Archive for December 2017


Another promise kept

Right after Trump kept his promise to cut the top personal income tax rate from 43.4% to 25%, another promise was also kept:

President Trump is celebrating Republicans’ passage of the tax overhaul bill as a two-fer: On Wednesday, in addition to tax cuts, he checked off his promise to repeal Obamacare, pointing to a provision in the bill to end the penalty on Americans who don’t get health insurance.

“We have essentially repealed Obamacare,” Trump told reporters during a Cabinet meeting at the White House.

I’m hoping that in a similar fashion Trump also keeps his promise to build the wall, end trade agreements, construct infrastructure and expel Dreamers.

Further thoughts on NeoFisherism

David Beckworth recently interviewed Stephen Williamson, who is an advocate of the NeoFisherian approach to thinking about monetary policy and interest rates.  Williamson argues that a policy of permanently reducing interest rates is disinflationary.  Others think this idea is crazy.  I’m not in either camp, and I keep looking for ways to explain why.  Here are some facts about monetary policy, which seem related to this issue:

1. In the short run, nominal interest rates can be reduced with a tight money policy.

2. In the short run, nominal interest rates are usually reduced with an easy money policy.

3. Because money is neutral in the long run, any monetary policy that permanently reduces nominal interest rates must be disinflationary.

4. A tight money policy reduces the natural rate of interest.

All of these claims are pretty easy to justify, and none seem particularly controversial.  But they raise an interesting puzzle.  Points #1, #3 and #4 all seem sort of NeoFisherian in spirit, consistent with the claims made by Stephen Williamson and John Cochrane.  So why are so many mainstream economists horrified by NeoFisherism?  I think the sticking point is #2.

The vast majority of the time, a reduction in interest rates on any given day represents an easier monetary policy than a counterfactual policy where the central bank doesn’t reduce interest rates.  Not always (in which case #1 and #3 would no longer be true), but the vast majority of the time.  But the NeoFisherian thought experiment requires that the lower rates be achieved via tighter monetary policy.

I think that people are confused about what NeoFisherians are talking about when they discuss policy option number three.  In the minds of most economists, switching to a permanently lower interest rate seems like an expansionary monetary policy, because on any given day cutting interest rates usually is an expansionary monetary policy.  Here’s why they are wrong:

1. If you don’t want the price level to blow up, then any permanent switch to a lower interest rate must be done with a tighter monetary policy.  If the central bank tried to do it with an easier money policy then they’d have to inject larger and larger amounts of liquidity, eventually causing hyperinflation and then complete collapse of the system.  So any sustainable policy of low interest rates must be contractionary.

2.  A contractionary monetary policy lowers the natural rate of interest.  I think many economists picture a world where the natural rate of interest is not affected by monetary policy.  In that world, lowering the policy rate makes policy more expansionary, because the stance of monetary policy is the gap between the policy rate and the natural rate (assumed to be stable).  In fact, any sustainable policy of low rates must be caused by tight money, and any tight money policy will reduce the natural rate of interest so much that monetary policy does not get easier, despite the lower fed funds target.  This is Japan since 1995.

So far I’ve presented a picture that is somewhat sympathetic to the NeoFisherians.  Let me conclude with a discussion of what I don’t like about the way NeoFisherians present their theory.

1.  The listener is led to believe that if you want lower inflation, you need to cut interest rates.  I’d say if you want lower inflation you need to cut interest rates via a tight money policy.  Any attempt to achieve lower inflation via a cut in interest rates achieved through an easier money policy will end in disaster.

2.  Because the vast majority of rate cuts represent easier money than the counterfactual of not cutting rates on that given day, it is not accurate to imply that the first step to lowering inflation is for the central bank to do the sort of rate cut that it often does do–i.e., liquidity injections.  Instead, the NeoFisherians should argue that the first step to lower inflation is for central banks to do the sort of rate cut that the Swiss National Bank did in January 2015, when they simultaneously appreciated their currency and created a credible policy of further currency appreciation going forward.  That credible promise led to lower nominal interest rates via the interest parity condition, and lower inflation expectations via the currency appreciation (combined with PPP.)

