I wish this editorial wasn’t at CATO

“Conservatives” hate the unemployed so the facts on display in this editorial are obviously ideologically tainted. (h/t Wilkinson)

Look at the JOLTS data yourself: unemployment is being driven by a slow hire rate (fire rates are at about their normal level). Hiring rates could be depressed because of low demand for workers or for low supply of job hunters. GDP is rising which suggests demand for workers should be increasing. Unemployment benefits, on the other hand, have risen substantially so there are incentives to stay unemployed. Finally, we know the disincentive effect is large because of research by conservative stalwarts such as Larry Summers and Alan Krueger ((both somehow sneaked their way into high posts in the Obama administration)).

Mike in The Nation

“Let’s look at several of the problems that happened over the past few years in the financial sector, and see how legislative efforts have attempted to address them. (Spoiler alert: not very well.)”

Mike tells this story:

Our regulator’s goal isn’t to make a system in which there are never failures but a system in which failures are cleaned up in an orderly and nondisruptive fashion. Like an elaborate game of Jenga, even removing the smallest piece can collapse the entire structure, and regulators need to be able to remove any piece without having the entire real economy collapse.

This is a great story. Can it be rationalized? What objective function of regulators would lead them to aim to prevent “disruption”? A disruption now and again might be good by standard measures of welfare. Does Mike have a public choice model in mind? Do bailouts improve the chances of re-election?

Is the system as precarious as Mike suggests? Bailouts are sold to the public using a counterfactual that is rarely, if ever, observed. Namely, if the bailed out institutions were allowed to fail, it would have produced an undesirable level of systematic risk. When have failed banks caused systematic risk? The Great Depression had bank runs which caused a bad situation to get worse. But bank runs weren’t, by far, leading the causal chain. You need deflationary expectations, no deposit insurance and no branch banking to get those sorts of bank runs.

Besides, is the recent banking crisis evidence of the system’s precariousness or evidence against it? A long time transpired between banking crises in the US.

UPDATE: What is systemic risk?


You can call Federal Reserve policies aimed at the sending of signals that alter the expected rate of future inflation “monetary policy” if you want, but then you lose analytical clarity–because the way such policies work (if they work) is not the “normal” way that “normal” monetary policy works.

Prof. Delong

New rule: to opine on monetary policy you have to have opened a textbook on the subject that was written in the last 30 years.

From Micheal Woodford’s text (in a section in the introduction called “Central Banking as Management of Expectations”):

For successful monetary policy is not so much a matter of effective control of overnight interest rates as it is of shaping market expectations of the way in which interest rates, inflation and income are likely to evolve over the coming year and later. On the one hand, optimizing models imply… behavior should be forward looking… Moreover, given the increasing sophistication of market participants… it is plausible to suppose that a central bank’s commitment to a systematic policy will be factored into… forecasts… Not only do expectations about policy matter, but… very little else matters…

From Carl Walsh’s text:

Macroeconomic equilibrium depends on both the current and expected future behavior of monetary policy.

From Dornbusch, Fischer and Startz’ undergrad text:

You will remember that the nominal interest rate has two parts: the real interest rate and expected inflation… should [a zero interest rate liquidity trap] occur… policymakers are prepared… to pump money into the economy [and thus raise expected inflation].

From Jones’ new (and excellent) undergrad text:

To the extent that policymakers can influence, or manage, these expectations, they can reduce the costs of maintaining a low target level of inflation. This is one of the most important lessons of modern monetary policy… To the extent that the central bank can coordinate people’s expectations of inflation, it can maintain low and stable inflation without the need for [the bank to induce] recessions. Such coordination requires credibility and transparency on the part of the central bank.

From the Encyclopedia of Economics James Tobin says:

While not all monetarists endorse Friedman’s rule, they do stress the importance of announced rules enabling the public to predict the central bank’s behavior… Long rates depend heavily on expectations of future short rates, and thus on expectations of future Fed policies. For example, heightened expectations of future inflation or of higher federal budget deficits will raise long rates relative to short rates because the Fed has created expectations that it will tighten monetary policy in those circumstances.

Walk out?

I don’t think I’ll be participating in the planned walk out Thursday at UC campuses. I’m not clear what the goals of the walk out are to be. Are they to protest a short-term budget shortfall? To dispute the priorities in budget balancing? To lament the lack of voice in the process?

