In 1994 Milton Friedman wrote about Judy Shelton: "In a recent Wall Street Journal op-ed piece (July 15)... Judy Shelton started her concluding paragraph: “Until the U.S. begins standing up once more for stable exchange rates as the starting point for free trade...” It would be hard to pack more error into so few words.... A system of pegged exchange rates, such as the original IMF system or the European Monetary System, is an enemy to free trade. It is no accident that the 1992 collapse of the EMS coincided with the agreement to remove controls on the movement of capital..." https://miltonfriedman.hoover.org/friedman_images/Collections/2016c21/NR_09_12_1994.pdf. To turn monetary policy away from internal balance toward preventing exchange rate movements that market fundamentals wanted to see occur was, in Friedman's view, the road toward disaster. It was simply wrong. And it could be held together only if economies moved from free trade back toward managed trade—and so beggared not just their neighbors but themselves.
Hoisted from the Archives: From Eight Years Ago: The Way the World Looked to Me in the Summer of 2011
Hoisted from the Archives: The Way the World Looked to Me in the Summer of 2011: Back in the summer of 2009, Barack Obama had five economic policy principals on the Treasury Bench:
No Longer Fresh at Project Syndicate: Is Plutocracy Really the Problem?: After the 2008 financial crisis, economic policymakers in the United States did enough to avert another Great Depression, but fell far short of what was needed to ensure a strong recovery. Attributing that failure to the malign influence of the plutocracy is tempting, but it misses the root of the problem.... In fact, big money does not always find a way, nor does its influence necessarily increase as the top 0.01% captures a larger share of total income.... The larger issue...is an absence of alternative voices. If the 2010s had been anything like the 1930s, the National Association of Manufacturers and the Conference Board would have been aggressively calling for more investment in America, and these arguments would have commanded the attention of the press. Labor unions would have had a prominent voice as advocates for a high-pressure economy. Both would have had very powerful voices inside the political process through their support of candidates. Did the top 0.01% put something in the water to make the media freeze out such voices after 2008?... Read MOAR at Project Syndicate
Very interesting to see: usually—always IIRC, with the possible exception of Alan Greenspan's use by the Bush administration in 2001 to support their tax cut—Fed Chairs and ex-Fed Chairs try as hard as they can to avoid choosing a partisan side. It appears that they have, as a group, decided that that is no longer possible: Clair Jones: Former Fed chairs gang up on Trump : "Every living former US Federal Reserve chair has ganged up on US President Donald Trump in an op-ed with the Wall Street Journal.... 'When the current chair's four-year term ends, the president will have the opportunity to reappoint him or choose someone new. That nomination will have to be ratified by the Senate. We hope that when that decision is made, the choice will be based on the prospective nominee's competence and integrity, not on political allegiance or activism. It is critical to preserve the Federal Reserve's ability to make decisions based on the best interests of the nation, not the interests of a small group of politicians....' The Journal article is diplomatic, eloquent and reflective. Everything that Trump isn’t, then. The trouble is, in an era of short attention spans and pick-A-side politics where the Fed chair finds himself regularly called out on Twitter, relying on things like evidence, or a coherent argument, might not cut it.... Earlier this year, when addressing Trump’s threat to replace Powell, former Fed vice-chair Stan Fischer put it bluntly. If the US President used his re-election in 2020 to choose a Fed chair with views close to his own, there was a chance of the US becoming 'a Third World country'. Stark and not exactly politically correct. If they are to retain their independence, though, the world’s central bankers might need a bit more of Fischer’s zing...
The Federal Reserve is not an intelligence: it does not think. Individual members of the Federal Open Market Committee, however, do think. And the center of gravity of their individual thoughts now runs something like this:
1980-1985 was a disaster: 3 x 6 x 0.5 = 9%-point-years of lost jobs for Americans, jobs that would not have been lost had the Federal Reserve done its proper job and kept inflation under control in the 1970s:
Inflation exploded in the 1970s because of demand-pull: the Federal Reserve let employment get above full employment, and outgo workers and firms rapidly concluded that this was a permanent situation in which they had to act first to boost their incomes:
We cannot let this happen again: hence three times since 2010—in 2013, 2016, and 2018—we have used our policy tools of rates, quantities, and jawboning to push interest rates higher because we thought we were rapidly closing in on the full employment point at which inflation would start to move up substantially:
All three times we were wrong: we were not rapidly closing in on the full employment point at which inflation would start to move up substantially.
