Archive for April 2013


Simon Wren-Lewis on the British stagnation

Nick pointed me to a Simon Wren-Lewis post that does a great job of illustrating the British predicament in three graphs.

The first shows that British RGDP is lower than the levels of 5 years ago.  The second shows that British labor productivity has fallen about 15% below trend since 2008.  And the final graph shows a rise in unemployment, which is currently 7.9%.  Wren-Lewis speculates that the elevated unemployment rate reflects a demand shortfall.  I tend to agree, with reservations.

Unfortunately we don’t know the natural rate of unemployment in Britain, or even whether the natural rate is stable.  If you take the longer view, it’s pretty obvious that the natural rate is not stable over time.

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We also know that other European countries (notably France) have seen huge increases in their natural rate of unemployment since 1980.  And we know that the size of the UK government expanded sharply after 2000, from about 37% of GDP to the high 40s.  Note that the expansion was larger than the data suggests during the good years (2000-07) and smaller than the data suggests during the bad years (2008-12.)  That’s because government spending should normally fall as a share of GDP during expansions, and rise during recessions.  Thus the rise during 2000-07 is far more significant than many assume.  This might have boosted the natural rate of unemployment, at least slightly.  Note that unemployment rose 0.8% between 2005 and late 2006, a pattern that is highly unusual for an expansion, even given the slow RGDP growth.

Here I’d like to make the assumption that is most favorable to the Keynesian view; a stable natural rate that is lower than the actual unemployment rate during most years.  Something in the 5.4% to 5.9% range.  Anything much lower would imply that unemployment is consistently above the natural rate, which would of course be inconsistent with the natural rate model.  Then the current unemployment rate is probably 2.0% to 2.5% above the natural rate, which suggests that high unemployment has depressed output by 4% to 5%.

To summarize, if we make the most Keynesian assumption that is plausible, a low natural rate of unemployment which has not been rising, and if we assume that 100% of unemployment is due to a demand shortfall, and if we assume that unemployed workers are just as productive as employed workers (no ZMPers), then it still appears that the recent British stagnation is 75% to 80% supply-side and 20% to 25% demand-side.

In other words, when Keynesians blame the slow British RGDP growth on the mythical “austerity” they are talking nonsense.  This is partly because the unemployment numbers suggest that the British economy does not have a particularly large output gap, when compared to other developed economies, which means their massive budget deficit (trailing only Egypt and Japan) really does indicate a fairly expansionary fiscal stance.  And second, because even if fiscal policy is quite austere, the slow RGDP growth is mostly due to supply-side factors such as declining North Sea oil output, less froth in high finance, and perhaps other factors such as labor shifting out of home-building.  (I’m open to suggestions.)

Let me end on a positive note, by pointing to some areas where I agree with Wren-Lewis:

1.  I agree with his claim that slow nominal wage growth suggests the elevated unemployment is mostly due to demand-side factors.

2.  I agree that demand stimulus is appropriate, although unlike Wren-Lewis I’d rely 100% on the BoE.  Ed Balls made things much harder for the BoE when he opposed changing their 2% inflation target.  His comments were disgraceful, as one reason the government is reluctant to do more monetary stimulus is fear of being hammered by Labour on the “inflation” issue.

3.  I agree with Wren-Lewis’s claim that NGDP targeting is not always optimal.  I’ve argued (for instance) that the monetary authority could do a bit better by targeting NGDP net of indirect business taxes.  Because these taxes rarely change significantly in the US, (which lacks a VAT) I tend to gloss over this problem.  And there are a few other potential problems with NGDP targeting, especially in smaller and less diverse economies.  But NGDPLT is a vast improvement over IT.

HT:  Bill Woolsey

Krugman on R&R (pot, kettle, etc)

Steve pointed me to this:

OK, Reinhart and Rogoff have said their piece. I’d say that they’re still trying to have it both ways, on two fronts. They deny asserting that the debt-growth relationship is causal, but keep making statements that insinuate that it is. And they deny having been strong austerity advocates – but they were happy to bask in the celebrity that came with their adoption as austerian mascots, and never to my knowledge spoke out to condemn all the “eek! 90 percent!” rhetoric that was used to justify sharp austerity right now. Sorry, guys, but with so much at stake you have a responsibility not just to put stuff out but to make crystal clear what you think it implies for policy.

