Archive for December 2018


Bad advice from the Financial Times

The Financial Times is hardly alone in misdiagnosing Japan’s problems, but I can’t resist commenting on this misguided advice from the Editorial Board:

Yet it is still puzzling that such an extreme monetary policy, which has seen the assets of the BoJ rise to an extraordinary level of 100 per cent of gross domestic product, has had so limited an effect on inflation. One reason is that it has not led to overheating of the economy. Another is that the exchange rate against the US dollar has actually appreciated since 2015. A still more important reason must be that inflation expectations became so stubbornly anchored at close to zero. . . .

At the same time, it [the BOJ] will probably need more help from the government. The proposed increase in the consumption tax in October of next year needs to be abandoned until the inflation target is reached. Indeed, the idea that the best target for increased taxation is consumption makes no sense in a country with such exceptionally low shares of consumption in GDP. It would be far better to tax something else, such as undistributed and uninvested profits. It is also possible that explicit resort to “helicopter money” will be required. The aim now should not just be for the BoJ to keep carrying on, but for the government to co-operate fully with it, to lift Japan out of its deflation trap.

“Extreme monetary policies” are exactly what you get when a contractionary monetary policy drives NGDP growth over several decades to the lowest rate ever seen in any country in modern history.  It’s not “puzzling” that this policy is associated with low inflation.

The proposed solutions are exactly backwards.  Japan should increase its consumption tax next year because it needs the revenue and this is one of the most efficient of all taxes.  Or perhaps I should say the least bad tax.  Of course if they wish to cut spending instead, that would be fine.  But there’s almost no chance of that occurring, and a tax increase is less bad than an exploding debt.  A helicopter drop is just more fiscal stimulus, piled onto a public debt that is already roughly 250% of GDP.  Taxes on capital income are much less efficient that consumption taxes, and Japan’s consumption is not an “exceptionally low share” of GDP:

Screen Shot 2018-12-17 at 11.51.45 AMThe BOJ should instead adopt a more expansionary monetary policy combined with fiscal austerity.  There are many options, including NGDP level targeting.  As for the policy instrument, I suggest either exchange rate targeting, or a “do whatever it takes” approach to QE.  So far, the BOJ has refrained from either approach.  If the BOJ prefers a smaller balance sheet, then they should set a higher NGDP (or inflation) target.  And by all means, shift from growth rate targeting to level targeting.

Of course the “concrete steppes” crowd will whine “but they’ve already done so much . . . ”  Nonsense.  As Yoda said:

Do. Or do not. There is no try.

Off topic, Trump believes that Fed decisions on the proper level of IOR should be determined by car bombings in Paris:

“It is incredible that with a very strong dollar and virtually no inflation, the outside world blowing up around us, Paris is burning and China way down, the Fed is even considering yet another interest rate hike. Take the Victory!,” he said in a tweet just a day before the start of the final Fed policy meeting of the year.

America cities were burning in 1967 and 1968.  And what happened to inflation?

(And please don’t comment on whether it makes sense for the Fed to raise interest rates. Leave that for another post.)

“Yes, we can” in a deterministic universe

If you make policy suggestions to Europeans, they’ll tell you that they can’t do that.

Consider the problems that the ECB is having raising the core inflation rate closer to 2%.

Why not do unlimited QE? — “We can’t do that”
Why not raise the inflation target? — “We can’t do that”
Why not level targeting? — “We can’t do that”

They can’t do anything that would actually work.

Consider the problem of sluggish growth.

How about injecting dynamism into France and Italy through supply-side reforms? — “We can’t do that.”

Consider the Brexit fiasco.

How about a better Brexit, say the Norway option? — “We can’t do that.”
How about another Brexit referendum? — “We can’t do that.”

There a sense in which the naysayers are right. In politics, the law of large numbers is very powerful. Things happen for a reason. Options are not chosen because there currently is not enough support for those options.

So what is to be done? One solution is to look for alternative solutions that are politically feasible. But those do not exist. For the moment, there is no hope for Europe. There is virtually no chance that Europe will snap out of its malaise in the next three days.  They won’t do any of the things that might work.

As we look further out into the future, however, things gradually become more hopeful. The longer the malaise continues, the greater the appetite for changes that currently are not politically feasible.