PS.  Has anyone commented on the similarity between the NeoFisherian puzzle identified in points #1 – #4 above, and the puzzle that led to the Dornbusch overshooting model?  The overshooting model was an attempt to resolved the following puzzle in a conventional Keynesian fashion:

Puzzle:  Easy money seems to lead to both actual currency depreciation and expected currency appreciation.

Rudi Dornbusch wanted to show how easier money could lead to expected currency appreciation (which is an implication of lower nominal interest rates combined with the interest parity condition.)  His solution was overshooting.

The NeoFisherian model assumes a permanent change in the interest rate, which rules out Dornbusch’s resolution to this puzzle. If you make the rate cut permanent than his solution no longer works; you take overshooting off the table.  In that case, the NeoFisherian result is the only explanation left standing.  Now it is a tighter money policy that reduces interest rates, and that tighter money also makes the currency become expected to appreciate forever, lowering inflation.

Will the tax cut boost growth?

I am enough of a supply-sider to think the answer is “yes”, and enough of a realist to think the growth effects will be quite modest, maybe a couple tenths of percent per year over the next decade (mostly front-loaded).  Michael Darda recently provided a much better explanation than I can:

Our friend Scott Sumner often says “real economists don’t forecast, they infer market forecasts”. On this score, those who believe that the Tax Cut and Jobs Act will drastically ramp up growth typically point to the stock market gains YTD and then argue that a gush of capital will come flowing in as corporate tax rates fall. There are a few major problems here, in our view. First, we have had a global equity market boom in 2017, with markets in Europe and Japan up by similar magnitudes and emerging market equities up 30% YTD, outperforming the S&P 500 by 1000 bps. Surely, the TCJA cannot explain why emerging market equities are outperforming domestic equities as the latter are the ones supposedly being lifted by fiscal policy expectations. Moreover, if markets expected a “rush of capital” to come pouring into the U.S., why has the dollar basically done nothing as the tax bill’s chances of passage have become almost certain? Some argue that this is because the Fed is going to “accommodate” the tax cut, meaning that despite projections for higher deficits, they will not tighten more as a result. Well, this is very hard to square with the bond market, which shows no significant pop in real rates (which is consistent with the dollar story); hence, there is no big expected jolt to supply-side growth expectations and also very little movement in inflation breakeven spreads, which means no big expected pop to the demand side. If the tax cut were expected to be expansionary, and the Fed were expected to accommodate said tax cut, why is the yield curve continuing to flatten instead of steepening?  . . .

With all this in mind, why, you may ask, are we advancing a debt-funded tax cut at a time of near full employment, which will likely add at least an additional trillion to a net $10 trillion in cumulative deficits over the next decade (HT, Caroline Baum<>)? We do not know and no one in Congress has given a good explanation as to why.

I would add that the market forecast of the impact of new policies is the optimal forecast (pity we don’t have a RGDP futures market) and anything we observe subsequently will be less informative than the market prediction.  Recall my posts on how there is no “wait and see” with monetary policy initiatives.  You discover within 5 minutes almost everything you will ever know about the effectiveness of moves like QE.

I see the market response to the tax cut as being consistent with my view of “some effect, but modest”.  A lot like QE!

The truth that dare not speak its name (or perhaps two truths?)

There’s a very good new post by Benn Steil and Benjamin Della Rocca that explains why the BOJ does not emphasize the exchange rate channel in their monetary stimulus:

In September 2016, the Bank of Japan adopted a new strategy to boost the flagging Japanese economy: “yield curve control,” or YCC. The aim was to widen the gap between long- and short-term interest rates, by keeping shorter-term (10-year) government bond (JGB) rates at 0%, as a means of encouraging bank lending. . . .

BoJ Governor Haruhiko Kuroda has trumpeted the policy’s success in boosting lending. As shown in the bottom left figure, though, lending did not increase because of the mechanism underlying YCC—that is, a widening of the gap between what banks pay to borrow funds short-term and what they receive from borrowers longer-term. . . .

What happened, then? After YCC was announced, the BoJ’s pledge to hold 10-year JGB rates at 0% pushed bond investors to find yield outside Japan. . . .this caused the yen to fall sharply, which boosted exports. . . .

