Archive for the Category United Kingdom

 
 

Monetary policy is boring. That’s good.

You’ve probably noticed that I no longer do as many posts on monetary policy.  That’s partly because I put my better posts over at Econlog and partly because there’s currently not much to talk about.  NGDP growth has been in the 3% to 5% range for 9 years, and I see no sign of anything changing in the near future (except perhaps a bit slower NGDP growth after this year, which is currently featuring above 4% growth.)  While boring is bad for me, it’s good for the economy.

Today, interest has turned to the question of when the next recession will occur.  The short answer is the same as always—no one can predict recessions.  But I’d like to talk about the issue anyway, since everyone seems interested in the question.

I’ve recently been catching up on David Beckworth’s podcasts, and listened to a very interesting discussion he had with Michael Darda.  Michael is a market monetarist who works in the investment area, and is known for having an excellent grasp of macroeconomics.  He knows the data quite well and he has a rare ability to interpret macro data correctly.  Lots of people are good at one, but he’s extremely good at both—no doubt partly due to his upbringing in Madison, Wisconsin.
Screen Shot 2018-08-25 at 3.48.02 PMAt one point they began discussing the yield spread, which has been one of the better recession forecasting tools.  I’d like to put in my two cents worth.

As you can see from the following graph, the yield curve often inverts before a recession.  Here it’s important not to over interpret the correlation, as US expansions never last more than 10 years, and yield curves typically don’t invert until well into an expansion, and the lag between inversion and recession varies somewhat over time.  Furthermore, yield curves did not invert before recessions in the 1933-58 period.  Still it’s one of our most reliable forecasting tools.

Screen Shot 2018-08-25 at 2.34.50 PMHere are a few observations:

1.  Over at Econlog, I argued that while the yield spread is pretty good at predicting recessions, it’s much less good at indicating when money is too tight.

2.  It’s possible that the yield spread is reacting to changes in the unemployment rate.  Consider the following hypothesis.  The yield spread gets relatively flat whenever the unemployment rate falls to a level close to the natural rate of unemployment.  Let’s also assume that the unemployment rate falling close to the natural rate is a good predictor of recessions:

Screen Shot 2018-08-25 at 2.32.30 PMIn that case we should be worried, as the unemployment rate has recently fallen to a level that is probably close to the natural rate.

Interestingly, there is one notable case when unemployment falling close to the natural rate did not lead to a recession.  In 1966, unemployment fell to 3.8% and there was no recession until 1970.  But that false signal is equally true of the yield spread, which also inverted in 1966.  Coincidence?

[On the other hand, the natural rate of unemployment is time varying (higher during 1975-95) and hard to measure, which makes the yield spread a better forecasting tool.]

When the unemployment rate is trending lower, it’s rational to expect the expansion to continue.  It may not always continue (consider 1981) but it’s a rational forecast.  And when unemployment is trending lower, the yield spread tends to be positive.  That’s because investors expect the future economy to be stronger than the current economy, and interest rates are highly correlated with the strength of the economy.

Conversely, when unemployment has fallen close to the natural rate, it’s no longer rational to expect lower unemployment in the future.  Indeed it’s quite likely that we’ll soon enter a recession.  That’s why the yield curve gets flat, and sometimes inverts.  In plain English, we never seem to achieve soft landings.  But Australia frequently does, and thus it’s not impossible.  The UK achieved a soft landing in 2001, and hence their 1990s expansion lasted until 2008.  If they can do it, so can we.

Memo to Jerome Powell:  Your mission, should you decide to accept it, is to avoid the hard landings that so often occur, but also avoid the 1966 scenario, where the Fed pulled up too soon, never landed at all, and instead soared off into the Great Inflation.  To do this, you need to avoid an excessively expansionary policy, which sometime triggers the inflation that later causes overly tight policy, and also avoid overly tight policy, which can directly cause a recession.  Let’s see . . . how about 4% expected NGDP growth?

Given that we’ve never had an expansion last for more that 10 years, you might wonder why I expect this one to go beyond a decade.  Well, until 2006-12 we’d never had a housing crash.  Until 2016, we’d never elected a lunatic as President.  Until 2018, we’d never adopted a wildly expansionary fiscal policy during a period of peace and prosperity.  None of those examples have any bearing on how long this expansion will last, rather they show that it’s really common for things to happen that have never happened before in the US.  And notice that other countries have had housing crashes before 2006, and lunatic presidents, and reckless fiscal policies during peace and prosperity.  That’s why I mentioned Australia and the UK (and there are many other such examples.) They provide an important clue that there is no inherent age limit on expansions.

Inductive reasoning can be useful, but must be handled with care.