The solution is not to look for alternatives to sound economic policies; there are no alternatives. Fiscal stimulus will not get Europe to 2% inflation. Rather, the solution is to keep beating our heads against the wall, day after day and year after year, until the time is right for effective solutions to be adopted. NGDP targeting plus free market reforms. That’s what I’ll keep promoting. The zeitgeist determines the policy mix; there’s nothing I can do about that. The universe is deterministic. But I can affect the zeitgeist, at least a tiny bit.

You can too.

My views on foreign policy

Many commenters have great difficulty understanding my views on foreign policy.  I presume this is because many (most?) commenters think this way:   “Sumner said X.  People who say X usually believe Y.  Therefore Sumner thinks Y”.  That might work for most people, but it doesn’t work for me.  Actually, my views on foreign policy are boringly conventional and quite moderate:

1. Some of my commenters accuse me of being a bloodthirsty warmonger, because I support NATO.  I.e., I think we should go to war against Russia if they invade Estonia.  I also think we should go to war against China if they invade Japan or Australia, due to our defense treaties with Pacific powers.  I like mutual defense treaties among countries that have their act together.  AFAIK, it’s the only “foreign policy” that seems to consistently work.  They are one of humanity’s greatest achievements.

2. Another group of commenters think I’m a lily-livered, Neville Chamberlain appeaser, because I don’t wish to go to war against China over Taiwan or Xinjiang.

3.  Another group thinks I don’t care about human rights abuses in foreign countries, even though I passionately care about human rights abuses in foreign countries—far more than 90% of Americans, and infinitely more than Trump—who is quite upfront about not caring at all.  Reading about the Rohingyas and the Yazidis literally brings tears to my eyes.  I care so much about foreigners that other commenters say I’m not patriotic enough, putting the interests of the most oppressed people in the developing world ahead of red-blooded Americans.  I can’t win.

4.  Another group claims I don’t believe that distinct regions should be free to secede from larger entities, even though I’ve expressed support for peaceful examples of secession, as with the Czechoslovakia.  They confuse my statements about the current agreed upon rules of international law (no secession without consent) with my personal views as to what sort of world would be best.  My claim that Taiwan would be foolish to secede from China without their permission, thereby triggering a horrific war, makes me a Chinese apologist in their view.  Taiwan already has all the advantages of de facto independence, and is fortunately too smart to take the advice of my rash commenters (safely out of harms way) and commit mass suicide by seceding. While I have no problem with the idea of an independent Taiwan achieved peacefully with Beijing’s consent, the US should tell Taiwan “If you formally secede, you’re on your own.”  I’d guess we already have.  And in any case, Taiwan is currently doing fine.  If it ain’t broke, don’t fix it.

Are there other occasions where you might want to use military force, beyond mutual defense treaties?  As a utilitarian I cannot say there are no circumstances where military force is appropriate, but I’m generally almost as skeptical as Bryan Caplan.  Perhaps military force should be used to stop extreme human rights abuses like genocide.  But how many now favor a US invasion of Myanmar, where the government is massacring the Rohingyas?  There are enormous practical problems with that policy option. Saddam Hussein had an appalling record in many different dimensions, and indeed in 2003 I thought there was a pretty good utilitarian case for getting rid of him.  (I wrongly assumed a quick war like the 1991 Gulf War.)  The 2003 Iraq War obviously turned out to be a disaster, and this has helped to shape my views on foreign policy.

I’m now more skeptical of the hawks than before.  History is full of examples where the hawkish stance turned out to be a complete disaster (1914, Vietnam, Iraq War, etc.)  Even cases where we had a quick victory (Spanish-American War) look like clear mistakes in retrospect.  People often point to 1938 as an example of the doves being wrong.  But even there, a hawkish stance by Chamberlain would have merely triggered the “Phony War” portion of WWII a year earlier, resulting in a less clear cut historical record that the Nazis were 100% the aggressors.  Would you want a modern Germany full of Germans who feel that Germany was picked on twice?  So I still say we should use the military primarily for self (or mutual) defense, and any other use should be exceedingly rare. Countries allowed into mutual defense pacts should be free of ongoing border disputes.

There’s a better case for using economic sanctions as a foreign policy tool.  But here again, the historical record is quite unimpressive.  Yes, the sanctions against South Africa may have contributed to the end of apartheid.  But for every success like that there are far more failures, such as the Cuban sanctions.  If you are using sanctions because of human rights abuses in the targeted nation, the goal should be to make the people in the targeted nation better off.  Thus it helps if you have popular support, which seems to have been the case in South Africa (but not Cuba.)

