DeLong's Panel Report

Brad DeLong managed a rough transcript of a panel discussion comprising him as the moderator, Carlo Cottarelli the IMF FAD head, the ever-effervescent Krugman, Valerie Ramey and the black sheep (if you could call it that!) Harald Uhlig from Chicago. The discussion tries to stay focussed on recessions from a macro perspective and the whole role of fiscal policy in a ZLB era with highly unconventional central bank measures. Here are DeLong's questions to get them started:

1. Are there policies the Federal Reserve, the ECB, and the rest of the government could adopt that would quickly move the civilian adult employment-to-population ratio back toward what from 1985-2007 we thought of as "normal"--that could produce in the next couple of years rates of employment growth within shouting distance of those the U.S. economy experienced over the Reagan boom of 1982-1989?
2. If so, what are those policies?
3. If so, are those policies desirable ones that the Federal Reserve, the ECB, etc. and the rest of the government should adopt?
4. How is your view on questions (1) through (3) different today than it was six years ago?

It's quite long so i'll just post some snippets from each of them that I thought were telling. 

Cottarelli:

"This change (the IMF's fiscal stance post 2008) was prompted by three factors: First of all, it was felt that the magnitude of the shock was such that there was a risk of things getting out of control—it was not an ordinary recession. Second, it was felt that although the recession had originated in a house price boom and then dysfunction in the financial sector, it has turned quickly into a demand recession—a recession in which lack of aggregate demand was causing a further and further decline in economic activity, and as a result there was rising unemployment and a lot of uncertainty about future economic prospects. This was a world in which the relevant textbook was The General Theory of John Maynard Keynes. Third, it was felt that with credit markets not working properly monetary policy had exhausted its room for activity with short-term nominal interest rates at zero percent and could not provide enough support."

"But in general as much as possible we favor a gradual approach to fiscal adjustment—it should not be front-loaded. We have done this for two reasons. First, we feel that the fiscal multiplier is pretty large under current circumstances, essentially output right now is demand-determined. In principle, it would be preferable to postpone fiscal adjustment altogether until some future time in which there is too much private-sector demand rather than implementing it at a time when there is not enough private-sector demand."

"The second reason why we favor a gradual approach to fiscal adjustment is called “too much of a good thing”. It is possible that if you tighten fiscal policy up front with multipliers in their current range, you end up with a decline in GDP growth so large as to be counterproductive, to cause not a decline but an increase in interest rates as markets become worried about the decline in GDP."

"We have argued that gradual adjustment should be accompanied by a continuing use of monetary policy to support economic activity because there will be a cost of even gradual fiscal tightening. All of this focuses on the demand side. At the same time we have focused on the need for supply-side medium-term growth from structural reform. Although at present output is demand-determined, over the medium-term it is important for the advanced economies to raise their rate of potential growth. That has huge implications for the fiscal situation over the years.

So this is essentially our view of what fiscal policy should do: gradual fiscal adjustment, as much as possible, accompanied by relaxed monetary conditions for as long as necessary, and structural reform."

Krugman:

"If an economist from 1958 had seen what is going on now, he—and back in 1958 it would have been “he”—would have said: “OK. Private sector does not want to spend. The government should spend. This is a powerful case for fiscal stimulus to prevent this from causing a persistent slump.” We have not done that."

"Think about the objections to stimulus. I would put them into three categories:

First, perhaps we do not have nearly as much economic slack as people like—well—me say. Perhaps there is something much more structural going on, and we do not have that much room to expand. We have a huge economic failure, but the failure is not for the most part a simple failure of aggregate demand.

Second—you do not hear this story that much, but it is important to set up the third—is that we should not be using fiscal policy but should instead by using monetary policy. That is a more popular argument in the more informal discussion in the econoblogosphere than it is in academia. But there is the question of what you can do.

Third, even though we are at the zero lower bound, fiscal policy is a lot less effective than the man from 1958 would say it is, and that multipliers are quite low even under urgent conditions."

