Brad DeLong

Alas, My "Foreign Affairs" Review of Alan Blinder's Superb "After the Music Stopped" is a "Premium Article"...

Sorry, guys and dolls…

I will let it out from behind the paywall when I am allowed to…

J. Bradford DeLong: The Second Great Depression: Why the Economic Crisis Is Worse Than You Think:

Alan Blinder is only the most recent in a series of prominent economists who have produced analytic accounts of the U.S. economic downturn. His crisp narrative lays out the policy options that were available at each stage of the crisis, and his analysis is infused with a deep understanding of macroeconomics. Overall, it is the best general volume on the subject that has been published to date.

John Cochrane: "What Chicago Does 'Know' Is Scholarship… We Take a Little Time to Research What People Actually Have to Say Before Calling Them… Less than 'Half-Intelligent' [like] DeLong [Does]…"[1]

Reading Paul Krugman calls to mind that I never reacted to John Cochrane's July 2012 failure to mark his beliefs to market and, instead, doubling down on his claim that the biggest risk the U.S. economy faces is that of becoming "Argentina" "quickly".

I must say that if I had been opining stridently about issues of public policy without doing my homework five years ago, and if between then and now events had developed in directions strongly contrary to my expectations, I would not double down on what I had thought then--I would rather try hard to do my homework and to mark my beliefs to market.

And if I were going to criticize people for not citing my work, I would not claim that a sentence they wrote which comes immediately after a four-paragraph quote from me as an example, and I would have read their explanation of why they think expansionary fiscal policy right now does not raise the risks of "fiscal dominance" rather than remain in ignorance of it.

But to each his own.

Cochrane:

The Grumpy Economist: Krugman, Delong and Inflation: Yes, I've been worried for some time that our current debt could lead to inflation. And yes, that inflation has so far not happened…. Well, they made fun of Friedman when he said in 1968 that inflation was coming. They made fun of Greenspan when he said in 1996 that stocks seemed awfully high, and stocks went up for a few more years.

I gotta interrupt: Friedman in the late 1960s was right. He--correctly--saw inflation rising because he had theory and evidence on supply and demand in the labor market. But Greenspan in 1996 was wrong: since late 1996 the S&P 500 has produced a real return of 5.6%/year.

Does Cochrane know this?

Has he looked at the numbers?

Back in 1996 I agreed with Greenspan. I worried too that the market was overvalued. We thought this for a bunch of reasons. We were wrong.

Why does the fact that our worries were wrong then make Cochrane's worries right now?

Hoisted from the Archives from a Year Ago: John Cochrane Claims the U.S. Is at Risk of Becoming "Argentina": Noah Smith: Noah Bravely Takes the Cochrane-Argentina Side of the Bet…

UPDATE (June 2013): We now have two years to run. If Noah wants to back out of his position, I will buy it back from him at 99.9 cents on the dollar. At this point I think that core inflation above 5% with unemployment above 6% starting in a year really is a 1000-1 shot, even with fat tails.

---

A 5%/year inflation rate is not "Argentina", but we want to bend over backward to give the John Cochrane side a chance…

The bet, made in July 2012:

If, at any time between 7/28/2012 and 7/28/2015, core consumer prices, as recorded in the FRED database series CPILFESL, are up more than 5% in the preceding 12 months, and if over the same 1-year period monthly U3 unemployment (as recorded in FRED database series UNRATE) has not averaged below 6%, then Brad DeLong agrees to buy Noah Smith one dinner at Zachary's Pizza at 1853 Solano Ave. in Berkeley CA, and to pay Noah 49 times the cost--including tax but excluding tip--of Noah's meal at Zachary's in Federal Reserve notes, or in alternative means of payment accepted by Zachary's should Zachary's Pizza no longer be accepting Federal Reserve notes at the date of the dinner. This cost will be assessed as the total cost of the dinner to all, divided by the number of people present, regardless of how much pizza is consumed by or how much alcohol is drunk by specific individuals.

Monday DeLong-Being-Stupid Self-Smackdown Watch: Expansionary Fiscalists vs. Expansionary Monetarists and the Federal Reserve's Shift from a Time- to a State-Based Policy Rule: Will It End Our "Lost Decade"?

The Federal Reserve's announcement last December that it was switching from a time- to a state-based policy rule has not REPEAT NOT raised expectations of inflation over the next five, ten, or thirty years. Perhaps this is because Federal Reserve communicators have spent a lot of time telling people that the shift does not mean that the Federal Reserve will tolerate higher inflation. Perhaps it is for other reasons.

This is a powerful empirical piece of evidence that it is much harder to summon the Inflation Expectations Imp than economists like Greg Mankiw had thought. It is a point for the expansionary fiscalists in their debate with the expansionary monetarists.

And it is a smackdown of me for my fit of enthusiastic expansionary monetarism last December, when I wrote: Brad DeLong: The Federal Reserve's Shift from a Time- to a State-Based Policy Rule: Will It End Our "Lost Decade"?.