I’m not sure how walking off the job on Thursday will change the short-run budget issues. Short of printing their own money, neither the State nor the University can do much about the deficit. Of course, they could have done things in the past to have mitigated some of these problems (e.g. the University could be less dependent on State funds and the State could have institutions that make it less of a fiscal mess). But a protest today can’t change past actions. The best that can be said on this front for the walk out is that it could provide a modest encouragement towards making structural changes in the way the State and University do business; a very modest encouragement.

Also, the president doesn’t act as dictator nor the Regents an oligarchy. Shared governance means the University is also run by the faculty and they’ve weighed in on the issue. According to them, faculty and research quality should have precedence over access and affordability. “Our view about affordability is simple: if the state of California once again adopts the view that access and affordability are public goods worth supporting, they will be readily achievable.” To them, getting poor folks into the University is a public good and thus, it should be provided by the public, not from cuts in their paychecks.

Now voice: maybe there’s a point in protesting because we didn’t have a say in the process. But we do have a say. Students, mostly new students, can vote with their feet. There are plenty of private universities in the State and plenty of competition of all stripes outside the State. If fellow grad students don’t like the product they’re buying, then they should stop buying it.

Sam, Fred and the deer in the road

A story:

Fred is driving a car down a deserted highway in the middle of the night. His friend Sam is in the passenger seat. Fred reaches down to pick up something he dropped, taking his eyes off the road ((or maybe he doesn’t know he’s driving)). When he lifts his gaze back to the road, a deer has appeared.

What should Fred do? What should Sam do?

Clearly Fred should make a measured jerk of the wheel and swerve out of the way of the deer and Sam should do nothing. If Fred doesn’t swerve out of the way, he is responsible for the resulting crash. If Sam yanks on the wheel causing the car to go out of control and slam into a guard rail, he’s responsible for making the crash much worse.

The deer in the road is ultimately the cause for the crash, but as a force of nature he can’t be blamed for it. It is the actions or inactions of the people in the car that determine culpability. Because their actions determine whether or not the crash occurs and its severity, their culpability may not limited to not preventing the crash but for making it worse.

Friedman and Swartz found that Fred was at fault for the crash because he didn’t swerve when he should have. Ohanian has conjectured and has found some support in the data for the idea that Sam is at fault for making the crash worse because he jerked on the wheel.

But in the historical example, didn’t Sam jerk the wheel again after the car hit the guard rail? Yes, but jerks on wheels can, by luck, right out-of-control cars. Luckily for Sam, Eggertsson has found this was the case in the historical example. In that case, a jerk on wheel in the right direction happened to be productive.

Notice this doesn’t mean wildly jerking the wheel and sending cars out of control is a good idea. Also, the lucky productivity of the second jerk on the wheel doesn’t mean the first wasn’t bad.

“The Fed” now has two meanings

In a comment someone really, really smart (and handsome) said:

Believers in fiscal policy should be thinking of ways to fix the administration of it. Maybe an independent fiscal authority with a precisely defined policy instrument (e.g. stimulus checks and a consumption tax) and mandate (e.g. keep consumptions spending smooth)?

Eric Leeper has a new paper (pdf):

In this lecture, I argue that there are remarkable parallels between how monetary and fiscal policies operate on the macro economy and that these parallels are sufficient to lead us to think about transforming fiscal policy and fiscal institutions as many countries have transformed monetary policy and monetary institutions. Making fiscal transparency comparable to monetary transparency requires fiscal authorities to discuss future possible fiscal policies explicitly. Enhanced fiscal transparency can help anchor expectations of fiscal policy and make fiscal actions more predictable and effective. As advanced economies move into a prolonged period of heightened fiscal activity, anchoring fiscal expectations will become an increasingly important aspect of macroeconomic policy.

The paper is human friendly and is best read as a history of monetary economic thought. Leeper underscores that expectations are key to the success of fiscal policy (like they are to monetary policy). For example, if the public expects deficit spending to be followed by increased taxes in the future, GDP can contract today (i.e. negative multipliers). He suggests that, like in monetary policy, transparency and commitment would make for better fiscal policy, but he points out:

For many reasons it is not an easy task to enhance fiscal transparency by providing information that helps to anchor expectations of future fiscal choices. The two most prominent reasons offered for the difficulties are:
(1) Fiscal policy is complex;
(2) Current governments cannot commit future governments.
These reasons are true. But they also underscore why enhanced fiscal transparency is potentially so valuable.

