Hello Discretion

Today, the much-anticipated first Fed policy statement of the Yellen era came out. FOMC statement, here.

Some interesting tidbits:

The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. ... asset purchases are not on a preset course, and the Committee's decisions about their pace will remain contingent on the Committee's outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases. 

In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. 

With the unemployment rate nearing 6-1/2 percent, the Committee has updated its forward guidance. 

In other words, the committee will do whatever it feels like doing, whenever it feels like doing it, based on whatever information it decides is relevant. The Committee updated its forward guidance by throwing it under a bus, or at least by clarifying that it is of the form "here is what we think now we will want to do in the future, but we can change our minds at any time."

The larger context is the debate between commitment or rules and discretion. Discretion wins.

You might expect me to be fulminating. I'm not. (Though I'm waiting for a rules vs. discretion blast from John Taylor! (Update: here it is.)  I regard this as simply stating reality.

Making fun of people's names?

Paul Krugman is now reduced to making fun of my name.

I was alerted to the fact that we were living in a Dark Age of macroeconomics when the same cockroach put in an appearance at the University of Chicago.

Oh how clever. I haven't heard that one since about, hmm, first grade, circa 1965. (Follow the link if you're not sure who he's talking about.)

Paul continues

Now, some people get all upset by this terminology. Why can’t I be serious and respectful? Well, the answer is that we’re not having a serious conversation

No, the royal "we" are not.

I suppose I should read this as a welcome sign of desperation; that Krugman, having run out of ideas, and unwilling to read the interesting "serious conversation" regarding stimulus that the rest of us are having in the academic literature (say, my own recent modest contribution), is reduced to endlessly flogging the old "Say's law" calumny and now this.

Here are Krugman's similarly profound thoughts about Narayana Kocherlakota's name.

New vs. Old Keynesian Stimulus

While fiddling with a recent paper, "The New-Keynesian Liquidity Trap" (blog post), a simple insight dawned on me on the utter and fundamental difference between New-Keynesian and Old-Keynesian models of stimulus.

Ferguson on Krugtron

A fun show is breaking out. Niall Ferguson on "Krugtron the invincible."

Paul Krugman, for a while now, has been lambasting those he disagrees with by trumpeting their supposed "predictions" which came out wrong, and using words like "knaves and fools" to describe them -- when he's feeling polite. These claims often are based on a rather superficial, if any, study of what the people involved actually wrote, mirroring the sudden narcolepsy of Times fact-checkers any time Krugman steps in to the room. Niall has lately been a particular target of this calumnious campaign.

Niall's fighting back. "Oh yeah? Let's see how your "predictions" worked out!" Don't mess with a historian. He knows how to check the facts. This is only "part 1!" Ken Rogoff seems to be on a similar tear. (and a new item here.) This will be worth watching.

Dupor and Li on the Missing Inflation in the New-Keynesian Stimulus

Bill Dupor and Rong Li have a very nice new paper on fiscal stimulus: "The 2009 Recovery Act and the Expected Inflation Channel of Government Spending" available here.

New-Keynesian models are really utterly different from Old-Keynesian stories. In the old-Keynesian account, more government spending raises income directly (Y=C+I+G); income Y then raises consumption, so you get a second round of income increases.

New-Keynesian models act entirely through the real interest rate.  Higher government spending means more inflation. More inflation reduces real interest rates when the nominal rate is stuck at zero, or when the Fed chooses not to respond with higher nominal rates. A higher real interest rate depresses consumption and output today relative to the future, when they are expected to return to trend. Making the economy deliberately more inefficient also raises inflation, lowers the real rate and stimulates output today. (Bill and Rong's introduction gives a better explanation, recommended.)

So, the key proposition of new-Keynesian multipliers is that they work by increasing expected inflation. Bill and Rong look at that mechanism: did the ARRA stimulus in 2009 increase inflation or expected inflation?  Their answer: No.

Rogoff on UK Defaults

Ken Rogoff wrote a very interesting FT oped on UK finances (FT original, Rogoff webpage if you can't see FT.)

The issue: Should we worry about huge sovereign debts of advanced countries? Or was the only problem with fiscal stimulus that it was not big enough?