As an example, I’d guess that 98% of the Chinese public would oppose Western economic sanctions.  The Chinese are very nationalistic and intensely feel the humiliation imposed on them by Western powers in the 19th century.  None of that may matter to you, but it will definitely impact the effectiveness of any sanctions that try to force China to change its ways.  US sanctions on China will certainly make the US worse off, and certainly make China worse off in the short run, and definitely make China more prickly and nationalistic.  For that sort of “human rights” policy to pass the utilitarian test you’d need a series of political changes in China that are about as likely as making a 4 bumper shot in billiards.  How’s our previous track record in that regard?  In contrast, economic development usually (not always) improves human rights.  And yes, Xi Jinping is an exception.

I’m particularly amused by my right-wing friends who are outraged by human rights abuses against Muslims in Xinjiang, but are silent about Modi’s record in India. Or Saudi Arabia’s appalling record in Yemen.  Or who had no problem with the US torturing Muslims and imprisoning them without trial. (And no, I’m not saying these abuses were anywhere near as bad–but do you have consistent principles?) Or those conservatives who favor economic sanctions against the Chinese for violating human rights in Xinjiang, but used to complain that sanctions against South Africa under apartheid “hurt the people they were supposed to help”.  (A view I held at the time, but now less certain about.) Unlike many people on both the left and the right, I don’t tailor my views to whether the human rights abuses are committed by a right wing or a left wing government.

A better argument for sanctions is as a deterrent to countries that engage in dangerous military behavior.  Thus sanctions on Russia were appropriate after they conquered part of the Ukraine, and sanctions on China would be appropriate if they attacked Taiwan without provocation.  Perhaps sanctions are appropriate on North Korea; I think that’s a close call.

My views are pretty simple.  We should have defense treaties with like-minded countries to deter aggression.  Otherwise try to avoid going to war.  Trade freely with all nations, except under a few very limited conditions.  I have an open mind as to what sort of military behavior or human rights abuses calls for sanctions, but in general I think the bar should be pretty high.

What about non-military predatory behavior, such as what China is accused of?  First we need to figure out the facts.  The news media has recently reported claims of Chinese spying that turned out to be false.  When there is Chinese spying, or related behavior, it should be handled in the same way we’d handle spying from Russia or some other country.  Tit for tat is fine.  If they punch us, then punch back.  But it’s extremely unlikely that a policy such as 25% tariffs on Chinese goods, which was first developed as a weapon to be used to reduce our trade deficit, would suddenly be the appropriate policy for Chinese human rights abuses in Xinjiang, or Chinese spying on US tech firms.  What sort of tariff should we have on Vietnam, for its severe human rights abuses?  (Vietnam is in many ways the most similar country to China.  A reforming communist East Asian country that is growing fast and still has lots of human rights abuses.)

Some regard China as a military threat to the US, which I think is implausible.  The combined strength of NATO plus Japan, South Korea, Australia and New Zealand towers over anything else on the planet.  These mutual defense pacts are hugely successful and will almost never be attacked by outsiders (except possibly by the accidental launch of nukes or, of course, terrorism.)

To summarize, I’m a utilitarian on foreign policy.  Show me evidence that an alternative plan will make the world a better place, and I’ll support it.  I’m not an ideologue.  But right now the evidence suggests that mutual defense and free trade are generally the best options.

I’m certainly no expert on foreign policy.  But when I read some of my commenters, I feel like most other people are even more clueless than me.

One final point.  Whenever you read a commenter saying,”Sumner believes . . .” you can be pretty confident that I do not in fact believe what comes next.  And when you read, “Because he has a Chinese wife, Sumner believes . . .” LOL.

Update:  I recommend this Edward Luce piece in the FT:

In most professions, such a litany of errors would prompt a soul-searching. Heads would roll. Schools of thought would close down. The magic of Mr Trump is that by uniting the elites in revulsion against his abrasive style, he has restored their sense of moral self-belief. Last month, William Kristol, a leading Never Trumper and Iraq war cheerleader tweeted: “Shouldn’t an important foreign policy goal of the next couple of decades be regime change in China?”

