Friday, August 23, 2019

Summers tweet stream on secular stagnation

Larry Summers has an interesting tweet stream (HT Marginal Revolution) on the state of monetary policy. Much I agree with and find insightful:
Can central banking as we know it be the primary tool of macroeconomic stabilization in the industrial world over the next decade?...There is little room for interest rate cuts..QE and forward guidance have been tried on a substantial scale....It is hard to believe that changing adverbs here and there or altering the timing of press conferences or the mode of presenting projections is consequential...interest rates stuck at zero with no real prospect of escape - is now the confident market expectation in Europe & Japan, with essentially zero or negative yields over a generation....The one thing that was taught as axiomatic to economics students around the world was that monetary authorities could over the long term create as much inflation as they wanted through monetary policy. This proposition is now very much in doubt.
Agreed so far, and well put. "Monetary policy" here means buying government bonds and issuing reserves in return, or lowering short-term interest rates. I am still intrigued by the possibility that a commitment to permanently higher rates might raise inflation, but that's quite speculative.

and later
Limited nominal GDP growth in the face of very low interest rates has been interpreted as evidence simply that the neutral rate has fallen substantially....We believe it is at least equally plausible that the impact of interest rates on aggregate demand has declined sharply, and that the marginal impact falls off as rates fall.  It is even plausible that in some cases interest rate cuts may reduce aggregate demand: because of target saving behavior, reversal rate effects on fin. intermediaries, option effects on irreversible investment, and the arithmetic effect of lower rates on gov’t deficits
Central banks are a lot less powerful than everyone seems to think, and potentially for deep reasons. File this as speculative but very interesting. Larry has many thoughts on why lowering interest rates may be ineffective or unwise.

The question is just how bad this is? The economy is growing, unemployment is at an all time low, inflation is nonexistent, the dollar is strong. Larry and I grew up in the 1970s, and monetary affairs can be a lot worse.

Yes, the worry is how much the Fed can "stimulate" in the next recession. But it is not obvious to me that recessions come from somewhere else and are much mitigated by lowering short term rates as "stimulus." Many postwar recessions were induced by the Fed, and the Great Depression was made much worse by the Fed. Perhaps it is enough for the Fed simply not to screw up -- do its supervisory job of enforcing capital standards in booms (please, at last!) do its lender of last resort job in financial crises, and don't make matters worse.

But how bad is it now? Here Larry and I part company. Larry is, surprisingly to me, still pushing "secular stagnation"
Call it the black hole problem, secular stagnation, or Japanification, this set of issues should be what central banks are worrying about...We have come to agree w/ the point long stressed by Post Keynesian economists & recently emphasized by Palley that the role of specific frictions in economic fluctuations should be de-emphasized relative to a more fundamental lack of aggregate demand. 
The right issue for macroeconomists to be focused on is assuring adequate aggregate demand.  
My jaw drops.


The unemployment rate is 3.9%, lower than it has ever been in a half century. It fell faster after about 2014 than in the last two recessions.



Labor force participation is trending back up.



Wages are rising faster and faster, especially for less skilled and education educated workers.



 There are 8 million job openings in the US.

Why in the world are we talking about "lack of demand?



Larry had a point about secular stagnation in about 2014. The Great Recession was dragging on seemingly forever. There was a good debate about "secular stagnation" vs. sand in the gears -- the cumulative effects of Obamacare, Dodd Frank, and the regulatory war on capital. But those days are over. How can anyone be seriously talking about "lack of demand" now?

Yes, despite the clearly full employment labor market, GDP is growing more slowly than I think is possible, and I can infer Larry agrees. But at full employment slow GDP growth comes from too slow productivity growth.

Let me suggest the alternative:
The right issue for macroeconomists to be focused on is assuring adequate aggregate supply.  
[This is me, not Larry]. We need now a "pro-growth" agenda. When you're out of recession and financial crisis, further growth comes from "supply." And there is plenty to work on there. Alas, supply requires a Marie Kondoing of our public life, not a grand new initiative. Fix all they little things: zoning, agricultural policy, tax reform, reducing disincentives of social programs, continued regulatory reform, cutting tariffs, occupational licensing, and on and on. Macroeconomists (and growth economists) should be focusing on microeconomics.