Now the inverted yield curve tells us that the market thinks that we have overdone interest rate increases, and will be substantially cutting rates by 100 basis points over the next two years:
The market could be right and it could be wrong. An inverted yield curve has been a reliable warning signal in the past, but the world is different now, and perhaps that matters. However, failing to begin to validate market expectations now would shake confidence and raise uncertainty. We have no warrant for believing that our models are more knowledgeable right now than the market. And there is pronounced asymmetry here: we can always deal with too-high inflation via tighter money, but it is not obvious what we could do to fix the situation if a negative demand shock were to push the prime-age employment rate down two or four percentage-points.
Hence we will validate market expectations and drop our policy rates by 25 basis points at our next meeting. What will follow that... will be data-dependent...
Hoisted from July 3, 2008 Optimal Control: Was the Federal Reserve too volatile and hair-trigger? Or was the ECB too sluggish?:
BNN: Jerome Powell 'should have cut rates today': Professor: "Brad DeLong, economics professor at the University of California Berkeley, joins BNN Bloomberg to discuss his take on the Fed rate decision to leave interest rates unchanged...
More than Two Decades of Macroeconomic History Through the Lens of Four Key Components of Aggregate Demand
It is remarkable the extent to which you can tell the story of the U.S. macroeconomy over the past twenty-five years through the reactions of four components of aggregate demand to policies and shocks:
- The dot-com boom unleashed by the Clinton deficit-reduction program and high-tech innovation.
- The dot-com bust.
- The housing boom.
- The successful rebalancing of aggregate demand—housing sits down, while exports and business investment stand up as money flows are successfully redirected.
- The Fed well behind the financial-stability curve: the financial crisis and the collapse.
- Inadequate recovery: The Geithner Treasury and the Obama White House's failure to do anything to promote a recovery of residential construction.
- Inadequate recovery: Republican (and Obama) fiscal austerity.
- Inadequate recovery: Bernanke's highly premature taper tantrum.
- The Trump rebound.
Hoisted from the Archives: This serves as a good index of how much Milton Friedman's redefinition of "neutral monetary policy" to mean "whatever monetary policy keeps nominal GDP on its trend growth path" led people prone to motivated reasoning in a laissez-faire direction completely and horribly astray. It also serves as an example of an astonishing failure to mark one's beliefs to market. Never mind that the rough constant of M2 velocity before 1980 had been an obvious example of Goodhart's Law, and never mind that even before 1980 forecasts of the state of the economy one and two years out based on M2 were inferior to other forecasts, by 1997 James Buchanan had just seen a remarkable five-year 30% runup in M2 velocity. and the complete ditching of monetary aggregates not just as targets but even as indicators by Alan Greenspan in favor of a neo-Wicksellian "neutral interest rate" approach that had nothing whatsoever to do with an "effective monetary constitution" of any type:
Dotting i's and Crossing t's with Respect to Olivier Blanchard's "Secular Stagnation" Fiscal-Policy-in-an-Era-of-Low-Interest-Rates AEA Presidential Address
Consider the semi-canonical Diamond (1965) overlapping-generations model, with a wedge between the safe government-bond interest and the risky profit rate driven by risk aversion. Blanchard (2018) shows that the effects of increased debt have two effects that:
- raise (lower) reprentative-agent utility,
- evaluated after the resolution of uncertainties when the agent is young:
- a direct-transfer effect that holds when the safe government-bond rate is lower (higher) than the economy's growth rate, and
- a factor-price effect that holds when the risky average profit rate is lower (higher) than the economy's growth rate.
Robert Waldmann has convinced me that this second factor-price effect can be neutralized by a balanced-budget profit tax-funded wage subsidy.