"Monetary policy: When I arrived at Princeton in 2000 there was a group of us—“Japan worriers”. I am the only one still there. Mike Woodford, Lars Svensson, who is now run off to the Riksbank, me, and Ben Bernanke—I wonder what happened to him? All of us were very concerned by what was happening to Japan in the 1990s. Some people looked at it and said: “That just shows how messed up the Japanese are.” Some of us looked at us and said: “Surface differences apart, Japan looks a lot like us: big advanced country, lots of room to maneuver, government officials who might not be the most brilliant but who were not complete idiots, and if they could get trapped in this sort of deflationary stagnation then it could happen to us.” Sure enough, it did."

"Finally, Ricardian effects. It is really important to understand how many people misunderstand that. There are many people who believe that higher government spending now means higher taxes later and this will crowd-out private spending now. But higher spending now means higher incomes now as well. In the simplest Ricardian setup, if you believe that resources are unemployed and if interest rates are zero, the multiplier is not zero but one. It is very difficult to come up with a story in which the current multiplier would be less than one. Invoking the expectation of future tax increases as a reason for a multiplier less than one is a much more difficult story to tell than people seem to imagine."

"The immediate objection is that causation is not reversed? This is where the Blanchard-Leigh stuff comes in: They look at forecast errors in output growth and forecast errors in future policy, and find that their forecasts of output growth which assumed a multiplier of 0.5 underestimated the true multiplier by about 1.0, systematically understating economic contraction in countries with larger-than-expected degrees of austerity.

I think their work is good. Of course, it fits what I wanted to believe, so you have to be careful. But very important stuff, if true.

The final point is policy: Are we sure that expansionary fiscal policy is the right thing to be doing and that austerity is a terrible, terrible mistake? No. We are absolutely sure of nothing. But the consequences, if that is the truth, and I think the evidence tilts that way, is that what we are doing right now is absolutely disastrous. And that is where we are right now."

Ramey:

"I think a key structural reform that would significantly help the economy—the labor market and also the long-run budget deficit—would be to reform the health-care sector. I spend a lot of my time teaching micro pub(l)ic policy. There are huge potential efficiency gains, as I will show."

Uhlig:

"Here is a really simple picture. You just take government spending—the business cycle component—and do the same for real GDP. Government spending is cyclical. If you look at postwar data for the United States, government spending is simply the most cyclical macro variable that is out there. The U.S. economy got into recessions without government spending. It got out of recessions without government spending."

"When you talk about fiscal stimulus, doing back-of-the-envelope estimates, it is always surprising how different people look at the same data in different ways. For example, in 2009 did fiscal stimulus help us? Well, there is one view that suggests that it did not do very much because whatever the federal government did was offset by the states anyway. "

"You look at Japan. Japan has a debt to GDP ratio that is way in excess of 200%. Boy have they tried fiscal stimulus! Look where they are! It does not look like a huge success story to me, but of course you can make the case that if they had not done that they would be in much worse shape. So again, how do you tell these things apart?

You remember episodes of stagflation in the 1970s. I remember these charts when you were a kid where you could choose between 5% unemployment and 5% inflation and eventually you were getting all of that combined with high government debt. It took us decades to get out of these traps again. So I do not think that these episodes are encouraging. "

"Let me talk more about the theory side—quantitative theory. Most important theory is dynamics. We are beyond shifting IS-LM curves around. There are periods. There is 2013, and 2014. Life goes on. We use dynamic models. And there are lots of theories that try to look at that. For example, this comparison exercise where they looked at very quick stimulus: what does it do? They assume sticky prices—Keynesian features and all these other features, non-Ricardian agents, and so forth. They find a fiscal multiplier that is larger than one. That is informative. That is useful. That is good. But this is not the kind of fiscal stimulus that they have seen."

"There are fiscal limits. And they are serious. Valerie Ramey has shown us the plot on health care spending. I wish Alan Auerbach were here. He always shows these plots from the Congressional Budget Office that if we keep on going as we are with Social Security you eventually reach a debt-to-GDP ratio of 500% or 600% in 2100 or so. Ridiculous numbers. Clearly something is going to happen before that. But we do not want to wait until then. We want to get our fiscal house in order way head of that. It is a ticking time bomb. We should do something about this. And we should not be complacent about this."

