Brad DeLong

DeLong Smackdown Watch: Tim Duy Comes to the Defense of and Explains Kansas City Fed President Esther George

Brad DeLong : There Is Something I Do Not Understand About Kansas City Fed President Esther George's Reasoning Here: The Fed's current Quantitative Easing ∞ program involves its buying risky bonds--thus diminishing the pool of risky assets that the private sector can hold. Esther George objects because… it does not make complete sense to me…. Because there is less in the way of risky assets for the private sector to hold--and because that pushes prices of risky assets up and returns on risky assets down--QE ∞ actually makes private-sector portfolios riskier? Is that the argument? It could be--the world is a surprising place, and lots of things can happen. But my first thought would be that a world in which the Federal Reserve takes risk off of private-sector balance sheets and onto the government's balance sheet is one in which the private sector is holding not more-risky but less-risky portfolios…

Tim Duy performs the smackdown:

Safe Assets and the Coordination of Fiscal and Monetary Policy - Tim Duy's Fed Watch: DeLong is looking at a continuum of assets from safe to risky, where cash anchors the safe end of the continuum.  Right next to cash is the somewhat riskier Treasury… by exchanging cash for Treasury securities, you by definition must be removing risk… and thus the public's portfolio is now less riskier. But… this is obviously not how George views the situation…. George… believes that [Fed policies] are in fact making the public's portfolio more, not less, risky…. I think a way you can explain George's position if you consider Treasuries as less risky than cash…. [T]he Treasury bond may be perceived as a safer because it provides some return…. [F]or any given inflation rate, the Treasury bond will thus be a safer store of value [if held to maturity].  If you viewed the world from this perspective, then the Fed is increasing riskiness of the public's portfolio…. George appears to be saying that the Fed is eliminating (more accurately, removing) the safe assets that the public wants to hold.  Suppose that this is true.  Does this mean that the Fed should reverse policy to increase the proportion of safe assets in the public's hands?  Or does it mean that another agency - perhaps a fiscal authority, hint, hint - should take action to increase the proportion of safe assets in the public's hands?  

Once again, we come back to the issue of coordinating monetary and fiscal policy.  If the public has a strong demand for noncash safe assets, monetary policy has something of a secondary role by providing an accommodative environment by which the fiscal authority can issue those assets. If the proportion of safe to risky assets is not "correct", the the fiscal authority should have a role in correcting that imbalance.  In this world, then, it is not really the actions of the monetary authority that is creating the financial sector imbalances that concern George.  It is the lack of action by the fiscal authority that creates those imbalances.  George should be criticizing the fiscal authorities, not the monetary authority.

In other words, if a recession is the result of the public shifting to safe assets, the Fed is trying to respond by taking away the option of safe assets, leaving only risky assets.  Instead, the Fed should view their role creating an environment (making clear that default is not an option) that allows the fiscal authority to issue more safe assets.

All of this, however, suggests that fiscal policy has a much greater role in stabilizing economy activity than conventional wisdom would hold.  I suspect, however, that thinking along these lines is anathema to Federal Reserve officials who maintain that stabilization policy is the domain of monetary policy only.  But if in fact there needs to be greater cooperation, and instead we continue to rely solely on monetary policy, then we will continue to experience less-than-satisfactory economic outcomes which will eventually endanger the cherished independence of central banks.

In short, I don't think you can have a discussion about the influence of monetary policy on the riskiness of the public's portfolio without including some discussion about the role of the issuer of those safe assets, the fiscal authority.

This is, I think, why I want the Fed's QE ∞ policies to take the form of buying genuine long-term risky securities more risky than Treasurys or MBS. If the point is to remove risk from the private sector balance sheet-if the point is to take Vienna--then remove risk from the private sector balance sheet--take Vienna! If the point is to expand the supply of cash to create expectations that interest rates will stay lower for longer, then it is better to buy assets the unwinding of which must by the nature of things be gradual and prolonged rather than buying assets positions in which can be unwound nearly costlessly in the blink of an eye. If the point of QE ∞ is neither to remove risk from the private sector balance sheet nor to back up guidance that interest rates will stay low for a long time, I do not understand what the point of the policy is.

And, of course, he is 100% right that expansionary fiscal policy by credit-worthy governments (or expansionary financial policy via loan guarantees) is the right policy to deal with a shortage of safe nominal assets leading economic agents to try to cut their spending below their income. This is, of course, the reason that I think a proper assessment of Tim Geithner's tenure at the Treasury would be a very harsh one indeed.

Tim's point that for an economic agent with a five-year horizon a five-year Treasury dominates cash is a good one, and I think it points to a flaw in my visualization of the Cosmic All that I do not know how to repair.

Between Greece and Zimbabwe

Within limits—until it starts printing money fast enough to become Zimbabwe—a country that controls its own currency and can print its own money does not face a tight and binding government budget constraint: the government spends what it wishes, taxes what it wishes, borrows what it wishes, prints money to make up the difference, and the exchange rate and the price level and interest rates then do their things as investors try to figure out on what terms they want to hold domestic as opposed to foreign assets and on what terms they want to hold bonds rather than cash.

By contrast, a country with a fixed exchange rate has its money stock nailed by the requirement that it maintain its exchange rate peg. That then forces spending, taxes, and borrowing into a configuration in which bond vigilantes believe that the debt will be paid off—and if they don’t believe that, then spending must be equal to taxes minus the debt repayment the bond vigilantes demand.

But suppose that you are in an intermediate case, where the Treasury and the central bank do not want to peg the currency (and the internal price level) but do not want to let it (them) do their own thing without limit either? Suppose the Treasury Secretary believes that a strong dollar is in America’s interest. What you then have is a mix of the polar gold-standard and MMT cases. But what are the proportions of the mix?

Mark Thoma: What can Washington do to boost the U.S. economy?

What can Washington do to boost the U.S. economy? - CBS News:

[T]he nation's most pressing economic problem remains the slow recovery, particularly the job market. Unemployment is still far too high and the rate at which we are creating new jobs is far too low…. Monetary and fiscal policymakers could accelerate the return to full employment through tax cuts, increases in government spending -- particularly in areas that tend to create lots of jobs -- and further monetary easing. However, the ability of monetary and fiscal policymakers to combat the slow recovery is constrained by three things: fear that aggressive monetary policy will drive up inflation to an unacceptable level; fear that tax cuts or increases in spending will worsen our long-run debt problem; and political disputes over taxes and the size and role of government….

