Interesting links
Jim Glass sent me a very good piece by Greg Ip of the WSJ:
The U.S. economy has downshifted rather abruptly in the last few months, prompting new discussion within the Federal Reserve about delaying its first interest-rate increase. Yet the growth deceleration should not come as a surprise, because the Fed has already tightened.
True, the Fed’s interest-rate target remains close to zero. But the Fed tightens through its words, not just its actions, and the drumbeat of chatter from the Fed in the last year has made it clear that officials plan to start raising rates sometime this year.
That chatter has made itself felt in stock, bond, and most important foreign exchange markets. The dollar’s sharp rise in the last six months is not due not just to the European Central Bank‘s dramatic easing of monetary policy through quantitative easing (QE, the purchase of bonds with newly created money), but to the juxtaposition of the ECB’s action against anticipation that the Fed will soon tighten.
. . .
This is a reminder of something investors and Fed officials routinely forget: Markets discount the Fed’s actions long before they actually occur, in ways that are not obvious at the time. We saw that with the 2013 “taper tantrum” that sent mortgage rates up sharply and soon produced a notable slowing in housing and other interest-sensitive parts of economic growth.
The Fed should therefore respond to this in one of two ways. First, the tightening in financial conditions has already done much of the work that its first interest-rate increase was supposed to accomplish. This is a good reason to either delay the start of tightening, tighten more slowly, or both.
Second, if Fed officials feel the tightening in financial conditions is excessive, they should change how they talk. The dovish message of the March Fed meeting arrested the rise in the dollar, and more officials are expressing concern about the tone of recent data.
Some economists think of the stance of monetary policy as the future path of the target rate, relative to the future path of the Wicksellian equilibrium rate. But it’s easy to lose sight of the fact that changes in the stance of monetary policy generally involve changes in the future path of the Wicksellian rate far more than changes in the future path of the actual rate.
Here’s a good piece by Tim Worstall:
Much as I enjoy seeing people shouting at the EU and the ECB for the near idiot manner in which they have conducted monetary policy in the past few years, for I yield to no one except Scott Sumner in my estimation that their performance has been terrible, I can’t let this from Paul Krugman pass. For he appears to be rewriting economic history on the hoof over this idea of expansionary austerity.
. . .
That the ECB and the EU Commission screwed up I’ll accept, even fervently endorse. But that’s not the same as being able to show that expansionary austerity doesn’t work: because the EU and the ECB didn’t actually try it. For the poster child for expansionary austerity is actually my native UK in the 1930s. Yes, it involves reducing the deficit and it can thus be described as austerity. But what is really being done is that austere fiscal policy along with a riproaringly expansionary monetary policy. Rather like, umm, doing QE in fact. What Britain did in the 1930s was to come off the gold standard and devalue the pound by 25% or so. We thus got the expansion through that monetary policy and it worked: two years later we were back above pre-recession levels of output. The other examples of the idea also had significant devaluations of the currency in question. Such a devaluation being an important part of the overall policy.
All of the successful examples of expansionary austerity that I know of involve monetary stimulus. And that includes the massive $500 billion decline in the US budget deficit between calendar 2012 and 2013, which was accompanied by a speed up in GDP growth, a speed up in job creation, and a speed up in the rate of decline in the unemployment rate. Of course in early 2013 Paul Krugman thought the austerity would slow the recovery.
In early 2014 Krugman suggested that we would soon get a test of the hypothesis that extended unemployment benefits had raised the unemployment rate, as the benefits were being scaled back. More recently, he seems to have gone quiet about that test, just as he did after the 2013 test of market monetarism. The Economist explains why supply-side economics matters, even at the zero bound:
A research paper from the Federal Reserve Bank of Chicago estimates that, if real wage growth had followed its historical relationship with the unemployment rate, by mid-2014 it would have been 3.6 percentage points higher than it actually was. Three big things, though, have held back pay: changes to America’s unemployment-insurance system, the behaviour of firms, and the persistence of labour-market “slack”.
America’s unemployment-insurance system underwent a big change at the end of 2013. Before then, the average American could get 53 weeks’ worth of unemployment benefits; in three states they could get 73 weeks’ worth. Congress then decided to make benefits stingier: the average limit dived to 25 weeks, cutting off 1.3m Americans immediately. With nothing to fall back on, the wage expectations of many unemployed people fell, says Iourii Manovskii of the University of Pennsylvania. Employers in some sectors quickly took advantage of this newly cheap pool of workers. A big chunk of the 3m extra jobs created during 2014 were in poorly paid industries (see chart 3).
And here’s one on Neo-Fisherism in Turkey:
Mr Erdogan claims””against all the evidence and in complete contradiction to orthodox economics””that cutting rates will somehow lower inflation. As a devout Muslim, he may also be uncomfortable with usury; he says a rate of zero is the ideal. And the small businessmen who are loyal AK voters tend to borrow domestically in liras, not abroad in dollars.
If Mr. Erdogan thinks zero is ideal, then he presumably regards Switzerland as having the West’s most Islamic financial system. On the other hand, given the speed at which the Turkish lira is losing value, I wouldn’t look for zero rates in Istanbul anytime soon.
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19. April 2015 at 19:11
Expansionary austerity could be the right policy during a recession by coincidence. Consider a period in which the government had been over investing, investing in lots of project that had NPV less zero at the borrowing rate, when a demand shock occurs. The monetary authority lowers short term rates to zero and finds that is not enough to return NGDP or the price level (what ever its target) to trend and so keeps buying more and longer term assets — QE — to the extent politically feasible and talks about increasing future inflation/NGDP to the extent politically feasible. It could happen that because of the earlier over-investment, the government has no portfolio of projects with positive NPV at the ZLB that it can invest in or can induce the private sector to invest in and so it would NOT increase deficit-financed investment in response to the fall in rates.