The best line in the paper:

Further complicating the fiscal decision process is a stunning fact: a clearly defined and attainable set of objectives for fiscal policy is rarely specified. Many fiscal authorities lay out their objectives on their web pages. Sustainable fiscal policy is the most common goal. But achieving sustainable policy is equivalent to aiming to avoid government insolvency. If a company’s CEO were to announce to shareholders that the company’s overarching goal is to avoid bankruptcy, the CEO would soon be replaced. Surely people can ask for more than minimal competence from their public officials.

He has a few suggestions for increasing transparency. First, have better projections of fiscal policy and its impact. “Fiscal authorities could produce more sophisticated projections, grounded in economic
reasoning, that characterize outcomes that, as a matter of economic logic, could occur.” Second, there could be a fiscal Fed that sets deficits. Third, agree on some basic fiscal policy objectives that can be easily measured. Fourth, define some fiscal policy rules that meet those objectives. Lastly, establish credibility.

And my vote for the understatement of the year: “But fiscal decisions are only a small subset of the votes that legislators place, so fiscal votes can easily get lost in the morass of electoral politics.” I wonder, though, if it was ever thought that monetary authorities would have as much credibility, transparency and independence as they do today.

He ends on the ARRA, “I shall end with an egregious example of non-transparent fiscal policy: the recent $787 billion American fiscal stimulus plan.”

Gauti B. Eggertsson watch

I like this guy. This paper suggests deficit spending is productive at the zero lower bound because by increasing the deficit it increases expectations of inflation. Its important, however, for the central bank to coordinate its policy with the fiscal authorities to make this result happen. He very nicely shows that rules-constrained central banks, while not having the inflation bias of discretionary central banks, have deflation bias at the zero lower bound.

Here’s his Palgrave definition of liquidity trap. He argues if the Fed follows a Taylor rule, the liquidity trap really is a trap. Also,

if a central bank is discretionary, that is, unable to commit to future policy, and minimizes a standard loss function that depends on inflation and the output gap, it will also be unable to increase inflationary expectations at the zero bound, because it will always have an incentive to renege on an inflation promise or extended ‘quantitative easing’ in order to achieve low ex post inflation. This deflation bias has the same implication as the previous two irrelevance propositions, namely, that the public will expect any increase in the monetary base to be reversed as soon as deflationary pressures subside.

This should make Sumner happy:

There is a large literature on the different policy rules that minimize the distortions associated with deflationary shocks… Eggertsson and Woodford (2003) and Wolman (2005)… show that, if the government follows a form of price level targeting, the optimal commitment solution can be closely or even completely replicated, depending on the sophistication of the targeting regime. Under the proposed policy rule the central bank commits to keep the interest rate at zero until a particular price level is hit, which happens well after the deflationary shocks have subsided.

This should make Sumner unhappy:

Perhaps the most straightforward way to make a reflation credible is for the government to issue debt, for example by deficit spending. It is well known in the literature that government debt creates an inflationary incentive (see, for example, Calvo, 1978). Suppose the government promises future inflation and in addition prints one dollar of debt. If the government later reneges on its promised inflation, the real value of this one dollar of debt will increase by the same amount. Then the government will need to raise taxes to compensate for the increase in the real debt. To the extent that taxation is costly, it will no longer be in the interest of the government to renege on its promises to inflate the price level, even after deflationary pressures have subsided in the example above.

In other words, the best way to fight deflation, to increase expectations of inflation, is deficit spending.

The ARRA was a fight over distribution. As an economist, I have no dog in that fight. As a libertarian, well…

Oh yeah, that too

In the last post, I concluded that the macro debate today is about whether or not at the zero lower bound monetary policy can be effective. Theory says yes; data is inconclusive.

I neglected to mention that the debate is also about whether or not fiscal policy is effective at that lower bound. Martin Feldstein, in a highly readable and short paper that anticipates and takes the reader through this whole debate, says fiscal policy can be effective in such a situation (search google scholar for a free version).

Given we haven’t seen deflation so far, fiscal stimulus is a hedge against it. Once stimulus finally comes on line, if the economy is in a deflationary spiral, it will help get it out. Of course, we all trust that if that contingency doesn’t come to pass, the spending will be quickly unwound. Right? Right!?