Joe Gagnon is a former Fed economist now located at the Peterson Institute in Washington.  He’s also arguably the world’s leading expert on QE. The conversation with David was excellent from beginning to end.

Here are a few highlights (from memory):

1.  Gagnon’s research suggested that QE was somewhat effective at lowering long-term interest rates.  That’s also the consensus view of dozens of other studies he looked at.  He suggested that QE probably led to higher bond yields in the long run, which reflected the higher nominal growth of countries that engaged in more aggressive monetary stimulus.  He seemed to suggest this was a rather surprising result, but I think it’s in line with the previous views of monetarists like Milton Friedman.

2.  Gagnon likes NGDP targeting, and is somewhat split between growth rate and level targeting.  At one point he seemed to suggest an option somewhere between those two extremes.  I’d guess that reflects the behavior of the economy after 2007, when (in retrospect) a continued 5% NGDP growth rate might seem a bit too aggressive.

3.  He suggested that the Fed may have been held back around 2009-10 from doing even more QE by a fear of the unknown.  It was a new and untried policy instrument.  Gagnon also indicated that (in retrospect) it probably would have been better to do all three or four QEs right up front.  (I’m glad he said 3 or 4, as I’ve always been a bit unclear as to whether the first QE was in late 2008, or March 2009. It seems the leading expert also views the number of QEs as ambiguous.  The official number was three, but it seems like there were four.)

4.  David asked him about the options for monetary policy that he came up with as a researcher at the Fed during 2008-09.  I kind of regret not hearing him talk about whether the Fed looked at the options for Japan that were outlined in Bernanke’s 2003 paper.  There’s been a lot of criticism (from me and others) of the fact that Bernanke’s Fed did not pursue some of the more aggressive options that Bernanke recommended to the BOJ, in his famous paper that discussed the need for “Rooseveltian resolve.”  (Here I’m especially thinking of price level targeting.)  That’s not to say there are not good answers.  Bernanke got in hot water in 2010 for suggesting we needed to raise the inflation rate (to 2%).  If he had indicated a need to raise it to 3% or 4% to catch up to the trend line, the policy would have been even more controversial.

5.  Gagnon gave an excellent summary of recent events in Japan.  His view is similar to mine, but he’s followed things more closely and has much more knowledge of the situation.  The original Abe/Kuroda push for 2% inflation was partially successful.  Core inflation expectation quickly rose by about 200 basis points, from minus 0.75% to 1.25%.  They needed one final push, and in early 2016 tried to do so using negative IOR.  Unfortunately, the negative rate was only 0.1%, which was too little to have much effect.  Even worse, there was a political backlash.  That led the markets to lose confidence in the BOJ, and since then the yen has soared in value.  Thus inflation expectations are now coming down.  In retrospect, they would have been better off doing more QE.  Gagnon even suggested buying equities as an option.  He thought it was really important that the BOJ hit its 2% inflation target, and I agree.  That’s not because I favor inflation targeting (I don’t) but rather because I think it’s really important for central banks to hit their targets, for credibility reasons.  Unfortunately, it appears the Abe government has lost interest in this policy target.

6.  Gagnon pointed out that before the Great Recession most economists thought that a 2% inflation target would be enough to keep us away from the zero bound.  He also noted that early discussions of the pros and cons of a higher inflation target took account of the likelihood of hitting the zero bound.  Then Gagnon said something to the effect; “Well, we now know something new”.  We know that the zero bound problem can occur with a 2% inflation target.  So if economists thought that 2% inflation target was optimal for the US, then that can’t possibly be the case now.  Speaking for myself, I’m disappointed that so few economists are forcefully explaining why this new information suggests that we need a new target.  And it does not have to be 3% or 4% inflation, it could be NGDPLT.  But clearly some change is required.  And yet as far as I can see the Fed seems determined to continue muddling along with a 2% inflation target, which makes their “conventional” policy tool (interest rate targeting) almost useless going forward.