On China, Mr Trump and the blob are ominously coming around to the same view — that it must be confronted. They differ on methods. Mr Trump’s critics would prefer the US to build an allied consensus to win the “new cold war.” They dislike Mr Trump’s bilateral pugilism. They also bemoan his obliviousness. How could he have not known of the arrest of one of China’s business stars on the same day he was negotiating a truce with its president?

Yet they concede that Mr Trump has identified the right target. All of which presages danger. Whenever Mr Trump leaves office, the chances are that the blob will find itself back in the situation room. The story of this young century is a series of US blunders that boosted China’s power far beyond its expectations. It would be odd to hand back control to the people who brought this about.


The Republican Party’s future

Here’s the state of Britain’s right wing party, supposedly being torn apart by Brexit:

Alan Duncan, a junior minister in the Foreign Office, said of the Tory MPs who had triggered the confidence vote: “This is an act of irresponsibility, foolishness and national vandalism.”

“Any attempt to replace the prime minister in the middle of all this is utterly reckless and brainless. Anyone who has done this should be ashamed of themselves. They are not acting in the national interest.”

If Mrs May lost a vote of confidence or decided to resign, it would plunge the party into a formal leadership contest; there is no clear frontrunner to replace her and any contest would be highly divisive and could take weeks to play out.

Now let’s look at the condition of the right wing party in an English-speaking nation facing no Brexit crisis, which has a healthy economy that has been growing for 27 straight years, and no immigration crisis:

Mr Morrison owes his current eminence (if, again, that is the right word) to a cabal of what a senior Liberal calls a bunch of “crazy, right-wing nutjobs”. In August they defenestrated the man, Malcolm Turnbull, who had called and won the previous election, and had attempted to govern as a pro-business and socially liberal centrist. One of the cabal, Peter Dutton, a vituperative populist, failed to secure Mr Turnbull’s crown. In the ensuing scrimmage, which did few of its participants credit, Mr Morrison won it almost by accident. The most competent moderate, Julie Bishop, was swiftly trampled. . . .

In politics, says one senior party member, you used to make progress through compromise. “Now, it’s, ‘If you don’t give me something I want, I’ll blow the place up.’” Perhaps Mr Abbott and his like really do have a death wish. Perhaps they fancy that defeat by the Labor Party will have a wonderfully purgative effect, clearing the wets out of the Liberal Party and allowing their faction to enjoy unadulterated rule. What is nearly certain is that a grand old party faces a whipping next year. The question is whether it can survive at all.

As I keep telling you, there’s something in the water. (Or the internet?) I’m sure that some commenters will say that politics is always like this.  Actually, this is much worse than usual.  I predict that the US Republican party will be torn apart by a similar crisis, at some point in the next few years.

PS.  This also caught my eye in the Australia article:

As if in support, the women’s minister, Kelly O’Dwyer, said in a leaked discussion with colleagues that the party’s leaders were seen as “homophobic, anti-women, climate-change deniers”.

Anti-women? So it’s not just Brazil, the Philippines, the US, Italy, and Russia.  Add Australia to the list of countries featuring increasingly misogynistic leadership.  Is that enough to count as a trend?  Maybe Time’s “Man of the Year” should have been, “The angry, homophobic, misogynist, authoritarian, gas guzzling, macho male.”

PPS.  This made me smile:

“Now, it’s, ‘If you don’t give me something I want, I’ll blow the place up.’”

Trump has said that if Congress doesn’t give him the new Nafta, which is quite similar to the old one, he destroy Nafta entirely.

What should the Dems do?  Feed the beast, or see if Trump is bluffing?


Natural interest rate bleg

I suppose I should know what the natural rate of interest is, given that I’m a monetary economist.  But I see the term used in two radically different ways, and am not sure which version is correct:

1.  The real interest rate that would exist if the economy were at full employment and stable prices (or on-target inflation).

2.  The real interest rate that would be expected to push the economy back to full employment and stable prices (or on-target inflation).

A recent NY Fed piece used the first definition:

The Laubach-Williams (“LW”) and Holston-Laubach-Williams (“HLW”) models provide estimates of the natural rate of interest, or r-star, and related variables. Their approach defines r-star as the real short-term interest rate expected to prevail when an economy is at full strength and inflation is stable.

The accompanying graph shows their estimate of the natural real rate for the US:

Screen Shot 2018-12-10 at 3.22.38 PMObviously, it would have been a disaster if the Fed had set the real rate at that level during the Great Recession.  Rather the authors are showing the real rate that would be appropriate in the counterfactual case where the economy was at full employment.

