Archive for April 2017


How bad is the Italian debt situation?

Tyler Cowen recently linked to a John Cochrane post, discussing Larry Kotlikoff’s views on public debt sustainability.  Here’s Cochrane:

(By the way, if you’re feeling superior and taking comfort that Europe will go first off the cliff, Kotlikoff disagrees. Europe’s debts are larger, but their social programs are better funded, so their fiscal gaps are much lower than ours. The winner, it turns out, is Italy with a negative fiscal gap. Answering the obvious question, Kotlikoff offers

“What explains Italy’s negative fiscal gap? The answer is tight projected control of government- paid health expenditures plus two major pension reforms that have reduced future pension benefits by close to 40 percent.”Don’t get sick or old in Italy, but perhaps buying their bonds is not such a bad idea.)

I am a bit skeptical of that claim; so I decided to check with God, er . . . I mean I decided to check with the ultimate arbiter of truth, the asset markets:

Screen Shot 2017-04-24 at 4.13.10 PMAs you can see, Italian 10-year bonds offer considerably higher yields than German, French and Dutch bonds, and even higher yields than Spanish bonds. Italy has a massive public debt (third largest in the world), an economy that has shown almost no growth since 2000, and a very dysfunctional political system (which the voters recently decided not to reform.)

I greatly respect Kotlikoff, and even more so John Cochrane.  But I respect the markets far more than any mere mortal.   So unlike Kotlikoff and Cochrane, I remain relatively pessimistic about the Italian debt situation.

PS.  I am back from 5 days in Turks and Caicos (is there a law in the Caribbean mandating nothing but Bob Marley music at resorts?), and I am starting to get caught up.

I have a new post on Bretton Woods as an example of the guardrails approach to policy, and another post commenting on the French elections.

My guardrails post is intended to address tiresome criticism of NGDP targeting by people who have never bothered to actually read what I have written on the topic. No, neither the current lack of interest in NGDP futures trading nor the risk of market manipulation pose any kind of problem for the system I am actually advocating.  (Unless you believe, “Bretton Woods could not possibly have worked because speculators would have manipulated the market.”)

Most shocks don’t matter

Over the past 18 months we’ve seen three major shocks, each of which were expected to have a significant impact on growth:

1.  The late 2015 Chinese yuan devaluation/capital outflow shock

2.  Brexit

3.  The Trump election

Many people expected the Chinese economy to slow sharply in 2016.  It didn’t.

Many people expected the UK economy to slow sharply after mid-2016.  It didn’t.

Many people expected growth and inflation to rise significantly after Trump was elected.

The third prediction still might come true, but this FT article suggests that investors are moving away from the “reflation” trade.

We are nearing the anniversary of a great market turning point. Like most such turning points, it was not obvious as such at the time, but in early July last year markets reached the lowest point of their fear of deflation — falling prices amid a stagnating economy — and started to position for reflation.

The shock of last summer’s Brexit referendum brought bond yields, the market’s most direct expression of its belief in deflation, to a historic low. The rebound started as the effects of China’s economic stimulus were felt, while it grew clear that Brexit had not sparked a financial crisis.

It gathered momentum after Donald Trump’s victory in the US presidential election. The theory was that the Trump administration would pick up the baton from China, which looks over-leveraged and will soon need to ease off its stimulus, and would bring in its own growth-friendly policies, including tax cuts and infrastructure spending. From “reflation off”, we moved emphatically to “reflation on”.

Stock markets have risen this year, but 2017 has seen a gradual shift back to “deflation-off”. Short-term inflation expectations have moved sharply in recent weeks. The bond market’s implicit forecast for US inflation over the next two years, once at 2.15 per cent, has dropped to 1.35 per cent.