"Right now it is easy to be complacent in the United States because you say well interest rates are really low so we could do a lot more spending and run up more debt and postpone adjustment into the future. What is there to worry about? Once this becomes a problem it will be signaled because interest rates will rise a little bit. Well they don’t. Interest rates in financial markets on government securities—once financial markets start to have doubts on whether governments are serious about repaying their debt they have a tendency to jump. And once they jump the catastrophe is there. Let’s not wait until that happens. I am not saying that that is going to happen anytime soon in the United States, but the dynamics you want to have in your mind is a dynamics where you keep on piling up these fiscal problems and eventually the problem hits you overnight. You may not have much time to react."

"I don’t want to be alarmist about the United States. In the United States there is still quite a bit of fiscal room. I think we still have some time to change paths. But in other countries—they are squeezed. See Greece there. The interest rates they are facing are just unsustainable. They cannot possibly repay them. You also get some of the other countries that are supposed to be the guarantors in the European system like Germany and France. We have to be really careful. Once financial doubts emerge their room for maneuver is not that high either to extract tax resources to be able to credibly say higher interest rates no problem. We can repay them.

The federal debt-to-GDP ratio has risen dramatically and is now at World War II levels and I want to get that genie back into the bottle, and I want to get it back into the bottle by getting the government out of private activity because it is private activity that makes stuff happen. That is how we get out of recessions. And so we have to cut back on fiscal spending rather than doing more fiscal stimulus."

"Now in the longer run we have to worry about taxes, we have to worry about debts, we have to worry about long-run sustainability with the Social Security system. These are real obligations. These are not nominal obligations. We cannot inflate them away. We have to get our house in order. We have to do something about them. And if we don’t, doubts in financial markets will lead to a situation in which disaster strikes."

As you may have noticed, most of it's from Krugman and Uhlig because they're so contrasting and well, Uhlig just sounds very run-of-the-mill not to mention right-thinking. So, in his honor (and Krugman's!), the last quote comes from Krugman:

"OK. I disagreed with everything Harald said. With respect to Valerie, there are two points I want to make"

An RMB appreciation?

There's a small piece over at voxeu on the appreciation of the renminbi (rmb). I think all the banter that went to and fro on the valuation of the rmb seems to have cooled down after the election cycle but also because the rmb has appreciated significantly over the last few years especially in real terms:

You have to be careful when you discuss issues of manipulation, fairness and the like. Far from it being a mathematical issue, there are opinions everywhere on conceptually disputing this. Some of the thinking is that when looked at from a savings-investment dynamic point of view, the accumulation of foreign reserves that China is so famous for - essentially is a reflection of distortions and imperfections in the domestic financial market. The authors in this case, try and link an expected gradual decline in savings with an appreciating currency as opposed to the Balassa-Samuelson approach of productivity differentials.

In fact, if one considers a semi-open economy (China's has a restricted capital account), then theoretically I could see inconsistencies with being able to keep an exchange rate undervalued over the long term. If higher savings is linked to the CA surplus (CA = S - I after all), then an undervalued nominal rate would persistently boost exports and feed back into the economy in the form of higher domestic price levels and wage pressure as well. Eventually, the real effective rate would have to normalize.

Without the free flow of capital, the balance of foreign reserves becomes a reflection of what's happening in the current account. So the central bank can accumulate international reserves and finance them by issuing domestic saving instruments that boost private saving further. The key here, as should be noticed by now is where the adjustment lies. Without a completely open capital account, domestic interest rates will factor into the necessary adjustment.

Monetary Mapping

Some interesting reads in the FT. Here's one of them:

Gillian Tett has an article on the McCulley-Pozsar paper that delves into a sort of formal mapping of the interaction of monetary and fiscal policy in certain situations or cycles of deleveraging etc. This plays on the approach a few years ago to map the shadow system in a detailed manner and what they essentially propose this time is a quadrant-based approach to central banking reactions that argue against the whole idea of independence in unusual times. The charts are really interesting, I'll try and post them up as well. 

Perhaps it simplifies things once you take the diametrically opposite approach, i.e: either the private sector is leveraging or deleveraging and the fiscal stance is that of consolidation or stimulative. If both are stimulative, there could be rapid credit growth (which the central bank needs to keep under control). When one is and the other isn't, a mixed pattern is likely and when both sectors are deleveraging, there is likely to be a deflationary environment - when monetary policy hits the ZLB and loses traction, a boost to the monetary base does nothing to stimulate spending and the economy experiences a liquidity trap. 