John Quiggin on the (Failed) State of Macroeconomics

John Quiggin:

Is there a consensus? Clearly there was a consensus as of early 2008…. Everyone agreed that the core business of macroeconomic management should be handled by central banks using interest rate adjustments to meet inflation targets. In the background, central banks were assumed to use a Taylor rule to keep both inflation rates and the growth rate of output near their target levels. There was no role for active fiscal policy such as stimulus to counter recessions, but it was generally assumed that, with stable policy settings, fiscal policy would have some automatic stabilizing effects…. It was generally agreed that this approach to macroeconomic policy, combined with financial deregulation had produced a ‘Great Moderation’ in the volatility of economic activity>This broad consensus was destroyed by the Global Financial Crisis and the Great Recession, but it wasn’t replaced by anything resembling a real debate. Rather, different groups have gone off in different directions. Academic macro went on more or less as before…. Central banks have, in effect, treated the entire period since 2008 as a Schmittian “state of exception”, during which normal rules cease to apply. They have used the crisis to push governments to adopt “reforms” favored by the financial sector, such as cutting welfare benefits and other areas of public expenditure. But their central concern has been to restore the status quo ante, and the exclusive primacy of monetary policy, as soon as possible. From the central bank viewpoint, the restoration of low and stable inflation after the shocks of the 1970s is their crowning achievement and one to be maintained at any cost….

UPDATE: Stimulus or Stymied? The Macroeconomics of Recessions: 10:15 AM-12:PM, January 6, 2013, San Diego, CA, Manchester Grand Hyatt, Elizabeth Ballroom F

Panel Moderator: J. BRADFORD DELONG (University of California-Berkeley)

Panelists:

• CARLO COTTARELLI (International Monetary Fund)
• PAUL KRUGMAN (Princeton University)
• VALERIE A. RAMEY (University of California-San Diego)
• HARALD UHLIG (University of Chicago)

Between 1985 and 2007--the period of the "Great Moderation"--the Federal Reserve and the rest of the U.S. government on the west edge and the central banks and institutions of the European Union on the east edge of the Atlantic Ocean provided a broadly stable macroeconomic environment within which private-sector businesses, workers and investors could make their economic plans. In the U.S., on an annual basis: the rate of nominal GDP growth dropped below 4% for only 3 of those years and rose above 7% for only 2 of those 22 years; the rate of consumer price inflation rose above 5% for only 3 and fell below 2% percent for only 2 of those 22 years; and the civilian adult employment-to-population ratio remained between 60% and 64% for that entire period. And Western Europe experienced a similar "Great Moderation" with low inflation, relatively smooth growth, and diminishing unemployment.

Then in 2008-9 the rate of nominal GDP growth in the U.S. crashed to -3%--a major, major downward surprise to anybody expecting and relying on a continuation of "Great Moderation" rates of nominal spending growth--the rate of consumer price inflation on an annual basis bottomed out at -2%, and the employment-to-population ratio dropped from 63% to between 58% and 59%, since when it has flatlined. In Western Europe the initial recession was smaller, but the subsequent labor market performance was even more disappointing, so that now the net fall relative to trend in Western European productio and employment exceeds that in the United States.

In this context, we are here to explore four questions:

1. Are their policies that the Federal Reserve and the rest of the U.S. government on the west edge and the ECB and the governments of the European Union on the east edge of the Atlantic Ocean 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 that are, say, 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 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?

---

Alas! I failed in my task as moderator: communication among the panelists was by and large not achieved…

Valerie Ramey brought bad news for multipliers--but left a glimmer of hope in that there is still no evidence or argument that the multiplier at the ZLB would not be much greater than the normal-time monetary-offset multiplier. She talked about the need for comprehensive cost-saving health-care reform, an argument would have applied just as well to 2007 or 2017 as to today.

Carlo Cottarelli presented the IMF’s new, revised view on the multiplier. He did not promise that there were policies that could lead to a rapid recovery to full employment or criticize government.

Paul Krugman ably presented his view, which is my view, that governments should borrow and spend more to boost employment and production and that the limits to fiscal policy for credit-worthy governments are so far beyond the bounds of the politically-feasible that there is no point in talking about them.

Harald Uhlig… I am going to have to listen to Harald’s presentation again. It is clear that Harald Uhlig agrees with Valerie Ramey that there are no policies “that the Federal Reserve and the rest of the U.S. government on the west edge and the ECB and the governments of the European Union on the east edge of the Atlantic Ocean could adopt that would quickly move the civilian adult employment-to-population ratio back toward what from 1985-2007 we thought of as ‘normal’”. But it is not at all clear to me why he believes this…

Matt O'Brien vs. Martin Feldstein on Quantitative Easing

Matthew O'Brien:

There are two things you need to know about the Federal Reserve right now. First, it's had to resort to unconventional measures ever since short-term interest rates, its usual policy lever, fell to zero back in 2008. And second, everything you've been told about these unconventional measures has been wrong. The wrong story… the Fed has cut long-term rates by buying long-term bonds…. Lower borrowing costs should mean more borrowing, and more borrowing should mean more growth…. It's the same story you always hear… it's the one Harvard professor and former Reagan adviser Marty Feldstein tells in the Wall Street Journal. Well, kind of. Feldstein worries this story has some unintended consequences -- namely, higher deficits and higher inflation -- that will give it an unhappy ending….

More on the Current State of Macro...

Howard Schneider:

“[IMF] Forecasters significantly underestimated the increase in unemployment and the decline in domestic demand associated with fiscal consolidation,” [Olivier] Blanchard and co-author Daniel Leigh, a fund economist, wrote…. Blanchard… writes… that he could not actually determine what multipliers economists at the country level were using …. The number was implicit in their forecasting models…. Heading into a crisis that nearly tore the euro zone apart, in other words, neither Blanchard or any one of the fund’s vast army of technicians thought to reexamine whether important assumptions about the region would still hold true in times of crisis. That, it turns out, was a big mistake. Multipliers vary… get larger if interest rates are low, output is falling and the banking system is creaky – conditions that make everyone, from households to investors, less likely to spend, and thus makes the role of government-generated demand that much more important.