7.  Gagnon also did an excellent job explaining the problems with helicopter drops–it’s too effective if expected to be permanent.

You see a lot of recent talk about the message being sent by voters, especially in the US and Europe.  For instance, both the Trump phenomenon and Brexit are widely seen as a revolt of the struggling working class against the affluent elites. Like many generalizations, there is a grain of truth here. But I find the mountain of non-truth to be much more interesting.

For instance, Trump is likely to win a majority among affluent voters, while Brexit also did well affluent southern English counties, outside of London.  So it’s not just economics.  Each voter has their own reasons.

Ross Douthat has new piece discussing the blind spots of cosmopolitan liberals:

They can’t see that paeans to multicultural openness can sound like self-serving cant coming from open-borders Londoners who love Afghan restaurants but would never live near an immigrant housing project, or American liberals who hail the end of whiteness while doing everything possible to keep their kids out of majority-minority schools.

Douthat is a quite thoughtful and persuasive writer, but I believe things are much more complicated that he suggests.  Consider the issue of schools. Affluent American parents don’t want their kids going to public schools in poor (African-American) areas of Detroit or Cleveland.  But note that these are areas that have relatively few immigrants.  And immigration is supposed to be the big policy issue that is propelling nationalistic politics in the US and Europe.  I would add that white working class parents also don’t want their kids going to those schools.  On the other hand, most affluent parents and most working class parents would be happy to see their child get into (mostly non-white) UCLA:

So I don’t think it’s obvious whether the core issue here is diversity or income.  It’s quite likely that UCLA grads will tend to have fairly successful careers, and that there will be lots of intermarriage among those groups.  Here’s an analogy.  In the 1800s, there was lots of resentment against immigration of Irish, Italians and Jews. These groups were seen as a threat to the dominance of the “WASP tribe”.  Today there is very little concern about this issue, even among mainstream conservatives. The WASP tribe has been replaced by the “white tribe”.  And we can already look ahead a few decades and see the white tribe being replaced by a sort of beige tribe looking like UCLA students; composed of whites, Asians and the upper half of the Hispanic income distribution, which all intermarry quite frequently.

When I was young there was lots of anxiety about the Italian-American mafia. (Younger readers will have no idea what I’m talking about, but people my age will understand.)   The fear that Americans once had of the mafia has been replaced by a fear of terrorism.  Those who (in the 1960s) wanted to claim that organized crime was deeply embedded in southern Italian culture actually had a strong argument. After all, even today the mafia is deeply embedded in southern Italy.  But for some unknown reason those cultural traditions did not prevent southern Italian immigrants from successfully assimilating once they got to America.  They are now three times richer than their relatives who stayed in Naples or Sicily.

Should we be complacent that assimilation will continue to occur in the future?  I’m not very worried about Australia and Canada, rather I’m much more worried about Western Europe.  The US is somewhere in between these extremes.

Now I’ll take off my liberal hat and put on my conservative hat.  Here’s the problem that I see in Western Europe (Denmark in this case):

Yet many Danes I talked to are less concerned about terrorism than about the threat they see Muslims posing to their way of life. Though Muslims make up less than 5 percent of the population, there is growing evidence that many of the new arrivals fail to enter the workforce, are slow to learn Danish, and end up in high-crime immigrant neighborhoods where, while relying on extensive state handouts, they and their children are cut off from Danish society. In 2010, the Danish government introduced a “ghetto list” of such marginalized places with the goal of “reintegrating” them; the list now includes more than thirty neighborhoods.

Popular fears that the refugee crisis could overwhelm the Danish welfare state have sometimes surprised the country’s own leadership. On December 3, in a major defeat for the government, a clear majority of Danes—53 percent—rejected a referendum on closer security cooperation with the European Union. Until now, Denmark has been only a partial EU member—for example, it does not belong to the euro and has not joined EU protocols on citizenship and legal affairs. In view of the growing threat of jihadism, both the government and the opposition Social Democrats hoped to integrate the country fully into European policing and counterterrorism efforts. But the “no” vote, which was supported by the Danish People’s Party, was driven by fears that such a move could also give Brussels influence over Denmark’s refugee and immigration policies.

