Archive for August 2016


Fix monetary policy; there are no alternatives

The annual Fed meeting at Jackson Hole will soon begin.  I hope they discuss how to fix monetary policy.  I fear they will be distracted by impractical fiscal/monetary schemes.

The recent discussion about monetary policy has been horribly confused.  Here are a few examples:

1. Prior to adopting a 2% inflation target, there was lots of discussion about where to set the target.  I recall almost universal agreement that the target had to be at least high enough to prevent a zero bound problem.  Now that we have experienced a zero bound problem, has that view changed?  If so, why?

2.  I see a lot of discussion to the effect that the Fed is unable to hit its inflation target, because it’s out of ammunition.  That’s not just wrong, it’s a freshman economics level error.  The Fed raised rates in December (and refused to cut them a few weeks ago), precisely because they are worried about overshooting their inflation target.  Indeed at least since the taper tantrum of 2013, the Fed hasn’t believed the US economy needed any more monetary stimulus than they are already providing.  This discussion of the Fed being out of ammo shows a profession that is deeply confused on some of the most basic ideas in monetary economics.  It’s not a pretty sight.

3.  When I discuss the possibility of reforms such as level targeting, or NGDP targeting, the response is often that the proposal is “politically unrealistic”.  Then the naysayers turn around and recommend fiscal/monetary coordination, which shows an almost laughable naïveté about the actual way that fiscal policy is implemented in the US.  And even if by some miracle the GOP Congress would agree to countercyclical policy, the proponents don’t even seem to know what it is.  They propose fiscal stimulus right now, even though doing so at a time of 4.9% unemployment would constitute a procyclical policy, and hence would make the US economy even more unstable.

I hope the economists at Jackson Hole discuss possible ways to fix monetary policy, and don’t get distracted by hopeless fiscal/monetary chimeras, but what I read in the opinion sections of elite media and blogs makes me very pessimistic.

Anand sent me to a post by Paul Krugman:

And I realized something not too flattering about myself: I’m feeling nostalgic for 2011 or so.

Liquidity-trap macroeconomics — which I didn’t invent, but did play a role in bringing back into the mainstream — had become the story of the day. And the basic message of the models — that everything changes when you hit the zero lower bound — was being overwhelmingly confirmed by experience.

The thing is, it was all beautifully hard-edged: a crisp boundary at zero, a sharp change in the impact of monetary and fiscal policy when you hit that boundary. And the predictions we made came out consistently right.

Yes, except for all the things they got wrong, which the market monetarists got right.  Like the 2013 austerity.  Or the removal of extended UI in 2014. Or whether the BOJ would be able to devalue the yen.

But now things have gotten a bit, well, murky.

Now Krugman is being much kinder than I was at the top of this post.  Since we exited the “liquidity trap” the discussion has been borderline incoherent.

The zero lower bound is not, it turns out, quite as hard a boundary as we thought.

Does “we” include the guy who twice recommend negative IOR in published papers in early 2009, and was scoffed at?

More important, probably, is the fact that two of the major advanced economies — the US and, believe it or not, Japan — are arguably quite close to full employment. We don’t know how close, because we don’t know how much pent-up labor supply is still waiting on the sidelines. But you can no longer argue that supply limits are no longer relevant.

Correspondingly, you can also no longer argue with confidence that there can be no crowding out, because the Fed won’t raise rates.

Yes, before you had to argue they’d do less QE to crowd out the fiscal stimulus.

We are, if you like, half-out of the liquidity trap, with one foot on dry land — but the other foot is still hanging over the edge, and it wouldn’t take much to topple us right back in.

What I would argue is that in this murky, fragile situation we should be conducting policy largely as if we were still in the trap — because we badly need to get both feet firmly on dry land with some distance between us and the quicksand.

(The link advocated fiscal stimulus.)  He seems to be arguing that we need fiscal stimulus because we need to raise rates so they we can cut them again if we get into trouble in a few years. That’s 100 times better than arguing the Fed should raise rates so that it can cut them again (an insane idea you sometimes see in the business press), but I still don’t quite buy it.