This is the main point that Tett takes away and it's primarily the reason for the paper - that in this special circumstance of a dual lack of stimulus, could central bank independence (price stability) be counter-productive? Because loose money won't work, perhaps an MoF needs to work in tandem to ensure fiscal support as well. 

Tett ends with this:

" We are not in the same place today: the US, say, faces modest inflation, not deflation. But it would be a bold investor who would assume history could never be replayed, if the economic crises grind on.

If there is one thing we learnt in the 2008 financial crisis, it is that events which once appeared unimaginable do sometimes occur. In retrospect, the only reason we were surprised by events was that we had a bad (or limited) mental map of how the world worked. Shadow banking was one case in point. It is unlikely to be the last."

The Power of Monetary Policy

I spent a fair bit of time poring over the money multiplier, the base and the money supply among others so maybe I'll have something on that later. Naturally there arose some relationships (historically) that seemed a bit confusing to me so I'm being forced to hold that though. You know the story though - exploding base post-recession, tame price levels and a consistent money stock - and of course, the almost-90 degree spike in excess reserves; it's not hard to put the narrative together...

...in the meantime, however, I came across a Romer(s) draft that I think was presented at the AEA (I can't remember). It's a really interesting read and strongly recommended. What they basically do (in a lot more detail than it seems at first!), is analyze the perceptions of the power of monetary policy based on how the Fed has acted and reacted historically. 

Now this would lead to two approaches - either you have an 

1) "Overinflated belief" that contributes to an error. For example, banking too much in the power of monetary policy and getting it wrong, as in the mid 60's when a highly expansionary policy led to the inflation nightmare of the 70's.

2) A more relevant and recent idea that involves a sense of pessimism as to what monetary policy can accomplish - for example, believing that monetary policy would be ineffective and perhaps too costly  in stimulating the recovery this time around. 

The paper focuses on the latter and is aptly titled, "The Most Dangerous Idea in Federal Reserve History: Monetary Policy Doesn't Matter". And naturally, the greatest error (if you could call it that), was the Great Depression when the money stock, price level and output all plummeted by about 25%! In such a case, the Romers argue that while there is no known evidence of an over-reaching belief, there is general consensus that an "overly pessimistic assessment of the Federal Reserve's ability to combat the downturn was critical in this period", i.e: that policymakers believed that expansionary action would involve high costs and lack effectiveness. 

Essentially, the sense one gets from historical accounts of statements made is that the two vastly different eras weren't all that different when it came to policy fear. The typical response to doing more bordered around the fear of failure and a damage to credibility - that if a decision/move/action had little impact, the Fed's credibility would take a beating. Also, expansionary monetary policy approach can never seem to shake off the inflationary bogieman - the fear that easy credit encourages overborrowing and that an expansion "might well add unwise stimulus to the inflation of prices" or that "a further increase in excess reserves of member banks might give added impetus to existing inflationary tendencies"  - all these are fears that have been voiced recently too. 

Take the 70's - put into fresh perspective for me post the Volcker book. Once inflation gathered steam, a lack of faith or perhaps a fear of the cost of monetary policy played a role, the paper states, to NOT do anything about it. Tightening would bring up fears of output costs and after the mild recession of '69-'70 the Fed under Arthur Burns started to believe that the natural rate wasn't so low after all - and that more importantly, inflation was being unaffected by a drop in economic activity. 

In any case, the more important issue is the relevance of this over the past few years which obviously leads us to believe that the Fed story has not and cannot be written just yet. It takes a much longer period of time to rightfully assess the impact of policies. It is in this section that the authors draw the parallel in beliefs across these three eras mentioned above. In each case, policy makers to an extend, believed that the tools at their disposal were perhaps not effective enough and simultaneously potentially costly. 

There have been all kinds of new fears and questions raised. Why should there be a need for additional liquidity when "so much is presently lying fallow"? Another stresses the danger of a ZRP in increasing the misallocation risk of real resources and perhaps aid a rise in new bubbles. And of course, there is the old inflation demon, the fear that inflationary expectations will quickly spiral out of control. 

Perhaps policy makers at times, try to ensure that the belief that monetary policy can accomplish everything does not gain traction as this diverts attention from other areas, as Bernanke stated most recently. 