Yes, crystal clear.  For instance, think of the damage that might be done to policy in the US, Europe, and Japan if the world’s most widely-read economic pundit put out one statement after another leading paleo-Keynesians to believe that monetary stimulus is ineffective at the zero bound, while he or she actually believed that a higher inflation or NGDP target could be effective.  That might cause people like Ed Balls to oppose a higher inflation target.

Krugman’s double standard

Paul Krugman has a new post that fails on every level possible.

as Mike Konczal points out, we are in effect getting a test of the market monetarist view right now, with the Fed having adopted more expansionary policies even as fiscal policy tightens.

And the results aren’t looking good for the monetarists: despite the Fed’s fairly dramatic changes in both policy and policy announcements, austerity seems to be taking its toll.

Let’s start with the obvious double standard, identified by one of my commenters (Hellestal):

During 2009, the administration came up with a stimulus plan to fight the downturn in the economy. Keynesians like Krugman said, clearly and repeatedly, that the plan was in the right direction but that it would be insufficient to fight the downturn.

After the plan “failed” “” for whatever reason “” there were some who blamed Krugman for having advocated stimulus. Keynesian had been tested, they said, and it had failed. Krugman denied this, pointing out (correctly) that he had been saying from the beginning that the plan could be too small to make a difference. He linked repeatedly to his old posts, where he explicitly mentioned the possibility that the plan was insufficient. He vigorously defended the viewpoint that this “test” of his views was not proper.

Now we have Mike Konczal saying that market monetarism has been tested. We can, once again, go back to the original posts of the market monetarists to see what expectations they had. We can, once again, compare the actual policy that was implemented against what the original recommendations were. A brief search will indicate, once again, that the monetarists “” like Krugman before them “” believed that the plan was in the right direction but insufficient.

We remember, yet history still manages to repeat itself.

Ah, there is a difference. This time, Krugman is saying “we are in effect getting a test of the market monetarist view right now”. This is a rather ostentatious double standard.

But it’s even worse.  Fiscal stimulus is costly, as it increases the burden of future taxes, whereas monetary stimulus is free.  Indeed monetary stimulus actually reduces the burden of future taxes.  So it makes some sense to talk about the “effort” that fiscal policymakers put into stimulus, but no sense to talk about monetary policymakers “making an effort.”  The analogy for monetary stimulus is steering a ship.  It’s not “how hard should they try,” it’s “which direction do they want to go?” The Fed believes their policies will lead to roughly 5% NGDP growth; hence they don’t want to do more.  I think they overestimate the effect, and want them to do more.  But that difference of opinion has nothing to do with the validity of market monetarism.

But it’s even worse.  RGDP growth (which is what the Keynesians focus on) actually accelerated in Q1.  The sharp slowdown predicted by the Keynesians failed to occur.  But they are so convinced by the accuracy of their model that they simply assume that a sharp slowdown occurred because by God it should have occurred. I really can’t understand how any thinking person could take Krugman’s “proof” of Keynesianism seriously.  BTW, the Keynesian model implies they should be focused on NGDP as an indicator of aggregate demand, as supply-side factors also impact RGDP.  This leads me to wonder whether Keynesians even understand their own model.

In any flawed model there’s usually a grain of truth.  The Fed presumably did enough stimulus to offset the fiscal contraction they expected in 2013.  But if the sequester turns out to be more than the Fed expected then growth will slow in Q2, as the Keynesians predict.  Then the Fed will have to do another monetary offset.  But this is all a sideshow, over longer periods of time the Fed is driving NGDP, and that’s where Mr. Krugman should be focusing his attention.

Of course none of this has anything to do with the validity of “market monetarism”.  At best it addresses one implication of market monetarism, the “monetary offset” claim.  But regardless of whether the Fed does or doesn’t offset the effect of fiscal austerity, the fact remains that monetary stimulus is the only plausible solution to our demand shortfall, as fiscal stimulus isn’t even being considered.

