Micro vs. Macro

The cause of sclerotic growth is the major economic policy question of our time. The three big explanations are 1) We ran out of ideas (Gordon); 2) Deficient "demand," remediable by more fiscal stimulus (Summers, say) 3); Death by a thousand cuts of cronyist regulation and legal economic interference.

On the latter, we mostly have stories and some estimates for individual markets, not easy-to-use  government-provided statistics. But there are lots of stories.

Here is one day's Wall Street Journal reading while waiting for a plane last Saturday:

1) Holman Jenkins,

... unbridled rent seeking.  That’s the term economists use for exercising government power to create private gains for political purposes. 

Channelling Jefferson,

Mr. Obama’s bank policy dramatically consolidated the banking industry, which the government routinely sues for billions of dollars, with the proceeds partly distributed to Democratic activist groups. 

His consumer-finance agency manufactured fake evidence of racism against wholesale auto lenders in order to facilitate a billion-dollar shakedown.

The new voodoo

Scott Sumner sums up contemporary stimulus proposals well

...Old hydraulic Keynesianism from the 1960s was already a pretty implausible model. But what's happened since 2009 involves not just one, but at least five new types of voodoo: 

1. The claim that artificial attempts to force wages higher will boost employment, by boosting AD.

2. The claim that extended unemployment benefits---paying people not to work---will lead to more employment, by boosting AD.

3. The claim that more government spending can actually reduce the budget deficit, by boosting AD and growth. Note that in the simple Keynesian model, even with no crowding out, monetary offset, etc., this is impossible.

4. More aggregate demand will lead to higher productivity. In the old Keynesian model, more AD boosted growth by increasing employment, not productivity.

5. Fiscal stimulus can boost AD when not at the zero bound, because . . . ?

In all five cases there is almost no theoretical or empirical support for the new voodoo claims, and lots of evidence against. There were 5 attempts to push wages higher in the 1930s, and all 5 failed to spur recovery. Job creation sped up when the extended UI benefits ended at the beginning of 2014, contrary to the prediction of Keynesians. The austerity of 2013 failed to slow growth, contrary to the predictions of Keynesians. Britain had perhaps the biggest budget deficits of any major economy during the Great Recession, job growth has been robust, and yet productivity is now actually lower than in the 4th quarter of 2007.

Interview, talk, and slides

I did an interview with Cloud Yip at Econreporter, Part I and Part II, on various things macro, money, and fiscal theory of the price level. It's part of an interesting series on macroeconomics. Being a transcript of an interview, it's not as clean as a written essay, but not as incoherent as I usually am when talking.

On the same topics, I will be giving a talk at the European Financial Association, on Friday, titled  "Michelson-Morley, Occam and Fisher: The radical implications of stable inflation at the zero bound," slides here. (Yes, it's an evolution of earlier talks, and hopefully it will be a paper in the fall.)

And, also on the same topic, you might find useful a set of slides for a 1.5 hour MBA class covering all of monetary economics from Friedman to Sargent-Wallace to Taylor to Woodford to FTPL.  That too should get written down at some point.

The talk incorporates something I just figured out last week, namely how Sims' "stepping on a rake" model produces a temporary decline in inflation after an interest rate rise. Details here. The key is simple fiscal theory of the price level, long-term debt, and a Treasury that stubbornly keeps real surpluses in place even when the Fed devalues long-term debt via inflation.

Here is really simple example.

Clinton Plan

The WSJ asked me to review the Hillary Clinton economic plan, motivated by her August 11 speech introducing it.  The Op-Ed is here.

I read a good deal of the "plan" on hillaryclinton.com. What I discovered is that there is so much plan that there really isn't any plan at all.

Summers on growth and stimulus

Larry Summers has an important, and 95% excellent, Financial Times column. Larry is especially worth listening to. I can't imagine that if not a main Hilary Clinton adviser he will surely be an eminence grise on its economic policies. He's saying loud and clear what they are, so far, not: Focus on growth.

WSJ growth oped -- full version

WSJ Oped. Now that 30 days have passed, I can post the whole thing. Previous post.