Hmm, 53% voting against a referendum that would “give Brussels influence over Denmark’s refugee and immigration policies.”  I vaguely recall something similar occurring recently in another EU country.

From an economic perspective, the government’s embrace of the populist right was anomalous. With its unique combination of comprehensive welfare and a flexible labor market—known as flexicurity—Denmark has an efficient economy in which the rate of job turnover is one of the highest in Europe, yet almost 75 percent of working-age Danes are employed. At the same time, the country’s extraordinary social benefits, such as long-term education, retraining, and free child care, are based on integration in the workforce. Yet many of the qualities about the Danish system that work so well for those born into it have made it particularly hard for outsiders to penetrate. . . .

Yet the immigration overhaul also had strong foundations in the Liberal Party. In 1997, Bertel Haarder, a veteran Liberal politician and strategist, wrote an influential book called Soft Cynicism, which excoriated the Danish welfare system for creating, through excessive coddling, the very stigmatization of new arrivals to Denmark that it was ostensibly supposed to prevent. Haarder, who went on to become Fogh Rasmussen’s minister of immigration, told me, “The Danes wanted to be soft and nice. And we turned proud immigrants into social welfare addicts. It wasn’t their fault. It was our fault.”

I think this is the key.  Either bring in high skilled immigrants, as in Australia or Canada, or bring in low skilled immigrants, and push them into work via a meager welfare state, as in Texas.  Western Europe has not chosen either route, and is paying the price.

California has much more generous welfare than Texas, and there is a danger that California’s new $15 minimum wage will create an even larger Hispanic underclass than currently exists.  Some proponents of a higher minimum wage, like Ron Unz, hope that it will price potential low-income (Hispanic) immigrants out of the job market, and discourage immigration.  Maybe.  But another risk is that you end up like many third world countries, where official jobs pay far more than what workers could earn in the informal economy.  Peasants move to the big cities and queue up for these well paying jobs.  Even if you are only able to work 6 months out of the year at $15/hour, that’s better than full time at $7.25/hour.  At least better for the individual, I suspect it’s much worse for society to have a huge cohort of disgruntled immigrants, going in and out of unemployment.

To summarize, I don’t think recent events are a wake-up call that we need to be concerned about an “end to whiteness”.  Rather it suggests that we might want to nudge our immigration policy somewhat in the Australia/Canada direction (which would basically mean more immigrants from India and China, and fewer from Oaxaca and El Salvador).   The problem is not the prospect of an increasingly cosmopolitan society—because of intermarriage it will not seem cosmopolitan when we actually get there.  (BTW, the young in Britain are already there–voting 3-1 against Brexit.) Rather the problem is a society where large segments of the population are socially excluded because they don’t work.  In America, a big chuck of the excluded are Native American and black non-immigrants.

Nor is it obvious that voters are rebelling against neoliberalism.  Among developed countries, you often see the most extreme populism in the least neoliberal countries.  (Compare Australia and Hungary, or Sweden and Greece.)  In Latin America, there is currently a backlash against socialism and in favor of neoliberalism.  And yet I see one pundit after another pontificating that the voters are sending a message in favor of more Keynesian spending, or less neoliberalism, or whatever that pundit tends to favor.  Trump wants massive tax cuts for the hedge fund class–how’s that a backlash against neoliberal elites?  (Just to be clear, he says he wants them to pay more taxes, but his actual proposal calls for a top rate of 25%, which would sharply cut their taxes, even if the cap gains rate was bumped up to 25%.)

PS.  It’s ironic that many of my commenters obsess about the decline of America’s white population, which they see as being culturally superior.   They are the flip side of the campus PC nuts that obsess about “white privilege” and view talk of a “colorblind society” as covert racism.  These left and right-wingers share an obsession with race that I don’t have.  I am not horrified by the fact that Orange County, CA (or Texas) is no longer majority white–it still seems like a pretty good place to live; indeed I might live in “the OC” someday.