Blanchard and Leigh deduced that IMF forecasters have been using a uniform multiplier of 0.5, when in fact the circumstances of the European economy made the multiplier as much as 1.5, meaning that a $1 government spending cut would cost $1.50 in lost output…

"Liquidate Labor, Liquidate Stocks, Liquidate the Farmers, Liquidate Real Estate!… Even a Panic Is Not Altogether a Bad Thing" Weblogging

Robert Murphy says that in the absence of Bernanke's excessive inflationary policies we would now be undergoing deflation at a rate of 10%/year.

But he does not understand "why [predicting] price inflation (and interest rates) are the decisive criteria for whose model and hence policy recommendations are right."

And, in his view, Bernanke's policies remain bad and impious: we would have been better off without the expansion of the Federal Reserve's balance sheet from $700 billion to $3 trillion, and with 10%/year deflation right now.

And Jon Hilsenrath of the Wall Street Journal Gets One Wrong...

Jon Hilsenrath: >Fed's Computer Models Pose Problems:

When the Federal Reserve said in December that it would keep short-term interest rates near zero until the unemployment rate falls to 6.5%, it was backed by… [the] computer-modeling programs the central bank uses…. In December…. Fed officials decided to announce they would keep interest rates near zero until the unemployment rate drops to 6.5%. The models told them such a commitment would help nudge unemployment lower—it was 7.7% in November—and wouldn't risk a big burst of inflation.

But here is the problem: The models are deeply flawed. They failed to foresee the financial crisis in 2008 and have tended to overestimate the strength of the economy for several years. Could they fail the Fed again?… Despite all their complexity and sophistication, they have long been plagued by gaps in how they read and project the economy. One of the biggest is that they have ignored the nuances of the financial system—one of the primary channels through which Fed policy works….

The financial gaps in the models worry Nathan Sheets, a Citigroup C -0.62% economist who was Mr. Bernanke's top international adviser at the Fed from 2007 to 2011. Mr. Sheets points to 1994 as an example of why. Back then, small increases in short-term interest rates by the Fed led to a surge in long-term interest rates. The models didn't foresee the financial chaos that would ensue, including the collapse of investment bank Kidder Peabody & Co., the bankruptcy of Orange County, Calif., and the Mexican peso financial crisis…

I was just last week going through my notes from 1994. Yes, the Federal Reserve's model (and other models) "failed": they all forecast that the 1994 raise in the Federal Funds rate from 3%/year to 6%/year would carry with it an increase in long-term nominal Treasuries from 6%/year to 6.75%/year; instead, long-term Treasuries peaked at 8%/year because of (a) an absence of forward interest rate guidance by the Fed and (b) unexpectedly-large endogenous moves in the duration of MBS.

But the unexpectedly-adverse reaction of the bond market in 1994 did not cause the Mexican peso crisis: an extra 1% rise in U.S. bond interest rates is not big enough to cause the Mexican peso to lose 75% of its value. Neither Orange County nor Kidder Peabody had any business holding a portfolio that would be bankrupted by a 10% fall in the value of the long-term Treasury bond. And it is not the business of the Federal Reserve to make sure that nobody holding an over leveraged portfolio goes bankrupt. The "financial chaos" of 1994 had no effect on the real economy in the United States: there was no recession in 1995, but rather the beginnings of the great dot-com boom.

The point of Hilsenrath's article appears to be that something bad may

happen when Fed officials raise interest rates…. The models make predictions about unemployment and inflation, but Mr. Sheets worries they might not foresee new financial shoes poised to drop. "They've really internalized these models and that's very risky," Mr. Sheets said…. in a lower interest rate, and Ferbus spits out predictions of how much growth and inflation should follow. Punch in some other event—like a sudden contraction in government spending or a jump in tax rates—and it spits out predictions of how the economy should respond…. The fingerprints of Ferbus and its friends are all over the Fed's latest interest-rate decisions…. [G]iven the unknowns about unconventional Fed policies, Mr. Sheets's warning warrants attention.

Mr. Sheets's warning certainly warrants attention if you are a hedge fund or an investment bank thinking of replicating Kidder Peabody's or Orange County's portfolio--but you should have already known not to do that.

But should Mr. Sheets's warnings have led the Federal Reserve to do something different than it has done? In retrospect the Federal Reserve certainly wishes that it had given more guidance at the start of 1994 as to the likely shape of its interest-rate tightening cycle and that it had at the start of 1994 incorporated the endogenous duration of MBS into its models in the way that it had incorporated them by the end of 1994. However, if the employment and output recovery evolves going forward as the recovery of the 1990s evolved in 1994 and thereafter, the Federal Reserve will be not dismayed but ecstatic.

Robert Murphy's Bet That Inflation Was Just Around the Corner Has Gone Absolutely Horribly Wrong

Terrifying to see:

Robert Murphy: October 2011: Update on My Inflation Bets: I know that a while ago I made two inflation bets… [with] David R. Henderson… [the] terms:

At any point between now and January 2013, if there is a year/year increase in seasonally adjusted CPI that is at least 10%, then [Henderson pays Murphy] at that time $500.

If we get to January 2013, and there has not been any 12-month stretch in which the above happened, then [Murphy pays Henderson] $500 at that time….

I made the above bets in December 2009. Things are obviously not progressing on the timetable I had thought…. If it weren’t for the crisis in Europe (which is pushing people to flock into dollars), I would still be fine [as of October 2011[!!!!]] with [the bet with Henderson], but it may turn into a nail biter…

The most terrifying thing of all is that being completely, comprehensively, unmistakably, fundamentally, fatally, totally wrong has not led Robert Murphy to rethink or modify any of his analytical positions or ideological beliefs by even one iota.

I mean, one would expect an announcement on his weblog like: "I have been totally wrong, about everything. I am closing down this weblog for five years to avoid misleading readers while I intellectually retool. You will find me sitting at the feet of Paul Krguman, chanting 'om mani padme hum' until I achieve enlightenment."