Ending America’s Slow-Growth Tailspin

Sclerotic growth is America’s overriding economic problem. From 1950 to 2000, the U.S. economy grew at an average rate of 3.5% annually. Since 2000, it has grown at half that rate—1.76%. Even in the years since the bottom of the great recession in 2009, which should have been a time of fast catch-up growth, the economy has only grown at 2%. Last week’s 0.5% GDP report is merely the latest Groundhog Day repetition of dashed hopes.

The differences in these small percentages might seem minor, but over time they have big consequences. By 2008, the average American was more than three times better off than in 1952. Real GDP per person rose from $16,000 to $49,000. And those numbers understate the advances in the quality of goods, health and environment that came with growth. But if U.S. growth between 1950 and 2000 had been the 2% of recent years, instead of 3.5%, income per person in 2000 would have risen to just $23,000, not $50,000. That’s a huge difference.

Looking ahead, solving almost all of America’s problems hinges on re-establishing robust economic growth. Over the next 50 years, if income could be doubled relative to 2% growth, the U.S. would be able to pay for Social Security, Medicare, defense, environmental concerns and the debt. Halve that income gain, and none of those spending challenges can be addressed. Doubling income per capita would help the less well off far more than any imaginable transfer scheme.

Summers on roadblocks to infrastructure

The bureaucrats of Massachusetts have done the nation a wonderful service, by parking an abject lesson in America's infrastructure sclerosis right in front of Larry Summers' office.

Summers and Rachel Lipson have written a remarkable Op-Ed in the Boston Globe, and Larry a deeper follow-on piece on the Washington Post Wonkblog, detailing the 5 year struggle to repair a bridge that took 11 months to build in 1911.

The narrow story:

How, we ask, could our society have regressed to the point where a bridge that could be built in less than a year one century ago takes five times as long to repair today?

In order to adhere to strict historical requirements overseen by the Massachusetts Historical Commission, the Massachusetts Department of Transportation had to order special bricks, cast by a company in Maine, to meet special size and appearance specifications from the bridge’s inception in 1912.

...extensive permitting and redesigns haven’t helped. 

And the rest reads like a typical Wall Street Journal oped anecdote of regulatory incompetence, fodder for my next weekly summary.

Larry's Post follow on is deeper:

Investigating the reasons behind the bridge blunders have helped to illuminate an aspect of American sclerosis — a gaggle of regulators and veto players, each with the power to block or to delay, ...

At one level this explains why, despite the overwhelming case for infrastructure investment, there is so much resistance from those who think it will be carried out ineptly. 

Stop for a moment here. This sentence is a watershed moment. Larry is one of our foremost public-intellectual economists. He's been arguing for years for infrastructure spending, first as "shovel-ready" stimulus to fight the recession, lately as the remedy for "secular stagnation." So far, he's been arguing mostly for more money, and not highlighting regulatory roadblocks. The Democratic party (not Larry) line is that infrastructure is the fault of stingy Republicans who won't spend the money.

But here is Larry, listening, and urging his readers to listen. Savor the sentence: "This explains why.. there is so much resistance from those who think it will be carried out ineptly." How often, in American public life these days, do we see a prominent, party-aligned, public intellectual listen hard and understand what's bothering the other side? No, it's not that they are stingy, mean-hearted, evil, or whatever. It's that they don't trust the money to be spent on the right thing, in the right place, in finite time. They have a point.

Global Imbalances

I gave some comments on “Global Imbalances and Currency Wars at the ZLB,” by Ricardo J. Caballero, Emmanuel Farhi, and Pierre-Olivier Gourinchas at the conference, “International Monetary Stability: Past, Present and Future”, Hoover Institution, May 5 2016. My comments are here, the paper is here 

The paper is a very clever and detailed model of "Global Imbalances," "Safe asset shortages" and the zero bound. A country's inability to "produce safe assets" spills, at the zero bound, across to output fluctuations around the world. I disagree with just about everything, and outline an alternative world view.

A quick overview:

Why are interest rates so low? Pierre-Olivier & Co.: countries can't  “produce safe stores of value”
This is entirely a financial friction. Real investment opportunities are unchanged. Economies can’t “produce” enough pieces of paper. Me: Productivity is low, so marginal product of capital is low.

Why is growth so low? Pierre-Olivier: The Zero Lower Bound is a "tipping point." Above the ZLB, things are fine. Below ZLB, the extra saving from above drives output gaps. It's all gaps, demand. Me: Productivity is low, interest rates are low, so output and output growth are low.