PS.  Krugman gratuitously lumps us in with the wacky MMTers.  I’m sure Krugman knows better, he’s a very bright economist.

PPS.  For those who (wrongly) insist on judging the stance of monetary policy by “gestures,” consider that the Fed has been much more aggressive than the ECB and BOJ, and of course US NGDP has grown much faster than in those two economies.  So why not do even more?

PPPS.  Meanwhile, government output in the US has been falling at the sharpest rate in decades, and yet NGDP keeps chugging along at 4%.  So is Keynesianism a model that applies to the UK, but not the US?  Or have we had monetary offset?

HT:  Michael Darda

Mike Konczal on fiscal austerity

Here’s a recent claim by Mike Konczal:

We rarely get to see a major, nationwide economic experiment at work, but so far 2013 has been one of those experiments “” specifically, an experiment to try and do exactly what Beckworth and Ponnuru proposed. If you look at macroeconomic policy since last fall, there have been two big moves. The Federal Reserve has committed to much bolder action in adopting the Evans Rule and QE3. At the same time, the country has entered a period of fiscal austerity. Was the Fed action enough to offset the contraction? It’s still very early, and economists will probably debate this for a generation, but, especially after the stagnating GDP report yesterday, it looks as though fiscal policy is the winner.

I’m puzzled by this.  The first quarter RGDP numbers show a growth rate of 2.5%, which is actually higher than the growth rate of 2012.  NGDP growth is similar to 2012.  How does that show fiscal policy is slowing the economy?

Perhaps fiscal policy is slowing the economy, but I just don’t see it in the data.

BTW, if fiscal austerity did slow the economy, the solution would not be fiscal stimulus, it would be monetary stimulus.  If the Fed is unwilling, an employer-side payroll tax cut would be a good form of fiscal stimulus, much more effective than what they did in 2009.

And I can’t speak for Beckworth and Ponnuru, but I very much doubt the Fed did “exactly what Beckworth and Ponnuru proposed,” which was NGDPLT, if I’m not mistaken.

HT:  Ramesh Ponnuru

Sticky wages really do explain the recent recession

From a study by Mary Daly and Bart Hobijn at the San Francisco Fed:

Although our model simulations are not intended to match the data, they are remarkably consistent with data on both individual level wage changes and the dynamics of unemployment and wage growth observed for the U.S. since the 2007 recession. To show this, we update the results from Card and Hyslop (1997) and compare the changes in the histogram of log nominal wage changes between before the recession in 2006 and after the recession in 2011 with the changes in the distribution of log nominal wage changes implied by our model along its transition path.

In addition, we construct a U.S. wage Phillips curve for 1986-2012 and show that, since 2007, (i) unemployment first rose significantly while wage growth remained flat and (ii) subsequently fell while wage growth decelerated. This is consistent with the two ways in which downward nominal wage rigidities bend the Phillips curve following a large negative demand shock in our model.

We interpret these results as evidence that downward nominal wage rigidities have been an important force shaping the dynamics of unemployment, wage growth, and inflation over the period from 2006-2012.

File under further confirmation of the “musical chairs” model.

PS.  Saturos sent me an excellent FT piece by Chris Giles.  But I’d quibble slightly with this:

With the annual growth rate of nominal GDP being so important, it is extremely disappointing that Mark Carney, incoming governor of the BoE, has backed-away from his suggestion that targeting its value would help in a depressed environment.

I think the real problem here is that Cameron and Osborne didn’t give the BoE an NGDP target.  Without that sort of explicit mandate, it’s awful hard for Osborne to suddenly shift BoE policy so radically.  Perhaps the government felt that abandoning the 2% inflation target it would be too controversial, especially with Ed Balls insisting that the 2% target should be maintained.  Why is Balls so opposed to higher AD?

And Britmouse wonders why Paul Krugman is calling for fiscal stimulus, rather than a higher inflation target in Britain.