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Build the NGDP and businesses will come with the goods and services

This recession may well end up being worse that the Great Recession. But it probably doesn’t have to be:

1. The recession will certainly be deeper than the Great Recession, indeed it probably already is.  But deeper doesn’t mean worse.

2. The recession may have to be worse than the Great Recession, if the medical situation turns out to be far worse than I expect.

3.  However, if the medical situation turns out to be about as I expect, then we could have economic growth in the second half of 2020, and full employment in 2022.

I say, “could have” because it will also depend on monetary policy.

In my view, the most likely medical outcome is a sharp reduction in new caseloads in May.  There will also be improvements in PPE for workers and lifestyle changes will persist.  This will allow some (but not all) businesses to begin reopening, starting in May.  Then, sometime in 2021, we will likely have a vaccine or drug treatment or vastly improved PPE, or some combination that allows for a more normal economy.  I’m not certain this optimistic scenario will be correct, but I suspect something will turn up, given the enormous pressure to solve the problem.  So I believe it’s more than 50% likely.

The point of this post is not to give you my worthless predictions on the coronavirus, rather to point to some misconceptions I see in the media.  One theme is that it may be difficult for the economy to recover once the medical crisis is over, because firms have gone bankrupt.  Nonsense.

US economic history is full of examples of explosively fast recoveries when the initial problem is no longer impacting the economy, and even when it is (as in March-July 1933, a period when much of the banking system was shut down.)  A good example is the extremely fast 1921-22 recovery.  In July 1921, we were at the bottom of a very deep recession, and by December 1922 we were booming—“the Roaring 20s”.   How about having an extremely fast 2021-22 recovery!

The 1921-22 recovery was aided by a great deal of wage flexibility, more than we have today.  But we have the advantage of a fiat money system and hence can print enough money to get NGDP back up to the trend line by 2022.  We don’t need wage flexibility.  And we certainly don’t want a repeat of the needlessly anemic recovery from then 2008-09 slump.

I cannot emphasize enough that in the absence of a shutdown for medical reasons, our economy is capable of rapidly returning to full unemployment if the Fed provides adequate NGDP.  Recall the movie line, “build it and they will come”.  I’d say, “Build the NGDP and businesses will come with the goods and services.”

Don’t believe the pessimism; we should expect and indeed demand that the Fed provides adequate NGDP once the epidemic is over.  If the economy is not at full employment in early 2022, it will likely be because NGDP is not 8% above 2020:Q1 levels, not because of mythical “hysteresis”.

Jay Powell seems to have his heart in the right place:

Jay Powell said the Federal Reserve would use its powers “forcefully, proactively and aggressively” until the economy recovers from the coronavirus shock, as the US central bank moved to offer an extra $2.3tn in credit and support the market for high-yield corporate debt.

But good intentions are not enough; we need level targeting, announced ASAP.

PS.  Bonus prediction:  This summer the media will begin dividing countries up into safe and infected categories.  The safe category will include Australia and New Zealand, China, Taiwan, Vietnam, Iceland and a few others.  Soon South Korea, Hong Kong and Norway will join the list, and then gradually more and more countries.  By “safe” I mean community transmission of less than 2 cases per week.  There will be a lot of chatter in the media about how to move from the infected to the safe category, and a lot of political disagreement on the topic.

PPS.  In the US, the epidemic began in western states.  Today, the epidemic is dramatically worse in states east of the Texas/Louisiana border, even accounting for population.

Update:  Just as France was hit much harder than Northern Europe, Quebec is being hit much harder than the rest of Canada.  Then there’s Louisiana . . .

PPPS.  The recovery from mid-1938 to late-1939 was also very rapid, despite a pause after minimum wages were enacted in the fall of 1938:

Or how about the rapid recovery during 1983:

Or how about 1958:

Wall Street, Main Street, and NGDP

In 2008, the Fed tried to save Wall Street without boosting aggregate demand. They were accused of trying to rescue Wall Street while not helping Main Street. The effect was a collapse of AD, which hurt even Wall Street.

Today, the Fed seems to be trying to help both Wall Street and Main Street, without boosting AD, at least not adequately.