Here's what I wrote last December:

Joe Gagnon: Saving Abenomics

Joe Gagnon is right: there is no (good) alternative to Abenomics:

Saving Abenomics: No Time for Cold Feet on QE: Prime Minister Shinzo Abe captured the attention of economists, pundits, and global markets with his bold plans to boost growth and inflation in Japan. Stock prices soared, real bond yields plummeted, and the yen dropped sharply. These trends boded well for Abe’s success. More recently, markets seem disappointed with the details (or lack thereof) on Abe’s structural reforms and the unwillingness of the Bank of Japan (BOJ) to implement its quantitative easing (QE) plans flexibly. In this post I focus on what the BOJ should do to achieve its inflation goal and how that will help reduce the long-run burden of Japan’s large national debt.

Dear Mr Carney... Memos to the New Bank of England Governor

Dear Mr Carney…:

Wage settlements are subdued, and more than 2.5 million people are out of work in the UK: thus the top priority for the Bank of England has to be to boost aggregate demand.

With possibilities for expanded government spending blocked by the ideological fundamentalism of the parliamentary majority, the interest rates the Bank of England controls at rock-bottom, and quantitative easing of unknown effectiveness, only one obvious lever remains: the exchange rate.

It is time for the governor to announce that a (somewhat) weaker pound is in Britain’s (short-run) interest--and to make it so.

The Properly-Formulated Bagehot Rule Has Four Parts

The properly-formulated Bagehot Rule is that in a financial crisis, the lender-of-last-resort:

1. Lends freely,
2. At a penalty rate,
3. On collateral that is good in normal times, and
4. Institutions that are still underwater get "resolved" immediately and completely.

That was not done in Greece in 2010.

Brad DeLong (2009): Generating a Robust Recovery: Hoisted from the Archives from Three and a Half Years Ago Wednesday Weblogginng

Larry Mishel reminds me…

CAP’s rethinking of the grand bargain path is good. Now CAP should rethink their role in putting us on that path: On September 30th, 2009, EPI sponsored a forum, 'Generating a Robust Recovery', on the need to undertake further action to generate jobs. Princeton’s Paul Krugman, Berkeley’s Brad DeLong and EPI’s John Irons were featured in a panel…

Nick Eberstadt and the "Takers" Once Again: More Reflections on the General Theory of the Moocher Class

Today Democracy Journal puts up Nick Eberstadt's complaint about my review of his book, A Nation of Takers, and my reply in response.

This has gone wrong.

Eberstadt--for whom I have the highest respect, and from whom I have learned an immense amount over the years--is disappointed in me, and I am disappointed in him.

Eberstadt:

Although I disagree with him on a number of policy questions, I also hold Brad DeLong’s scholarly work in high regard. Thus I was pleased to hear he was reviewing my recent book A Nation of Takers: America’s Entitlement Epidemic. I was looking forward to an intelligent, principled, and spirited critique. I was perplexed to find instead an essay [“Shrugging Off Atlas,” Issue #28] that betrayed only glancing familiarity with the real existing text I wrote. I was left to wonder: Did Brad actually read the book he reviewed?

DeLong starts by getting the publisher wrong with his very first mention of the book. A Nation of Takers was not, as he states, published by the American Enterprise Institute (AEI) as part of its “ ‘New Threats to Freedom’ series.” The actual publisher is Templeton Press, of the Templeton Foundation: It says so on the back cover. (AEI has no “New Threats to Freedom” series.)

A little later, DeLong observes that “Eberstadt’s conservative comrade Veronique de Rugy reports that 35 percent of Americans receive some ‘means-tested benefit.’” But on page 130 of A Nation of Takers, I cited Census Bureau data to exactly that effect: “As of 2010, over 34 percent of American households were obtaining means tested benefits.” Why not cite my text—instead of work by a researcher with whom I have never collaborated? Did DeLong just not read that far?

There are findings and assertions in my book that should concern all public-minded citizens. Among them: 1) the federal government has effectively been transformed into an entitlements machine over the past two generations; 2) the explosive growth of entitlement spending in postwar America has coincided with a long-term “flight from work” by adult men; 3) the government’s disability entitlements—from which over 12 million working-age Americans were drawing awards last year—are rife for misuse and abuse; 4) over the past four decades America has increasingly resorted to the device of funding its federal spending—now mainly entitlements—through borrowing, in effect taxing the Americans of tomorrow for our unprecedented levels of current entitlement consumption today.

Your readers unfortunately learn none of this, because DeLong did not bother to describe those arguments, much less evaluate or challenge them, in his 3,000-plus-word review. Did he even know those arguments were there?

Early on, DeLong writes, “We need venture no further into A Nation of Takers than the bottom of the second page….” Taken in context, this sounds like a confession.