Not gonna happen...

Ben Bernanke's Secret Message to Congress: More Stimulus, Please

Matt O'Brien:

Ben Bernanke's Secret Message to Congress: More Stimulus, Please: The Fed is already buying $85 billion of bonds a month on an open-ended basis and has promised not to raise rates before unemployment falls below 6.5 percent or inflation rises above 2.5 percent.

But it still thinks inflation will remain subdued, despite its bond-buying.

In other words, the Fed is telling us it will tolerate a bit more inflation, but it won't create it. That's as good an invitation as Congress is going to get to cut taxes or increase spending, at least until inflation is around 2.5 percent. Now, the Fed might buy fewer bonds than it otherwise would if Congress does more, but we know it won't raise rates--there's little guessing how much fiscal stimulus the Fed will allow. The multiplier is big now.

It's right out of Ben Bernanke's playbook. As Tim Duy, a professor at the University of Oregon, points out, Bernanke's often cited "helicopter drop" speech about how to stop deflation -- the idea was you could drop money from the sky as a last resort -- did not say a central bank could do this on its own. Bernanke said a "determined government" could "always generate higher spending and hence positive inflation," emphasis on the word government.

Bernanke wants Congress to help him, and he's doing everything he can to let them know.

Glenn Hubbard's Countrywide Deposition

http://www1.rollingstone.com/extras/Deposition-Transcript-of-Glenn-Hubbard.pdfMatt Taibbi observes:

Glenn Hubbard, Leading Academic and Mitt Romney Advisor, Took 1200 an Hour to Be Countrywide's Expert Witness: What's fascinating in the deposition is the way Hubbard repeatedly tries to avoid answering the question about what kind of research he did, or didn't do…. His sneering annoyance shines through as brightly as it did in Inside Job, but this time he couldn't just say, "You've got three more minutes." Here, for instance, he actually tries to play dumb when asked if he looked into Countrywide's origination practices:

Q. Did you make any inquiry into how Countrywide actually originated its loans?

A. I'm not sure exactly what you mean by that.

Department of "Oh Dear!": Basic Macro Briefing Weblogging

I have been complaining strongly about the failure of Republican economists to adequately brief their political principals.

It looks like it is sauce-for-the-gander time:

Paul Krugman:

Guess Who Still Believes in Invisible Vigilantes: Lots of chatter about the WSJ’s [Republican-sourced] account of how the deficit negotiations broke down…. But here’s a passage that bothered me:

On Dec. 13, Mr. Boehner went to the White House…. The president told him he could choose one of two doors. The first represented a big deal. If Mr. Boehner chose it, the president said, the country and financial markets would cheer. Door No. 2 represented a spike in interest rates and a global recession.

Oh, dear — does the president still believe that failure to reach a Grand Bargain will cause an attack by the invisible bond vigilantes, and that this is the reason we should fear the fiscal cliff?

Back When I Feared the Bond-Market Vigilantes: Maundering Old-Timer Reminiscence Weblogging

I think Paul Krugman gets one partially wrong today…

Paul writes, correctly:

Maya and the Vigilantes: Maya MacGuineas… is the queen of the deficit scolds, having run the Committee for a Responsible Federal Budget, perhaps the most prominent of the many Pete Peterson-backed organizations trying to scare us about the deficit…. As Scheiber points out… her efforts actually make the situation worse. Her stock in trade is denouncing partisanship… but she (like pretty much all the deficit scolds) actually empowers hyperpartisanship by always condemning both sides equally… making excuses for hardliners in the GOP…. [R]emember that CRFB was one of the three deficit-scold organizations that gave Paul Ryan an award for fiscal responsibility. As I’ve pointed out many times, Ryan’s “plan” was essentially a scam: all the alleged deficit reduction came from revenue allegedly generated by closing loopholes, which he refused to specify, and from huge cuts in discretionary spending, which he refused to specify. What he really offered was huge tax cuts for the rich, only partly offset by savage cuts in aid to the poor. But CRFB, in pursuit of the image of even-handedness, chose to pretend that Ryan was a Serious, Honest Conservative, thereby removing any penalty for being, in fact, deeply unserious and dishonest….

I agree. I applaud. Maya MacGuineas spends time giving fire-chief hats to budget arsonists. And this is profoundly unhelpful.

But then I think Paul falls into a degree of heresy and error:

Neil Irwin: There Is No Spoon Weblogging--Fiscal Crisis Edition

Neil Irwin:

There is no fiscal crisis. What that means for the U.S.: Here are two numbers to know about the United States and Japan: 1.79 percent and 0.77 percent. Those are the yields on 10-year bonds in those two nations as of Thursday morning, the price their governments must pay to borrow money for a decade. In other words, investors are willing to fling their savings at those two seemingly dysfunctional governments for next to nothing…. Name a country with… a stable political system, a central bank to call its own, and a free flow of capital across its borders… and it has, right now, extraordinarily low interest rates…. [A]round the world there are all sorts of savers--pension funds, wealthy individuals in emerging nations, governments that want to ensure they have reserves put aside in case there were to be a run on their currency--for whom the goal is not so much to get a big yield on their savings, but rather to ensure that they will get their money back when they need it…. There are three points to draw from that.

One is that as the United States looks to reduce budget deficits, it should do so on its own terms…. Second, if there are things we can do with the cheap money the world is flinging at us that would make the U.S. economy more competitive in the longer run, we should take advantage…. The third point… is… there is an unfortunate tendency to treat the size of budget deficits and the level of inflation or unemployment in moral terms. Surely when a nation sins through fiscal irresponsibility and tempts the devil inflation, it ought to receive the wrath of a vengeful god. But that's not how it is. Macroeconomics is not a morality play…

I Think Noah Smith Gets One Wrong: State-of-Macroeconomics Weblogging

If Noah Smith does not want to call what I see as serious and significant deficiencies “failures of technique”, then what does he suggest that I call them?