I say, “seems to” because I’m not actually sure that’s their intention. But at the moment it looks like that will be the result.

In 2008, they thought that if they rescued Wall Street then aggregate demand would take care of itself. That did not turn out to be true. It might be true this time around (the situation is quite different), but we can’t be sure it’s true. The markets are certainly skeptical, predicting weak AD for years to come.

In 2008, the Fed had programs targeted at specific sectors, and tried to sterilize the effect on the broader money supply. Today, they don’t seem to be actively sterilizing the impact, but they aren’t going after the low hanging fruit that would be expected to boost NGDP growth expectations.

In my view, the Fed should set a level target for prices or (better yet) NGDP, and then do as many purchases of safe assets as needed to get growth expectations back on target for 2021 and 2022. That means I don’t favor the alphabet soup of programs targeted at specific sectors of the credit market. The Fed’s job is to print money, not encourage lending.

Of course one side effect of printing lots of money right now would be to encourage more lending. And credit is an essential part of our economy. But loans are much less likely to default when NGDP is expected to grow at a rate of 4% or more. Let banks and individuals make loans, let the Fed create money.

That doesn’t mean the Fed’s current actions are harming the economy; indeed the actions are helping, at least relative to the Fed not engaging in some of these initiatives. Rather the Fed is missing an opportunity to have a much more expansionary policy, which is also much less intrusive, less distortionary, less likely to create moral hazard.

What would I do? Set a level target and buy as many safe assets as necessary to hit the target. Ten trillion, twenty trillion, whatever. Promise to buy unsafe assets if necessary, but don’t actually buy them, as it likely won’t be necessary.

Odds and Ends:

1. The Wuhan lockdown just ended.  Nice story in the NYT, which puts a human face on Wuhan.  Things are getting better, but still a long way from normal.

2.  Interesting paper on the TB vaccination angle.  I don’t find it entirely convincing, but there’s probably at least a small beneficial effect.  And even “small” can be really important in a disaster this large.

3. I don’t entirely agree with this left wing rant:

The slow COVID-19 response from U.S. leadership seems to have been tailor made for people with salaries, with the ability to drive cars, with large houses (and their room for exercise equipment and grocery hoarding), and with private yards for their kids to play in. . . .

If we cared about hourly-wage families who get around without cars and who live in small homes — people who rely more heavily on the shared things like parks, playgrounds, and transit that have reduced access now — we’d have had strict shut-downs immediately, so as not to drag this out longer. . . .

How very convenient for wealthy, salaried people embedded in car-centric places, who can ride out the storm while feeling proud of their individualism.

But I’m also not sure it’s entirely wrong.

4.  Tyler Cowen notes that Peter Navarro warned of the potential impact of the coronavirus way back in late January.  I agree with Tyler that Navarro deserves credit for that warning.  But I also think it’s important to understand the precise nature of the subsequent failure.  This risk was widely understood at the time (or soon after), by almost everyone who was well informed.  I knew it might happen.  There were were numerous media articles quoting leading experts saying 50% of the world would become infected, or 60%, or 40% to 70%.  What I did not expect is that the predicted impact would actually occur.

The big failure here was not an inability to understand the risk, rather the failure to act appropriately.  If there’s a 10% chance of a disaster that will cost $10 trillion dollars, you take that risk very seriously even though you believe there’s a 90% risk probability it will not occur.  We did not do that.  I did not do that.

5.  On a more optimistic note, signs that the Trump administration might be beginning to understand that globalization makes it easier to address this crisis:

The Trump administration has reached a deal with 3M, the US manufacturer, to import 166.5m N95 respirator masks into America from abroad, easing tensions between the White House and the Minnesota-based company.

The agreement was announced by Donald Trump, US president, at his daily news briefing on the administration’s response to the coronavirus pandemic on Monday afternoon. Crucially it will allow 3M to continue selling its US-made N95 masks to Canada and Latin America, deals that had been threatened by a crackdown by the Trump administration on exports of protective medical equipment.

6.  On a more pessimistic note, you can’t very well have inspector generals if you plan to turn your country into a banana republic, can you?

