Archive for November 2014


At the other extreme . . .

A quick follow up to my previous post.  Australia has seen 3% RGDP growth over the past 12 months, and 2.7% the year before, and 3.6% the year before.  Great news eh?  Here’s Australia’s unemployment rate over Screen Shot 2014-11-18 at 9.56.23 AMthe past 12 months:

That’s what happens when you have a high trend RGDP growth rate.


The USA doesn’t have any debatable recessions. That’s about to change

The US has a really weird economy.  All our recessions are 100% clear-cut.  Either we have a recession or we don’t.  Normal countries have borderline recessions.  Not us.  Either our unemployment rate rises far too little to be viewed as a recession, or so much that 100% of economists agree it’s a recession.  I don’t know why that is. And I don’t know why other economists don’t view it as really weird.  Maybe people just notice things that happen, not things that don’t.  Not dogs that don’t bark.

I believe this weird pattern is about to end, and very soon we’ll have debatable recessions.  This post is partly motivated by my previous post on Japan.  I don’t think people realize how much changes when your trend rate of RGDP growth becomes zero, or even negative.  Some pointed to the fact that Japan is “weird” because unemployment rose very little in the 2007-09 recession. Sorry, but Japan is now pretty normal; it’s the US that is weird.  Here’s some crude data using annual changes in RGDP and the rise in unemployment from the 2007 low to the 2009 high.  Note that Germany’s recession was confined to 2008-09:

Japan:  Drop in RGDP = 6.5%,  Rise in unemployment = 2%

Germany:  Drop in RGDP = 5%, Rise in unemployment  = 2%

Britain:  Drop in RGDP = 5.5%,  Rise in Unemployment = 2.8%

USA:  Drop in RGDP only 3%, Rise in Unemployment = 5.5%

Quarterly data would be slightly better, but wouldn’t change the overall pattern.  A relatively large fall in RGDP in other countries doesn’t lead to much extra unemployment.  That’s partly lower trend RGDP growth (Germany and Japan have falling populations) and partly the more flexible US labor market.

And now it looks like the US trend rate of RGDP growth will fall from 3% to barely over 1%.  After we “recover” it will no longer be unusual to see two straight quarters of falling RGDP.  But will they be true recessions?  Or the sort of phony “recession” that people think they are seeing in Japan, and that was reported in the UK a couple years ago, which later vanished with revisions in the data? (I’m referring to Britain’s triple dip; even the double dip was very debatable, with only a 1/2% rise in unemployment.)

Is it possible I’ll be wrong about the US trend growth?  Sure, a change in immigration policy, or supply side reforms to boost the LFPR could help, but I don’t see much sign of that happening. The prime age workforce will soon stop growing, and productivity growth is slowing as well.  Get ready for lots of phony “recession” stories, especially when the party in power is not well liked by the intelligentsia. (Which party would that be in America?)

PS.  I believe I was the first blogger to blow the whistle on the phony 2011 tsunami “recession” in Japan.  I’m still waiting for the delayed unemployment effect from the tsunami . . .

Japan has supposedly been in recession for 7 months—I’m sure their unemployment rate will soar any day now.  Especially with Japanese firms complaining they can’t find enough workers to fill the job openings.

Update:  For those that have trouble understanding why there are no debatable recessions, consider the following graph.  During an actual recession, unemployment rises by at least 2%. When there is no recession the biggest rise was 0.8% in 1959 (nationwide steel strike) and that was really brief.  Look at that tiny spike in 1959, then look at the actual recessions, and marvel at the vast difference.

Note how different it is from a random walk graph (like the stock market) where you see small, medium and large fluctuations.  All we see are small and large, no medium.

Screen Shot 2014-11-18 at 10.38.56 AM


Is Japan in recession?

The media says yes.  I say if Japan is in recession it’s time to redefine the term. Here is the Japanese unemployment rate over the past few years:

Screen Shot 2014-11-16 at 8.59.24 PMThe unemployment rate in Japan is currently 3.6%, one of the lowest figures in decades.  It’s true that the Japanese unemployment statistics are a bit peculiar, but so are all their other data.  And when they are unquestionably in recession, as during 2008-09, the unemployment rate in Japan rises just as in any other country.

Welcome to the new world of business cycles.  Japan is a country with low productivity growth and a working age population that is shrinking by 1.2% per year.  The trend rate of RGDP growth is somewhere near zero, perhaps negative.  Japan will have lots more “recessions” during the 21st century.

