him.

Our clinical message trial showed Cruz’s anti-Trump actually made voters more likely to vote for Trump, boosting his support by 3 percentage points overall. That’s not a very large increase for the sample as a whole (and not statistically significant). But for blue-collar voters, the attack ad increased support for Trump by 18 percentage points; and it increased support among blue-collar men by more than 33 percentage points. (36 percent of the blue-collar men who watched the coke ad, for example, said they would vote for Trump—compared with 69 percent of the blue collar men who watched the anti-Trump ad.) And in both subgroups, incidentally, the anti-Trump ad caused actually support for Ted Cruz to fall.

One theory is that (some) voters are simply in the mood to support a bad boy, and the worse you make Trump sound, the more the voters like him.  He’s bigoted against Muslims and Mexicans?  So much the better!

It reminds me of what Borges said about Argentine Nazis in 1940:

I always discover that my interlocutor idolizes Hitler, not in spite of the high-altitude bombs and the rumbling invasions, the machine guns, the accusations and lies, but because of those acts and instruments.  He is delighted by evil and atrocity. The triumph of Germany does not matter to him; he wants the humiliation of England and a satisfying burning of London. He admires Hitler as he once admired his precursors in the criminal underworld of Chicago. The discussion becomes impossible because the offenses I ascribe to Hitler are, for him, wonders and virtues. The apologists of Amigas, Ramirez, Quiroga, Rosas, or Urquiza pardon or gloss over their crimes; the defender of Hitler derives a special pleasure from them. The Hitlerist is always a spiteful man, and a secret and sometimes public worshiper of criminal “vivacity” and cruelty. He is, thanks to a poverty of imagination, a man who believes that the future cannot be different from the present, and the Germany, till now victorious, cannot lose. He is the cunning man who longs to be on the winning side.

PS.  When Trump refused to disavow David Duke, the GOP establishment was highly critical.  Rightly so.  So why is there so little criticism of GOP leaders who refuse to disavow the racist and xenophobic Trump?  Why aren’t more announcing that they will never vote for him?  Perhaps the GOP wants to re-brand itself as the party for people who are slightly less racist and xenophobic that David Duke and slightly more racist and xenophobic than France’s National Front.

If so, they are doing a great job.

PPS.  I agree with this comment by Tyler Cowen:

I have been seeing so many pieces about how GOP elites are responsible for the rise of Trump.  These pieces offer many valid criticisms, but I have an alternative or should I say complementary theory: the people who have voted for Trump are responsible for the rise of Trump.  How is that for a complex account of causation and individual responsibility?

Tyler links to a Scott Winship study that shows Trump support is about “cultural anxiety”, not the economy.  I suspected as much when Trump won my own (booming) state of Massachusetts by more than any other state, even the affluent counties.  Here are some of the disgruntled factory workers who form Trump’s “core”:

Screen Shot 2016-03-24 at 9.09.09 AMPPPS:  A poll shows Trump favored in only one country, Russia:

Screen Shot 2016-04-20 at 10.42.44 PMHmm, let’s start where he’s least popular:

1. Mexico:  He called us rapists and drug dealers, and then wants us to pay for his wall? No thanks.

2. Italy:  A businessman who’s a fan of Putin and knows nothing about policy?  Been there, done that.

3. South Korea:  Threatens to assassinate Kim Jung-un, and then pull out the defense umbrella?  What could go wrong?

4. Germany:  A right-wing, racist nationalist?  I think we’ll pass.

And the only country where he’s favored (and by a huge margin):

Russia:  Idolizes Putin?  Da!

Kocherlakota on negative supply shocks

Marcus Nunes directed me to an article by Narayana Kocherlakota, discussing the impact of negative supply shocks:

Let’s consider three ideas that have been popular on the campaign trail.

  • Increasing the minimum wage. What if Congress decided to increase the federal minimum wage by 10 percent a year over the next five years? Typically, economists would be concerned about the impact on employment: Higher wages might lead businesses to employ fewer workers. With monetary policy out of the picture, though, the move might actually help. The expectation of higher wages would cause consumers to expect more inflation over the next few years, leading them to buy more goods and services now, before prices went up. To meet this added demand, businesses would have to boost production and hiring.
  • Increasing import tariffs. Suppose Congress gradually raised tariffs on imported intermediate goods, such as steel and sugar. Economists would worry that this would reduce the benefits of free trade. But as long as the Fed didn’t respond by raising interest rates, there would also be a positive effect: Households would expect higher prices, which would again   prompt them to demand more goods and services today — creating much-needed demand for businesses.
  • Imposing restrictions on immigration. Most economists would oppose such a move, because immigration is seen as an important contributor to overall growth. Yet again, though, the logic changes somewhat if inflation is too low and the Fed is passive. Households might expect the relative scarcity of labor to drive up wages and prices, triggering purchases that would benefit businesses and the economy more broadly.

The Fed’s response is crucial in all these cases. Typically, the central bank reacts to increases in inflation by raising interest rates sharply — a move that would choke off any demand that the policy measures might generate. With inflation running well below target, however, it’s appropriate for the Fed to hold rates low even if it sees a modest increase in inflationary pressures. It’s this subdued reaction function that allows the policy initiatives to have more positive effects.