President Donald Trump has removed the head of a team of U.S. auditors that will oversee the $2 trillion in federal coronavirus relief spending, his latest move against inspectors general who are supposed to serve as independent watchdogs. . . .

Michael Horowitz, head of a council of federal inspectors general, chose Fine for the new role of pandemic-spending watchdog last week.

“Mr. Fine is no longer on the Pandemic Response Accountability Committee,” Dwrena Allen, a spokeswoman for the Defense Department inspector general’s office, said in a statement Tuesday.

Trump has increasingly taken action against inspectors general he considers insufficiently loyal. He tweeted criticism of another inspector general on Tuesday. Last week, he fired Michael Atkinson, the intelligence community inspector general, who informed Congress — over White House objections — of the whistle-blower’s complaint that ultimately led to Trump’s impeachment.

No need to insure the $2 trillion is spent in a non-corrupt fashion; it’s just pocket change these days.

7.  This caught my eye:

Although the Riverside County Sheriff’s Department has been given the authority to ticket or arrest potential violators of the county’s latest health order to help slow the spread of coronavirus, Sheriff Chad Bianco said it was the last thing he wanted to do.

Don’t wear masks!  You must wear masks!  How about “It’s up to you”?

The WHO is both stupid and immoral

Update:  On second thought, the post should have been entitled “This WHO official is both stupid and immoral”.  I didn’t mean to suggest that everyone who works at the WHO falls into that category.

The video where a WHO official refuses to mention the word “Taiwan” has gone viral.

The immorality of his action is obvious.  Less obvious is the stupidity.  You might think that he caved in to China’s demand that the WHO not recognize Taiwan.  But China does not demand that people refuse to recognize the existence of Taiwan.  Indeed China itself recognizes Taiwan, as a province of China.  (As does Taiwan’s constitution.)  People talk about Taiwan all the time in China.  The weather reports I used to watch on Beijing TV show forecasts for each provincial capital city, including Taipei.  The Chinese don’t act like Taiwan doesn’t exit; they officially regard it as just another province of China.  All the WHO official had to do is say, “The Chinese province of Taiwan has done a very fine job in controlling the epidemic.”  What a dummy.

And then there’s this:

On Jan. 14, the World Health Organization sent a tweet that turned out to be one of the most significant statements in the world’s fight against the virus now known as Covid-19. Based on information from China, the global health agency wrote, the new coronavirus didn’t appear to spread via human-to-human transmission.

Two weeks earlier, health authorities in Taiwan had reached the opposite conclusion. Not only did Taiwan’s Centers for Disease Control surmise that people were passing the disease to each other, they notified the WHO of their suspicions through the UN agency’s International Health Regulations reporting window, a platform for sharing information and updates.

“We tried to get clarification from the IHR on what’s going on in Wuhan,” Taiwan Foreign Minister Joseph Wu told me. “But the response from the WHO was, ‘OK, we’ll take it from here.’” The Taiwanese never heard back.

BTW, the epidemic is finally slowing in Europe, and there are even a few signs that the curve might be beginning to bend in the US.  This is a very positive sign:

Austria has set out plans to become the first country in Europe to ease its lockdown against the coronavirus pandemic, with shops due to reopen as early as next week.

I’d expect the following from the GOP.  But the Democrats?

“We are concerned that Treasury Department’s recent guidance on the ‘Airline Industry Payroll Support’ Program does not fully reflect the intent of Congress,” they wrote in the letter, which also was signed by House Transportation Chairman Peter DeFazio and Sherrod Brown, the ranking Democrat on the Senate Banking Committee.

Pelosi and DeFazio have previously said that demands for airline equity stakes in exchange for the $25 billion in grants designed to save jobs are onerous and could prompt carriers to decline the help.

It’s bad enough that both parties want to throw money at the airlines (more specifically airline stockholders like me), but now the Democrats seem to oppose any provision that would allow taxpayers to claw back some of that reckless spending.

Wouldn’t it be so sad if the airlines refused the $25 billion we were trying to give them. . . .

Why does money matter?

