Archive for October 2016


The Fed’s bizarre call for infrastructure spending

Here’s something that caught my eye:

Federal Reserve officials are increasingly making the case that Congress should spend more money to stimulate the economy, with an eye on the infrastructure package that could hit the agenda next year.

Federal Reserve Chairwoman Janet Yellen and Vice Chairman Stanley Fischer have both nudged Congress in recent speeches. They said federal spending that bolsters demand and increases the labor force would take pressure off of monetary policy and help grow the economy.

“There are ways in which the response of fiscal policy to shifts in the economy could be strengthened, which could help take some burden off of monetary policy,” said Yellen in a September press conference.

“Fiscal policy has traditionally played an important role in dealing with severe economic downturns,” said Yellen in an August speech, suggesting work on “improving our educational system and investing more in worker training; promoting capital investment and research spending, both private and public; and looking for ways to reduce regulatory burdens while protecting important economic, financial, and social goals.”  (emphasis added)

I don’t use the term ‘bizarre’ lightly, as this stuff is not just wrong, or doubly wrong, it’s quintuply wrong.  It’s not even slightly defensible:

1.  The Fed claims the economy does not need any more demand stimulus.  Indeed any boost to AD from more spending would be offset by tighter money.  So what’s the point?

2.  Even if fiscal stimulus were needed, it should be done via tax cuts.  It’s not efficient to vary spending for anything other than standard cost/benefit reasons, where benefits do not include demand stimulus.  And why should the central bank be telling Congress where to spend money?

3.  The Fed might respond that fiscal stimulus would not boost demand, but it would allow the current demand to be achieved with less monetary stimulus.  But why is that desirable?

4.  The Fed might argue that it would prefer a higher trend rate of nominal interest rates, so that it hit the zero bound less often in future recessions.  But fiscal stimulus is an absolutely HORRIBLE way to achieve that objective:

a.  Fiscal stimulus can only boost nominal interest rates by raising the global real rate of interest.  Just imagine how much fiscal stimulus it would take to boost the global real rate of interest by even 100 basis points.  (Hint: far, far beyond anything Congress would ever contemplate.)  Then think about how Japan did a massive amount of fiscal stimulus in the 1990s and 2000s, and ended up with some of the lowest interest rates the world has ever seen.

b.  In contrast, monetary stimulus can easily raise nominal interest rates by 100 basis points, merely by raising the inflation target from 2% to 3%.  So why would the Fed prefer fiscal stimulus as a way of raising nominal rates?  Is the Fed seriously arguing that the sort of fiscal stimulus needed to boost global real interest rates by one percent is more efficient than simply raising the inflation target by 1%?  And if so, why is it that when inflation targeting was first being discussed and implemented in the 1990s, all of the academic discussion focused on the importance of setting the inflation target high enough to avoid the zero bound problem, and approximately zero effort was devoted to the idea that fiscal stimulus could raise the long term trend real interest rate, if the zero bound were a problem.  Were the economists of the 1990s stupid?

5.  Economists agree, or used to agree that the US and other developed countries face severe long-term fiscal changes, due to an aging population.  The consensus is, or used to be, that now is a good time to start addressing these issues. (Remember Simpson/Bowles?) It would be one thing if the Fed were proposing a short-term fiscal stimulus to boost demand right now.  But they aren’t, they don’t think we need more demand right now. Instead they are proposing a long-term fiscal stimulus, which would massively worsen the already worrisome long-term fiscal trends in America.  A decade ago, sensible economists (like Krugman) criticized these sorts of proposals as reckless, and they were right.  Japan has already shown that decades of fiscal stimulus do nothing to raise NGDP growth, and merely leave you with a higher debt/GDP ratio.  Why would we want to copy Japan’s failed experiment?  All they ended up with is lots of highway projects that are little used, and destroyed some of the once beautiful Japanese countryside.

6.  What does improving education have to do with fiscal stimulus?  The US already spends more on public education than most countries, and education experts seem to agree that the real problem is poorly designed schools or bad home environment, not lack of money.  Would throwing a few more billions of dollars at the LA school system boost growth?  Would it turn the LA system into the Palo Alto system?  How?

The passage I quoted is modern progressivism at its worst.  A lot of nice sounding bland generalities, that mean nothing.  I mean seriously, “working training”?  What a brilliant idea!!  Amazing that humanity never thought of that before, in 5000 years of human history. While we are at it, let’s reduce federal spending by 10% solely by cutting “waste, fraud and abuse”, without touching any “needed programs”.