I find this peculiar, for a number or reasons.  First, I doubt that any demand-side effects of negative supply shocks would overcome the negative supply-side effects of these policies.  Second, I deny that these policies would boost demand, even at the zero bound. Higher minimum wages will lead to expectations of lower profits, and this will reduce investment.  What makes corporations invest more is higher expected NGDP.  What makes firms build more houses, is more immigration.  The crackdown on immigration in 2006 slowed the housing boom.

If you prefer Keynesian language, negative supply shocks reduce the Wicksellian equilibrium interest rate, making the “zero bound” problem worse.  Low immigration is exactly why the zero bound problem is most severe in Japan, and high rates of immigration is one reason why Australia never even hit the zero bound.  Fast NGDP growth leads to higher nominal interest rates, and no zero bound problem.

So even at the zero bound these policies do not work, as we found out when FDR raised wages sharply in July 1933, aborting a robust recovery in industrial production.  But it’s far worse.  We are not at the zero bound, and hence the Fed would simply raise rates to neutralize the effect on inflation.  Kocherlakota writes the final paragraph in a way that almost seems to suggest the Fed agrees with him, and would react the way he wishes.  But clearly they would not, or the Fed would not have raised rates in December.  So it’s a moot point.  Elsewhere, Kocherlakota says:

The Federal Reserve faces a big challenge: It wants to get inflation up to its 2-percent target, but so far its stimulus efforts have failed to reach that goal.

That’s simply inaccurate, for reasons that Kocherlakota has himself explained numerous times.  The Fed raised rates in December over Kocherlakota’s (wise) objections.  That means the Fed does not share Kocherlakota’s inflation objectives, or else they think they’ve already succeeded in the sense that expected future inflation is 2%.  But either interpretation is inconsistent with Kocherlakota’s “tried and failed” suggestion.  Either they are not trying, or they think they’ve succeeded. Take you pick, there are no other plausible options.

In fact, these initiatives would tend to reduce NGDP growth, as monetary policy would tighten to prevent any increase in inflation, thus reducing real GDP growth. Because wages are sticky, lower NGDP growth would boost unemployment.  And in the case of higher minimum wages, the unemployment effect would be especially large.

The fact that even a dove like Janet Yellen is aggressively raising interest rates to keep inflation from exceeding the Fed’s two percent target is a shot across the bow to progressives.  Yellen is essentially saying; “You go ahead and raise wages to $15/hour.  But we aren’t going to allow higher inflation.  Instead, we’ll raise interest rates enough to create lots more unemployment.”  The progressives have been warned, the only question is whether they care.

I’m starting to see a trend in the comment section that I never thought I’d live to see.  Progressives write in complaining that it’s cruel to have an economic system where low productivity people need to work (even with wage subsidies.)  Instead we should have a guaranteed annual income, so they can pursue other activities, such as hobbies, or volunteer work.

Maybe my lack of empathy comes from the fact that I was abused as a child.  My father tried to give away surplus games to charity, from his little store.  Things like Monopoly games with a few pieces missing.  But the charity would not take them, insisting that children receiving these slightly flawed gifts would be mentally scarred.  So instead he gave them to us.  Since then, I’ve never been the same.

Even worse, I ingested megadoses of lead.


Krugman suggests that New Keynesianism has disappeared (in the long run all theories are dead)

Here’s Paul Krugman:

Brad DeLong asks why monetarism — broadly defined as the view that monetary policy can and should be used to stabilize economies — has more or less disappeared from the scene, both intellectually and politically.

That’s not just a description of monetarism; it also describes New Keynesianism, as DeLong pointed out in 1999.  Is New Keynesian economics actually dead?  Here’s an example of New Keynesianism, from the same year that DeLong wrote the article:

What continues to amaze me is this: Japan’s current strategy of massive, unsustainable deficit spending in the hopes that this will somehow generate a self-sustained recovery is currently regarded as the orthodox, sensible thing to do – even though it can be justified only by exotic stories about multiple equilibria, the sort of thing you would imagine only a professor could believe. Meanwhile further steps on monetary policy – the sort of thing you would advocate if you believed in a more conventional, boring model, one in which the problem is simply a question of the savings-investment balance – are rejected as dangerously radical and unbecoming of a dignified economy.

Will somebody please explain this to me?

Yes, I’d say that NK view from 1999 (expressed by Paul Krugman, BTW) is essentially dead.  I’m not sure what we have now: new, new Keynesianism, old Keynesianism, or as many Keynesianism as there are Keynesians.  (I vote for the latter.) Just as old monetarism is mostly dead, having been replaced by market monetarism.

Krugman also suggests that monetarism is dead because real world governments don’t implement our policies, exactly as we sketch them out.  (He forgets that market monetarists invented negative IOR).  Which of course means that Krugman’s Keynesianism is also dead, as governments are certainly not doing the sort of fiscal stimulus that he recommends.  Indeed the Japanese recently combined fiscal austerity with monetary stimulus, and he seemed to think the Japanese were doing a pretty good job when he met with them recently:

We are all very much wishing, I am a great admirer of the policy moves that have been made by Japan, but they are not good enough, partly because all of the rest of us are in trouble as well.

Yes, he would have preferred they not raise taxes, but the tax increase did not cause a setback to the labor market:

Screen Shot 2016-04-16 at 12.51.44 PMAnd monetary stimulus did get them out of deflation:

Screen Shot 2016-04-16 at 12.57.07 PM

However the BOJ needs to do much more if they don’t want to slip back into deflation.

PS.  Ramesh Ponnuru also has a reply to Paul Krugman.

HT:  James Elizondo