Data: I Don't see a big change in dynamics at and before the ZLB. If anything, things are more stable now that central banks are stuck at zero. Too slow, but stable.  Gaps and unemployment are down. It's not "demand" anymore.

Next Steps for FTPL

Last Friday April 1, Eric Leeper Tom Coleman and I organized a conference at the Becker-Friedman Institute,  "Next Steps for the Fiscal Theory of the Price Level." Follow the link for the whole agenda, slides, and papers.

The theoretical controversies are behind us. But how do we use the fiscal theory, to understand historical episodes, data, policy, and policy regimes? The idea of the conference was to get together and help each other to map out this the agenda. The day started with history, moved on to monetary policy, and then to international issues.

A common theme was various forms of price-related fiscal rules, fiscal analogues to the Taylor rule of monetary policy. In a simple form, suppose primary surpluses rise with the price level, as
\[ b_t = \sum_{j=0}^{\infty} \beta^j \left( s_{0,t+j} + s_1 (P_{t+j} - P^\ast) \right) \]
where \(b_t\) is the real value of debt, \(s_{0,t}\) is a sequence of primary surpluses budgeted to pay off that debt, \(P^\ast\) is a price-level target and \(P_t\) is the price level. \(b_t\) can be real or nominal debt \( b_{t}= B_{t-1}/P_t\), but I write it as real debt to emphasize the point: This equation too can determine price levels \(P_t\). If inflation rises, the government raises taxes or cuts spending to soak up extra money. If inflation declines, the government does the opposite, putting extra money and debt in the economy but in a way that does not trigger higher future surpluses, so it does push up prices.

(Note: this post has embedded figures and mathjax equations. If the last paragraph is garbled or you don't see graphs below, go here.)

That idea surfaced in many of the papers.

Deflation Puzzle

Larry Summers writes an eloquent FT column "A world stumped by stubbornly low inflation"

Market measures of inflation expectations have been collapsing and on the Fed’s preferred inflation measure are now in the range of 1-1.25 per cent over the next decade.

Inflation expectations are even lower in Europe and Japan. Survey measures have shown sharp declines in recent months. Commodity prices are at multi-decade lows and the dollar has only risen as rapidly as in the past 18 months twice during the past 40 years when it has fluctuated widely

And the Fed is forecasting a return to its 2 per cent inflation target on the basis of models that are not convincing to most outside observers. 

Central bankers [at the G20 meeting] communicated a sense that there was relatively little left that they can do to strengthen growth or even to raise inflation. This message was reinforced by the highly negative market reaction to Japan’s move to negative interest rates.

So why is inflation slowly declining despite our central banks' best efforts? Here is a stab at an answer. I emphasize the central logical points with bullets.

• Interest rates have two effects on inflation: a short-run "liquidity" effect, and a long-run "expected inflation" or "Fisher" effect.  

Sanders multiplier magic

The critiques of Gerald Friedman's analysis of the Sanders economic plan  continue. The latest and most detailed and careful so far is by David and Christina Romer.

Bottom line:

1. The central idea in Friedman's analysis is that taking $1 from Peter to give to Paul raises overall income by 55 cents.  From this, you get multipliers from raising taxes and spending, from higher minimum wages, more unions, and so forth. 
2. I chuckle a little bit that so many economists who previously liked multipliers now don't like their logical conclusions. 
3. The Romers charge a serious, elementary arithmetic mistake in treating levels vs. growth rates. If they're right Friedman's whole analysis is just wrong on arithmetic.

The analysis

One might have expected that a sympathetic analysis of the Sanders plan would say, look, this is going to cost us a bit of growth, but the fairness and (claimed) better treatment of disadvantaged people are worth it.

Friedman's having none of that. In his analysis, the Sanders plan will also unleash a burst of growth, claims for which would make a fervent supply-sider like Art Laffer blush.

"The Sanders program... will raise the gross domestic product by 37% and per capita income by 33% in 2026; the growth rate of per capita GDP will increase from 1.7% a year to 4.5% a year." And, apparently, raise the growth rate permanently.

Negative rates and FTPL

I've devoted most of my monetary economics research agenda to the Fiscal Theory of the Price Level in the last two decades (collection here). This theory says, fundamentally, that money has value because the government accepts it for taxes, and inflation is fundamentally a fiscal phenomenon over which central banks' conventional tools -- open market operations trading money for government bonds -- have limited power.