PS.  The Hypermind NGDP prediction market is currently forecasting 4.8% NGDP growth from 2018:Q1 to 2019:Q1.  However, since the 2nd quarter is already in and growth was quite strong, this implies (annualized) 3.9% NGDP growth from 2018:Q2 to 2019:Q1.  Monetary policy is right on course.

PPS.  Because money is now boring, and my Trump posts are always stupid, please feel free to recommend other topics.  On the other hand, money is the only topic on which I have anything interesting to say.

Natural experiments: Can we handle the truth?

Natural experiments are being conducted all the time.  And yet I often feel like people really don’t care about the outcome of these experiments.

Let’s consider 5 popular hypotheses:

1.  The mortgage interest deduction has a major impact on the housing market.

2.  The NASDAQ was obviously wildly overvalued in 2000.

3.  Switzerland was forced to revalue its currency in January 2015.

4.  The US housing market was obviously wildly overvalued in 2006.

5.  Brexit would cause a recession in the UK economy.

In my view, natural experiments have strongly suggested that all 5 of these hypotheses are false.  And these are not trivial unimportant hypotheses, they were widely held views about some really important issues.

1. The tax bill that passed last year sharply cut back on the mortgage interest deduction.  Before that happened I read about 1000 articles warning that if we took away this deduction it would severely hurt the housing market.  We didn’t completely eliminate the deduction, but it’s more than half gone.  And yet housing continues to boom.  I have yet to see a single news article discussing this important natural experiment.

2.  The Nasdaq is now far higher than in 2000.  Of course it could be wildly overvalued today.  Unlike in 2000, however, there is no widely held view that it is wildly overvalued today.  That’s a problem for the hypothesis that it was wildly overvalued in 2000.  If true, why don’t people feel that way about the current stock market?  And you can’t point to changing economic circumstances, such as lower nominal interest rates, as those factors are linked to other changing economic circumstances, such as an unexpected slowdown in trend NGDP growth.  I.e. where would Nasdaq be today if NGDP had grown during 2000-18 as rapidly as people expected back in 2000?  Maybe 10,000?

Screen Shot 2018-06-24 at 12.31.44 PM

3.  Tyler Cowen correctly noted that Denmark would provide a good test of whether Switzerland was forced to revalue in January 2015.  We now know that Denmark was not forced to revalue.  Even worse, evidence suggests that the Swiss revaluation did not have the intended impact on the SNB balance sheet, which kept growing. That was claimed as the reason the Swiss needed to revalue.  And yet despite this natural experiment, experts continue to claim that the Swiss were forced to devalue, as in this recent podcast. It seems obvious to me that the Swiss simply made a mistake—are there any good counterarguments?

4.  There are two powerful pieces of evidence against the claim that the US housing market was overvalued.  First, many who made that claim also said the same thing about housing markets in Canada, Australia, the UK, and other countries.  And yet many of those other countries did not crash.  Even worse, America’s housing market has mostly recovered, and yet I see almost no one currently saying “America’s in a huge housing bubble, and when it crashes we’ll have another Great Recession”.  So why continue to claim the 2008 recession was caused by a housing bubble that no longer even looks like a bubble at all?  (And don’t point to housing construction; that’s shifting the goalposts.  In 2008, everyone pointed to the historically high level of house prices in 2006; housing construction never reached unusual levels during the boom.)

Screen Shot 2018-06-24 at 12.30.41 PM

5.  This one hasn’t been entirely ignored, as the Brexit supporters pointed to a strong economy after the June 2016 vote.  The Financial Times claims that Brexit is now slowing British growth:

Screen Shot 2018-06-24 at 4.01.02 PM

In my view it’s too soon to claim that Brexit is slowing growth.  I expect it will, but the graph the FT presents does not look statistically significant to me.

Ditto on the recent corporate tax cut—it’s too soon.  Both supply-siders and Keynesians expected a short term boost to growth, for different reasons.  Only the supply-siders predicted a longer term boost.  My own view was somewhere in between.  I expect some sort of long run supply-side boost, but much less that the Larry Kudlows of the world expect.  I see perhaps an extra 2% in RGDP growth spread out many years, with most of the boost coming soon after the tax cut.  Supply-siders see the growth rate rising to a new trend of roughly 3%/year, which seems unlikely to me.  If growth is still running at 3% in late 2019, then I clearly will have underestimated its impact.  I hope I did.

I’ve done a number of previous posts on this general topic, discussing earlier experiments such as the 2013 fiscal austerity, and the 2014 elimination of extended unemployment benefits.  Those who suggested that these would be good natural experiments often ignored the results when they didn’t go as expected.  (GDP growth accelerated in 2013, and job growth accelerated in 2014.)