Fiscal stimulus is a demand-side policy.  It’s not going to have a significant impact on trend RGDP or trend NGDP.  So if we do more fiscal stimulus when unemployment is 4.9%, we probably won’t see dramatically higher nominal interest rates.  I will concede that it’s possible the Fed would have a bit more “conventional” ammo the next time a recession hit (from rates being a bit higher), but that additional monetary ammo would come at the expense of less fiscal ammo.  In Krugman’s view, fiscal stimulus doesn’t come from high G, it comes from rising G.  If we already have high G when we go into the next recession, it’s going to be that much harder to get rising G.  If fiscal stabilization policy is to work it must be countercyclical, that means don’t do it now.  This new “fiscal stimulus forever to put sand under the tires of monetary policy” (my words, not his) seems more than a bit ad hoc to me, a proposal from people who want shiny new airports and high speed rail, and will grasp any half way plausible model to justify that preference.  I put Larry Summers in that camp, maybe even more so that Krugman.

So I don’t think more fiscal stimulus today would make the US economy any more stable in the long run. Instead we’d just be:

Another day older and deeper in debt


So many deranged and unhinged conservative commentators

I’m not the only one who has become deranged and unhinged.  Here’s Howard Kurtz some other mental cases:

David Brooks unloaded in the New York Times:

“With each passing week he displays the classic symptoms of medium-grade mania in more disturbing forms: inflated self-esteem, sleeplessness, impulsivity, aggression and a compulsion to offer advice on subjects he knows nothing about.

“His speech patterns are like something straight out of a psychiatric textbook.”


“He also cannot be contained because he lacks the inner equipment that makes decent behavior possible. So many of our daily social interactions depend on a basic capacity for empathy. But Trump displays an absence of this quality…He is a slave to his own pride, compelled by a childlike impulse to lash out at anything that threatens his fragile identity.”

Charles Krauthammer, perhaps Trump’s most prominent critic on Fox, seemingly uses his training as a psychiatrist to diagnose the candidate:

“It’s that he can’t help himself. His governing rule in life is to strike back when attacked, disrespected or even slighted. To understand Trump, you have to grasp the General Theory: He judges every action, every pronouncement, every person by a single criterion — whether or not it/he is ‘nice’ to Trump.

“This is beyond narcissism…His needs are more primitive, an infantile hunger for approval and praise, a craving that can never be satisfied. He lives in a cocoon of solipsism where the world outside himself has value — indeed exists — only insofar as it sustains and inflates him.”

Some of Krauthammer’s words on Fox are being used in a Hillary ad.

The Wall Street Journal’s Peggy Noonan has jumped on the crazy train:

“Here is a truth of life. When you act as if you’re insane, people are liable to think you’re insane. That’s what happened this week. People started to become convinced he was nuts, a total flake.”

George Will, who took the step of leaving the Republican Party, accuses Trump of practicing “post-factual politics”:

“He seems to understand that if you produce a steady stream of sufficiently stupefying statements, there will be no time to dwell on any one of them, and the net effect on the public will be numbness and ennui. So, for example, while the nation has been considering his interesting decision to try to expand his appeal by attacking Gold Star parents, little attention has been paid to this: Vladimir Putin’s occupation of Crimea has escaped Trump’s notice.

Will says politics is “being poisoned by the injection into its bloodstream of the cynicism required of those Republicans who persist in pretending that although Trump lies constantly and knows nothing, these blemishes do not disqualify him from being president.

If you’d polled conservatives a few years ago, and asked which commentators are the best, these four would probably have made the list.  And note that there are not employed by the media because of their knowledge of the nuances of DSGE models of the economy, they are regarded as shrewd observers of society.

[BTW, isn’t Krauthammer a great name for an austere conservative?]