Hence in the semi-canonical Diamond (1965) overlapping-generations model the economy is dynamically-inefficient—can be made better off by reducing its productive capital stock and introducing sustainable pay-as-you-go transfer schemes—whenever the safe government-bond rate is less than the economy's growth rate, no matter what the level of the expected profit rate:
What a difference six months makes! And now the Fed really wishes it had not raised interest rates in the second half of 2018 and yet is unwilling to move them now back to the summer-of-2018 level. Why they are unwilling I do not know:
Hoisted from the Archives: Next week the Federal Open Market Committee—the principal policymaking body of the United States's Federal Reserve system—is overwhelmingly likely to raise the benchmark interest rate it controls, the Federal Funds rate that governs short-term safe nominal bonds, by one quarter of a percentage point from the range of 1.75-2% per year to the range of 2-2.25% per year. That would make it a little more expensive to borrow and spend and a little more attractive to cut spending and save. Thus there would be a little less spending in the economy, and so a few fewer jobs. Economic growth would be a little slower. The economy would be a little less resilient in the face of adverse shocks to resources or confidence that might generate a recession. These are all minuses—small minuses from a 25 basis point increase in the Federal Funds rate, but minuses.
Larry Lindsey and John Taylor: "PLEASE APPOINT US TO SOMETHING!! WE ARE LOYAL!!!! WE ARE NPOSTLTE PEOPLE!!!!!! PLEASE!!!!!!!!"
At some level, this is hilarious: HA HA HA!!!
Greg Mankiw has said the obvious: that Stephen Moore is not qualified to be a Fed Governor. Kevin Hassett—Kevin Hassett!—appears to are frantically trying to organize internal opposition to the nomination of a grotesquely-unqualified governor who admits he is grotesquely-unqualified. Kevin:
As the process moves forward, if Steve ends up being the nominee, he'll have good explanations for his positions. You're right that he's gone through his career being a pundit and having really interesting things to a whole range of topics, but as a nominee you have to be more careful about every little word that he says. I'm sure that he's going to be pulling back his op-eds and preparing for confirmation, should that [nomination in fact] arise..."
And so John Taylor and Larry Lindsey decide that now is the time for them to demonstrate that they are NO PLATE OF SHIT TOO LARGE TO EAT people, as far as a Republican White House is concerned. note that they do this even though they may well in so doing alienate Banking-Committee Republican senators with likely long future tenures who this it kinda important that the Fed be, you know, a functional institution. Or are all the Repubilcan senators on the Banking Committee NPOSTLTE people too?
David Patten: Trump Fed Nominee Stephen Moore Targeted by Liberal Resistance: "Moore's roster of big-name advocates include... Bush economic adviser Larry Lindsey... two-time runner-up to serve as Fed Chairman John Taylor...
Dan Drezner: The Worst Piece Of Conventional Wisdom You Will Read This Year: "OK, so, a few things.... Stagflation in the 1970s was caused primarily by an inward shift of the aggregate supply curve due to a surge in commodity prices, particularly energy. Some central banks responded with accommodating monetary policies that accelerated inflation even further. Fiscal policy was an innocent bystander to this whole shebang. So I honestly don’t know what the hell Kinsley is talking about...
No Longer Fresh at Project Syndicate: The Fed Should Buy Recession Insurance: The next global downturn may well not be yet at hand: odds that the North Atlantic as a whole will be in recession in a year are now down to about one-fourth. German growth may well be positive this quarter. China might be rebounding this quarter. The U.S. is definitely slowing to 1% growth or so this quarter, but it is not yet clear that this slowdown will be more than a blip.
The very sharp Mohamed A. El-Erian misses one important thing here: almost always, recessions are much deeper than any naive computation of the size of the initial shock minus the sum of monetary and fiscal offset would predict. Why? Because businesses and investors are forward-looking, and take recession signals seriously. As Tim Duy says: everyone's "recession indicator... probability models... [are] raising red flags". It's a multiple-equiibrium thing. So while a recession in the next year is not certain and may not be probable it is not unlikely: Mohamed A. El-Erian: Inverted Yield Curve Doesn't Necessarily Mean Recession Is Nigh: "This rather benign economic outlook conflicts with the traditional signal of an inverted curve for four main reasons....  Europe... puts downward pressure on U.S. yields....  The Fed... a remarkable and rapid U-turn.... Other segments of the bond market are not signaling a major economic slowdown.... The erosion in inflationary expectations may... [be a] realization that many of the underlying drivers are structural.... This curve inversion is unlikely to be the traditional signal of a U.S. recession...