In each case I expected some effect, but less than the consensus.  In the case of China and Brexit, even the very mild slowdowns I predicted proved too bearish. I’ve learned my lesson from Brexit, and in the future will pay no attention to “uncertainty shocks”.  Always a skeptic, I am now convinced that uncertainty has virtually no significant business cycle effects.  And never bet against Chinese growth. Someday it will falter, but no one can predict when.

[In macro, the forecast most likely to be true is, “Not much will change”.  However the way to build a reputation is to forecast dramatic changes.  You will usually be wrong, but the public will forget those mistakes and give you undeserved praise on the few occasions when you are correct.]

I’m sticking with my prediction that Trump’s policies might lead to a couple tenths of a percent faster NGDP growth.  Monetary offset will keep inflation close to 2%, and Trump’s supply-side reforms are likely to be modest (at best).  An extra couple of tenths of one percent NGDP growth is so small it will be almost impossible to tell if I am correct—especially given that growth is likely to slow as we approach full employment.  If there is a recession, however, or 5%-6% NGDP growth persisting for a few years, then I will clearly be wrong.

Maybe the French will give us another shock later today.

PS.  I still believe that Brexit itself will reduce UK growth.  This post discusses the effect of pre-Brexit uncertainty, not Brexit itself, which is still years away.

PPS.  I believe the US should withdraw from the IMF.  Not because the IMF is not good enough for the US, rather because America is not good enough for the IMF. If we don’t leave, I hope the other IMF members expel us:

Finance ministers and central bankers from around the world have dropped a pledge to resist protectionism, in a further sign that the new US administration’s stance on trade is shifting the global debate.

The group from International Monetary Fund member countries issued a statement on Saturday saying they would “promote a level playing field in international trade” but did not reiterate a previous commitment to “resist all forms of protectionism”.

The change of stance mirrors a similar move made by the finance ministers and central bank governors of the G20 countries after they met in Baden-Baden in March. On that occasion, the US was unwilling to endorse forthright language on protectionism.



It was not “inability”

Over at Econlog, I have a post discussing Bernanke’s views on price level targeting.  Here I’d like to nitpick a couple passages from Bernanke’s post:

As price-level targeting and “make-up” policies are closely related, they could be combined in various ways. For example, by promising to return the price level to trend after a period at the zero lower bound, the Fed could use the language of price-level targeting to make precise its commitment to make up for its inability to respond adequately during the period when rates are at zero.

It was not inability to cut rates that prevented the Fed from acting after Lehman failed in September 2008.

It was not inability that caused the Fed to raise the interest rate on reserves in October 2008.

It was not inability that caused the Fed to refuse to cut rates to zero in November 2008.

It was not inability that caused the Fed to refuse to do negative IOR, when Sweden adopted the policy in 2009.

It was not inability that caused the Fed to prematurely end QE1 in late 2009.

It was not inability that caused the Fed to prematurely end QE2 in mid-2011

It was not inability that caused the Fed to prematurely talk about tapering in 2013.

It was not inability that caused the Fed to prematurely raise rates in 2015.

Now Fed policy is roughly appropriate.  But it was obviously too contractionary for many, many consecutive months and years, just as had been the case in Japan.  Just to refresh your memories, Bernanke’s paper that criticized the BOJ on almost precisely the same grounds as I criticized the Fed was entitled:

Japanese Monetary Policy:  A Case of Self-Induced Paralysis?

And the answer he gave was a resounding yes.  That’s not to say the Fed’s job is easy.  I might have done no better than Bernanke, if I were in his shoes.  There are all sorts of political pressures within the Fed and also from the outside.  It’s a very hard job.  But it’s never about inability; it’s about the Fed’s willingness to do whatever it takes.  It’s willingness to show what Bernanke once called “Rooseveltian resolve”.