But now (we are to believe) these four wise, distinguished commentators have all, simultaneously, become as deranged and unhinged as yours truly. Is there some sort of virus going around, causing mass hysteria?

Actually there is, but the people being infected are not the ones who see Trump for what he is.

Bernanke on the Fed’s new view of the economy

Ben Bernanke has a post discussing the Fed’s evolving view of the economy:

I’ll focus here on FOMC participants’ longer-run projections of three variables—output growth, the unemployment rate, and the policy interest rate (the federal funds rate)—and designate these longer-run values by y*, u*, and r*, respectively. Under the interpretation that these projections equal participants’ estimates of steady-state values, each of these variables is of fundamental importance for thinking about the behavior of the economy:

  • Projections of y* can be thought of as estimates of potential output growth, that is, the economy’s attainable rate of growth in the long run when resources are fully utilized

  • Projections of u* can be viewed as estimates of the “natural” rate of unemployment, the rate of unemployment that can be sustained in the long run without generating inflationary or deflationary pressures

  • Projections of r* can be interpreted as estimates of the “terminal” or “neutral” federal funds rate, the level of the funds rate consistent with stable, noninflationary growth in the longer term

He then explain how over the past few years the Fed has tended to consistently overestimate these variables:

Why are views shifting?  The changing views of FOMC participants (and of most outside economists) follow pretty directly from persistent errors in forecasting economic developments in recent years:As the table shows, FOMC participants have been shifting down their estimates of all three variables—y*, u*, and r*—for some years now.

Notice that there is no mention of the fact that the markets, and hence market monetarists, have generally been more accurate than the Fed.  We take financial market predictions seriously, and thus immediately discounted the Fed forecast of 4 rate increases in 2016, made back in December.  Indeed for years I’ve been arguing that the Fed’s dot plot is too optimistic about the Fed’s ability to raise interest rates under its current policy regime.

More than two years ago I suggested that 3% NGDP growth and 1.2% RGDP growth were the new normal, at a time when the Fed was still forecasting considerably higher rates.  Bernanke says the lower natural GDP growth rate is partly due to surprisingly low productivity growth.  Back in 2011, I suggested that we were having a “job-filled non-recovery“, just the opposite of the jobless recovery being discussed by many pundits.  Since then we’ve continued to have a job-filled non-recovery, with faster that expected job creation and a fast falling unemployment rate, accompanied by slower than expected RGDP growth.  This is just another way of saying that productivity growth has been lousy (indeed negative for three quarters in a row.)

It’s nice that the Fed is finally seeing the light on issues that market monetarists have been emphasizing for many years.  But I’d feel better if they took this as a lesson that they need to change their entire operating system, and start relying much more on market forecasts.

Back in 1997, Bernanke published a paper with Michael Woodford (in the JMCB) suggesting that market forecasts could be useful to policymakers, if they revealed information about the impact of different monetary policy instrument settings.  OK, so why doesn’t the Fed take Bernanke’s advice and create a set of prediction markets for inflation and output, one for each plausible instrument setting.

PS.  By “job-filled non-recovery” I did not mean that we were not getting closer to the natural rate, I meant we are not recovering in the sense of going back to the old trend line.  Clearly the labor market has been gradually recovering.

HT:  Bill Beach, Patrick Horan


Stephen Moore on Trump’s new tax plan

Trump’s previous tax proposal seemed like some sort of joke.  The Trump campaign is coming out with a new tax plan tomorrow, and Stephen Moore gives us a preview of some of the highlights:

The heart of the plan is a 15% corporate tax rate.  That’s down from the current rate of 35%.  . . .   And then there will be a middle class tax cut.  Every time we’ve met with him, Trump has said, “I want it oriented toward the individual, helping middle class, and financially stressed out families.”  we’re running the numbers now, and the average middle class family will save somewhere in the neighborhood of $1,500-$2,000 a year on their federal income taxes. It eliminates the estate tax. It eliminates the marriage penalty. It eliminates the alternative minimum tax. About 90% of Americans would no longer have to itemize deductions because they would be able to take a standard deduction.