In contrast, an article by Vasco Cúrdia at the San Francisco Fed uses a very different concept when describing the natural rate:

The natural rate of interest is the real, or inflation-adjusted, interest rate that is consistent with an economy at full employment and with stable inflation. If the real interest rate is above (below) the natural rate then monetary conditions are tight (loose) and are likely to lead to underutilization (over-utilization) of resources and inflation below (above) its target.

At first glance, that sounds similar to the New York Fed’s definition, but he later clarifies that this is the rate expected to lead to full employment, and that the natural rate will fall when the economy is depressed:

During the economic recovery, the natural rate was kept low by weak demand due to a larger propensity to save in the aftermath of the financial crisis.

As a result, Cúrdia’s estimate of the natural rate is dramatically lower than the NY Fed estimate:

Screen Shot 2018-12-10 at 3.28.14 PM

I like Cúrdia’s definition better, and it’s the one I’ve always used.  During the Great Recession, the Fed would have had to initially cut real rates to very low levels to push the economy back to full employment.  But if a magic wand (say a quick adjustment of wages and prices by God) had suddenly gotten us back to full employment, then the equilibrium interest rate would be much higher, as is normally the case during booms.  That’s the NY Fed estimate.

Alternatively, if monetary policy had been expansionary enough to prevent a Great Recession, the natural rate would not have fallen as sharply.

Here’s the problem.  I see each version of the natural rate being used by various economists, and I don’t know which use is conventional.  This makes it hard to communicate with other macroeconomists.

Personally, I don’t like speaking Spanish or Keynesianism. But when speaking with Mexicans I at least try to use a bit of Spanish, and when speaking with Keynesians I at least try to use a bit of Keynesianism.  But if I don’t know the proper meaning of the terms, then it’s hard to communicate.

Can someone please help me?

Cúrdia explains the difference this way:

Williams (2015) estimates the natural rate to be low by historical standards, but not nearly as low as those shown in Figure 1. The main difference is that Williams uses the statistical model of Laubach and Williams (2003), which is better suited to determine the longer-run level of the natural rate. By contrast, my analysis is suited to find short-term fluctuations in the natural rate.

But that doesn’t seem adequate to me; it seems like they are describing entirely different concepts.  And even if it’s correct, it suggests that economists should never refer to the term ‘natural rate of interest’ without first specifying whether it is the short or long run version.  Indeed Cúrdia hints at this inadequacy when describing how one could draw incorrect policy implications from the alternative definition:

This distinction is important in evaluating monetary conditions. In contrast to my results, the interest rate gap using the Laubach-Williams measure of the natural rate has been negative since the recession. According to their estimate, the Fed response to the crisis was expansionary because it lowered the real interest rate below its longer-run natural level.

Obviously, if the natural rate is defined as the rate that would prevail if the economy actually were at full employment, it’s of zero value in determining whether monetary policy is expansionary in an economy that is far from full employment.  So this isn’t just “semantics”, there are important policy issues at stake here.

Nor can the natural rate of interest be described as the appropriate real interest rate on long-term bonds, as that rate will itself depend on the future path of monetary policy.

Update:  Commenter Judge Glock left the following comment, which seems correct to me:

Maybe this isn’t helpful, but I think it just has to do with referring to different parts of the Taylor Rule. For the “long-term” natural rate, people mean the r* as in r* + a1(infl – desired inflation) + a2(output gap – desired output)= i, or, in other words, the intercept of the Taylor Rule, or its equivalent. Other people seem to refer to the natural rate as the final i, the dependent variable of the Taylor Rule, or the output of the equation, which represents the short-term rate when factoring in output and inflation gaps. It may be mere preference or semantics, but it seems to me the i more closely approximates the original Wicksellian understanding of the “natural rate,” or the rate that will keep the economy at equilibrium, while the r* more closely approximates the combination of growth rate and time preference. The confusion, though, could be emerging from the original Laubach-William paper, which, if I’m reading it correctly, estimates the “natural rate” or “r*” by looking at output gaps and real interest rates over time, thus treating the r* as something like the Taylor Rule’s i, even while they also refer to r* as the combination of the economic growth rate and household time preference not dependent on output gaps.

Update#2:  Rayward directed me to an excellent 2015 Tyler Cowen post on the topic.