All this discussion however, leads the authors to ask what is desirable and key to a central banker's success. Hubris can have disastrous effects - as the belief that monetary policy could cheat the trade-off between low inflation and below-normal unemployment led to a pursuit of seemingly reckless policies. But hubris, in human nature always has these effects. What is more intriguing, and perhaps is the gist of this entire draft, is that humility can have equally disastrous consequences because it can translate into a pessimism and lack of belief that can further lead to inaction. 

This leads to their conclusion, that a central banker needs to have a balanced appreciation of both the limitations as well as the capabilities of the power of monetary policy and a comprehensive understanding of what a particular policy can accomplish and when it can accomplish it. 

Moar Multiplier Musings

I wanted to discuss the detailed Blanchard-Leigh WP at the AEA that brought up multiplier-mania again but still haven't read it in enough detail, so I thought I'd postpone before I came across a Noahpost that he deems incendiary. Why? Because it's conveniently titled (more web hits!) - "Why the multiplier doesn't matter". 

That aside, there are some valid points here. Namely that the first thing he does is add these caveats:
The multiplier doesn't matter:
1) The 'Theoretical" multiplier
2) in the United States
3) At this time in history

And the basis for his argument is that it doesn't matter what the multiplier is period. The bottom line is that the US should be investing in infrastructure. That's why the multiplier doesn't matter. Theoretically, discussing the multiplier in a strictly Keynesian model makes sense if you assume that the Fed is deaf to what's going on fiscally and furthermore has been banned to react in any way. That much, is obvious.

As Noah points out further though, what about public goods? What if there's something the private sector can't provide or won't provide or maybe even shouldn't provide? If these goods are complements (in a good way!) to the private sector then a low multiplier shouldn't matter. Smith then cites the Baxter and King paper from 1993 (I haven't read it and am not likely to soon!) on "government capital" which describes a situation where 'government spending on "government capital" is efficient even without any aggregate demand deficiencies at all. Efficient, that is, as long as the current amount of "government capital" is below the optimal amount - in other words, as long as the country has recently been underinvesting in things like infrastructure.'

That's the point. If you're looking at investment in infrastructure as some sort of a counter-cyclical measure etc. then you're missing it totally. The benefits of infrastructure investment don't differ whether you're in the biggest boom or the biggest bust but the cost of borrowing does - and the cost of capital is so low! 

The Keynesian multiplier doesn't have to be x or y or z to justify repairing a severely underinvested infrastructure. 

If you can't see that, your vision is poor. 

If you choose not to see that, you're a modern-day Republican.

What Am I Reading?

Umair Haque on some certain ways America is excelling at...mediocrity. Noah Smith has a sort of rebuttal on this but it's partially fair. The truth is that while there are several things still good and great, it's becoming increasingly difficult to deny the erosion of the bedrock that made America a global hegemon - infrastructure.

In the broader sense of the word, schools/education, institutions, transportation etc which cost money to build, maintain, revamp, upgrade. It's true, the pace of convergence (and divergence now for some!) vis-a-vis other developed nations is startling. Sooner or later, this is going to start telling a lot more.

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Feldstein has an interesting piece on India Shining: Part (I've lost count - insert number here). I could save you the read and encapsulate bits into a paragraph:

"The Indian economy is coming back. After several years of disappointing performance, the authorities are shifting to policies aimed at boosting the annual growth rate closer to the roughly 9% level that India achieved from 2004 to 2008...All of this is an enormous undertaking – one that 

confronts innumerable potential impediments, both economic and political. But I am betting that India is rising again: millions more will be lifted out of poverty in the coming years, while the increasingly prosperous Indian middle class will expand further." 

Nope, that's not really fair is it? Time to quit being a skeptic and put in the other bits:

"Although India has outstanding universities and technological institutes, the primary-education system is disastrously poor...India’s infrastructure is inadequate for a modern economy. With too little electricity, blackouts are common. Ports are inefficient, roads are congested, and traffic is astonishingly chaotic...Likewise, India’s recent decision to allow large foreign retailers like Wal-Mart to enter the market reflects an encouraging change of attitude that is important beyond the specifics of the particular firms that will now come to India. And legislation will soon create the opportunity for expanded foreign ownership in the financial sector...On the fiscal front, the shift from a complex system of state-level indirect taxes to a national goods and services tax (a type of value-added tax) will improve efficiency and raise revenue. Lowering the subsidy for diesel fuel was politically difficult, but will reduce both the fiscal deficit and excessive use of diesel products...Government investment in infrastructure, both alone and in partnership with private firms, will also directly benefit growth and attract larger inflows of foreign investment."