If someone asks you why monetary policy is so important, you might mention the business cycle, and/or financial crises. But suppose they ask you how you know that monetary shocks cause business cycles? How would you answer?

One reason that market monetarists remain in the distinct minority is that this question is really hard to answer, indeed harder than almost any other question. You can’t just say “because blah, blah blah”, you have to carefully lay out a very complex argument. In this post I’ll try to present the general shape of this argument, and also explain why it’s so complicated.

To begin with, you must explain two basically unrelated points, each of which is non-obvious:

1. Why do we believe that money determines nominal fluctuations?

2. Why do we believe that nominal fluctuations create business cycles?

The first is much easier to explain, because it fits in with basic (classical) economics, indeed basic supply and demand theory. Because nominal values are measured in money terms, changes in the value of money affect all nominal values. And as with any other good, changes in the supply and demand for money impact its value.

Thus it’s pretty easy to explain how monetary policy could create fluctuations in NGDP. Just assume that the central bank changes the supply (QE) or demand (IOR) for base money in a way that destabilizes nominal aggregates such as the CPI and NGDP.

Still, even though this is really basic stuff, the person inquiring about why money is important has to have internalized this relationship before proceeding to the much more difficult question—why do monetary shocks have real effects? And because of “money illusion”, even this simple classical argument is really hard for many people to grasp. Most people don’t think of inflation (or NGDP growth) as a fall in the value of money.

I’m going to break the second question (nominal/real interaction) down into two components, to make thing simpler:

1. The core set of theory and evidence in favor of nominal shocks creating business cycles.

2. Auxiliary evidence in favor of nominal shocks creating business cycles.

The core theory and evidence has 4 distinct parts, which in combination strongly point the finger at nominal shocks creating business cycles:

a. The existence of “odd” looking business cycles, with unemployment occurring for reasons that are not immediately obvious. (Note that today we are at the beginning of the first non-odd business cycle I’ve ever experienced. Unlike with most cycles, the reason for the high unemployment is immediately obvious right now.)

b. An obvious correlation between nominal shocks and business cycles, something noticed even by David Hume.

c. Off the shelf theories of price floors and price ceilings creating surpluses and shortages, right out of EC101.

d. Prices and especially wages that are obviously somewhat sticky in the real world.

None of these 4 points are particularly persuasive, considered one at a time. But in combination, they are incredibly powerful. When know from point #1 above that contractionary monetary policy can reduce NGDP, and we generally also see RGDP fall at the same time. This is associated with millions of workers no longer working, even though they seem to wish they were working. That looks like the “disequilibrium” that occurs under a price floor. Labor supply exceeds labor demand. And we know that nominal wages are sticky, in which case an unexpected fall in NGDP should cause mass unemployment.

The four pieces of this argument fit together like a fine Swiss watch. Everything clicks into place.

That’s actually enough for me to be sold on the basic monetary model of the business cycle. But in fact there are a number of other auxiliary arguments, which also point in the same direction:

3. Natural experiments: Monetary policy is hard to “identify”. But there are cases where central banks intentionally create monetary shocks, and then we experience the business cycle impact that is predicted. In 1981, Volcker’s Fed set out to reduce inflation with a tight money policy. Unemployment rose to 10.8%, as expected by the basic model.

One particularly interesting sort of natural experiment is switching from a fixed to a floating exchange rate regime. If money were neutral in the short run, then this policy switch should have no impact on the volatility of real exchange rates. In fact, real exchange rates become dramatically more volatile under a floating rate regime than a fixed rate regime, as we saw after the end of Bretton Woods, or when the US left gold in 1933. The only plausible explanation is that money is non-neutral in the short run, and sticky wages and prices are the only plausible explanation that has been offered for that non-neutrality.

Another very interesting natural experiment is that countries tended to recover from the Great Depression after they left the gold standard. There’s also some evidence (not as strong) that countries in Europe did better if not in the euro, as they could devalue to boost output.

4. The Natural Rate Hypothesis was developed by Friedman and Phelps in 1967-68, and later the model was confirmed by events. This model assumes that money is non-neutral in the short run. If the model were not true, then why was it confirmed by later events?