The New-Keynesian Liquidity Trap

I just finished a draft of an academic article, "The New-Keynesian Liquidity Trap"  that might be of interest to blog readers, especially those of you who follow the stimulus wars. 

New-Keynesian models produce some stunning predictions of what happens in a "liquidity trap" when interest rates are stuck at zero.  They predict a deep recession. They predict that promises work: "forward guidance," and commitments to keep interest rates low for long periods, with no current action, stimulate the current level of consumption.  Fully-expected future inflation is a good thing. Growth is bad. Deliberate destruction of output, capital, and productivity raise GDP. Throw away the bulldozers, let them use shovels. Or, better, spoons. Hurricanes are good. Government spending, even if financed by current taxation, and even if completely wasted, of the digging ditches and filling them up type, can have huge output multipliers.

Even more puzzling, new-Keynesian models predict that all of this gets worse as prices become more flexible.  Thus, although price stickiness is the central friction keeping the economy from achieving its optimal output, policies that reduce price stickiness would make matters worse.

In short, every law of economics seems to change sign at the zero bound. If gravity itself changed sign and we all started floating away, it would be no less surprising.

And of course, if you read the New York Times, people like me who have any doubts about all this are morons, evil, corrupt, and paid off by some vast right-wing conspiracy to transfer wealth from the poor to the secret conspiracy of hedge fund billionaires.

So I spent some time looking at all this.

Job market doldrums

Three recent views on the dismal labor market pose an interesting contrast.

Alan Blinder wrote a provocative WSJ piece on 6/11, Fiscal Fixes for the Jobless Recovery. A week prviously, 6/5, Ed Lazear wrote about The Hidden Jobless Disaster. And John Taylor has a good short blog post Job Growth–Barely Keeping Pace with Population

All three authors emphasize that the unemployment rate is a poor measure of the labor market. Unemployment counts people who don't have a job but are actively looking for one. People who give up and leave the labor force don't count. Employment is a more interesting number, and the employment-population ratio a better summary statistic than the unemployment rate. After all, if unemployment falls because everyone who is looking for a job gives up, I don't think we'd see that as a good sign.

Source: Wall Street Journal

Ed Lazear made this interesting chart. As he explains,

Local Austerity

The Wall Street Journal had a really heart-warming article, Europe's Recession Sparks Grass-Roots Political Push  about groups taking over local governments in southern Europe, and cleaning out years of mismanagement. An excerpt

At her inauguration Ms. Biurrun [the new mayor of Torroledones, Spain] choked up before a jubilant crowd.

Then she began slashing away. She lowered the mayor's salary by 21%, to €49,500 a year, trimmed council members' salaries and eliminated four paid advisory positions.

She got rid of the police escort and the leased car, and gave the chauffeur a different job. She returned a carpet, emblazoned with the town seal, that had cost nearly €300 a month to clean. She ordered council members to pay for their own meals at work events instead of billing the town.

Debt and growth in 10 minutes

This is a short video from last year. I only just found out it exists. It still seems pretty topical, and (for once) condensed because Lars Hansen really forced me to obey the 10 minute time limit!

There is a better link here from the BFI page here that covers the whole event, but I couldn't figure out how to embed those.

Growth in the UK?

I thought European "austerity," meaning mostly large increases in marginal tax rates on anyone daring  to work, save, invest, start a company or hire people, while spending stays north of 50% of GDP, was a pretty bad idea.

So I was glad to read the tiltle, when a friend sent me a link to the Telegraph, announcing Osborne to unleash raft of policies to kick-start growth. Great, I thought, after trying everything else, the British will finally try the one thing that will work.

Comic of the day

Greg Mankiw posted this lovely "comic of the day." He called it "not completely fair." I'm not sure what he meant.

Perhaps it's in need of a better caption. To be fair to Keynesian economics, perhaps the caption should continue,

"When you're done, another half a box will magically appear on the wall." 

Maybe this is a good time for a cartoon caption contest!

Bloomberg TV on debt and magic

I did a short interview on Bloomberg TV this morning. Nothing new for readers of this blog, but fun anyway. Coffee just starting to kick in at 6:15 AM. As always, walking home I figured out 10 better ways to answer.