Noah Smith:

Noahpinion: Macro, what have you done for me lately?: Paul Krugman says the state of macroeconomics is rotten. Steve Williamson disagrees…. On the question of whether macro is divided into warring "schools", I'd say Williamson is 85% right, and Krugman only 15%. Yes, there are some systematic disagreements, but they're not very bitter or rancorous, and everyone uses mostly the same "language". The old "freshwater"/"saltwater" distinction is still there to a limited degree among older faculty, but younger faculty don't seem to see much of a dividing line…. So if collegiality and similarity of technique are measures of a field's health, then macro is doing quite well...

I think that is wrong. It depends, I think, on what you take "technique" to mean:

Hoisted from the Archives: Paul Krugman in 2009 on the Future of Macroeconomics

Where Does Macroeconomics Go From Here?: SEPTEMBER 03, 2009: Paul Krugman has questions:

How Did Economists Get it So Wrong?: Between 1985 and 2007 a false peace settled over the field of macroeconomics. There hadn’t been any real convergence of views between the saltwater and freshwater factions. But these were the years of the Great Moderation — an extended period during which inflation was subdued and recessions were relatively mild. Saltwater economists believed that the Federal Reserve had everything under control. Fresh water economists didn’t think the Fed’s actions were actually beneficial, but they were willing to let matters lie.

But the crisis ended the phony peace. Suddenly the narrow, technocratic policies both sides were willing to accept were no longer sufficient — and the need for a broader policy response brought the old conflicts out into the open, fiercer than ever. Why weren’t those narrow, technocratic policies sufficient? The answer, in a word, is zero.

We Should Be Raising, Not Cutting Social Security Benefits Now...

After a financial crisis showed the fragility of private retirement savings, it's crucial that we decrease Social Security payments! #what?

— Adam Kotsko (@adamkotsko) December 18, 2012

Coffee with Stephanie Kelton

As of January 1, 2016, enough time will have passed for us to be able to judge whether the Federal Reserve's policy shift to the Evans rule plus an open-ended $1 trillion a year of balance sheet has been a success or not.

Stephanie Kelton is almost certain it will not be a success. I think it might well work. Mike Woodford is almost certain that it will work. It seems to me that there is an opportunity here for me to lock in a profit of some sort here…

The first stage of this is crafting a bet that Stephanie Kelton would accept for what states of the economy on January 1, 2016 would qualify as success for the Fed, and what states of the economy would qualify as failure. She does expect a better economy in three years--She expects private sector deleveraging to continue at its slow pace And as a result the forces making for balance sheet recession to ebb. Success would, for her, have to count as stronger than expected improvement in the economy given this positive underlying trend.

How should I phrase the bet? And then what bet should I offer Mike Woodford when I run into him by accident in San Diego?

DeLong Smackdown Watch: Paul Krugman Says That I Make the Story too Complex Weblogging

Paul Krugman:

Inaction is the Greatest Risk: Inaction is the Greatest Risk (Wonkish) Brad DeLong is exasperated with people who insist that the Fed's modest moves toward more support for the economy are "risky", but cannot explain why in any intelligible fashion…. It is just bizarre to angst about how the Fed might "distort" markets that are already hugely distorted.

But my first take on the nature of that distortion is a lot simpler than Brad's.

Another Person Who Thinks That the Fed's Policy Is "Risky", But Cannot Intelligibly Explain Why...

Muhammed El-Erian:

How risky is the Fed's major move?: A bold and necessary move? Yes, but the Fed's growing activism has limits and is ultimately inconsistent with the proper efficient functioning of a market economy.

Wow! That is what I suspect many investors said when they heard Wednesday's policy announcement…. Yesterday's Fed announcement will go down in the history books…. The Fed took two major steps on Wednesday, one expected and one less so. First, it added to its expected purchases of market securities, doubling the dollar amount to $1 trillion for 2013…. Second, the Fed shifted to quantitative (unemployment and inflation) targets for forward policy guidance…. This further leap into the policy unknown was motivated by continued disappointment with the economy's sluggish growth, persistently high unemployment and increasing concern about joblessness becoming more structurally embedded into the economy….

The bad news is that the institution, with its imperfect tools for the challenge at hand and with other federal government entities essentially MIA, may be taking on an unsustainable burden…. [T]he outcome of the Fed's unusual activism is neither predictable nor costless… an increasing risk of collateral damage and unintended consequences… ultimately inconsistent with the proper efficient functioning of a market economy. With a market share that will end 2013 between 30% and 45% depending on the securities, the Fed is heavily involved in markets as both a referee and player. As such, it distorts their functioning, the price discovery process and the allocation of capital….

What Are the Risks and Costs of Expanding the Federal Reserve's Balance Sheet?

Does anybody understand what Richard Fisher is talking about here?

Fed’s Fisher Worries About ‘Hotel California’ Monetary Policy: Dallas Fed President Richard Fisher said Friday on CNBC he opposed the Federal Open Market Committee‘s recent decision on employment thresholds and that he was extremely concerned that it would become increasingly difficult to exit the Fed’s accomodative monetary policy.

We are at risk of what I call a ‘Hotel California’ monetary policy, referring to the Eagles’ song, where we can check out any time we want from this program, but we can never leave….

We’ve done enough… businesses are awash in liquidity…. We cannot count on central banks to carry an economy. There has to be the right incentives to take what the central banks do, provide monetary stability, provide just the right amount of liquidity to the economy, incentives to put all that to work, and grow the economy...

Does anybody understand what Richard Fisher means?

Mark Thoma vs. John Makin: with a Real Government Borrowing Rate of -1.5%/Year, Government Should Be Borrowing and Spending More

Mark Thoma is, of course, correct:

Economist's View: 'Trillion-Dollar Deficits are Sustainable for Now': John Makin of the American Enterprise Institute says that "trillion-dollar deficits are sustainable for now, unfortunately." I don't agree with… the "unfortunately" in the title… but I appreciate that he is trying to play it straight rather than support the nonsense other Republicans have tried to foist upon the public:

Trillion-dollar deficits are sustainable for now, unfortunately, by John H. Makin: Congress is attempting, unsuccessfully, to reduce “unsustainable” deficits and debt accumulation by engineering “crises” that are meant to force politically challenging action… The tactic of threatening to go over the fiscal cliff will fail… because deficits have been, and will continue to be for some time, eminently sustainable. The Chicken Little “sky is falling” approach to frightening Congress into significant deficit reduction has failed because the sky has not fallen…. [T]he real inflation-adjusted cost of deficit finance averages –1.5 percent…. The debt-to-GDP ratio is not a reliable guide for gauging the sustainability of deficits…. The United States Is NOT Greece ... The hyperbolic claim that the United States is becoming Greece because of the absence of dramatic progress on deficit and debt reduction is unfortunately ridiculous…. The real danger… contrary to the cries of imminent “crisis”… [is that] probably much later than most pundits claim… the Federal Reserve’s monetary accommodation… will cause inflation to rise… [force] the Fed is forced to tighten [and] borrowing costs for both the government and private sectors will rise…

The Federal Reserve's Shift from a Time- to a State-Based Policy Rule: Will It End Our "Lost Decade"?