5. I’ll end with a piece of evidence that is more tenuous but still interesting. It seems like the short run non-neutrality of money is believed by a wide variety of people that approach the issue from very different perspectives. Consider central bankers, economists and investors.

Central bankers actually make adjustments in monetary policy. That’s their job. They then see the economy react in ways that convinces them that money is non-neutral. You don’t typically see extreme RBC-types running central banks, as the impact of their policy decisions would often contradict their theories. They’d be confused.

Most economists believe in the non-neutrality of money for the reasons listed at the top of this post.

And investors (as a whole, not individually) also seem to believe in the non-neutrality of money. Asset prices react to unexpected money announcements in a fashion consistent with market monetarism being true. That’s not surprising, give that MMs believe that market responses are optimal forecasts of policy effects. But this suggests that the “wisdom of crowds” also in some sense believes money is non-neutral in the short run.

To summarize, there is no brief “elevator speech” for the monetary theory of business cycles. The core argument has 5 components, a nominal model and 4 pieces of theory and evidence supporting real effects. This alone is a pretty convincing argument, perhaps even for Ray Lopez. But there are also a number of auxiliary arguments, only some of which are listed here.

A few arguments against short run non-neutrality of money have been offered, especially in the early days of real business cycle theory. But all have been addressed, and none are now viewed as persuasive.

Time to put conspiracy theories into a burial urn

In the past, I’ve criticized claims that 40,000 Wuhan residents died of Covid19, roughly 16 times the official total. While the official total undoubtedly missed some cases, I find it implausible (but not impossible) that it was that far off.

Most experts believe the actual mortality rate from coronavirus is around 1%, or perhaps 2% at most, if one accounts for all the mild cases that are never tested. And unlike Italy, Wuhan does not have a large population over age 70.  So the claim that Wuhan had 40,000 deaths is equivalent to a claim that it had 2 to 4 million cases, in a city of 11 million.

A new study of the genetic makeup of numerous Covid19 viruses, suggests that as of February 8 the entire world had about 55,800 cases, with a 95% confidence interval around 17,500 and 194,400:

Here, we use a phylodynamic approach incorporating 53 publicly available novel coronavirus (nCoV) genomes to the estimate underlying incidence and prevalence of the epidemic. This approach uses estimates of the rate of coalescence through time to infer underlying viral population size and then uses assumptions of serial interval and heterogeneity of transmission to provide estimates of incidence and prevalence. We estimate an exponential doubling time of 7.2 (95% CI 5.0-12.9) days. We arrive at a median estimate of the total cumulative number of worldwide infections as of Feb 8, 2020, of 55,800 with a 95% uncertainty interval of 17,500 to 194,400. Importantly, this approach uses genome data from local and international cases and does not rely on case reporting within China.

February 8th was roughly half way through the Chinese epidemic, with 37,198 reported cases.  However, on February 12 China changed its reporting methods and the official caseload jumped sharply.  Thus we can infer that even as early as February 8th the caseload was higher than reported, at least 40,000.

Of course there were also many cases that had not been tested, so there could easily have been 80,000 or 120,000 cases by that day.  But given that the entire world likely had no more than 200,000 cases on February 8, and given that China was roughly half way through its epidemic by that time, it seems very unlikely that Wuhan ever had 2 to 4 million cases.  And if you want to argue that the Chinese underreporting occurred after February 8th, you run into all sorts of problems.  There is very clear evidence that the epidemic slowed sharply in China in mid-February.  And as mentioned above, on February 12 the reported caseload in China jumped sharply as the government attempted to make the figures more accurate.

The estimate of 40,000 deaths was based on the number of burial urns being order by Wuhan mortuaries.  Unless someone can discredit this paper, I’ll go with the phylodynamic approach to virus evolution as being more accurate than counting burial urns.

It’s fine to hate and distrust the Chinese government; I do as well.  But that’s no excuse for not confronting reality.  If China got the epidemic under control, we need to know that.  Even more importantly, we need to know how democratic countries in East Asia got their epidemics under control without shutting down their entire economies.

HT: Razib Khan