PPS.  I have a new Econlog post discussing a new Krugman post that endorses my February critique of Autor, Dorn and Hanson on China trade.

Tim Duy has a very good new post, showing how Jerome Powell is moving in a more dovish direction.  The following quotation is Powell, with the remark about the flat Phillips curve being Tim:

When I was first exposed to macroeconomics in college, more than four decades ago, the view was that inflation was strongly influenced by the amount of slack in the economy. But the relationship between slack and inflation has weakened substantially over the years.

Or, in other words, the Phillips Curve is flat. Not quite flat as a pancake, but pretty darn flat. More important:

In addition, inflation depends importantly on the inflation expectations of workers and firms. A widely shared view among economists today is that, unlike during the 1970s, expectations are no longer heavily influenced by fluctuations in inflation, but are fairly constant, or anchored. For both these reasons, inflation has become less responsive to cyclical changes in the economy.

I’d go even further.  The Phillips curve is not useful because it is NGDP, not inflation, that best explains how nominal and real variables are related. And the causation goes from the nominal to the real (NGDP to unemployment) not the real to the nominal (unemployment to inflation).

Once again, here’s Powell, with a follow-up comment by Duy:

I am often asked why rates remain so low now that we are near full employment. A big part of the answer is that, at least for the time being, the appropriate level of rates is simply lower than it was before the crisis. As a result, policy is not as stimulative as it might appear to be. Estimates of the real interest rate needed to keep the economy on an even keel if it were operating at 2 percent inflation and full employment–the “neutral rate” of interest–are currently around zero. Today, the real short term interest rate is about negative 1-1/4 percent, so policy is actually only moderately stimulative. I anticipate that the neutral rate will move up over time, as some of the headwinds that have weighed on economic growth ease.

The Fed increasingly recognizes that policy is not highly accommodative simply because rates are zero. The stance of policy is relative to the real interest rate, and a lower real rate means that policy is actually only “moderately” stimulative. Translation: There is no need to hike rates soon because policy is not particularly accommodative.

Of course market monetarists have been saying  that low rates don’t mean accommodative policy ever since 2008.  I’d go even further.  Not only is the current policy not as accommodative as it seems, it’s not accommodative at all.  NGDP growth (or inflation) are likely to undershoot the Fed’s goals.

Over the period since 2009, we’ve seen macroeconomic discourse evolve as follows:

1.  NGDP may be a more useful indicator of nominal conditions than inflation.

2.  The Phillips Curve is not very useful.

3.  Low interest rates do not imply that money is easy.

4.  Expansionary fiscal policy may be offset by an inflation targeting central bank.

5.  The zero lower bound does not prevent negative IOR.

6.  At the zero bound, a premature increase in interest rates will lead to lower interest rates in the long run.

Of course no one has a monopoly on these views, but which set of bloggers were most forcefully making these points in early 2009?

With the post-Brexit vote plunge in global bond yields, any doubts that low rates are the new normal are gone.  The Fed’s been much slower than the markets to understand this new reality, but they aren’t stupid.  At some point the Fed will realize that its preferred (“conventional”) policy tool simply doesn’t work.  Rates will immediately fall to zero in all future recessions, so “conventional” monetary policy will be useless.  How will the Fed react:

1.  NGDP targeting

2.  A higher inflation target

3.  Level targeting

4.  Miles Kimball’s negative IOR plan

5.  Throw up their hands and ask for support from fiscal policy

I hope and pray they don’t choose option #5. Because it won’t work.

PS.  Tyler Cowen just reported that Swiss yields are negative out to 50 years.  That’s why I opposed the Swiss decision to revalue the franc upward last year.  The upward revaluation was motived by a fear of inflation (and no, I’m not kidding.)