Three views of consumption and the slow economy

I'm still digesting New-Keynesian models. As part of that effort, today I offer some thoughts on how economists come to such different views of the current situation and desirable policies. It's a nice story, in the end. Real economists, unlike much of the commentary and blogging world, come to different conclusions by using much the same model, but making different assumptions and simplifications, each of which we can look at and evaluate, and hopefully come to some consensus.

The economy is not doing well. The black line in the graph shows log consumption. (The units are percent increase in consumption since 2002.) After trending up steadily at close to 3% per year through the previous decade, consumption -- along with output and everything else -- took a dive, totaling 10% loss relative to the red trendline. And consumption has been stuck there ever since.

So, the big questions: why, and what might be done about it?

More new-Keynesian paradoxes

Last week I saw Johannes Wieland's paper "Are negative supply shocks expansionary at the zero lower bound?"  A side benefit of the job market season is that we see interesting new papers like this one, and it contributed to my project of trying to better understand new-Keynesian models.

Though starting academic papers with blog quotations is usually a bad idea, Johannes starts with a great and very appropriate one,

As some of us keep trying to point out, the United States is in a liquidity trap: [...] This puts us in a world of topsy-turvy, in which many of the usual rules of economics cease to hold. Thrift leads to lower investment; wage cuts reduce employment; even higher productivity can be a bad thing. And the broken windows fallacy ceases to be a fallacy: something that forces firms to replace capital, even if that something seemingly makes them poorer, can stimulate spending and raise employment.” -Paul Krugman

I endorse this quote, because it is an accurate and pithy description of the properties of many careful new-Keynesian analyses in the academic literature.

Christina Romer on Stimulus

(Small update to clarify in response to early comments)
Christiana Romer has an important column in Sunday's New York Times on the stimulus. You will recall that as chair of the Council of Economic advisers, she played a big part in designing the stimulus, and forecasting its effects. She also is one of the preeminent academics who have done empirical work evaluating the effects of stimulus programs. You expect a thoughtful essay.

Are recoveries always slow after financial crises and why

Carmen Reinhart and Ken Rogoff have an interesting new Bloomberg column, "Sorry, U.S. recoveries really aren't different." They point to the great Barry Eichengreen and Kevin O'Rourke "Tale of two depressions: what do the new data tell us" columns. (Hat tip, commenter Tim to "slow recoveries after financial crises" who asked what I think. Here's the answer)

Reinhart and Rogoff go after the sequence of studies who have questioned their assertion that recessions after financial crisis are deeper and recoveries slower.

Unraveling the Mysteries of Money

Harald Uhlig and I did a fun interview run by Gideon Magnus (Chicago PhD) at Morningstar. We talk about the foundations of money, fiscal theory, monetary policy, European debt problems, etc. Gideon framed it well, and Harald is really sharp. Somebody combed my hair. A cleaned up version of the interview appeared in the Morningstar Advisor Magazine (html) (A prettier pdf)



A link in case the video doesn't work or doesn't embed well (if you see "server application unavailable" the link usually still works), or if you want the original source.

The video starts a little abruptly, as it left out Gideon's thoughtful introduction (it's in the Magazine) and framing question:

Gideon Magnus: I want to discuss the value of money and the idea that money is valued similarly to any other asset. Are there really assets backing money? If so, what are they? John, please explain.

Woodford at Jackson Hole

Mike Woodford's Jackson Hole paper is making a big buzz, and for good reasons. Readers of this blog may be surprised to learn that I agree with about 99% of it. (Right up to the "and hence this is what we should do" part, basically!)

Any student of economics should read this paper. Mike lays out in clear if not always concise prose, and remarkably few equations, the central ideas of modern monetary economics, on all sides, along with important evidence.

Mike's central question is this: how can the Fed "stimulate," now that interest rates are effectively zero, and given that (as Mike reviews), "quantiative easing" seems extremely weak if not completely powerless? He comes up with two answers: (Hint: starting with the conclusions on p. 82 is a good way to read this paper!)

CBO and the fiscal cliff

The CBO has released a report warning that a new recession could follow the  "fiscal cliff"

Background: Here's the CBO report and a Washington Post story  A few snippets from the CBO: