Archive for August 2024

 
 

Are we moving toward fiscal dominance?

A recent Bloomberg article suggested that we may be moving toward a regime characterized by fiscal dominance, at least part of the time:

In their paper, three economists from New York University, Stanford and London Business School argue that the US is moving from a regime of “monetary dominance” to one of “fiscal dominance.” In the former, the Fed controls inflation by adjusting short-term nominal interest rates. The government supports these efforts by committing to increase future taxes, ensuring that other interest rates don’t change too much and debt doesn’t overwhelm markets. Under a monetary dominance regime, interest rates and inflation are low and relatively stable.

I don’t agree with the claim that monetary dominance implies low and stable interest rates or inflation. We clearly had monetary dominance in the 1960s and 1970s, when budget deficits were small as a share of GDP. And yet inflation was high and unstable. Both in the Great Inflation, and in the more recent bout of high inflation, the problem was the Fed’s misguided belief that easy money is a good way to create jobs.

The regime changed during and after the pandemic, when wartime-sized debt was issued with no care of paying it back. . . . Under such a [fiscal-dominance] regime, the Fed is less powerful.

I wouldn’t say the Fed “manages” bouts of inflation, as that term makes them seem like an innocent bystander. The Fed created the high inflation of 2021-22 with a highly expansionary monetary policy. And the Fed was no less powerful than before, as it had plenty of “ammunition” to adopt a tighter monetary policy if it had wished to.

Not only is its job harder, but its tools are less powerful — it has less influence over interest rates.

Its power doesn’t come from control of interest rates; it comes from control over the gap between the target rate and the natural rate. And it has just as much power over that gap as before deficits became large.

After spending moderated and monetary policy became more restrictive, the US returned to a monetary policy regime. But the nation’s debt trajectory risks a future turn to fiscal dominance.

It moderated only relative to the Covid period. In absolute terms, fiscal policy is currently highly irresponsible, especially if compared to the Great Inflation of 1966-81. If the fiscal dominance model were true, the US would currently be experiencing very high inflation. On the other hand, I agree that our current path does impose at least some risk of slipping into fiscal dominance. That’s what tends to happen in banana republics.

Fiscal policy, which has become more ambitious in recent years, is finally doing the job it’s supposed to do. Both parties have been vocal in supporting policies that aim to shift production from services to manufacturing, either through tariffs or with industrial policy. There are also goals related to improving infrastructure, lowering the cost of housing, and reforming the immigration system. These policies change the supply side of the economy . . .

In a recent Econlog post, I pointed out that tariffs might end up shifting output toward services, by increasing the relative price of manufactured goods. (Tariffs might reduce the trade deficit, but probably won’t.) And those three goals sound fine, but I don’t see much action.

An American economic miracle?

Matt Yglesias directed me to this tweet:

If you looked at certain polls, you’d think the economy was doing poorly. On the other hand, if you looked at state economic performance polls, or polls asking about an individual’s personal financial situation, then things look far better. But one thing is clear—the US is outperforming the economies of other developed countries by a fairly wide margin. Why is that?

Let’s start with the macro. I think Pethokoukis somewhat overstates the supply shock and monetary headwinds. As you know, interest rates don’t matter. The thing that does matter (NGDP) has been a headwind, not a tailwind:

The growth rate has recently slowed, but remains well above the pre-Covid norm.

There were some supply shocks in 2022, but the energy situation is now pretty good, and many other supply line bottlenecks have been resolved. On the plus side, a big surge in immigration has added substantial labor force supply (even with the recent downward revision.)

At the micro level:

1. We have less regulation in some key industries like fracking, and this has boosted our GDP relative to Europe.

2. We have gains from agglomeration and network effects. When combined with an inflow of many highly talented individuals, this has led us to vastly outperform our rivals in high tech.

3. We have our Nimby problems, but in much of America it’s still pretty easy to build. Densely populated Japan and Europe (especially the UK) probably have more restrictions on building.

Note that all three of these micro factors are things that have become much more important over the past 10 or 20 years. And this roughly corresponds to the period when Europe stopped catching up to us and began falling further behind.

Jeffrey Ding on China

I’ve been amazed by the response to Russia’s invasion of Ukraine. The most militarily expansionist leader since Hitler and Stalin starts a war that threatens to spiral out of control. He leads a country with enough weapons to destroy most of the US population. He threatens to use nuclear weapons (and is scolded by China for doing so.) And in response we are told by our foreign policy establishment that “China is the real threat”.

A recent podcast provides some interesting historical parallels:

Jordan Schneider: Then in the 1980s, the concern was that Japan would overtake the US. David Halberstam — author of The Best and Brightest and Breaks of the Game — wrote in 1983 that Japan’s industrial ascent was America’s most difficult challenge for the rest of the century and a “more intense competition than the previous political-military competition with the Soviet Union.”

There was a deep consensus within the American body politic that America was losing the technological future and long-term productivity race to Japan. What didn’t Japan get right?

Jeffrey Ding: This was a very real threat in the eyes of the US. Henry Kissinger wrote an op-ed in The Washington Post saying that Japan’s economic strength and rise in high-tech sectors would eventually convert into military power and threaten the US. poll in the late 1980s found that more Americans were worried about Japan than the Soviet threat to US national security.

The trend that I see so clearly with all these historical examples is the US overhyping other countries’ scientific and technological capabilities. One reason we do that is because we don’t pay as much attention to diffusion capacity.

Japan was the real threat, not the Soviet Union?? Americans seem to have a deep-seated need to see Asians as the “real threat”, not Europeans. Recall the ethnic group that FDR put in concentration camps back in 1942.

Later, Ding points out that it’s not easy to determine what strategy toward China is best, even if we accept the premise that it is a threat:

Jeffrey Ding: We have shifted so far in the direction of US national security interests and the need to beat China in all these different forms of competition. The biggest risk is if China overtakes us on something, whether militarily, economically, or by soft power.

I’m not sure where I stand on this, but why are we not considering that the biggest national security risk for the US is a weak China and a China that can’t sustain its growth? For the longest time that was US State Department policy. A strong China is good for peace.

All this self-flagellation that’s been coming out in terms of China’s AI sector has been overhyped. China could also suffer economic stagnation. What would the national security consequences be for the US? They might not be good.

It’s not even in the Overton window. We’re not even talking about it anymore in Washington.

To be clear, both Schneider and Ding see China as a serious threat. Please read the entire interview. But at least they seem to have some historical perspective that is lacking in most other commentary on the issue.

Yglesias on political sorting

There has recently been a lot of discussion about how all of the conspiracy nuts are moving over to the GOP, whereas not so long ago they were at least as common among Democrats. Matt Yglesias has a very good post that points out how this is a problem for both sides.

The TLDR is that Republicans increasing suffer from a lack of people with the knowledge required to craft good public policy, and the Dems suffer from an epistemic monoculture with no dissenting views. Here are a few excerpts:

Similarly, I think policy-relevant research done in economics departments is a lot more useful and credible than other forms of social science, not because economists are so great but because an economics paper is much more likely to clear the “has at least one conservative read this?” test.

For reasons that sociologists, anthropologists, and social psychologists are probably better-situation to explain, if you work in an environment where all your colleagues and peer reviewers and people you talk things over with in a seminar are left-wing, you are going to get biased results. Again, not necessarily because anyone is trying to bias the results, but because each individual person has their own biases and when almost all of those biases are mutually reenforcing, you get a bad outcome. . . .

The basic problem is that just saying government programs should help address problems that aren’t addressed by the market alone, while true, offers basically no guidance about what to actually do. It is very, very important to come up with correct empirical analysis or else you’re not going to accomplish anything.

Yglesias uses this analysis to explain how the public health establishment screwed up during Covid.

The GOP has a different set of problems:

Are conservatives succeeding in building compelling institutions that can address their concerns about trends in American life? I think they pretty clearly are not, even according to conservatives. And on a policy level, they are completely up the creek without a paddle.

The pandemic revealed that many longstanding conservative criticisms of the drug approval process have some merit.

But there is no post-pandemic FDA reform push from the GOP, and certainly no agenda to take lessons learned from Operation Warp Speed and apply them to other issues. Republicans have become the party of conspiracy theorists who believe Bill Gates is using vaccines as a covert mind control program, so even when they hit on something that works, they don’t dare talk about it or build compelling narratives around it.

Read the whole thing.

Tyler Cowen has recently talked about how you need serious expertise to do effective deregulation. With the GOP well on the way to kicking all intellectuals out of the party, where will it find that expertise? Read some of JD Vance’s comments on economic policy, and just imagine him being put in charge. (Yeah, I know—the Dems. But doesn’t a country need at least one party that understands economics?)

Reason magazine has a very good article on how Trumpistas are jockeying for position in the next administration:

“A red flag went up if a prospective employee answered ‘deregulation and judges’ when asked to name their favorite Trump policies,” Swan wrote, also in 2022. “It was a sure sign the applicant could be a weak-kneed member of the establishment.”

But the solution to Trump’s first problem—ensuring his new staff is fully ideologically aligned with him—pulls against the solution to his second. He can have people who are true believers or he can have people who are competent; he probably can’t have both, because there are simply too few of them. . . .

“The best way to describe these lists is it looks like they’re looking for incompetence as the chief qualification,” says Cato Institute Senior Fellow Thomas Firey. “The bureaucracy, whether you love it or hate it, is an extremely complex machine that is extremely hard to operate….It’s like giving my 8-year-old the keys to a steam shovel. Nothing’s going to happen but a disaster.” . . .

Yes, a whole brood of groups, new and old, have positioned themselves to help a second Trump administration do better. But there are reasons to be skeptical that they’re up to the task. Behind the scenes, the various organizations are busy squabbling among themselves and jockeying for prominence. And several of them are gimcrack enterprises headed up by 20-somethings whose biggest claim to fame is acting out online via inflammatory social media posts.

Eh, what could go wrong? Read the whole thing.

PS. Razib Khan has a tweet showing that in per capita terms his blog has a much bigger audience in New York than Texas, and a much bigger audience in Washington than Florida. Even conservative bloggers are much more widely read in liberal states.

PPS. Watch this 60 seconds, and then extrapolate another 4 years of increasing senility. I’m going to have so much fun. Future historians will call this the era of senile old men.

The final nail for fiscal dominance?

One of my biggest frustrations over the past 15 years has been the economics profession’s drift away from certain well established propositions, such as the fact that the Fed controls the price level. But there are signs of light. David Beckworth has a twitter thread discussing how inflation has recently fallen sharply despite absurdly large budget deficits as far as the eye can see:

Ironically, our biggest inflation episode (1966-81) occurred during a period of relatively small budget deficits. The gross federal debt ratio fell from 40% of GDP in 1966 to 31% of GDP in 1981. Today, it’s over 120% of GDP and likely to rise much higher.

Read Beckworth’s entire thread.