Now Not Quite so Fresh at Project Syndicate: The Fed Should Buy Recession Insurance: If the United States falls into recession in the next year or two, the US Federal Reserve may have very little room to loosen policy, yet it is not taking any steps to cover that risk. Unless the Fed rectifies this soon, the US–and the world–may well face much bigger problems later.
Lesson one of central banking: yield curve inversion should only be allowed when the central bank wants to push inflation down. So what does the Fed think it's doing? Is it that confident that the bond market does not know what it is doing? Show me any optimal control exercise that says that right now is a good time to allow yield curve inversion: Vildana Hajric and Sarah Ponczek: Stock Market Today: Dow, S&P Live Updates for March 22, 2019: "U.S. equities fell and Treasuries rose after miserable data from the German manufacturing sector.... The yield on 10-year Treasuries, already at a more-than-one-year low, extended its decline. The three-year/10-year yield curve inverted for the first time since 2007...
This has certainly been one crazifying Fed tightening cycle.
The 10-year nominal Treasury rate is only 0.2%-points higher than it was back in mid-2015, when liftoff appears imminent. the 10-year real rate is back where it started at 0.65, after having gone as low as zero and as high as 1.1%. And—unless it is triggered by strong good growth news—any further increase in the federal funds rate would invert the yield curve, which the Federal Reserve has decided not to do.
I really wish I had some idea of just what the Federal Reserve plans to do to fight the next recession, whenever the next recession come along. It has know since at least mid-2010 that the bond market believes that secular stagnation—at least in its effect on long-term interest rates—is a very real thing.
Presumably the Fed still believes that when the next recession comes it has one job: to drop the 10-year real Treasury rate so that expanded construction and exports can take up some of the emerging labor-market slack and so cushion the downturn. But I have no idea what policies it thinks it will pursue that will accomplish that...
Morning Coffee Podcast: The Fed Needs to Be Buying Recession Insurance—But Is Not: Should the U.S. fall into recession soon, the Federal Reserve will have very little room to loosen policy to cushion the downturn. This is a large asymmetric risk. The right way to manage an asymmetric risk is to buy insurance: the Federal Reserve should be buying recession insurance. It is not. This is a substantial problem...
Fresh at Project Syndicate: The Fed Should Buy Recession Insurance: If the United States falls into recession in the next year or two, the US Federal Reserve may have very little room to loosen policy, yet it is not taking any steps to cover that risk. Unless the Fed rectifies this soon, the US–and the world–may well face much bigger problems later. The next global downturn may still be a little way off. The chances that the North Atlantic as a whole will be in recession a year from now have fallen to about one in four. German growth may well be positive this quarter, while China could rebound, too. And although US growth is definitely slowing–to 1% or so this quarter–this may yet turn out to be a blip. Let’s hope so. Because if the next downturn is looming, North Atlantic central banks do not have the policy room to fight it effectively... Read MOAR at Project Syndicate
That the Bernanke Fed responded to hitting the zero lower bound by lowering its inflation target always struck me as not sane. Yet that is what it did. It went from a 2.5%-per-year core PCE chain inflation target to an asymmetric 2%-or-less-per-year core PCE chain inflation target:
Paul Krugman back in 1999 demonstrated that a flexible-price economy in which Say's Law holds reacts to hitting the zero lower bound on interest rates with an immediate and discontinuous drop in the price level in order to generate the inflation it needs for the zero nominal interest rate to generate the right neutral real interest rate so that full employment can be maintained. A central bank has one major job: to make Say's Law true in practice even though it is false in theory by pushing the real interest rate to the neutral rate.
Thus there are two not-wrong ways to deal with the zero lower bound problem:
- Keep your inflation target high enough that you do not hit the zero lower bound.
- If you do hit the zero lower bound, immediately do everything you can to push the inflation rate up until the zero nominal interest rate you have generates the neutral rate interest rate you need.