Easy enough to be optimistic when you're not living the pessimism or in other words, easy enough to see the glass half-full when you're not the one drinking the water.

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And Stephen Roach comes down pretty hard on Abe's latest and greatest from the Land of the Rising Sun. In general, he comes down hard on easing measures taken globally and compares Japan's zombie corporations of the lost decade to America's zombie consumers, both products of ineffecient central banking I presume. 

What Roach does make clear though, is this: we're mired in a classic liquidity trap and the last thing Japan needs is to follow suit and backtrack on serious structural reform. Roach worries about the excess liquidity that is due to be 'sloshing around' in global asset markets without having boosted balance-sheet repair or led to structural change. 

In that sense, he's not wrong.

On the edge of a cliff

I made a mistake in running out of time to jot down some slope/cliff/crevasse/precipice notes and now there's just too much reaction for my liking. This seems quite undeserving because I don't see much to cheer about. Somehow one side of the spectrum has made it out to be a deal-that-saved-mankind when the reality is completely different. That said, the House Republicans really do play nasty and have now wrought the wrath of the scary Chris Christie! I'd be scared, Christie could snap Cantor and Boehner with his left hand - yes, picture that for a second will you.

Anyways...this is what was going around before the deal passed, note the consistency at least! DeLong makes the point of the actual difference the deal made from the status-quo negative impulse the economy would have suffered - not that great you see:

" The big reason to make a deal before January 1, 2013 was that detonating the "austerity bomb" would impose 3.5% of fiscal contraction on the U.S. economy in 2013, and send the U.S. into renewed recession. It was worth making a good-enough deal--sensible long-run revenue increases and tax cuts to close the long-run fiscal gap plus enough short-term fiscal stimulus to make the net fiscal impetus +1.0% of GDP--in order to avoid renewed recession. But by my back-of-the-envelope count, the deal the Obama administration has agreed to still leaves a net fiscal impetus of -1.75% of GDP to hit the U.S. economy in 2013. That is only 40% of the way back from the "austerity bomb" to where we want to be."

Krugman is more severe on Obama, claiming that although it seems like a 'progressive' victory - no benefits cut and tax increases for the first time - you can't help feeling cheated. To him, the POTUS has been drawing lines in the sand and repeatedly proceeded to erase them and draw another...and another.

And Jeffrey Sachs is on the next level of critical. From the HuffPo:

"Even Mitt Romney could never have accomplished for the Republicans what Obama has just done for them...Allowing the Bush tax cuts to expire today would have raised tax collections by around 2.5 percent of GDP, to around 21 percent of GDP by the end of the decade, thereby allowing the government to pay its bills assuming that the useless wars are ended and the bloated Pentagon budget is brought under control...With a revenue baseline of around 18 percent of GDP, there will be years of harsh spending cuts ahead. What will they be? Medicaid? Food Stamps? Roads? Water? Renewable energy? Education? Pre-School? Environment? It will probably be "All of the above." ..."

And lastly, Mankiw came down hard as well - from another angle - stating that everything the BS (yes that's what it is!) commission had espoused has largely been ignored - a perfect example of poor fiscal reform. 

You see, the problem is in everyone pretending to be two saviors at once - for the country's 'bankruptcy' (let's face it, some people are still hell bent on comparing the economy to a household!) and for social insurances. And it's hard to be both at once. 

Once the deal had been passed, naturally there was a varied response across the board. Tellingly, Andrew Semwick, the CEA's Chief Economist a decade ago, had this to say on the winner of the fiscal cliff, 

"Obviously, former President George W. Bush. Despite how much he has been vilified in the years since his departure from office, the Congress and the President yesterday decided to ratify almost all of his tax policy agenda...that even if top marginal tax rates are not lower than in the Clinton years, taxpayers with the highest incomes are still paying lower taxes because all the tax rates below the top are lower...In over eight years of blogging, you won't find a single word of praise for the Bush-Obama tax cuts. As a matter of revenue, we now permanently have a tax system that will not raise enough revenue to cover our expenditures..."