[S]hortly after Prime Minister Shinzo Abe took office, the Obama administration admonished Japanese authorities for public statements calling for yen depreciation. Abe and Kuroda learned the important lesson that one may only target the exchange rate if one does not speak of it.

Off topic, I don’t often blog on the Lucas Critique.  I wonder if anyone has commented on its applicability to the concept to sexual harassment.  Suppose that over a period of decades society does not take charges of sexual harassment very seriously.  In that environment, there may well be very few false claims of sexual harassment.  However if policy changes in such a way that accusations are presumed to be true, and also result in severe consequences, then the Lucas Critique predicts a sizable increase in false accusations.

That does not mean that harassment charges should not be taken more seriously than in the past, and also result in serious consequences.  (On balance I think they should, despite the Lucas Critique problem.)  Rather it suggests that this is not an easy black and white issue.  There is almost certainly some degree of presumption of guilt that would be counterproductive.  Imagine a world where everyone (and I’m including men, as this group is also sexually harassed fairly frequently) could destroy the lives of anyone they disliked.  No one would want that kind of world, which means that no one who claims that accusations should always be believed is telling the truth.  We are all skeptics, it’s just a matter of degree.

The world (and especially the internet/media) is like a giant high school, where we are all expected to conform to popular belief.  When that consensus changes, we are expected to dutifully fall in line.  I transferred from that high school to utilitarianism when I was in my 20s.

PS.  Here’s Scott Alexander:

About 30% of the victims of sexual harassment are men.

Don’t expect the future to be like the past

Garrett MacDonald directed me to a interesting article by Paul Donovan, chief economist at UBS.

What can we forecast about next year?

Among the many interesting points, this caught my eye:

The ups and downs of the economic cycle may be less violent than they used to be. Recessions are probably less recessionary in the future (see the July Chief Economists comment “Will recessions be less recessionary in the future”).

I often point out that the US business cycle has some very bizarre features:

1.  Expansions never last more than 10 years.

2.  There are no mini-recessions.

The first is bizarre because recessions seem to occur randomly, not according to any fixed cycle.  Expansions do not die of old age.  You’d expect some expansions to just randomly drag on for more than 10 years.  The second is bizarre because you’d expect that whatever process causes recessions (some sort of shock?) would create far more mini-recessions than sizable recessions.  Think about how there are far more small earthquakes than big earthquakes.  Instead, the United States NEVER has mini-recessions, defined as an increase in the unemployment rate of more than 0.8% and less than 2.0%.  That’s just bizarre.  (And even the one 0.8% increase was due to the unusual 1959 nationwide steel strike—normally there is almost no increase in unemployment beyond random noise, unless unemployment soars much higher.)

Before you respond with good reasons why these patterns are not bizarre, I’d like to point out that other countries such as Britain and Australia do have economic expansions that last much more than 10 years, and they do have mini-recessions.  So the US really is a very weird place.  But for some reason American economists don’t seem to pay much attention to this weirdness.

I’m on record as predicting that this will be the longest expansion in history, the first that extends for more than 10 years.  Now I’d like to go on record predicting that we will see some mini-recessions in the next few decades.  I don’t see any reason why we haven’t had them; other countries have them, so why can’t we?

Here’s another interesting point:

Economics can generally predict central bank policy. This is hardly surprising. Central banks – at least, the good central banks – are run by economists.

In the past I’ve argued that economists don’t blame central banks for recessions because central banks follow the consensus of economists, and economists don’t want to blame themselves.

Economists should not make forecasts.

In the past, I’ve argued that good economists don’t forecast, they infer market forecasts.

PS.  Here are 6 British mini-recessions, in each case with the unemployment rate rising by about 1%.

And here are three recent mini-recessions in Australia, in each case with unemployment rising between 1% and 2%:

Off topic:  Did Jesus once say: “Blessed are the beta males: for they shall inherit the earth”?  Scanning the recent news headlines, it almost seems like his prediction is coming true, after 2000 years.

PS.  Here’s an excellent USA Today editorial on Trump. The press has been way too soft on him.