And if the Fed is so worried about unemployment, how about telling the government not to raise the minimum wage to $15/hour?  Let me guess, that would not sound progressive.

Why macroeconomists need to study history

One of the ways that macro differs from micro is that macro is essentially a branch of history.  Micro is not.  And yet today’s macroeconomists often have not studied monetary history.  Marcus Nunes and Ramesh Ponnuru directed me to a paper by White House economics advisor Jason Furman:

A decade ago, the prevalent view about fiscal policy among academic economists could be summarized in four admittedly stylized principles:

1. Discretionary fiscal policy is dominated by monetary policy as a stabilization tool because of lags in the application, impact, and removal of discretionary fiscal stimulus.

2. Even if policymakers get the timing right, discretionary fiscal stimulus would be somewhere between completely ineffective (the Ricardian view) or somewhat ineffective with bad side effects (higher interest rates and crowding-out of private investment).

3. Moreover, fiscal stabilization needs to be undertaken with trepidation, if at all, because the biggest fiscal policy priority should be the long-run fiscal balance.

4. Policymakers foolish enough to ignore (1) through (3) should at least make sure that any fiscal stimulus is very short-run, including pulling demand forward, to support the economy before monetary policy stimulus fully kicks in while minimizing harmful side effects and long-run fiscal harm.

Today, the tide of expert opinion is shifting the other way from this “Old View,” to almost the opposite view on all four points.

I think this is right, but where Furman and I differ is on the desirability of this shift.

Furman refers to the view “a decade ago” but he might just as well have said 90 years ago.  The New Keynesian consensus is actually not all that far from the views of progressive economists back in the 1920s, which favored a price level target and were skeptical about fiscal policy.  After the 1930s, opinions moved in the old Keynesian direction.  It wasn’t until the 1960s that the tide started swinging away from the “vulgar Keynesian” view that fiscal policy was more important than monetary policy.  Friedman and Schwartz started he counterrevolution, and by the 1990s it was pretty much complete.  Stabilization policy should rely on monetary policy.

And now we have still another swing of the pendulum, back toward the old Keynesian views of the post-1936 period. Here’s Furman:

The New View of fiscal policy largely reverses the four principles of the Old View—and adds a bonus one. In stylized form, the five principles of this view are:

1. Fiscal policy is often beneficial for effective countercyclical policy as a complement to monetary policy.

2. Discretionary fiscal stimulus can be very effective and in some circumstances can even crowd in private investment. To the degree that it leads to higher interest rates, that may be a plus, not a minus.

3. Fiscal space is larger than generally appreciated because stimulus may pay for itself or may have a lower cost than headline estimates would suggest; countries have more space today than in the past; and stimulus can be combined with longer-term consolidation. 

4. More sustained stimulus, especially if it is in the form of effectively targeted investments that expand aggregate supply, may be desirable in many contexts.

5. There may be larger benefits to undertaking coordinated fiscal action across countries.

Those old Keynesian views of the late 1930s were rejected for lots of good reasons.

I’m not quite sure what is more humiliating for the profession of macroeconomics:

1.  That we keep making the same mistakes, over and over again.

2.  That we change our views of macro on “new information”, which in fact is not new to anyone with an even passing interest in macro history.  (I.e., who know that the temporary QE of 1932 had little impact, just as the more recent temporary QE had little effect.)

3.  That we don’t pay attention to the empirical studies that refute old Keynesianism.

4.  That many macroeconomists are not even aware of the cyclical nature of their field.

It’s not unusual to find this sort of cyclicality in the arts.  For instance, in the arts there are swings back and forth between a more “classic” style and a more “romantic” style.  But it’s kind of embarrassing to see this in a science.

(And don’t embarrass yourself by arguing macroeconomics is not a science.  Of course it’s a science.  It’s failed science, but then so are some of the other sciences, at least based on what I’ve read about the crisis in replication.  The term ‘science’ is not a compliment, it’s not some sort of award given to a field, like a Nobel Prize.  It’s simply a descriptive term for a field that builds models that try to explain how the world works.  Saying that science must be successful to be viewed as science is as silly as saying that a work of art must be good to be considered art.)