I like a good debate—I happen to think public policy and the common weal are promoted through the competition of ideas. More than that: We obviously need a serious national debate on the entitlements question. That is why my book includes, indeed showcases, critiques of my own findings from Bill Galston (on the left) and Yuval Levin (on the right).

It is a shame DeLong chose not to show up for that same debate. It is also a disservice—not least to your readership.

Are There Risks to Abenomics?

In the long-run, Paul Krugman says, responding to Koo and Smith and Rowe, the real interest rate on JGB is determined by the supply-side factors of risk tolerance, time preference, and growth--none of which are affected by Abenomics. In the short-run, Paul says, Abenomics raises expected inflation and thus reduces the short-term real interest-rate on the debt--that is the point of the policy.

Since today's long-term real interest rates are a combination of today's short-run short-term rates and the long-run future's short-term rates, Abenomics unambiguously reduces the overall cost of financing Japan's government debt and thus improves rather than erodes the fiscal position.

Monday DeLong Smackdown Watch: Paul Krugman on the Confidence Fairy, The Expectations Imp, and the Rate-Hike Obsession

Paul Krugman:

The Confidence Fairy, The Expectations Imp, and the Rate-Hike Obsession: Brad DeLong has a long meditation on policy that, surprisingly, includes some things I strongly disagree with. I guess I should start by saying that when he describes his fairly complacent view of macroeconomics on the eve of the crisis, he’s describing a view that many economists shared — but I wasn’t one of them. Japan’s troubles and the Asian financial crisis destroyed my faith that we had the business cycle under control; I wrote a whole book about the return of depression economics back in 1999.

Agreed: Paul was smart and I was stupid about the implications of Japan and 1997-8 in East Asia...

Krugman continues:

But here’s where I think Brad is getting something wrong now: when he says that: "It is unfair for Keynesians to be making fun of the people who call for austerity by saying 'confidence fairy' when they are making similar expectational-shift arguments themselves." He’s referring to calls for the Fed and other central banks to raise expectations of future inflation as a way to get some traction in a liquidity trap — which is certainly something I and others support. But there are two crucial differences between us and the expansionary austerity types.

First, our expectations argument is a hope; theirs is a plan… those of us hoping to summon the expectations imp want to do so with policies that are at worst harmless…. The austerians, on the other hand, have pushed directly destructive policies — fiscal contraction in depressed economies — in order to achieve their hoped-for shift in expectations. So this is the difference between “Let’s try this possibly ineffective remedy, it might work and in any case won’t do any harm” and “Let’s do the opposite of what standard analysis says we should be doing, just trust me”.

Touché… That is an important difference.

And:

One other thing: Brad takes fairly seriously the calls for higher interest rates to avoid bubbles, or something, essentially because low rates create moral hazard for the financial sector. Can we say that those moral hazard problems would have to be incredibly severe to justify contractionary monetary policy in a depressed economy?

I would say that the argument that low interest rates add to pressure for financial-sector moral hazard is an argument not so much for tighter monetary policies as for much easier fiscal policies--they are, principally, I think, arguments for much easier fiscal policies…

And Paul has an effective and accurate Parthian shot:

And… I don’t think we should ignore the evidence that some people always want higher rates, and just keep changing the justification.

Confusion: High Public Debt Levels and Other Sources of Risk in Today’s Macroeconomic Environment

The theme is: confusion. Confusion on the theoretical level, confusion on the empirical level, confusion on the policy level. I am confused and astonished that that we are here today facing the global macroeconomic situation we face today. Cast me back seven year, ask me then "what are the chances that we will be this far down in the lower tail of global nominal GDP distributions?" and I will answer you that there is only a 1-in-a-100, only a 1-in-a-1000 chance.

The fact that we are here makes me fear that much of what I thought seven years ago was just completely wrong.

Seven years ago, when asked, I said that as far as macroeconomic policy was concerned I was a fairly orthodox neoliberal monetarist. I agreed with Robert Lucas that the problem of depression prevention had largely been solved. But I would go on to say that the problem of ensuring that inflation expectations remained anchored had not been solved--hence central banks needed to set and meet firm inflation targets. And fiscal authorities needed to avoid even a whisper of a hint of fiscal dominance. Fiscal dominance--a situation in which the political system will not let the government raise the primary surpluses it needs to amortize the debt at the current price level--is the thing that most easily undermines anchored inflation expectations. Thus legislators should be prohibited for even thinking about using large debt expansions for any purpose short of total war. And rebalancing an economy in depression should be left to monetary policy. Central banks were able to do that job, with the unfortunate exception of the 1930s. But, otherwise, central banks had proved themselves very capable of boosting nominal aggregate demand whenever they wished to whatever target they wished. That was the implication I drew then from my belief that the principal macroeconomic stabilization policy problem on the inflation and employment front was that of ensuring that inflation expectations remain anchored.