HT:  David Levey

One of my few remaining thoughtful commenters (ChrisA) left the following comment:

On the UK exports being affected by tariff’s after Brexit – couldn’t that be taken care of by a fall in the pound vs the Euro? I don’t actually think a tariff war between the UK and the EU is actually going to happen, since the trade deficit is so much in favour of the EU they have a strong incentive to be sensible. But even in the worst case we couldn’t be talking about tariffs of more than 10%, which is easily taken care of by the fall in the pound that has happened over the last week. And remember that applies to all of the exports of the UK to all of the world, not just to the EU.

I see this claim quite often, but it doesn’t hold up to close scrutiny.  Tariffs on imports are essentially a tax wedge on trade, which reduces both imports and exports.  When people talk about using “currency depreciation” as a policy tool, they are often referring to an expansionary monetary policy.  However, although monetary stimulus does reduce the nominal exchange rates in both the short and long run, it only reduces the real exchange rate in the short run, until wages and prices have adjusted.  After that, the price level rises to restore the previous real exchange rate.

There’s no getting around the fact that trade barriers make economies less efficient, by diverting output from the tradable to the non-tradable sector.  This conclusion is not affected by whether the UK has a trade surplus or deficit, so I don’t agree that the EU has an “incentive to be sensible”.  Indeed, an import tariff might well reduce exports by just as much as it reduces imports, even if one’s trading partners do not retaliate.

Some commenters also criticized claims of a skilled labor shortage in Spain.  Over at Econlog, I have a new post that explains why they are wrong.

Over the past decade, the UK economy has presented a puzzling picture.  On the one hand, RGDP growth has been quite slow. On the other hand, the jobs market has been quite robust, as rapid jobs growth has pushed the employed share of the population to an all time high.  This puzzle can be resolved by looking at productivity numbers, which have been absolutely abysmal.

In modern economies, manufacturing tends to decline and services increase.  This trend is especially far advanced in Britain, which partly (not entirely) explains their poor productivity.  What little manufacturing is left is partly based on the UK being a springboard to the EU market.  Thus Nissan builds a factory in Sunderland, so they can export to the EU.  Interestingly, Sunderland voted overwhelmingly for Brexit.

The two leading candidates for the Prime Minister job are both somewhat anti-immigration.  They insist that they want to negotiate a single market agreement with the EU, and control immigration, but it’s not clear to me that this is possible.  For the moment, let’s assume Britain does indeed exit the EU, and the EU no longer gives the UK preferential trading rights.  And let’s assume the UK uses that freedom to crack down on immigration.  What then?

In that case, you’ve destroyed two of the UK’s primary growth engines in recent years, immigration and direct foreign investment using the UK as a platform to export to the EU.  I would predict slower trend economic growth.

And isn’t that exactly what the bond market is telling us?  British long-term bond yields are plunging lower at a startling pace.  I could not find indexed gilt yields (and someone help me?) but I’d guess they are also plunging rapidly.  The elderly voters of England just voted to make Britain more like another large island nation, just off the coast of another great economic power, which also led the industrial revolution in their part of the world.  And if the bond market is to be believed, they succeeded.

Here are some other straws in the wind:

1. A few days after I suggested the Fed should immediate cut IOR by 50 basis points.  Today that might seem rash, if you look at how stocks have recovered.  But if you look at the global bond markets, you might conclude I should have recommended a 75 basis point cut.  The fed funds futures now price in only a 50/50 change of one rate cut.  Not this year, but rather until February 2018.  That’s right; the US is also starting to look more and more like Japan.  How’s my “3% NGDP growth is the new normal” prediction starting to look?

2.  Today the ECB suggested it might expand its bond-buying program into more debt from the PIGS.  The euro depreciated.

3.  Yesterday the BOE suggested policy easing was on the way, and the pound immediately plunged.

4.  And for you Great Stagnation skeptics, chew on this story, from a country whose 20% unemployment rate is one of the most horrific in the entire world:

Spanish headhunter Samuel Pimentel just can’t find the candidates.

After a frustrating search for specialist consultants for a client, he’s given up and is casting his net elsewhere.