We need a “timeless” macro.  That is, theories should not be developed to meet the specific conditions in the economy, at that moment.  And yet that’s exactly what old Keynesianism is, which is why it goes in and out of style.  Instead, theories should be developed to explain the entire history of macroeconomics—the full data set.  If your model is not good at explaining hyperinflation, stagflation, liquidity traps and the Great Moderation, then it’s not a good theory.

Old Keynesianism is not a good theory.

PS. I’d like to congratulate Ben Klutsey for winning the Great Communicators Tournament in Washington DC on Wednesday night. Some of you may know that David Beckworth and I both participate in the Mercatus Center’s Program on Monetary Policy. Unfortunately we both live some distance from the headquarters in Arlington, VA. Ben is the program’s manager, and does a lot of the behind the scenes work that readers might not be aware of. I feel lucky to work with someone who is both a very nice guy and a highly talented manager.

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Also congratulations to runner-up Charles Blatz, another Mercatus employee.

A few thoughts on the election

The press continues to write stories suggesting it is basically over, even as the betting markets show otherwise.  Weird.

If Trump loses, there will be post-mortems claiming that Trump brought new people into the GOP, and that they need to appeal to these Trump voters in the future.  Maybe, but I’m skeptical.

Let’s assume the current polls are correct.  Trump is crushing Hillary in West Virginia by 24 points.  Doesn’t that show his support among downscale white voters?  The problem here is that snobby, elitist, don’t care about the 47% Mitt Romney won West Virginia by 26%.  Downscale whites have been trending toward the GOP for decades.  The real problem is that the GOP must win back the well-educated professionals of Virginia, which has turned blue as the hillbilly state trended red.  To do that they need two things to happen:

1.  The Dems must screw up.

2.  The GOP must nominate a candidate that appeals to smart, non-racist/sexist, fiscal conservatives (both Republican and independent professionals).

Parties often take power just four years after being totally crushed by the voters (think 1932, 1968, 1976.)  Trump will probably lose by about 6%. The GOP is still on track to win about 50% of the elections this century.

The race this most reminds me of is 1972.  There was a candidate who was viewed (wrongly in my opinion) as being totally out of the mainstream, totally unacceptable.  So much so that even many leaders in his own party abandoned him. The other candidate was seen as somewhat dishonest and corrupt, but people held their noses and voted for the lesser of evils.  After the election, the winning candidate faced more and more disclosures of corruption, on an issue that was already apparent before the vote, but overshadowed by the controversial nature of the losing candidate.  Then the economy got much worse, due to the statist policies of the winning candidate.  The losing party came back to capture the White House in the next election, after crushing the opposition party in the midterms.

Will history repeat?  Probably not, but FWIW, I do not believe that scandals are exogenous shocks.   There are certain environments where scandal becomes an endogenous response to events.  After wars, there may be a period when self-righteous people go after “enemies” (anarchists after WWI, commies after WWII, Nixon after Vietnam.)  In France, they went after “collaborators” after WWII. If a scandal occurs when people are not in a scandal mood, then the impact is muted.  People just didn’t want to hear about Harding’s problems in the booming 1920s, so the GOP won by a landslide in 1924.  In 1998, people just didn’t want to hear about Clinton’s sex scandals, as the economy was doing great.  So he dodged impeachment. Nixon was not so fortunate.  I’m not trying to defend Nixon (one of our very worst Presidents, and especially corrupt) but there were also abuses of power under people like LBJ and FDR, but the public was not in the mood to hold them to account.

Hillary will face some difficult challenges.  An economy that desperately needs supply-side reforms, and a party base under her that desperately wants to dramatically worsen the supply-side of the economy.  Add in an opposition party that despises her.

I wish her good luck, but I still see a one-term president.

[This post was written before the recent FBI revelation.  There is no longer any doubt in my mind that the stock market favors Hillary—stocks dropped suddenly on the news around 1pm, and Trump’s chances of winning are up to 23.5%.  If I thought Hillary was likely to be impeached within six months, that would make me more likely to vote for her.  Ditto for Trump.]

PS.  This guy’s tweets are funny:

As a woman inches closer to the White House, news is dominated by sexual misconduct of her opponent, her husband and her aide’s husband.

Also check out the clip from the Big Lebowski (and classic early Cary Grant).

And some of the retweets:

Everyone thought the Anthony Weiner subplot was irrelevant, but the writers found a clever way to tie it to the main story’s season finale

No sign yet of the UK “uncertainty shock” recession

I’ve done a number of posts over at Econlog on the massive uncertainty shock that hit the UK in June.  Most experts expected real GDP growth to immediately slow sharply, perhaps leading to a recession.  I had an agnostic view, and thought any negative effects were more likely to show up in lower RGDP than higher unemployment.  I still feel that way, although I’m starting to think that even RGDP will do better than I assumed:

The UK’s first official growth figures since the Brexit vote have confounded the government’s warnings of an immediate recession if Britain voted to leave the EU.

The economy was 0.5 per cent larger between July and September than three months earlier, according to the Office for National Statistics. The Treasury had predicted it would shrink 0.1 per cent.

[Those are quarterly figures, roughly a 2% annual rate.]  Why is the UK doing better than predicted?  I can’t be sure, but one possibility is that the BoE’s monetary offset was more effective than expected.  The British pound has depreciated sharply, even more than people expected:

“We would not get too carried away,” said Ruth Gregory of Capital Economics. “It could be that the economy is in a post-referendum ‘sweet spot’, whereby some of the positive developments since the vote, such as action by the MPC [BoE] have been felt before the major adverse consequences, such as a rise in inflation.”

I think that’s right, and I also still believe the actual Brexit (which will occur in about 2 1/2 years) will be modestly negative for growth.  But I can’t help pointing out that the only reason I think she’s right is because I totally reject the consensus of the economics profession on long and variables lags in monetary policy.  I believe that monetary policy affects NGDP within a month or two.  If I agreed with the consensus on lags I would have thought Ruth Gregory’s explanation was nonsense, and I would have looked for another explanation.  Those who do agree with the consensus on long and variable lags need to figure out how the UK economy held up after the Brexit vote.

To summarize:

1.  Brexit is an uncertainty shock, followed in 3 years by a real shock.

2.  The uncertainty shock might depress the economy by reducing AD (NGDP) or by reducing AS.  The central bank can prevent any reduction in NGDP.

3.  It appears that the impact of severe uncertainty shocks on AS is rather modest, although we’ll need another 6 months of data to have confidence in that preliminary judgment.

If the UK economy holds up, it will be further evidence that monetary policy drives the business cycle, especially in terms of changes in the unemployment rate.

That does not mean AS is not important, indeed in the long run it’s 10 times more important.  I.e. the US in a recession is more than 10 times better off than India in a boom.  Brexit still may have a long run negative supply-side impact on the UK; the size of the impact will depend partly on the sort of treaty they negotiate with the EU, and partly on how the political changes in the UK triggered by Brexit affect its economy.  My hunch is that the latter effect will be larger.  That is, the damage to Britain from May’s statist policies will exceed the damage from losing free access to the EU.

PS. It would be nice if the UK government had a NGDP prediction market, so that we’d know what the markets expected immediately after Brexit.

Beckworth and Hendrickson on NGDP targeting vs. the Taylor Rule

David Beckworth and Josh Hendrickson have a new working paper at Mercatus.  Here is the abstract:

Some economists advocate nominal GDP targeting as an alternative to the Taylor rule. These arguments are largely based on the idea that nominal GDP targeting would require less knowledge on the part of policymakers than a traditional Taylor rule. In particular, a nominal GDP targeting rule would not require real-time knowledge of the output gap. We examine the importance of this claim by amending a standard New Keynesian model to assume that the central bank has imperfect information about the output gap and therefore must forecast the output gap based on previous information. Forecast errors by the central bank can then potentially induce unanticipated changes in the short-term nominal interest rate, distinct from a standard monetary policy shock. We show that forecast errors of the output gap by the Federal Reserve can account for up to 13 percent of the fluctuations in the output gap. In addition, our simulations imply that a nominal GDP targeting rule would produce lower volatility in both inflation and the output gap in comparison with the Taylor rule under imperfect information.

It seems to me that this argument is becoming increasingly persuasive over time.  Both the natural rate of interest and the output gap are increasingly difficult to estimate, as both the natural rate of interest and the trend rate of growth seem to be becoming increasingly unstable.

Speaking of David Beckworth, I’ve enjoyed listening to his podcasts of people in monetary economics/finance.  The latest with Narayana Kocherlakota is particularly interesting, as it gives listeners a perspective on what things seem like for someone on the inside of the Fed.  (He recently retired as the Minneapolis Fed President.)