J. Bradford DeLong and Laura D. Tyson: Discretionary Fiscal Policy as a Stabilization Policy Tool: What Do We Think Now That We Did Not Think in 2007?

J. Bradford DeLong and Laura D. Tyson: Discretionary Fiscal Policy as a Stabilization Policy Tool: What Do We Think Now That We Did Not Think in 2007?

DRAFT 1.4: May 31, 2013: 31 pp. 8166 words

Six years ago there was near-consensus among economists and policymakers alike in support of Taylor's (2000) argument that aggregate demand management was the near-exclusive domain of central banks. Today central bankers like Federal Reserve Chair Bernanke (2013) are actively asking for help by fiscal authorities. What caused this shift? In part, the course of interest rates has made the costs of discretionary expansionary fiscal policy lower than anyone would have believed. In part, the benefits via Keynesian multiplier processes appear to have been much larger than was presumed. And in large part monetary policy has proven inadequate to the task without undertaking risky and untried non-standard policy measures at a scale that has so far proven too large for central banks to risk. Against this shift in the benefit-cost calculus toward use of discretionary expansionary fiscal policy in the current conjuncture we must set uncertain long-run costs of debt accumulation. These costs, however, remain especially hard to analyze, as they seem to substantially consist of “unknown unknowns”.

8362 words

That 90% Feeling...

Jim Henley reads the editors of Bloomberg:

Bloomberg: Oops on Austerity! bloomberg.com/news/2013-06-0…

— Jim Henley (@UOJim) June 7, 2013

Also the Bloomberg comments are full of what @delong calls stranded commandos who don't realize the war is over and they lost.

— Jim Henley (@UOJim) June 7, 2013

Fiscal Policy Issues in the United States

Biography:

• J. Bradford DeLong is a professor at the University of California at Berkeley, a research associate of the NBER, a visiting scholar at the Kauffman Foundation, and a visiting fellow at the Harvard Kennedy School. From 1993-95 he was a deputy assistant secretary of the U.S. Department of the Treasury.

C.V.:

• http://delong.typepad.com/files/20130401-delong-short-cv.pdf

Abstract:

• At the end of the 2008, the seriousness of the financial crisis and the resulting collapse in production and employment coupled with the Federal Reserve's exhaustion of its traditional monetary policy-management took, the open-market operation, raised the possibility that the U.S. government should consider using activist expansionary fiscal policy as a stabilization-policy tool. Doubters offered many reasons--some clearly invalid ex ante, others potentially valid--why such resort to activist expansionary fiscal policy as a stabilization-policy tool might be ineffective or harmful. How has our view of the validity of these doubts changed over the past six years? How has our view of the power of expansionary fiscal policy--especially when monetary policy is at and committed to remain at the zero lower bound--changed over the past six years? What are the current objections to more aggressive activist expansionary fiscal policy as a stabilization-policy than is contained in the current baseline? And what do we not know that we need to know in order to properly evaluate such policies?

Readings:

• J. Bradford DeLong and Lawrence H. Summers (2012), "Fiscal Policy in a Depressed Economy", Brookings Papers on Economic Activity http://www.brookings.edu/~/media/Projects/BPEA/Spring%202012/2012a_DeLong.pdf
• J. Bradford DeLong et al. (2013), "Rough Transcript: Stimulus or Stymied? The Macroeconomics of Recession" http://delong.typepad.com/sdj/2013/01/rough-transcript-stimulus-or-stymied-the-macroeconomics-of-recessions.html
• Carmen Reinhart et al. (2012), "Debt Overhangs Past and Present" http://delong.typepad.com/w18015.pdf

Brad DeLong: "Normalization"?

Right now we have a depressed economy, with the adult-employment-to-population ratio four and a half percentage points below what I see as its current normal demographic value of 63%. The adult-employment-to-population ratio fell from 63% to 58.5% in 2008-9. And since then--for four years--it has flatlined. I never thought I would see anything like this in my lifetime.

Right now interest rates are at levels far and away lower than I at least ever imagined I would see. Interest rates are extraordinarily low not just in the short term but all the way out the yield curve--if the United States government were to issue a nominal consul consol, its yield would be about 3.7% nominal. That would be an extraordinary low return in nominal dollars for giving your money to the federal government in perpetuity. If the U.S. government were to issue a real consol right now--I have no idea how to price it, because it would be a security that would have a duration of at least seventy years or so right now. I never thought I would see anything like this in my lifetime.

Michael Linden and the Center for American Progress: It’s Time to Hit the Reset Button on the Fiscal Debate

Michael Linden:

It’s Time to Hit the Reset Button on the Fiscal Debate: The federal budget has dominated the policy and political debate in Washington over the past three years. During this time, both the underlying fiscal landscape and the broader economic context for the debate have shifted in very important ways, yet the debate has remained remarkably static. Most policymakers, organizations, and policy leaders seem to be stuck in 2010, as if nothing has changed in the years since.

Much has changed, however, and the debate should change with it. If we are to move forward, it’s time to recognize all that has transpired in the past three years and begin the conversation anew. It’s time to hit the reset button on the entire fiscal debate.

Lawrence Summers: Opening Remarks to Senate Budget Committee Hearing on “The Fiscal and Economic Effects of Austerity” June 4th, 2013

Lawrence Summers: Opening Remarks to Senate Budget Committee Hearing on “The Fiscal and Economic Effects of Austerity” June 4th, 2013:

Thank you for the opportunity to speak before this committee. You have chosen to address issues relating to austerity at an opportune time as both our economic and our budget situations are in considerable flux and as a broad rethinking of reflexively austere policies is underway worldwide. In my testimony today I want to do three things:

First, I will characterize the economic and fiscal outlook. Second, I will reflect on the economics of austerity, arguing that too little of the policy debate in recent years has focused on the imperative of increasing economic growth which, in the short and medium term, goes back to issues relating to demand. Third, I will comment on some of what I see as policy priorities for the years ahead.

Transcript: Larry Summers on Austerity

Gerald F. Seib and David Wessel: Transcript: Larry Summers on Austerity:

JERRY SEIB: OK. So let’s get started. Thanks for coming. You all know Larry Summers. I won’t spend a lot of time introducing you to the former Treasury secretary, former Harvard University president, former head of the National Economic Council and all that. Larry, you know, you’re here – aside from the fact you wanted to have breakfast with us, you are here to talk about – to talk in Congress I guess later today about the great austerity versus no austerity debate. So maybe we can start in that neighborhood, if you don’t mind. So let’s see. Unemployment’s down. The deficit is dropping. Health care costs are slowing. Things seem to be pretty good. Should we just forget about reducing the deficit in the short term given that all those things are happening?

In Which I Finally Make Time to Shape-Shift Back into My Direwolf Form and Think About Michael Kinsley: Whiskey-Tango-Foxtrot-Bang-Query-Bang-Query Weblogging

So I finally made a chunk of time to read and think about Michael Kinsley's response to Paul Krugman's rebuttal of Kinsley's claim that Krugman was engaged in a "misguided moral crusade against" rather than a technocratic critique of "austerity".

First and most essential, I need to set some rules here: If I'm going to be called a canine of any form, standards must be maintained.

I insist that it be not "attack dog" but either:

• the Maoist "running dog", or
• Jon Snow's direwolf: Ghost.

Those are the approved options. Pick one. Use it. Stick to it. It's really not hard at all to do.

Capisce?

I hope that that is now clear...

The Fiscal and Economic Effects of Austerity

Committee Hearings - Senate Budget Committee: Jun 4 2013 10:30 AM:

SD-608: There will be a hearing of the Committee on the Budget on Tuesday, June 4, 2013 at 10:30 AM in Room SD-608 to consider The Fiscal and Economic Effects of Austerity

Witnesses:

• Larry Summers, PhD, President Emeritus and Charles W. Eliot University Professor, Harvard University

• Simon Johnson, PhD, Ronald A Kurtz (1954) Professor of Entrepreneurship MIT Sloan School of Management and Senior Fellow, Peterson Institute for International Economics

• Salim Furth, PhD, Senior Policy Analyst, Macroeconomics, The Heritage Foundation

Robert Skidelsky: Unrepentant Economists

Robert Skidelsky:

Unrepentant Economists: A bit of history to remind us where the economists stood on the matter of fiscal austerity: On February 14, 2010, the Sunday Times published this letter:

It is now clear that the UK economy entered the recession with a large structural budget deficit. As a result the UK’s budget deficit is now the largest in our peacetime history and among the largest in the developed world. In these circumstances a credible medium-term fiscal consolidation plan would make a sustainable recovery more likely. In the absence of a credible plan, there is a risk that a loss of confidence in the UK’s economic policy framework will contribute to higher long-term interest rates and/or currency instability, which could undermine the recovery…. The government’s goal should be to eliminate the structural current budget deficit over the course of a parliament, and there is a compelling case, all else being equal, for the first measures beginning to take effect in the 2010-11 fiscal year. The bulk of this fiscal consolidation should be borne by reductions in government spending….

Wolfgang Munchau: The Return of Austerity

Wolfgang Munchau:

Austerity, like a B-movie monster, will keep coming back: Did austerity end last week? This is what the headlines suggested when the European Commission gave five eurozone countries more time to meet their fiscal targets. The message from Brussels is that policy is no longer focused on austerity but on structural reforms. I am afraid that this apparent shift in policy amounts to little more than a tactical retreat….