This would be proper “expansionary austerity.” The austerity itself would not contribute to restoring NGPD or the price level, but it avoid future contraction in real GDP. It’s not what has been called expansionary austerity which seems to be reducing investment, not because there are no good projects, but for fear of future deficits.
That’s the kind of “expansionary austerity” that surely has been tried in the Eurozone and found wanting.
19. April 2015 at 19:34
” if real wage growth had followed its historical relationship with the unemployment rate, by mid-2014 it would have been 3.6 percentage points higher than it actually was.”
I extended the graph that was in the Economist article of median weekly wages, and added the unemployment rate. There isn’t much of a relationship in that comparison. If there has been any anomaly, it was the rise in wages when unemployment shot up.
http://research.stlouisfed.org/fred2/graph/?g=18mW
Average hourly earnings discounted with core PCEPI do have a decent long term relationship with the unemployment rate, and they have been unusually high until recently. Here’s a post where I have the graph of unemployment and real hourly wages. Wages were way above the norm until 2012. I suspect that the new unemployment insurance policy pushed up both wages and the unemployment rate.
http://idiosyncraticwhisk.blogspot.com/2015/01/the-complicated-role-of-homeowners-in.html
I count the fact that everyone talks as if wages have been mysteriously low as a piece of evidence that people are crazy. I wouldn’t mind if someone wanted to try to argue that, but it is treated as some sort of universally accepted fact associated with some sort of mystery.
By the way, the Chicago Fed paper can be found here:
https://www.chicagofed.org/publications/chicago-fed-letter/2014/october-327
I will note that before 2008, long term unemployment correlated very strongly with mid-term unemployment. The relationship they are talking about is mid-term unemployment and wages. What they find is that mid-term unemployment has dropped since 2010, but wages haven’t risen as much as they would expect. Again, I don’t get the mystery. In the past, long term unemployment didn’t affect wage growth much because long term unemployed were marginally attached to the labor force. Now we have a bunch of workers who were incentivized out of employment, and now they need back in after sitting out for 2+ years. So, we basically traded high unemployment and high wages in the recession for high unemployment and stagnant wages in the recovery. Not exactly a good trade-off, I’d say. This interpretation seems obvious to me. The closest the article from the Chicago paper gets to it in the conclusion is: “Thus, it appears that the slack in the jobs market still weighs heavily on the real wage prospects of American workers.”
Well the unemployed right now consists of 4.8% unemployment with a typical distribution of durations and about 0.7% unemployment that consists of a big bunch of unemployed workers who have an average duration of unemployment of over 2 years, plus some number who have temporarily left the labor force. It is a clear bifurcation. Where did that come from? It seems pretty obvious.
19. April 2015 at 23:32
Excellent blogging and also comments bt Erdmann.
And remember, there are 12 million Americans now collecting SSDA and VA “disability” benefits. The VA disabled are usually young. These are non-battlefield injuries.
The 12 million number dwarfs the number collecting unemployment.
In Los Angeles as of a couple years back a stock character wad the guy who wanted to work off the books for $10 an hour cash—he was collecting disability or unemployment…
20. April 2015 at 04:06
It is strange to call something “expansionary austerity” if expansion had nothing to do with austerity. We are saying that austerity had to do with fiscal side (which was presumably concerned with reducing debt/deficit), while expansion happened due to monetary policy, which increased AD. Is someone claiming that austerity increases AD? If not, why not call it “expansionary environmentalism”, or “expansionary affordable care act”, or two totally unrelated concepts which happened to occur at the same time?
For that reason, I have never understood why one can’t have both fiscal and monetary expansion, logically speaking. I understand the Fed would try to offset it, but why should it, assuming that money is too tight? Presumably if Fed does agree that money is too tight, it should loosen regardless of what happens on the fiscal side. Assuming that fiscal policy is not so loose that Fed actually needs to tighten to make it “just right” (I can’t imagine this is true).
20. April 2015 at 05:38
Thomas, Demand shocks don’t just “happen,” they are caused by tight money.
Kevin, I think the problem here is that lots of people are doing “reasoning from a wage change.”
Ben, Yes, that’s a big factor in labor force participation.
Anand, Yes, and notice I never use the term expansionary austerity. I’m trying to get people to think of fiscal and monetary as unrelated issues, as they did in the period before 2007.
20. April 2015 at 11:54
Off topic, but interesting…
Chinese authorities sprang into action just a few days after announcing a disappointing first quarter GDP growth rate. The People’s Bank of China (PBOC) last night reduced the banks’ reserve requirement by 1% to 18.5% with the intended goal of free, loanable funds in the banking system in order to stimulate the economy. It was not the first move by the Chinese central bank to support the economy: Just a few weeks ago, the PBOC slashed the required down-payment for purchasing a home; we expect more action to come. The benchmark one-year lending rate currently stands at 5.35% after two cuts in November and February; we anticipate an additional cut soon. The speed and size of the Chinese authorities’ response betrays serious concerns about the state of the economy.
20. April 2015 at 20:50
“But it’s easy to lose sight of the fact that changes in the stance of monetary policy generally involve changes in the future path of the Wicksellian rate far more than changes in the future path of the actual rate.”
No, the long term natural rate of interest is independent of monetary policy.
21. April 2015 at 09:31
@MF: “the long term natural rate of interest is independent of monetary policy.”
The real interest rate may be, but the nominal natural rate of interest is obviously not independent of monetary policy.
You’re being very sloppy about the difference between real and nominal, and this is why you remain confused.