Since I grew up in the 1970s, I figured the FTPL would have its day when inflation unexpectedly broke out, again, and central banks were powerless to stop it. I figured that the spread of interest-paying electronic money would so clearly undermine the foundations of MV=PY that its pleasant stories would be quickly abandoned as no longer relevant.

I may have been  exactly wrong on both points: It seems that uncontrolled disinflation or deflation will be the spark for adoption of FTPL ideas; that the equivalence of money and bonds at zero interest rates,  and central banks powerless to create inflation will be the trigger.

These thoughts are prodded by two pieces in the Economist, "Out of Ammo:" and "Unfamiliar Ways Forward" (HT and interesting discussion by Miles Kimball)

If you want inflation (a big if -- I don't, but let's go with the if) how do you get it? Ultra-low rates, huge bond purchases, and lots of talk (forward guidance, higher inflation targets) seem to have no effect. What can governments actually do?

Greece and Taxes

An interview for the Greek Reporter, in English, perhaps cheering the like-minded and sure to infuriate some conventional wisdom.

I agree with the "anti-austerians" on one point: Raising taxes was a bad idea. In my emphasis what counts are marginal tax rates on growth-producing activities, rather than Keynesian pump-priming, however, which is an important distinction.

The article says "A recently released study by the Economics Department at the National Kapodistrian University of Athens revealed that Greece has the third highest taxation rate among 21 European countries." If anyone has a link, especially if it's in English, send it in the comments.

Small shoes and headroom

I talked with Kathleen Hays and Michael McKee on Bloomberg Radio last week, and they asked (twice!) a question that comes up often in thinking about Fed policy: shouldn't the Fed raise rates now, so it has some "headroom" to lower them again if another recession should strike?

I could only answer with my standard joke: That's like the theory that you should wear shoes two sizes too small because it feels so good to take them off at the end of the day.

But the question comes up so often, it's worth thinking about a little more seriously. Under what views about the economy does this common idea make any sense?

Blanchard on Countours of Policy

Olivier Blanchard, (IMF research director) has a thoughtful blog post, Contours of Macroeconomic Policy in the Future. In part it's background for the IMF's upcoming conference with the charming title Rethinking Macro Policy III: Progress or Confusion?” (You can guess my choice.)

Olivier cleanly poses some questions which in his view are likely to be the focus of policy-world debate for the next few years.  Looking for policy-oriented thesis topics? It's a one-stop shop.

Whether these should be the questions is another matter. (Mostly no, in my view.)

As a blogger, I can't resist a few pithy answers. But please note, I'm mostly having fun, and the questions and essay are much more serious.

Levine on the Keynesian Illusion

David Levine has a very nice post on the Keynesian Illusion.

David Levine's analogy for Stimulus

Some big themes: Standard Keynesian economics violates budget constraints. He explains it well, but it is sure to occasion the usual venom from with the "Say's law fallacy" brigade that has a lot of trouble understanding the difference between budget constraints and equilibrium conditions.

David does a lot without equations. That broadens the appeal, but equations can be useful. For example equations clarify that crucial difference between budget constraints and equilibrium conditions. Equations can put to rest silly controversies. We might not still be writing papers, books, and blog posts about what "Keynes really meant," 80 years after the fact, or using "Say's law" as rotten tomatoes, if Keynes had written some equations.  Cynically, maybe the lesson is that lack of equations -- or even an equations appendix or citation -- keeps debate going and your name in the papers.

Bachmann, Berg and Sims on inflation as stimulus

Rüdiger Bachmann, Tim Berg, and Eric Sims have an interesting article, "Inflation Expectations and Readiness to Spend: Cross-Sectional Evidence" in the American Economic Journal: Economic Policy.

Many macroeconomists have advocated deliberate, expected inflation to "stimulate" the economy while interest rates are stuck at the lower bound. The idea is that higher expected inflation amounts to a lower real interest rate. This lower rate encourages people to spend today rather than to save, which, the story goes, will raise today's level of output and employment.

As usual in macroeconomics, measuring this effect is hard. There are few zero-bound observations, fewer still with substantial variation in expected inflation.  And as always in macro it's hard to tell causation from correlation, supply from demand, because from despite of any small inflation-output correlation we see.