First Half of 2013 Growth Looks Like It Will *Increase* the Output Shortfall Relative to Potential by 0.4% Points

Just saying. If the financial crisis of 2008 and the failure to respond to it appropriately does in the end knock the U.S. from a 2.7-3.2%/year long-run growth trajectory to a 2.0%/year long-run growth trajectory for even ten years, in the long run it will turn out to be a much bigger deal than the Great Depression…

Andrajit Dube: A Note on Debt, Growth, and Causality

Andrajit Dube: A Note on Debt, Growth, and Causality:

Abstract: This note documents the timing in the relationship between the debt-to-GDP ratio and real GDP growth in advanced economies during the post World War II period using the Reinhart and Rogoff dataset. I first show that the debt ratio is more clearly associated with the 5-year past average growth rate, rather than the 5-year forward average growth rate–indicating a problem of reverse causality. Indeed, there is little evidence of a lower growth rate above the 90 percent threshold when using the 5-year forward average growth rate.

I use a number of simple tools to account for some of the reverse causality in the bivariate regression–such as using forward growth rates, instrumenting the current debt ratio with its lag, and controlling for lagged GDP growth rates. These simple methods of accounting for reverse causality diminish the size of the association by between 50 and 70 percent, with the linear regression estimate indistinguishable from zero. Finally non- and semi-parametric plots provide visual confirmation that the relationship between debt-to-GDP ratio and growth is essentially flat for debt ratios exceeding 30 percent when we (1) use forward growth rates, (2) control for past GDP growth, or both.

Mark Thoma and Noah Smith on 'DSGE + Financial Frictions = Macro that Works?'

Mark Thoma:

Economist's View: 'DSGE + Financial Frictions = Macro that Works?': This is a brief follow-up to this post from Noah Smith….

In my last post, I wrote:

So far, we don't seem to have gotten a heck of a lot of a return from the massive amount of intellectual capital that we have invested in making, exploring, and applying [DSGE] models. In principle, though, there's no reason why they can't be useful.

One of the areas I cited was forecasting. In addition to the studies I cited by Refet Gurkaynak, many people have criticized macro models for missing the big recession of 2008Q4-2009. For example, in this blog post, Volker Wieland and Maik Wolters demonstrate how DSGE models failed to forecast the big recession, even after the financial crisis itself had happened…

This would seem to be a problem.

Miles Kimball Adds, on Debt-and-Growth

Miles Kimball:

Confessions of a Supply-Side Liberal: My Thoughts about What Brad Says in the Quote Just Above: As I noted above, my reaction is to what we Yichuan and I found is similar to Brad’s. There must be a negative effective of debt on growth through the bond vigilante channel [when it is active vis higher interest rates], as Yichuan and I emphasize in our interpretation. For example, in our final paragraph, Yichuan and I write:

…other than the danger from bond market vigilantes, we find no persuasive evidence from Reinhart and Rogoff’s data set to worry about anything but the higher future taxes or lower future spending needed to pay for that long-term debt.

The surprise is the pattern that when countries around the world shifted toward higher debt than would be predicted by past growth, that later growth turned out to be somewhat higher than after countries around the world shifted to lower debt. It may be possible to explain why that evidence from trends in the average level of debt around the world over time should be dismissed, but if not, we should try to understand those time series patterns. It is hard to get definitive answers from the relatively small amount of evidence in macroeconomic time series, or even macroeconomic panels across countries, but given the importance of the issues, I think it is worth pondering the meaning of what limited evidence there is from trends in the average level of debt around the world over time. That is particularly true since in the current crisis, many people have, recommended precisely the kind of worldwide increase deficit spending—and therefore debt levels—that this limited evidence speaks to. 

I am perfectly comfortable with the idea that the evidence from trends in the average level of debt around the world over time is limited enough so theoretical reasoning that shifts our priors could overwhelm the signal from the data. But I want to see that theoretical reasoning. And I would like to get reactions to my theoretical speculations above, about (1) supply-side benefits of lower taxes that reverse in sign in the future when the debt is paid for and (2) liquidity effects of government debt (which may also have a price later because of financial cycle dynamics). 

DeLong Smackdown Watch: Miles Kimball Says That Kimball and Wang Is Much Stronger than Dube as a Critique of the R-Team...

Apropos of Kimball and Wang…

Miles Kimball writes:

After Crunching Reinhart and Rogoff's Data, We Found No Evidence That High Debt Slows Growth: As I tweeted:

.@delong undersells our results. I would have read Arin Dube’s results alone as saying high debt does slow growth. Of course low growth causes debt in a big way. But we need to know if high debt causes low growth, too. No ev it does!

Now You, too, Can Pontificate About What's Driving Today's Markets Like Paul Krugman!

Rate Stories:

Miles Kimball and Yichuan Wang: Contra Reinhart and Rogoff, High Debt/GDP Primarily a Result of Rather than a Cause of Slower Growth

Miles Kimball and Yichuan Wang confirm Arin Dube: Guest Post: Reinhart/Rogoff and Growth in a Time Before Debt | Next New Deal:

Miles and Yichuan:

After crunching Reinhart and Rogoff’s data, we’ve concluded that high debt does not slow growth - Quartz: After crunching Reinhart and Rogoff’s data, we’ve concluded that high debt does not slow growth.