That sounds great, but of course we can’t afford it.  Interestingly, Moore did not mention any new income tax rates.  My prediction is that the new top income tax rate will be much higher than the 25% top rate proposed by Trump when he was trying to get the GOP nomination.  And it should be higher, given that Trump is not proposing that the income tax be replaced with a consumption tax.  (I say this despite the fact that the 25% top rate was the provision of his previous proposal that would have helped me the most.)  So the new plan will almost certainly be less bad than the old plan.  But it still seems unaffordable.  Moore then responds to questions about the revenue loss:

We will close loopholes on the corporate side. So stuff like investing and green-energy deductions will go away.  The plan will find a way to shift the way the corporate tax is implemented so that it would apply more to imports.  When countries like China, India or Mexico send products into the United States, we wanna tax those then, when American companies export our goods and services, we wanna reduce the tax on them. What we do now is we tax what we export, but we don’t tax what’s imported. This is called the Border Adjustable Tax, and so this will shift that.  When China sends $500 billion worth of goods and service to the United States there will be a tax applied.  This is not a violation of trade agreements. In fact, this is the way most other countries tax their business side, so we’re gonna skip to a border adjustable tax system that will help our exports, and reduce the trade deficit.

He’s right that other countries do things this way.  It’s a good tax proposal if you want to look like you are protecting us against imports, while actually still leaving the tax code neutral vis a vis foreign trade.  It would be like having a 10-cent tax on buyers of gasoline, combined with a 10-cent subsidy to sellers of gasoline.  And it will have little or no impact on the trade deficit.  But that’s good!

Q: Some people estimate the Trump tax plan alone will cost $10 trillion. What about the debt and deficits? Won’t all of this break the bank?

A. On the business side, most of the payoff is through closing loopholes. We do think it’ll generate more economic growth. It’s trickier on the individual side, because the vast majority of revenues that the government raises is not through the business tax, but through the individual income tax system. So we’re talking about some kind of a cap on deductions that people can take, especially wealthy people. This is not well known but there are dozens of loopholes and carve-outs in the tax system. Most of the benefits of those go to the highest-income people. Anyone who makes over $1 million will have most of their deductions phased out. They’re gonna pay a lower tax rate, but they’re gonna lose a lot of deductions. Hillary Clinton is running around the country saying it’s a $10 trillion revenue loss, but that’s not true. We’ve probably reduced the revenue loss to about one-third of that. We are also considering a sort of repatriation tax where companies are charged a small tax to bring the $2 trillion overseas back home. American companies like Microsoft, Apple, so many others have cash abroad.  They’ll be able to bring that money back for a tax of somewhere between 5-10%. that’ll bring a lot of that capital back to the United States and we’ll actually raise revenue. And there’s been some talk about using that money from the repatriation tax to pay for infrastructure spending.

I don’t see how the new plan will reduce the revenue loss to only one third of the $10 trillion (over 10 years) from the previous plan.  I’m skeptical, but we’ll see tomorrow.  Is he adding in growth effects (dynamic scoring?)  Is he counting the tax on repatriated profits?  That’s a one-time lump sum, not an ongoing flow.

Again, the types of reforms being proposed seem good, the problem is revenue. I’m all for eliminating the estate tax, the marriage penalty, the ATM, and replacing itemized deductions with a standard deduction, wherever possible.  I’d especially like to see high tax states like California lose the federal deduction for S&L taxes, even though that might hurt me in a few years.  The 15% corporate rate is also an improvement.  But I’m very skeptical about the numbers.  And the final line about using the repatriated money for infrastructure is just laughable.  We already have a sizable budget deficit, and Trump’s talking about massive tax cuts.  There will be no new money to spend!  The LA Times recently claimed that California’s high speed rail boondoggle is more likely to get built if Trump is president than if Hillary wins. Hillary won’t be able to get anything through Congress, and apparently Trump has a soft spot for really fast choo choo trains.  (FWIW, I support the proposed Dallas–Houston high-speed rail, and oppose the California project.)