This paper is an interesting part of the movement that uses microeconomic observations to illuminate such macroeconomic questions, and also a very interesting use of survey data. Bachman, Berg, and Sims look at survey data from the University of Michigan. This survey asks about spending plans and inflation expectations. Thus, looking across people at a given moment in time, Bachman, Berg, and Sims ask whether people who think there is going to be a lot more inflation are also people who are planning to spend a lot more. (Whether more "spending" causes more GDP is separate question.)

The answer is... No. Not at all. There is just no correlation between people's expectations of inflation and their plans to spend money.

In a sense that's not too surprising. The intertemporal substitution relation -- expected consumption growth = elasticity times expected real interest rate -- has been very unreliable in macro and micro data for decades. That hasn't stopped it from being the center of much macroeconomics and the article of faith in policy prescriptions for stimulus. But fresh reminders of its instability are welcome.

At first blush, this just seems great. Finally, micro data are illuminating macro questions.

Autopsy -- the Op-Ed

This was an Op-Ed in the Wall Street Journal December 22 2014. WSJ asks me not to post them for a month, so here it is now. I was trying for something upbeat, and to counter a recent spate of opeds on how ISLM is a great success and winning the war of ideas.


An Autopsy for the Keynesians

Source: Wall Street Journal

This year the tide changed in the economy. Growth seems finally to be returning. The tide also changed in economic ideas. The brief resurgence of traditional Keynesian ideas is washing away from the world of economic policy.

No government is remotely likely to spend trillions of dollars or euros in the name of “stimulus,” financed by blowout borrowing. The euro is intact: Even the Greeks and Italians, after six years of advice that their problems can be solved with one more devaluation and inflation, are sticking with the euro and addressing—however slowly—structural “supply” problems instead.

U.K. Chancellor of the Exchequer George Osborne wrote in these pages Dec. 14 that Keynesians wanting more spending and more borrowing “were wrong in the recovery, and they are wrong now.” The land of John Maynard Keynes and Adam Smith is going with Smith.

Why? In part, because even in economics, you can’t be wrong too many times in a row.

Deflating Deflationary Fears

Source: Charles Plosser

From a nice paper by Charles Plosser with that catchy title.  Yes, it's 10 years old, but the lesson is appropriate in today's hysteria. That dreaded deflationary spiral is always just around the corner.

Strange Bedfellows

Jeff Sachs has written a very interesting Project Syndicate piece on Keynesian economics. It's phrased as a critique of Paul Krugman, but his message applies much more broadly. Krugman was mostly articulating fairly standard views on stimulus, "austerity'' and so forth. (We need a better word than "Keynesian'' for what Jeff calls "crude aggregate-demand management.'' But I don't have one handy.)

This is a good example for people outside economics (and quite a few inside) who think all economists line up on an easy right-left divide. If you expected Sachs to support the standard Keynesian consensus because he's "liberal," or to use his words, in favor of "progressive economics," you would be wrong. He looks at the facts, the forecasts, and the Krugman's curious rewriting of history in a "victory lap," and comes to his own conclusions.

Needless to say, I'm happy to find someone else making many of the basic points in my
Autopsy for Keynesian Economics (ungated version). I'm even more happy that someone of a "progressive" political orientation comes to the same conclusions that I do from a more libertarian orientation.  I'll be curious to see if Sachs comes in for the same sort of venomous personal attacks -- with essentially no attempt to argue the content -- as my piece attracted from the politicized lefty economics blogosphere. Do they treat "friends" more nicely, or "traitors" more harshly? We'll see.

On infrastructure, Sachs writes

To be clear, I believe that we do need more government spending as a share of GDP – for education, infrastructure, low-carbon energy, research and development, and family benefits for low-income families. But we should pay for this through higher taxes on high incomes and high net worth, a carbon tax, and future tolls collected on new infrastructure. We need the liberal conscience, but without the chronic budget deficits.

Here too, we can almost agree. We can agree on the principle that infrastructure spending is important, and should be evaluated on the basis whether its benefits exceed its costs, not on the "stimulative" powers of its spending. Then we can go back to evaluating whether all of these particular investments have benefits greater than costs, and whether those particular taxes merit their distortions.