The Tribal Dislike of John Hicks and IS-LM: Wednesday Hoisted from the Archives from 1 1/2 Years Ago: History of Economic Thought Weblogging

Hoisted from the Archives: October 2011: The Tribal Dislike of John Hicks and IS-LM: History of Economic Thought Edition: When you do economics and apply it to the real world, you start with the simplest possible model. Does that help you understand enough of the real world to satisfy you? If not, you complicate it by adding the most important thing that you had left out. Does that help you understand enough of the real world to satisfy you? If so, you use that model--and then when you want to go further you complicate it in its turn.

Ryan Avent, Armed Cap-a-Pie, Enters the Lists Against the R-Team: Fiscal Expansion Is the Real Fiscal Prudence Weblogging

Ryan Avent:

Fiscal policy: Debt, growth and competing risks: CARMEN REINHART and Kenneth Rogoff have revived the debate over their work on debt and growth with an open letter to Paul Krugman. They accuse him of incivility, factual misstatements and general wrongness. On the first, he's guilty (but so are many economists, usefully). On the second, he is guilty of a lesser charge; Ms Reinhart and Mr Rogoff do seem to have made their data available as they turned it up, but they do not respond to charges that they were slow in making public their Excel spreadsheet, which is what allowed critics to understand what they had done and where they had gone wrong. On the third, Ms Reinhart and Mr Rogoff have swung and missed. They have retreated to the general position that a negative relationship exists between debt loads and growth. And on the matter of causality—which one might say is the crux of the debate—they can do no better than argue that the evidence is mixed.

There Is a Substantive Analytical Point at Issue Between Reinhart-Reinhart-Rogoff and Krugman (and Me) That It Would Be Nice to Thrash Out…

Can't we all get along?

Can't we all agree that in a better world than this the R-Team would never have written that 90% was an "important marker", and reacted much more aggressively to distance themselves from people who claimed that 90% was some sort of gross debt line of death? And can't we all agree that we have learned a lot from This Time It's Different and from SB on financial repression in historical perspective?

And can't we all agree that a considerable portion of the abuse directed at the R-Team should be redirected to Alberto Alesina (for Alesina and Ardagna) and Greg Mankiw (for his claims that it is easy and straightforward to summon the inflation-expectations imp via QE)?

And can't we move on to issues of macro substance?

In their open letter to Paul Krugman, the R-Team writes:

We don’t see your attraction to fiscal largesse as a substitute. Periphery Europe cannot afford it and for Germany, which can afford it, fiscal expansion would be procyclical.  Any overheating in Germany would exert pressure on the ECB to maintain a tighter monetary policy, backtracking some of the progress made by Mario Draghi. A better use of Germany’s balance sheet strength would be to agree on faster and bigger haircuts for the periphery, and to support significantly more expansionary monetary policy by the ECB…

Since I joined Team-K on March 20, 2008, when I saw the liquidity trap cometh, Team-K has been for more of:

1. Zero short-term safe nominal interest rates,
2. Higher inflation targets,
3. Cramdown,
4. Bank recapitalization,
5. Other forms of loan forgiveness to assist in deleveraging, and
6. Quantitative easing,
7. Expansionary fiscal policy

The R-Team have been members in good standing of Team-K, with the exception of (7), on which they have exercised a major line wobble. Unfortunately, the political and central-banking processes have frozen (1)-(5) over the past three and a half year, leaving the R-Team's impact on the policy process as one that is objectively pro-austerity.

But the interesting questions to me right now are: What is it about the R-Team's basic model, orientation, and understanding of the economy that has caused this line wobble on their part vis-a-vis the rest of us on Team K? And are they right?

I have taken my stab at answering this question here and here and here. But I am not at all sure that I am correct, and I would like some intellectual help here…

Noah Smith: Trolling Central Bankers with Gun and Camera

Noahpinion: What can you do with a DSGE model?:

When the Bank of England invited me to give a talk at their workshop on macroeconomics, I wasn't sure if they wanted me to provoke (i.e. troll) them with the kind of skeptical stuff I usually write on this blog, or to talk about my own research on artificial markets and expectations. So I did both…. I'd reproduce part of my talk in a blog post - the part where I talked about DSGE models. (In other words, the provocative part.)… To be "DSGE" your model probably has to have things like infinitely far-sighted rational expectations, rapid clearing of goods markets, certain simple types of agent aggregation, etc…. As of 2013, the most "mainstream" DSGE models of the business cycle are "New Keynesian" models. The most important of these is the Smets-Wouters model, which has gained a huge amount of attention, especially from central banks, for seeming to be able to forecast the macroeconomy better than certain popular alternative approaches. If you know only one DSGE model, Smets-Wouters is the one you should know.