One other quibble:

Support for a higher inflation target seems to be increasing along with worries about the ZLB. In a recent post entitled “The case for a higher inflation target gets stronger,” Stephen Cecchetti and Kermit Schoenholtz cite four arguments in favor:

  1. the persistent decline in normal interest rates;

  2. findings (like those of KR) that the frequency and severity of future ZLB episodes may be worse than previously thought, even given the low level of normal interest rates;

  3. some evidence, drawn from a study of the 1970s, that the costs of higher inflation might be less than previously believed; and

  4. calculations that suggest that standard inflation measures may overstate actual increases in the cost of living by more than had been understood.

I don’t have a big problem with this, but I don’t really like point four.  If higher inflation is a good idea, it has nothing to do with the fact that “standard inflation measures may overstate actual increases in the cost of living”.  There are several theories about the welfare cost of inflation, but none of them hinge in any way on the question of whether the BLS properly accounts for quality changes, or the substitution effect, or the new product effect.  The welfare costs of inflation have to do with things like menu costs for adjusting prices, or excess taxation of capital income when inflation is high.  Point four creates the misleading impression that economists want to control inflation so that consumers will benefit from a dollar that loses 2% of its purchasing power each year in terms of . . . what?  Utility?

I also disagree with this:

Second, although quantifying the economic costs of inflation has proved difficult and controversial, we know that inflation is very unpopular with the public. This may be due to reasons that economists find unpersuasive—e.g., people may believe that the wage increases they receive are fully earned (that is, not due in part to prevailing inflation), while simultaneously blaming inflation for eroding the purchasing power of those wages.

The thing that is unpopular with the public is called “inflation” by the man on the street, but it has nothing to do with inflation as defined by economists.  I talk a lot about how the American public in 1990 thought inflation was higher than in 1980.  But an even better example occurred in Europe, where polls showed that Europeans believed that inflation jumped dramatically after the euro was introduced.  I had European students tell me this with a straight face, back when I taught at Bentley.  I’m not sure what Europeans were annoyed about in 2002, but it was not “inflation” as the concept is understood by economists.  We need to stop trying to please a deeply confused public that doesn’t understand our terminology, and instead produce a macroeconomic environment with stable NGDP growth, stable growth in incomes, and stable employment growth.  They liked it in the 1990s, and they would like it now.

I vaguely recall reading that there were more complaints about inflation than deflation during the Great Depression.  (Can someone confirm?)

PS.  Here’s today’s headline from the FT:

Sign ‘Trumpflation’ sputtering as consumer prices fall

I’m still skeptical of the Trump reflation story.  Monetary offset is still in place, and supply side gains are likely to be a couple tenths of a percent at best, assuming he can get anything through Congress.

HT: rtd

Why Trump might keep Yellen

Many commenters have taken it as a given that Trump will replace Janet Yellen next year.  I certainly think that’s possible, but I’ve also argued that he might reappoint Yellen.  Now that seems a bit more likely:

Mr Trump has been highly critical of Ms Yellen in the past, saying that the Fed’s low interest rate policy had hurt savers.

He has also indicated that he would not nominate her for a second four-year term when her current one expires in February 2018.

But in Wednesday’s interview he said he now liked “a low-interest rate policy” and “respects” the Fed chair.

He also said she would not be “toast” when her current term ended, although he added: “It’s very early.”

The reason is simple.  When Trump asks his advisors for some possible names to replace Yellen, he’ll be given a list of conservatives.  Then Trump will ask whether interest rates will be lower under Yellen or under the conservatives.  The advisers will respond “Yellen”.  Trump will then say “Then why don’t we just stick with Yellen?

PS.  A few months ago I got a lot of grief from Trumpistas for suggesting:

1.   Flynn and Bannon are extremists and should not be on the NSC.

2.  Trump is just as militaristic as Hillary.

3.  Although China’s occupancy of some tiny uninhabited atolls is unfortunate and illegal, it’s trivial compared to what Russia is doing in the Ukraine and Syria.  Contrary to what Bannon claims, Russia’s the real threat.

4.  NATO is the most successful alliance ever, and is certainly not obsolete.

Now we read:

Trump spoke glowingly on Wednesday of a personal connection with Xi that he said had developed during the two days that the Chinese leader visited over the weekend.

“We had a very good bonding. I think we had a very good chemistry together,” Trump said of his time with Xi during a joint press conference with NATO Secretary General Jens Stoltenberg.

Trump, who added that he was “very impressed with President Xi,” repeatedly stated that he thought the Chinese leader had good intentions toward the United States. “President Xi wants to do the right thing,” Trump said. “I think he wants to help us with North Korea. … I think he means well, and I think he wants to help.”

There were other signs of goodwill between the Trump administration and China on Wednesday. Trump told the Wall Street Journal that he would reverse his previous pledge to label China a currency manipulator, which had been a cornerstone of his argument that China was cheating the U.S. and depriving American workers of jobs.

As for Russian President Vladimir Putin, a man that Trump has often spoken of in equally glowing terms, Wednesday’s assessment was not as kind.

“I don’t know Putin,” Trump said, before pivoting back to praise Xi, as well as NATO itself, in another sign of shifting relations between the White House and Russia.

Standing next to NATO’s top official, Trump said the European alliance that exists to counter Russian aggression was “no longer obsolete,” reversing himself on a term he’d used as recently as January to describe the group.

In Moscow, meanwhile, Secretary of State Rex Tillerson met with Putin for nearly two hours before declaring that “the current state of U.S.-Russia relations is at a low point.”

Trump himself added that “we may be at an all-time low in terms of relationship with Russia.”

I know it’s poor taste to rub “I told you so” into people’s faces; but in the case of alt-righters I’m willing to make a exception.

New predictions; contrary to campaign promises:

Trump won’t significantly change our trade relationship with Mexico and China.  China is not a “currency manipulator”.

Trump won’t do anything significant to help blue-collar workers.

Trump won’t repeal Obamacare, at best he’ll modify it.

Trump won’t significantly change immigration policy.

Trump won’t pay off the national debt.

Trump won’t significantly improve the economy.

Trump will hurt the GOP in the 2018 midterms.

Basically, Trump won’t Make America Great Again.  Instead he’ll mostly maintain Obama’s policies.  The economic performance will be similar to what it was under Obama.

Trump is bad in just about every possible away a person can be bad.  Fortunately some of those bad characteristics offset.  Thus his bad policy ideas are offset by his complete incompetence, which forces him to rely on experts.  Thank God there are damn few alt-righters who have the expertise required to be top policymakers.  It looks like people like Jared Kushner and Gary Cohn (who are basically Democrats) will run the show.

PPS.  I have no sympathy for that United Airlines passenger.

HT:  Saturos

Is the public opposed to NGDP targeting?

I just listened to a very interesting Macro Musings podcast—with David Beckworth interviewing Tyler Cowen.  Tyler sees the Fed passivity during the last decade as part of a broader increase in risk aversion across American society, part of what he calls the rise in complacency.  I like that hypothesis, and look forward to reading his new book on my vacation next week.

I’m less convinced by his argument that this also explains the public’s obsession with low inflation, and refusal to contemplate NGDP targeting.  I would argue that the public is not opposed to NGDP targeting, indeed they’ve never even heard of the idea.  So let’s try to disentangle what Tyler had in mind in his comments on this subject:

1.  The public might prefer the specific policy of inflation targeting to the specific policy of NGDP targeting.

2.  The public might prefer the outcome (in terms of economic performance) of inflation targeting over the outcome produced by NGDP targeting.

The first interpretation is a complete nonstarter.  If you asked the average American to discuss strict inflation targeting, flexible inflation targeting, symmetric inflation targeting, asymmetric targeting, growth rate targeting, level targeting, etc., you’d produce a glazed look on their faces.  And even that understates the problem.  Most people only understand the concept of supply side inflation; they have absolutely no understanding of demand side inflation.  Hence they think inflation is bad because it lowers their real income, but that’s only true of supply side inflation.  Even worse, the Fed only controls demand side inflation, so Fed policy has no impact on the only kind of inflation the public understands.  I used to ask my class whether the cost of living had actually increased if both wages and prices rose by exactly 10%.  And over 95% always got it wrong, claiming that the cost of living had not actually increased.  (Actually, it rose by 10%.)