Should we believe any of this?  You tell me.  Even Trump’s aides say the new tax plan is radically different from the old one, with just 1/3rd the revenue loss.  So we now know with 100% certainty that nothing Trump said about taxes before the convention can be trusted.  What about promises before he takes office?  I see no reason to take them any more seriously than the previous promises.

PS.  It’s been a while since I took public finance, but I seem to recall the proposed border adjustment tax would cause the dollar to appreciate by 10%. Is that right?

PPS.  I have a post on Fed policy over at Econlog.

Finally, a voice of reason

There’s a flood of articles being written now about central banks running out of ammo (which is of course ridiculous, as they still have massive stocks of paper and green ink.)  Thus I was very pleased when Stephen Kirchner sent me an FT article by Martin Sandbu, which cuts through all of the nonsense. Here’s the subtitle:

The monetary medicine is working. More is needed

There, that’s not so complicated, is it?  Even better, why not change the target so that you don’t have to use so much ammo?  How about level targeting?

There are two common reactions to this continuation of middling (or worse) news. One is to say the medicine is working but the dosage is too low. The other is to say it is not, so we should not expect better results from more of the same. An example of the latter was Michael Schuman’s Bloomberg View column that argues that the BoJ may be demonstrating “the outer limits and ultimate effectiveness of monetary policy”. That is a somewhat paradoxical reading after an announcement that was widely judged — even by Schuman himself — to have offered only minor additional measures.

Exactly.  The BOJ did less than expected.  So why is anyone surprised that the yen appreciated on the news?

There is a simple statistical measure that can make the point: the dollar, euro or yen value of the economies in question — that is to say nominal gross domestic product. In our current predicament with large debt overhangs everywhere holding back economic activity, there is a sense in which policymaking should be easy. NGDP could expand either because of inflation or real growth, but either way faster NGDP growth would be a good thing. If it doesn’t directly reflect greater production of goods on services it helps reduce the debt burden that is limiting the growth of such production. The chart below shows the rate of year-on-year NGDP growth in four economies. The main observation to make is that in the eurozone and Japan, whose central banks have redoubled their stimulus efforts in recent years, NGDP growth has duly picked up. In the US and the UK, where central banks have stood still or moved to tighten, it has been slowing since early 2014.

Monetary policy works and monetary policymakers know it. Which raises the question why do they not do more? That goes for all the main central banks. As Brad DeLong puts it in the US case: “If you had told the Federal Reserve at the start of last December that 2015Q4, 2016Q1, and 2016Q2 were going to come in at 0.9%, 0.8%, and 1.2%, respectively, a rational Fed would not only have not raised interest rates in December, they would have announced that they would not even think of raising interest rates until well into 2017, and they would have started looking for more things they could do that would safely boost demand.” And if that is true, surely they too should now aim to loosen further rather than tighten.

Again, what they really need to do is change the policy regime.  Their current discretionary approach will not work once the next recession arrives. It would be nice if they put NGDPLT in place right now.  Fix the roof while the sun is still shining.

PS.  Now watch everyone skip over my post, and comment on (Trump supporter) Newt Gingrich now saying that Trump is even more unacceptable than Hillary.

PPS.  Maybe Trump is a closet Libertarian.  He knew that Gary Johnson’s only chance of winning was if Trump got the GOP nomination, and then went down in flames.  The master plan is for Trump to pull out of the race in late October, and endorse Johnson.  Republican Hillary voters that were holding their nose will then swing to Johnson/Weld, once Trump has no chance.  Add together Trump voters, Johnson voters, and people supporting Hillary only because they hate Trump, and you might reach 50%.  A Libertarian President!

In my dreams.

PPPS.  Yes, I know, a Johnson/Weld America would be a nightmarish place, where every bakery was forced to carry Nazi wedding cakes.