Back in the middle of 2011, in the circles in which I traveled--policy-oriented macroeconomists who actually knew something about the world and about financial history--there was a rough consensus that we all ought to make one last charge for more aggressive policies to boost growth and reduce unemployment. We did not think there was much chance that we would actually influence policy: it was more to lay down a marker for the future, to make a demonstration that there were policies that could plausibly have gotten us out the fix of jobless recovery and slow growth--a kind of intellectual Charge of the Light Brigade, a "c'est magnifique, mais ce n'est pas la guerre".

We had, after all, worried in 2005 that the housing bubble might collapse and create a sticky macroeconomic situation. And we had been ignored. We had, after all, worried in 2007 that the major banks risk management structures were inadequate to the situation. And we had been ignored. We had, after all worried in 2008 that the Treasury and the Federal Reserve's focus On not enabling moral hazard meant that they were running enormous risks that they did not understand. And we had been ignored. In late 2008 and 2009 we were listened to. But by the end of 2009 when we were worrying about (a) the risk of a jobless recovery, (b) state-level fiscal contraction, and (c) the potentially poisonous interaction of the financial crisis with the structure of the eurozone in the context of southern Europe's policy imbalances--well, we were back to being ignored.

Thus in the summer of 2011 we expected to be ignored again.

Paul Krugman or Ben Bernanke?

What is your guess?

It has been about three and a half years since the economic recovery began…. [U]nemployment remains high. About 5 million people—more than 40 percent of the unemployed—have been without a job for six months or more, and millions more who say they would like full-time work have been able to find only part-time employment or have stopped looking entirely. The conditions now prevailing in the job market represent an enormous waste of human and economic potential. A return to broad-based prosperity will require sustained improvement in the job market, which in turn requires stronger economic growth. Meanwhile, apart from some temporary fluctuations that largely reflected swings in energy prices, inflation has remained tame and appears likely to run at or below the Federal Open Market Committee’s 2 percent [per year] objective in coming quarters and over the longer term…

Full Transcript Plus Video from Chairman Bernanke’s Press Conference: December 12, 2012

BERNANKE: Good afternoon.

It has been about three and a half years since the economic recovery began. The economy continues to expand at a moderate pace. Unfortunately, however, unemployment remains high. About 5 million people—more than 40 percent of the unemployed—have been without a job for six months or more, and millions more who say they would like full-time work have been able to find only part-time employment or have stopped looking entirely. The conditions now prevailing in the job market represent an enormous waste of human and economic potential. A return to broad-based prosperity will require sustained improvement in the job market, which in turn requires stronger economic growth. Meanwhile, apart from some temporary fluctuations that largely reflected swings in energy prices, inflation has remained tame and appears likely to run at or below the Federal Open Market Committee’s (FOMC’s) 2 percent objective in coming quarters and over the longer term.

Federal Reserve FOMC statement: December 12, 2012

FRB: Press Release--Federal Reserve issues FOMC statement--December 12, 2012:

Information received since the Federal Open Market Committee met in October suggests that economic activity and employment have continued to expand at a moderate pace in recent months, apart from weather-related disruptions. Although the unemployment rate has declined somewhat since the summer, it remains elevated. Household spending has continued to advance, and the housing sector has shown further signs of improvement, but growth in business fixed investment has slowed. Inflation has been running somewhat below the Committee’s longer-run objective, apart from temporary variations that largely reflect fluctuations in energy prices. Longer-term inflation expectations have remained stable.

Counterparties: Bernanke: "It's fair to say we've overestimated the pace of growth… from the beginning of the recovery" (Ya, think?)

Mark Thoma: The Federal Reserve's Double-Down All-in Game-Change

Mark Thoma:

Fed shifts approach in how it gauges U.S. economy: The Federal Reserve's monetary policy committee announced today that it will continue its policy of maintaining exceptionally low interest rates and expand its "quantitative easing" program by purchasing bonds at the rate of $85 billion per month… "at least as long as the unemployment rate remains above 6.5 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored." This signals a change from time-based Fed policies….

But it's important to recognize that these are thresholds, not triggers. A 6.5 percent unemployment trigger, for example, means that if the unemployment rate falls below this level, a new policy is necessarily triggered, meaning the policy ends. But a 6.5 percent threshold brings about a discussion and a reassessment at the Fed of the appropriate policy….

[O]ne of the problems the Fed has had in its communications strategy is convincing people it will carry through with this commitment even if inflation drifts above the 2 percent target. In some sense, the Fed has too much credibility on inflation. The adoption of numerical thresholds -- in particular an inflation threshold that is a half a percent above target and the commitment to maintain present policy "at least" until the thresholds have been met -- is an attempt to overcome this communication problem though a commitment to a clear, well-defined policy rule.

Jonathan Portes Writes to the Financial Times About All the Very Serious People Who Are Ruining Europe

Jonathan Portes: Eurozone recovery was imminent two years ago

Sir,

The EU commissioner for economic affairs brings us good news:

Since last spring, Greece has demonstrated a remarkable commitment to economic stabilisation – one certain to yield lasting returns. Spain is now also pursuing a broad reform agenda…. Europe’s recovery in the real economy has taken hold and is becoming self-sustaining.

So the commission’s strategy is working, it seems.

Except those quotes aren’t from Olli Rehn’s most recent article on your Comment page (“Austerity is working – Europe must stay the course”, December 11, 2012). They are from his article of two years ago: “New reforms can break Europe’s debt cycle”, January 11, 2011.