And even that understates the problem, because very few Americans even understand that the Fed can choose between 2% and 4% trend inflation like someone choosing between massaman curry and pad thai for their entree.  They don’t know that that is what the Fed does.  How many Americans know that the Fed’s tight money caused the Great Recession?

So I’m going to assume that what Tyler meant was that Americans would be happier with the outcome of inflation targeting as compared to the outcome of NGDP targeting.  I doubt that.  People might say they prefer 0% inflation to 2% inflation, but I doubt that they’d say they prefer America’s 2009 economy to its 2007 economy.  But the 2009 economy is what you get when you reduce inflation to 0%.  Actually, we were much closer to NGDP targeting in the period before 2007 than in the years immediately after 2007.  And yet Americans seemed much more unhappy with the post-2007 economy.  Now of course it’s entirely possible that if the Fed had kept NGDP growing at 5% after 2007, the public would have been even angrier than they were with the actual policy (a fall of 3% in NGDP between mid 2008 and mid-2009.)  But I doubt it.  I think they would have been a bit disgruntled by the stagflation, but nothing more.

Both David and Tyler believe that the Fed now views 2% inflation as a ceiling, not a symmetrical target.  I’m still not convinced; let’s look at this again in 10 years.  If it’s still a ceiling, I’ll throw in the towel.  It was clearly a symmetrical target before 2007—why would the Fed have suddenly changed?

PS.  David and Tyler also discussed the declining rate of innovation in the arts.  Here’s a quote from a different Tyler Cowen interview:

If you think about Renaissance Florence, at its peak, its population, arguably, was between 60,000 and 80,000 people. And there were surrounding areas; you could debate the number. But they had some really quite remarkable achievements that have stood the test of time and lasted, and today have very high market value. Now, in very naive theories of economics, that shouldn’t be possible. People in Renaissance Florence, they didn’t produce a refrigerator that we’re still using or a tech company that we still consult.

But there’s something different about, say, the visual arts, where that was possible, and it was done with small numbers. So there’s something about the inputs to some kinds of production we don’t understand. I would suggest if we’re trying to figure out, like what makes Silicon Valley work, actually, by studying how they did what they did in the Florentine Renaissance is highly important. You learn what are the missing inputs that make for other kinds of miracles.

That’s an interesting point–future generations will be more interested in our art than our technology.

Here’s another question to consider. In the arts, there are periods of rapid innovation (the Renaissance), followed by periods of stasis. In David’s interview, Tyler cites the rapid innovation in pop music during the 1960s, relative to the slower innovation today. Is that different from the observation that explorers no longer discover as many new lands as they did in the heyday of Portuguese and Spanish exploration?  Are we less talented at exploration, or are there simply fewer as yet undiscovered lands? Perhaps the analogy is silly, but let’s take it a step further.  The discovery of new planets, and the technology that allows us to get there, would presumably lead to another Golden Age of discovery.  Doesn’t the invention of new art forms (the novel, film, electronic music, etc.) open up vast new fields for artistic discovery? Isn’t Robert Gordon’s argument that innovation in existing fields has diminishing returns, and that we need to develop entirely new fields to supercharge innovation?  Thus we understand the physics of the non-microscopic world so well that it’s getting really hard to radically improve our houses, cars, airplanes, ships and washing machines.  The only area of rapid innovation is at the microscopic level (biotech, computer chips, etc.), which opened up only in the past 50 years or so.  Gordon doesn’t expect more such fields to open up, and thus predicts diminishing rates of innovation in the fields that we already have.  (I’m agnostic on that claim.)