Larry goes utterly in the opposite direction:
Obviously fiscal policy needs to be a major focus, especially given what low or negative interest rates mean for the sustainability of deficits.
But the level of demand is also influenced by structural policies: e.g. pay-as-you-go social security, higher retirement ages, improved social insurance, support for private infrastructure investment, redistribution from the high-saving rich to the liquidity-constrained poor.
OMG. In case you can't read between the lines, the first paragraph means deliberate even larger deficits. "infrastructure investment" in the US today means more $4 billion per mile subways and high speed trains to nowhere. Redistribution to the liquidity constrained means forcibly taking away hard earned money to give it to people who have maxed out their credit cards.

(The latter is an especially pernicious argument. If the point is to give money to those who will consume it more effectively than us hopelessly frugal savers, then give it to the liquidity constrained rich too, and do not give it to the frugal poor.  This is a classic case of an answer in search of a question, as the question does not lead to income-based redistribution.)

Larry isn't quite at the Magical Monetary Theory and Green New Deal blowout here. But I only infer that from his previous statements critical of those for going too far. This is darn close and all in the same direction.

One might defend Larry that previously he was talking about contingency plans for stimulus in a recession. But these are permanent, structural policies that come and stay for a generation.

I thought of Larry as the epitome of centrist, sensible, technocratic Democratic Party stalwarts, alongside say Alan Blinder, who wrote quite sensibly in the WSJ warning against the excesses of Green New Deal and health care for all. I still have hope that that sensible wing of the party will prevail, and join with the sensible wing of Republicans (there still is one) to fix the supply end of our country. But this is an amazing sharp left turn.

Larry's closers with another intriguing thought.
The high inflation and high interest rates of the 1970s generated a revolution in macroeconomic thinking, policy and institutions. The low inflation, low interest rates and stagnation of the last decade has been longer and more serious and deserves at least an equal response 
Well put and yes indeed. But in my view, Alvin Hansen's 1939 speculations about eternal lack of demand and a soft version of AOC-Sanders-Warren deficit financed spending blowout and "redistribution" aren't it. Marie-Kondoing the massive clutter and disincentives on the growth side of our economy is.


20 comments:

  1. "Yes, the worry is how much the Fed can "stimulate" in the next recession. But it is not obvious to me that recessions come from somewhere else and are much mitigated by lowering short term rates as "stimulus." Many postwar recessions were induced by the Fed, and the Great Depression was made much worse by the Fed. Perhaps it is enough for the Fed simply not to screw up -- do its supervisory job of enforcing capital standards in booms (please, at last!) do its lender of last resort job in financial crises, and don't make matters worse."

    This argument simply doesn't make sense. If the Fed can make things worse with too tight policy during recessions, how is it unable to make things better? Why does every market signal we have show that the Fed's monetary policy actions make a huge difference on future expectations if it's powerless to make anything better during a recession?

    ReplyDelete
    Replies
    1. In economics, as in life, not everything is linear. If, because of imperfect forecasting ability, central banks can only make things better or worse largely by accident, then its optimal strategy, as Cochrane suggests, is just not to "screw up".

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  2. In fairness to Larry Sumners, he was talking about a recession when it happens, not current circumstances. Summers is saying in the next recession the Federal Reserve, and other major global central banks, are already out of ammo.

    Interestingly, the world's largest asset manager, BlackRock, and the world's largest bond manager, Pimco, and the world's largest hedge fund manager, Ray Dalio, have all recently advocated some form of money-financed fiscal programs. Wall Street is already on board with some version of "helicopter drops."

    This is a fascinating turn of events, when the financial community, which for generations has held a florid and public reverence for tight money as a badge of honor and political- and virtue-signaling, now it says it wants money-financed fiscal programs.

    We live in interesting times.

    ReplyDelete
    Replies
    1. No, this is typical; generational behavior, well documented in 'This time is different'. The pattern is simple, the new generation looks and discovers none of the debt is theirs, they never voted for it. They default, usually by some monetary regime change. Then we get a group of young economists who claim to have figured it out, and 'This time is different'
      Wash rinse and repeat.

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  3. Yeah, every civilized place is growing. If anyone thinks the rate is too low, printing money cannot help. Real solutions to real problems.

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  4. And, oh yes, speaking with Keynes: Has a monetary policy a outrance been tried recently to get that price level up?

    The more things change, the more they remain the same.