A few months back I very reluctantly supported the sales tax increase, as their debt situation is so scary.  That was probably a mistake.  For some strange reason I thought that a country engaged in monetary expansionary to try to boost growth, that was also raising sales taxes by 300 basis points, must have been raising the sales taxes for the purpose of reducing the budget deficit.  Silly me:

The government approved a 5.5 trillion yen extra budget in December to help the economy weather April’s tax hike. Finance Minister Taro Aso has signaled readiness to boost stimulus and Abe said last week he would consider compiling an extra budget depending on the economy.

(OK, commenter dtoh, you win.)  So let me get this straight.  You raise the sales tax by 3 percentage points to reduce the budget deficit, and simultaneously raise spending by about 1% of GDP?  And the goal of all that activity is what?

In any case, Japanese stocks are still doing well, which suggests that Abenomics is still on track. (But on track to where?)  Adverse factors that have a multiyear impact on RGDP lead to higher unemployment.  The global recession of 2008-09 is a good example.  On the other hand temporary growth pauses don’t raise unemployment—the 2011 tsunami is an example.  This looks like a temporary pause, like 2011, as unemployment is not rising.  Even so, with zero or negative trend growth in Japan, expect many more negative quarters, many more “recessions.”  And that public debt? I have no idea what they plan to do about it.

This line from the Lewis Carroll classic seems relevant, in a reverse sort of way:

“When you say ‘hill'” the Queen interrupted, “I could show you hills, in comparison with which you’d call that a valley.” 

BTW, here’s a story that you would not have seen 6 years ago:

Kuroda last month led a divided BOJ board to step up asset purchases, with the aim of delivering 2 percent inflation. [Deutsche Bank’s chief economist for Japan] Matsuoka says there is more the central bank should do to rebuild the economy. He suggests “level targeting,” in which policy makers pledge to keep stimulative monetary policy until the inflation index or nominal GDP resemble what they looked like in the late 1990s.

HT:  Stephen Kirchner

PS.  This graph shows what the recessions of 2001 and 2008 looked like:

Screen Shot 2014-11-16 at 9.23.49 PM

The real “beggar-thy-neighbor” policy

Proponents of fiscal stimulus often call on Germany to adopt a more expansionary fiscal policy, in the hope that this will help rebalance and reflate the entire eurozone.  It’s possible it might work, but it’s also possible it might end up being a “beggar-thy-neighbor” policy.

Suppose the ECB is targeting inflation. Fiscal stimulus in Germany will be partly offset (in Germany) by tighter monetary policy. The ECB will want to keep overall eurozone inflation on target.  Hence it will offset any impact on NGDP.  But some of the effect of tighter eurozone monetary policy will be felt in the other countries. So if total eurozone NGDP and inflation are unaffected by the two policy changes, and German NGDP rises, then it is necessarily true that non-German NGDP falls.

Possible objections:

1.  The ECB would never be that cruel.  It’s not about the ECB being cruel; it’s about the ECB doing its job.  A better counterargument is that the ECB is incompetent and won’t do its job.

2.  The argument doesn’t apply at the zero bound.  I would remind you that during over 90% of the past 6 years the ECB has been doing normal monetary policy, raising and lowering its interest rate target with the goal of stabilizing inflation.  Only very recently has it hit the zero bound.  And yet people have been calling for German fiscal expansion for years.  And it’s also worth noting that fiscal proponents who claim that the zero bound “changes everything” were spectacularly wrong in their 2013 prediction that austerity would slow growth in the US. That doesn’t mean that monetary offset applies in each and every case—the ECB is unusually incompetent, but it’s certainly the baseline assumption.

3.  This is one of those ivory tower theories that don’t match the real world.  And yet the idea of fiscal stimulus being a beggar-thy-neighbor policy is actually the standard textbook explanation for the European exchange rate crisis of September 1992.  Germany did a massive fiscal stimulus in the early 1990s, to help rebuild East Germany.  This pushed up real interest rates in the ECU area. The higher real interest rates (combined with a Bundesbank monetary policy tight enough to prevent inflation) led to recession (or aggravated an existing recession) in countries like Britain and Sweden.  Eventually they were forced to devalue, and to this day remain outside of the euro.

So fiscal expansion in one country within a currency zone is a beggar-thy-neighbor policy in both theory and practice.  Over at Econlog, I have a new post explaining why low interest rates do not call for more public investment.