Joe Weisenthal: Goldman's Jan Hatzius on Sectoral Balances

http://www.businessinsider.com/goldmans-jan-hatzius-on-sectoral-balances-2012-12

Richard Green on Joe Nocera on Why We Would All Be Better Off without the American Enterprise Institute

Richard Green says:

Richard's Real Estate and Urban Economics Blog: Joe Nocera nails it

He writes:

...Peter Wallison, a resident scholar at the American Enterprise Institute, and a former member of the Financial Crisis Inquiry Commission, almost single-handedly created the myth that Fannie Mae and Freddie Mac caused the financial crisis. His partner in crime is another A.E.I. scholar, Edward Pinto, who a very long time ago was Fannie’s chief credit officer. Pinto claims that as of June 2008, 27 million “risky” mortgages had been issued — “and a lion’s share was on Fannie and Freddie’s books,” as Wallison wrote recently. Never mind that his definition of “risky” is so all-encompassing that it includes mortgages with extremely low default rates as well as those with default rates nearing 30 percent. These latter mortgages were the ones created by the unholy alliance between subprime lenders and Wall Street. Pinto’s numbers are the Big Lie’s primary data point.

Two things: First, Pinto and Wallison's definition of "subprime" is any loan that goes to a neighborhood they wouldn't live in or  to a person they wouldn't have lunch with.  According to the American Housing Survey, there were around 52 million mortgages outstanding in the US in 2009.  This means that according to Wallison and Pinto,  the median borrower is a subprime borrower.  I guess this means they think that that half of homeowners with mortgages should be renting in Potterville.

Second, Nocera should in his piece put quotes around the word "scholar."

"Voluntary Financial Repression" and Fiscal Policy: A Note

One potentially-important case outside the standard framework for thinking about fiscal policy in a depressed economy is the following: What if interest rates remained depressed not just for the short but for the long term as well? Call this case one of "voluntary financial repression". In it, the risk tolerance of investors is so low and the ability of private-sector investment banks to create safe assets is so impaired that investors are willing to pay the government to move their purchasing power forward in time. The economy is not dynamically sufficient in any standard sense, but the interest rate r on Treasury debt is lower than the growth rate g of the economy. There is then no binding government budget constraint. And the math then tells us that the government should borrow and spend--and then borrow and spend some more until it has pushed the interest rate on its Treasury debt back up above the growth rate of the economy and there is a binding government budget constraint once more.

Note that this case of "voluntary financial repression" is profoundly different from other episodes of financial repression. In the past situations in which Treasury bonds have carried negative real interest rates have arisen because of government policies that require financial intermediaries to hold excessive amounts of Treasury debt. The standard argument is then that the apparent free lunch of government borrowing offered by financial repression is really the collection of an inefficient tax on banking customers. The ultra-low interest rates on Treasury debt are a regulatory tax ultimately paid by banking customers and collected for the government by the banks. The policy recommendation is then not that the government should take advantage of low interest rates to borrow and spend. The policy recommendation is then, instead, that the government should reform its bank regulatory system so that it no longer imposes an inefficient tax on banking customers and financial depth.

This time, however, appears to be different. High demand for Treasuries at even ultra-low interest rates is not the result of legal requirements to hold Treasuries imposed by the government. Rather, it is the result of an extremely high degree of effective risk aversion on the part of investors and financial intermediaries. No argument can be made today that the government is levying excessive taxes on the banking sector. It has, instead, provided the banking sector with enormous benefits in terms of bailouts that provide free insurance against macro financial risks. It has not burdened the banking sector with excessive requirements that they hold reserves in the form of Treasuries. It has, if anything, done the opposite: burdened the reast of the economy by not imposing large enough reserve requirements on banks.

There is some lurking underlying market failure here--trusted financial intermediaries that can create safe private-sector assets for investors to hold appear to be absent. The natural fix for this market failure is for the government to create the safe assets that investors seek to hold: the government needs to borrow and spend, and keep borrowing and spending until the benefits from repairing this failure on the part of the private market to supply safe assets are exhausted--which will certainly not be the case until, for Treasuries r > g.

David Beckworth Correctly Says That the Hard-Money Austerians Are Not Entitled to Their Own Facts

He's looking at you, William Poole, David Warsh, Allan Meltzer, Arnold Kling, John Taylor, Michael Panzner, Mickey Levy, and others…

David Beckworth:

Macro and Other Market Musings: The Fed, The Budget Deficit, and The Facts: My last post generated some heated push back from the hard-money types. That post showed the Fed sill has about the same share of treasuries, 15%, as it did before the crisis. Thus, the large run up in public debt over the past four years has been funded mostly by individuals, their financial intermediaries, and foreigners. The Fed has not been the great enabler of the government deficits as claimed by the hard-money types. This fact seems to have been very uncomfortable for them because they largely ignored it.  Instead, they quibbled with my definition of debt monetization and resorted to ad-hominen attacks. 

Given these responses, it is probably too much to hope for further meaningful engagement with them.

May I Say That I Really Have Absolutely No Idea What Robert Lucas Is Talking About...

…when he claims that the post-World War II evidence "overwhelmingly supports the dominant importance of real shocks" to tastes and technologies in explaining fluctuations in unemployment at frequencies higher than 1/10yr?

What is that evidence?

Where is it? What shocks to tastes drove the unemployment rate up from 5.3% in 1989 to 7.6% in 1992? What shocks to technologies did so?

Economist's View: Fed Watch: Fiscal Madness

Tim Duy:

Economist's View: Fed Watch: Fiscal Madness: What is it about fiscal policy that brings out the crazy? Because it all seems pretty simple. Joe Weisenthal hits the nail on the head:

The U.S. recovery has been remarkable on a comparative basis precisely for one reason: Because despite all of the rhetoric, the U.S. has completely avoided the austerity madness that's gripped much of the world.

Weisenthal points us to Ryan Avent and Josh Lehner, both showing in different ways the better post-recession outcomes experienced by the US compared to other economies....