Many pundits can’t handle the truth, unless it confirms their prior beliefs.

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.

Where does Brexit stand today?

Here is the Financial Times:

Theresa May has been applauded by Brussels for her “constructive spirit” after she set out plans to keep Britain in the EU in all but name until 2021, five years after the country voted to leave the bloc.

In a conciliatory speech in Florence, Mrs May also said Britain would pay €20bn into the EU budget after Brexit and signalled the contribution was only a downpayment on what could be a considerably larger exit bill.

Although Britain will formally leave the EU in March 2019, under Mrs May’s model it would still be covered by all EU rules, European court judgments, the free movement of EU workers and budgetary contributions to Brussels until the transition ends. . . .

The speech delighted business leaders who believe Mrs May’s plan for a transition period of “around two years” after Brexit in March 2019 will avoid a cliff-edge and was welcomed by Michel Barnier, the EU’s chief negotiator.

Here are some comments:

1.  By now it should be clear why I distinguished between the economic effects of “Brexit uncertainty” and the economic effects of Brexit itself.  We now know that Brexit uncertainty had no noticeable impact on UK real GDP growth (which was about the same in the 12 months after Brexit as during the 12 months before.)  I still believe that Brexit itself will lead to somewhat slower growth, as do the currency markets.  But the delay in Brexit has allowed a partially recovery in the pound, which has bounced back to $1.35, after dropping from $1.46 to $1.23 after the vote (and subsequent “Brexit means Brexit” rhetoric.)

2.  I think it’s very unlikely that the UK will (de facto) leave the EU in March 2021 (if ever).  May is rumored to have favored an even longer delay, but worried about a leadership challenge from Boris Johnson.  Notice she said “around two years”, which could mean three years.  Britain really doesn’t want to leave; that’s obvious.

3.  And by 2021 or 2022, who knows what the political situation will look like in the UK?  What if the Tories need support from the Liberal Dems after the next election? Would the LDs demand further delays? What if Labour wins?  Every year that goes by, more older Brexit voters die off and more younger Brits who are comfortable with a cosmopolitan UK enter the voting rolls.  Like gay rights and pot legalization, globalization has massive momentum in the long run, as there are truly vast differences between the views of the young and the old.

PS.  So the Tories promised to do Brexit, but obviously don’t actually want to do so. In the US, the GOP has promised to get rid of Obamacare. When will that happen? When it comes to health care policy, is history on the side of the GOP?   And I’d say something similar about the Tories.  In 2040, the UK will be more tightly integrated into Europe than in 2010, even if they are not formally in the EU.  Bryan Caplan may lose his Brexit bet, but only on a technicality.

PPS.  I’m guessing that this was Obama’s expression earlier this afternoon, when he heard about McCain’s decision.

I think McCain made a defensible decision, but not Rand Paul.  Given Paul’s ideology, he really should have supported Graham-Cassidy.  It’s far more libertarian than any plausible alternative that Congress is likely to enact.

Trump and Corbyn; two peas in a pod

Here’s The Economist:

There are also signs that Mr Corbyn’s Teflon coating is wearing thin. On August 7th he returned from a cycling holiday in Croatia to face a barrage of questions about Venezuela. Why is a country that he once praised as a land of milk and honey turning into a giant gulag? Why had he said nothing while the regime beat and killed dissenters? Mr Corbyn eventually broke his silence only to say he condemned violence on “all sides”, seemingly oblivious to his own recent tweet that “If you are neutral in situations of injustice you have chosen the side of the oppressor.” This came on the heels of two other embarrassments. He back-pedalled on his promise to forgive all past student loans on the ground that, even in Labour’s free-spending Britain, writing off £100bn might be a bit irresponsible. And he clashed with the pro-European wing of his party when he insisted that Britain would leave the single market when it left the European Union.

Further skeletons lurk in Mr Corbyn’s closet. He has spent his life forgiving people their nastiness so long as they are hostile to the Great Satan of the United States.

BTW, lots of respectable “progressive” intellectuals supported this disgusting jerk.

Corbyn can’t quite bring himself to clearly condemn socialists because he is a socialist, just as Trump can’t clearly condemn alt-rightists because he is an alt-rightist.  Their supporters insist they aren’t the bad kind of extremist; Corbyn is not a Stalinist and Trump is not a Nazi.  That’s true, but their refusal to take a clear moral stand shows you where their heart is—with the bad guys.

PS.  It really doesn’t matter whether deep down Trump is a racist thug or just a thug.  The fact that he feels a need to pardon racist thugs is all that we need to know.