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  5. So I'm not an economist and don't play one on TV either. Whether the debate about secular stagnation is over or not, I couldn't say. I do think J. Bradford Delong's 2015 article "The Scary Debate Over Secular Stagnation" suggests that there are other serious economists out there who believe zero interest rates suggest there are macro economic problems Marie Kondo, or someone like her, can't fix. Your solution appears to anyone as untutored and unsophisticated as myself to be facile.

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    1. Focusing on fixing the supply side when there are few obvious problems on the demand side is "facile"? How so?

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  6. Prof. Cochrane - How does your model differ from Robert Mundell's "supply-side" model redirecting monetary policy to external balance and fiscal policy to domestic? Thank you.

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  7. Don't you think an NGDP targeting regime would have resulted in 3% gdp growth?

    Why did the fed start tightening? Inflation never went above 2%

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  8. Very interesting article. "Marie-Kondoing the massive clutter and disincentives on the growth side of our economy" would probably do far more than the crank suggestions of AOC or Warren. When your hull is encrusted with barnacles and trailing seaweed, you should scrape the hull, not add an engine.

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  9. To be fair, it does seem that Mr.Summers had not just the U.S. in mind but also the Euro area, other European countries with deep negative rates like Switzerland as well as Japan. For these the picture looks more groom.

    I also believe that we still do not understand well what inflation is doing recently (unconditionally and conditional on various monetary stimulus types), triggering these sort of speculations; and even if we did, it would be not clear what to do with it, as there does seem to be a mix of short term concerns and long term trends at play.

    Finally, aggregate supply boost would help, sure, but that's always true, and we are clearly not heading there right now.

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    Replies
    1. I agree. An what does this magic "aggtregate supply improvement" actually consist of: improved education and training? Well the amount spent on the latter should AT ALL TIMES be whatever maximises the return on that particular investment: whether we're in secular stagnation scenario or not!

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    2. Inflation is about on target. Unemployment is at a record low. Darned if I know what the problem is....:-)

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  10. Thank you for coining a new label for the State-theory of money: "Magical Monetary Theory." I had not seen that before, and I will pass it along.

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  11. Would an inadequate supply side with decent aggregate demand lead to higher real interest rates than is currently implied?

    ReplyDelete
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    1. I don't see by which mechanism that would happen in an open economy with free international capital flows - might work domestically, but nobody today lives in a purely domestic landscape.

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  12. The right issue for macroeconomists to be focused on is assuring adequate aggregate supply.
    [This is me, not Larry]. We need now a "pro-growth" agenda. When you're out of recession and financial crisis, further growth comes from "supply." And there is plenty to work on there. [sic] ... LIKE!!!

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  13. It is quite obvious. But not so much to those with an impacted indoctrination to economics. Secular strangulation is none other than the impoundment and ensconcing of monetary savings within the framework of the payment System. The "old school" economists recognized this - but dismissed it, because of a supposed residual "demand for money" offset. That ended in 1981 with the “S-Curve” dynamic damage (sigmoid function), the cumulative effect of catallactics, of structural changes in bank deposit innovations, which culminated by the first half of 1981 (with the widespread introduction of ATS, NOW, and MMDA accounts).
    Thus, as Leland Prichard, Ph.D., Economics, Chicago 1933, M.S. Statistics, Syracuse, pontificated in May 1980 that:
    “The Depository Institutions Monetary Control Act will have a pronounced effect in reducing money velocity”.
    The deceleration in N-gDp was axiomatic:
    Pritchard -1963: "The growth of time deposits (within the payment's system) shrinks aggregate demand and therefore produces adverse effects on gDp."
    NSA N-gDp’s growth rates by decade, percent ∆:
    1970’s growth = 1.76
    1980’s growth = 1.15
    1990’s growth = 0.76
    2000’s growth = 0.52
    2010’s growth = 0.43
    Unless savings are activated, put back to work, a dampening economic impact, a deceleration in money velocity, is engendered and metastases, resulting in secular strangulation (not because of robotics, not because of demographics, not because of globalization).
    And all commercial bank-held savings are unused and unspent, lost to both consumption and investment.

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  14. "...But these are permanent, structural policies that come and stay for a generation..."

    A generation or longer. That really is the problem, isn't it?

    Also, "fiscal stimulus" is actually the government buying goods and / or services from somebody (or many somebodies) or direct payments to citizens / residents. I think the recipients of these outlays can become dependent upon them (anecdotally, I know of at least one smallish business to which this happened), and it becomes politically unfeasible to curtail such outlays. They're never really the "temporary stimuli" people imagine.

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