Josh Hendrickson on the problem with “moneyless” NK models

Josh Hendrickson is sort of like my mirror image; he doesn’t post very often, but almost invariably has something interesting to say.  In a new post he discusses a flaw in one common New Keynesian (NK) model, which looks at monetary policy through the lens of interest rates.  But first, a quick review of interest rates and monetary policy.  The easiest way to see the relationship is with the equation of exchange:

M*V = P*Y

When the Fed raises interest rates, pundits tend to call the policy “contractionary.” That’s misleading for all sorts of reasons, but does contain a grain of truth.  The true part comes from the fact that in the very short run, the Fed engineers interest rate increases by reducing the monetary base. Note that by itself the rate increase is expansionary, as it tends to boost the velocity of circulation, by raising the opportunity cost of holding base money.  But that expansionary effect is more than offset by the direct contractionary impact of the lower monetary base.  Here’s Josh, looking at the opposite case, an increase in the money supply:

Now consider the effects of a change in the money supply. As illustrated in the figure above, the increase in the money supply causes the interest rate to decline. This means that when the money supply increases, velocity declines. However, the interest elasticity of velocity is often estimated to be rather small. The initial effect of the increase in the money supply is that the nominal interest rate to fall and nominal spending to rise. The decline in the nominal interest rate is an effect of the change in the money supply, but note that it is not the cause of the change in nominal spending.

So far so good.  But here’s where NKs get into trouble.  Josh says that their models imply that a higher interest rate is contractionary, even if there is no change in the money supply:

The New Keynesians, however, countered that they didn’t need to use open market operations to target the interest rate. For example, Michael Woodford spends a considerable part of the introduction to his textbook on monetary economics to explaining the channel system for interest rates. If the central bank sets a discount rate for borrowing and promises to have a perfectly elastic supply at that rate and if they promise to pay a rate of interest on deposits, then by choosing a narrow enough channel, they can set their policy rate in this channel. In addition, all they need to do to adjust their policy rate is to adjust the discount rate and the interest rate paid on reserves. The policy rate will then rise or fall in conjunction with the changes in these rates. Thus, the New Keynesians argued that they didn’t need to worry about money in theory or in practice because they could set their policy rate without money and their model showed that they could get a determinate equilibrium by applying the Taylor principle.

Nonetheless, what I would like to argue is that their ignorance of money has led them astray. By ignoring money, the New Keynesians have confused cause and effect. This confusion has led them to believe that they know something about how interest rate policy should work, but they have never stopped to think about how interest rate policy works when the central bank adjusts the nominal interest rates in a channel system versus how interest rate policy works when the central bank adjust the nominal interest rate using open market operations.

Unfortunately the post is hard to excerpt; you really need to read the whole thing.

This does not mean that NK interest rate policies will not “work.”  Rather I would argue that they work for reasons that NKs don’t understand, and when they fail they will fail for reasons NKs don’t understand.  Other economists such as Peter Ireland (who is cited by Josh) have pointed out that even with interest on reserves (IOR) you can never really ignore the quantity of money, and that certain quantity theoretic claims continue to hold true.

For me, the easiest way to understand this issue is to think about (non-interest-bearing) currency. Back in 2007 the base was about $850 billion, with about $800 billion of that being currency.  Now suppose Ben Bernanke had been instructed to use interest rates to double the price level over the next 30 years.  He was not allowed to use the monetary base.  For simplicity, assume he never ran into the zero bound problem.  Even in that case, where positive interest rates allowed him to continually use a Taylor Rule-type approach, it’s easy to see that the policy objective would be impossible to achieve.  There would not be enough base money to match the demand for currency at a price level double its current value.  I think this simple truth sometimes gets overlooked in models that focus on bank reserves and IOR, and/or periods of history where there are plenty of excess reserves.

I said that NK policy might work despite its theoretical weaknesses.  That’s because asset markets would probably (correctly) interpret a rise in the IOR rate as part of a broader Fed strategy to reduce future growth in aggregate demand.  Thus markets would assume that the base would also be adjusted over time in whatever direction was necessary for hitting the central bank’s target. (Surely there must already be a Nick Rowe analogy involving steering wheels and social conventions.) As always, monetary policy is 98% expectations, and 2% concrete steps.  What are those expectations about?  They are about future concrete steps, i.e. future changes in the supply of base money, relative to changes in the demand for base money.

PS.  I have a post criticizing Charles Plosser, and 99% of other economists, over at Econlog.  And also a libertarian rant.