Mark Thoma: "we do not yet have the regulation in place that is needed to address the problem of bank runs of 'privately created bank money'"

http://economistsview.typepad.com/economistsview/2012/11/banking-must-not-be-left-in-the-shadows.html

The Historical Examples Suggest a Bond Market Vigilante Attack Would Be Good for Workers and Manufacturers and Debtors and Equity Holders...

Paul Krugman:

Franc Thoughts on Bond Vigilantes: Suzy Khimm writes about the contrast between what financial industry honchos say worries them and what financial markets seem to be saying. The honchos declare that failure to reach a Grand Bargain would "spark a damaging loss of confidence in the U.S. government’s fiscal prospects, a run on Treasury bonds, and a spike in interest rates." But the bond markets are saying what me worry, with long-term rates at near-record lows….

[I]t’s actually quite hard to tell a story in which a loss of confidence in U.S. bonds hurts the real economy. Why wouldn’t it just drive down the dollar, and thereby have an expansionary effect? Yes, I know, Greece — but Greece doesn’t have its own currency…. The closest I can come to anything resembling the danger supposedly lurking for America is the tale of France in the 1920s, which emerged from World War I burdened by large debt, and which did in fact face an attack by speculators as a result…. It’s important to note, however, that France wasn’t a depressed economy in the 1920s, and therefore didn’t look much like America today…. [T]he really big effect was a sharp depreciation of the franc, which made France highly competitive and strengthened the economy:

But what about the brief but nasty slump in 1927? That wasn’t caused by spiking interest rates; it was, instead, caused by fiscal austerity, by the measures taken to stabilize the franc. So even when we look at the closest thing I can find to the scenario the deficit scolds want us to fear, it doesn’t play out at all as described.

N.N. Taleb vs. Runciman

http://fooledbyrandomness.com/totheeditor.html

Barney Frank: Obama Rejected Bush Administration Concession to Write Down Mortgages

Matt Stoller:

Barney Frank: Obama Rejected Bush Administration Concession to Write Down Mortgages « naked capitalism: Here’s Barney Frank, in an exit interview recently in New York Magazine, revealing unwittingly that Obama during the transition rejected a Bush administration concession to write down mortgages.  Here’s what Barney said.

The mortgage crisis was worsened this past time because critical decisions were made during the transition between Bush and Obama. We voted the TARP out. The TARP was basically being administered by Hank Paulson as the last man home in a lame duck, and I was disappointed. I tried to get them to use the TARP to put some leverage on the banks to do more about mortgages, and Paulson at first resisted that, he just wanted to get the money out. And after he got the first chunk of money out, he would have had to ask for a second chunk, he said, all right, I’ll tell you what, I’ll ask for that second chunk and I’ll use some of that as leverage on mortgages, but I’m not going to do that unless Obama asks for it.  This is now December, so we tried to get the Obama people to ask him and they wouldn’t do it.

John Hempton: How to Fake Your Accounts: The Case of Autonomy

http://brontecapital.blogspot.com/2012/11/hewlett-packard-and-autonomy-notes-from.html

 

Joe Weisenthal on Bill McBride aka Calculated Risk: "The Genius Who Invented Economics Blogging Reveals How He Got Everything Right and What's Coming Next"

http://www.businessinsider.com/bill-mcbride-of-calculated-risk-2012-11

 

Bergljot Barkbu, Barry Eichengreen, and Ashoka Mody: Financial crises and the multilateral response: What the historical record shows

http://www.sciencedirect.com/science/article/pii/S0022199612000219

Nassim Nicholas Taleb: Learning to Love Volatility

http://online.wsj.com/article/SB10001424127887324735104578120953311383448.html

The Unemployment Gap Between Europe and America

Yes, contractionary policies are contractionary…

Paul Krugman watches Europe's train wreck:

Transatlantic Divergence - NYTimes.com: pursuing the theme that America is doing the least worst among major economies, here’s a chart…. In the early stages… unemployment rose more rapidly in the US than in Europe. This mainly reflected differences in institutions: it’s much easier to fire people in America. From some point in 2010 onward, however, the US situation has gradually improved; initially some of the drop in unemployment was basically people leaving the labor force, but more recently there have been solid though modest gains in the ratio of employment to the relevant population (you have to adjust for aging). Meanwhile, Europe has gotten much worse; now formally in recession, but the truth is that it has been going downhill all along.

Why the divergence? The obvious answer is that the austerity stuff broke out in 2010, and the austerians took over policy much more completely in Europe than in the United States.

Owen Zidar sends us to: Paul Volcker: What the New President Should Consider

http://www.nybooks.com/articles/archives/2012/dec/06/what-new-president-should-consider/

Yes. Obama's Economic Policies Have Been the Best in the North Atlantic World--and Would Have Been Better Still Were It Not for Republican Obstruction. Why Do You Ask?

And Paul Krugman comments:

The Halt and the Lame: Ryan Avent reminds us just how poor economic performance has been since the crisis…. As John Quiggin has been emphasizing, this across-the-board poor performance puts the lie to claims that it’s all because of that scary Obama person; in fact, the US has done better than the rest, although still quite badly — this is indeed a race between the halt and the lame…. What accounts for the differences? The most obvious culprit is austerity…. Europe and the UK have fully reversed any stimulus introduced during the crisis…. You can always try to argue that this has nothing to do with the results we see. But since textbook macroeconomics says that contractionary fiscal policy is contractionary; since those of us who went with the theory rather than the confidence fairy said it would be contractionary; and sure enough, the areas pursuing austerity have done badly; the case for a connection is pretty strong.

And this means that much of the advanced world blithely repeated the mistakes of the 1930s.

Remind me, again, why Ed DeMarco still heads FHFA?

Bubble Weblogging: Back in 1997…

In the email:

Brad, you do NOT have permission to repost, though you might be able to say vague things like "policymakers at the highest levels had been warned about the Campbell-Shiller results [strongly suggesting the growth of a stock market bubble]…"

UK risks triple-dip recession, Mervyn King warns

http://www.guardian.co.uk/business/2012/nov/14/uk-risks-triple-dip-recession-mervyn-king

Tom Hoenig: A Better Alternative to Basel Capital Rules | The Big Picture

http://www.ritholtz.com/blog/2012/11/hoenig-a-better-alternative-to-basel-capital-rules/