The Federal Reserve did not do either of the two not-wrong things in the early 2010s. The Federal Reserve's forthcoming "fundamental rethink" will not include an acknowledgement that the Bernanke Fed did a wrong thing in the early 2010s. And according to Gavyn Davies it has already taken the possibility of adopting a policy of doing the right thing—doing either of the right things—off the table. This is not good:
Gavyn Davies: Federal Reserve’s Fundamental Rethink About Inflation: "One idea for avoiding the Japanese deflationary trap is simply to raise the existing inflation target... Clarida has specifically ruled this out.... When prices fall below the long-run 2 per cent target during a recession, the Fed would credibly commit to compensating for this error during the subsequent recovery... the short run inflation rate may exceed 2 per cent while the catch-up to the long-term path occurs...
Even though the first quarter of 2019 is only two-thirds over, practically all of the private-sector decisions that will determine the level of economic growth from the first quarter of 2018 to the first quarter of 2019 have already been made. Moreover, because of a statistical quirk 8/9 of the components of the growth rate have already occurred, and we have reasonable data on 2/3 of the components. So the Federal Reserve Bank of New York's forecast that the first-quarter growth rate will be only 0.9% is now a semi-solid thing: you cannot take it to the bank, but you can borrow on it (the last three month-out misses were 0, +0.2, and -0.4 respectively):
It's not a recession. Not quite. But it is clear that even if 2.4% were the right target for the short safe nominal interest rate two months ago, it is not the right target for the short safe nominal interest rate now. The Fed should cut.
The Federal Reserve in 2011 Debates Christina Romer's Ideas About the Need for "Regime Change": Weekend Reading
Weekend Reading: The Federal Reserve in 2011 Debates Christina Romer's Ideas About the Need for "Regime Change": https://www.federalreserve.gov/monetarypolicy/files/FOMC20111102meeting.pdf
I believe that in a generation or two the histories of the Bernanke Fed are overwhelmingly likely to concentrate on two puzzles:
The failure to seek an environment in which inflation was high enough to allow a Federal Funds rate of 5% or so at the [peak of the business cycle, so that Bernanke's successors would have room to respond to a downturn in aggregate demand.
The failure to use the credibility of its commitment to low inflation long and painfully built up by Volcker and Greenspan to support policies to rapidly return prime-age employment to its normal share of the population.
In late 2011, in a context in which prime-age employment was severely depressed and not going anywhere, the failure to see these two as policy priorities that called for, well, "regime change" is likely to appear largely inexplicable, and to be judged harshly:
Project Syndicate: U.S. Recession No Longer Improbable: Over the past 40 years, the U.S. economy has spent six years in four recessions: in a downturn 15% of the time, with the odds that a current expansion will turn into a downturn within a year being one-in-eight. Of these four downturns, one—the extended downturn of 1979-82—had a conventional cause: the Federal Reserve thought inflation was too high, and so hit the economy on the head with the high interest-rate brick to stun it and induce workers to moderate their demands for wage increases and firms to cut back planned price increases. The other three have been caused by derangements in financial markets: the collapse of sunbelt Savings-and-Loans for 1991-92, the collapse of dot-com valuations in 2000-2, and the collapse of mortgage-backed securities in 2008-9.
What Is “Modern Monetary Theory”?
Ever since the Great Depression it has been settled doctrine in the nations of the North Atlantic that the government has a responsibility to keep the macroeconomy in balance: The circular flow of spending, production, and incomes should be high enough to keep there from being unnecessary unemployment while also being low enough so that prices and inflation are not surprisingly and distressingly high.
To accomplish this, governments use fiscal policy—the purchase of goods and services, the imposition of taxes, and the provision of transfer payments—and monetary policy—the provision by the central bank to the system of those liquid assets called “money” and its consequent nudging up and down of interest rates and asset prices—to attempt to keep the circular flow of spending, etc., in balance with the economy‘s sustainable productive potential at the expected rate of inflation .
Modern Monetary Theory says (1) that that is all there is to worry about, and (2) that fiscal policy should play the principal role in this balancing process.
Needless to say, time has left me a lot wiser: We need to design economies so that they can operate without disaster even when deregulatory clowns like those of the George W. Bush or the Donald J. Trump administrations are in control of the levers of policy at key moments. How to do that is not so clear. What is clear is that only a fool today would think that our political economy would support a clever technocracy so that we might have our cake and eat it too. Indeed, the most likely scenario seems to be that we will be unable to eat our cake, and then the kleptocrats will steal it out from under our noses so that we will not have it either. In short: I should have listened harder to Jagdish 20 years ago...