“We were looking for people for two months,” Pimentel, a partner at Ackermann Beaumont Group for Spain and Latin America, said in a telephone interview. “We managed to find one in Spain. We turned to Argentina for others.”

Pimentel’s experience reflects a bizarre feature of the Spanish labor market that is hampering the country’s efforts to repair the damage from the economic crisis. Even with close to 5 million people out of work, the next prime minister will face labor shortages with employers struggle to find the staff they need.

“It’s a paradox,” said Valentin Bote, head of research in Spain at Randstad, a recruitment agency. “The unemployment rate is too high. Yet we’re seeing some tension in the labor market because unemployed people don’t have the skills employers demand.”

From software developers and mathematical modelers to geriatric nurses and care workers, a mismatch in qualifications means companies are struggling to fill posts, even though the unemployment rate at 20.4 percent is the second-highest in Europe.

But hasn’t Spain recently experienced strong jobs growth?  Yes, they have, of the British kind:

Caretaker Prime Minister Mariano Rajoy, the front-runner to lead the next government after posting gains in Sunday’s election, has pledged to add half a million jobs a year, but his campaign focused on posts for the legions of unemployed, rather than producing skilled workers to power the economy. Rajoy’s opponents say his policy of driving down wages and stripping back job protection has mainly created poorly-paid low-skill posts.

The failure to equip sufficient numbers of workers with the skills sought by modern companies is holding back the Spanish economy. The skills shortage is a drag on productivity, delays investment and strains a pension system dependent on new workers with good salaries to pay for an aging population, according to Sandalio Gomez, emeritus professor at the IESE Business School in Madrid.

There’s no question that the eurozone faced major demand shortfalls in 2008-09, and again in 2011-13, and then a slow recovery.  But some Keynesians keep pretending that demand is the only problem facing the world.  It’s not; the supply side has been gradually deteriorating for more than a decade.  Brexit will make this problem even worse.

5.  Japan is now seeing its 20-year bond yields approach zero.  Kuroda did a great job during his first three years, but the BOJ seemed to stop trying this year.  I’m not sure why, but there are news reports that the Abe government would like the BOJ to lower its inflation target to 1%.  That’s a crazy idea, but it seems to be the world we live in.

I encourage my readers not to become to fixated on any single number.  I talk a lot about stocks, because stock indices are often a good indicator of the impact of a policy shock on expected future growth.  But not always.  A capital gains tax cut would boost stock prices even if it did not boost growth (and I think it would boost growth, BTW.)  Think about the recent reaction of international stocks to Brexit.  A sharp decline, and then a partial (but far from complete) recovery.  That tells one story.  But if we look at interest rates we see a very different story.  Bond yields declined initially, but then kept on falling.  What does all that mean?  I’m not sure, but here’s one possibility.  Suppose the world is shifting to lower long-term growth, and more risk associated with protracted problems like Brexit negotiations, and fear of renewed crisis in the PIGS.  Problems that aren’t going away soon. A sort of “low level fever”.  These factors could easily depress long-term bond yields, both real and nominal.  But let’s also assume that there is perceived to be relatively little risk of a near term global recession.  So corporate profits are expected to do OK, or at least to decline only modestly.  Now think about discounting those future corporate profits at a much lower real rate of interest.  It’s not hard to see how stock prices might seem to be doing OK, even as long-term growth prospects fell further.

And finally, my knee jerk reaction was that Brexit might end up being a global problem, and that it might be a global monetary problem.  Given the plunging long term bond yields (even as British stocks partially recovery), and given that eurozone stock markets have not yet recovered, and given the panicky central bank moves to cut rates further, how’s my knee jerk reaction looking a week later?

In Britain, the real problem is real, while for the rest of the world the real problem (from Brexit) is nominal.  But that monetary shock is being superimposed on a globe with steadily deteriorating real growth prospects.  Fifty years ago Brazil was booming, building new cities like Brasilia.

Now all one reads about are unfinished subway lines and raw sewage flowing onto Rio’s beaches.  The world has forgotten how to grow.