Hoisted from the Archives: Reply to Bhagwati: "I open my May/June  issue of Foreign Affairs to discover myself pilloried in an article by Jagdish Bhagwati between Paul Krugman and Roger C. Altman (excellent company to be in, by the way: much better than I am used to) as a banner-waving proponent of international capital mobility, guilty of "assum[ing] that free capital mobility is enormously beneficial while simultaneously failing to evaluate its crisis-prone downside."
I rub my eyes in surprise. I had not thought of myself as a banner-waving proponent of international capital mobility.
Live at Project Syndicate: U.S. Recession No Longer Improbable: The next recession most likely will not be due to a sudden shift by the Fed from a growth-nurturing to an inflation-fighting policy. Given that visible inflationary pressures probably will not build up by much over the next half-decade, it is more likely that something else will trigger the next downturn.... The culprit will probably be a sudden, sharp “flight to safety” following the revelation of a fundamental weakness in financial markets. That... is the pattern that has been generating downturns since at least 1825, when England’s canal-stock boom collapsed.
Needless to say, the particular nature and form of the next financial shock will be unanticipated. Investors, speculators, and financial institutions are generally hedged against the foreseeable shocks.... The death blow to the global economy in 2008-2009 came not from global imbalances or from the collapse of the mid-2000s housing bubble, but from the concentration of ownership of mortgage-backed securities... Read MOAR at Project Syndicat
In the context of overall labor-market utilization trends, the rise in the household-survey estimate of the unemployment rate in December relative to November is worth a note:
- First, the rise in the unemployment rate is due predominately to yet another increase in labor force participation. It's not that people found it harder to find and keep jobs—it's that people who had thought it would be hard concluding that it will be easier, and so starting to look.
Nick Rowe: Worthwhile Canadian Initiative: "Are We at Full Employment Yet?": "Set aside the other benefits of switching from an inflation target to an NGDP level path target. If switching targets meant we wouldn't need to ask "Are we at full employment yet?" in order to figure out whether monetary policy is too tight or too loose, that would be a major advantage. Because it's a question we can't answer until it's too late. Instead we would simply hope that we are not at full employment yet: we would hope that target NGDP growth would in future be composed more of real GDP growth and less of inflation. And we would be forced to concentrate instead on microeconomic policies that might improve that composition...
The Federal Reserve Is Raising Interest Rates Again for Probably All The Wrong Reasons: Last Month Over at Equitable Growth
Last Month Over at Equitable Growth: The Federal Reserve Is Set to Raise Interest Rates Again for Probably All The Wrong Reasons: The meeting [last month] of the Federal Open Market Committee—the principal policymaking body of the U.S. Federal Reserve system—[was] overwhelmingly likely to raise the benchmark interest rate it controls, the Federal Funds rate. The rate, which governs short-term safe nominal bonds, is likely to go up by one-quarter of a percentage point, from the range of 1.75 percent to 2 percent per year to the range of 2 percent to 2.25 percent per year. That would make it a little more expensive to borrow and spend and a little more attractive to cut spending and save. Thus, there would be a little less spending in the economy, and so a few fewer jobs. Economic growth would be a little slower. The U.S. economy would be a little less resilient in the face of adverse shocks to resources or confidence that might generate a recession. These are all minuses—small minuses from a 25-basis-point increase in the Federal Funds rate, but minuses nonetheless.
Paul Krugman tells us: Paul Krugman: @paulkrugman: "The American Economic Association has a new discussion forum set up by Olivier Blanchard. First up is the question of whether low interest rates are leading to excessive risk-taking https://www.aeaweb.org/forum/311/have-low-interest-rates-led-to-excessive-risk-taking..." So I mossed on over and left three comments: one on the forum, one on secular stagnation, and one on whether there is any reason to fear low interest rates:
Is There Any Reason to Fear Low Interest Rates?: Have low interest rates led to excessive risk taking?: I suspect that the right way to make the accurate point that this line of discussion is hunting for is to focus not on the amount of risk but on, rather, who is bearing the risk...