Monday DeLong Smackdown Watch: Paul Krugman Calls Me Soft on Hippie-Punching and Soft on the Causes of Hippie-Punching Weblogging

Paul Krugman:

Macroeconomic Hippie-Punching: Brad DeLong interprets the Keynes-bashing opening of Ken Rogoff’s latest as strategic hippie-punching (see definition 2.2), designed to soften up his readers for the easy-money, debt-forgiveness message that follows.

Maybe that’s it, or maybe it’s just personal ire at some of the hippies. Either way, though, there is a question about whether it’s an effective strategy. I don’t think so.

A Note on Self-Defeating Austerity and Current Levels of Interest Rates

Joe Gagnon:

RealTime Economic Issues Watch | Self-Defeating Austerity and the Improved US Fiscal Outlook: Last week, Tyler Cowen of the blog Marginal Revolution asked “Have we seen self-defeating austerity in the United States?” Cowen declines to take a clear stand on the question, but his main point is that the well-known fiscal cuts of 2012 and 2013 have, in fact, reduced the US budget deficit. Ergo, goes the implication, austerity was not self-defeating. The problem is that the case for self-defeating austerity—described in a blog post by Paul Krugman and a paper [pdf] by Brad DeLong and Lawrence Summers to which Cowen provides links—focuses on the long-run fiscal impact… fiscal deficits are unusually cheap to finance and monetary policy is not going to move to offset much (if any) of the effects of fiscal policy on the economy….

Martin Wolf's Point About the British Industrial Revolution, Debt, and Growth...

Ah. I missed this at the time. Josh Bivens wrote:

A slight bit of substance on the Reinhart and Rogoff 90 percent debt threshold: A statistical association of high debt ratios with slow growth could well be (in fact is more likely to be) driven by causality that runs from slow growth to high debt ratios, and the not the reverse causality that R&R strongly argue. In an interview with Dylan Matthews, Reinhart dismissed this:

Reinhart dismisses these criticisms as wishful thinking. ‘We’re quite aware that you have causality going in both directions,’ she says. ‘But please point out to me what episodes from 1800 to the present have we had advanced economies who carried high levels of debt growing as rapidly or more rapidly than the norm.’

Answer: Britain after 1815. Debt of 240% of a year's GDP. Economic growth unprecedented both in earlier ages and in comparison with every place else in the world…

Deploying Germany's Debt Capacity for European Recovery: Saturday Morning Hippie-Punching Weblogging

Paul Krugman is annoyed by the hippie-punching at the start of Ken Rogoff's Project Syndicate column, in which Ken lands blows on Paul "Groovy Beads, Man!" Krugman and Martin "Flower Power" Wolf.

Me? I think that you are ahead as long as Ken does not consign you to the Gamma Quadrant. Some of us have the gift of prophecy and prophesy. Others have the gift of speaking in tongues and do so speak. Still others have the gift of communicating with Very Serious People and do so by punching hippies. As St. Paul said, so many gifts…

Ken Rogoff: For Europe, Debt Relief for the Periphery, Not Fiscal Expansion at the Core

There are two ways to think about why North Atlantic economies are depressed. The first is that would-be spenders (including people and businesses that buy durable capital goods) want to spend less than income earners would earn if there were full employment. The second is that would-be lenders want to lend more than would-be borrowers would want to borrow and than financial intermediaries would be willing to let them borrow if there were full employment. These two ways of thinking about it are, in the math, identical. But they highlight different aspects of the situation.

Now comes the very smart Ken Rogoff to say:

Europe’s Lost Keynesians: There is no magic Keynesian bullet for the eurozone’s woes. But the spectacularly muddle-headed argument nowadays that too much austerity is killing Europe is not surprising. Commentators are consumed by politics, flailing away at any available target, while the “anti-austerity” masses apparently believe that there are easy cyclical solutions to tough structural problems.

Kenneth Rogoff Is Smart Today

Here:

"Europe’s Lost Keynesians" by Kenneth Rogoff

But I don't have time to react…

“Unknown Unknowns”: High Public Debt Levels and Other Sources of Risk in Today’s Macroeconomic Environment

Robert Skidelsky Certainly Does Not Think There Is Only a Dime's Worth of Difference Between Cameron and Obama

Robert Skidelsky:

Austere Illusions: The doctrine of imposing present pain for future benefit has a long history – stretching all the way back to Adam Smith and his praise of “parsimony.” It is particularly vociferous in “hard times.” In 1930, US President Herbert Hoover was advised by his treasury secretary, Andrew Mellon:

Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. It will purge the rottenness out of the system...People will...live a more moral life...and enterprising people will pick up the wrecks from less competent people.

To “liquidationists” of Mellon’s ilk, the pre-2008 economy was full of cancerous growths – in banking, in housing, in equities – which need to be cut out before health can be restored. Their position is clear: the state is a parasite, sucking the lifeblood of free enterprise. Economies gravitate naturally to a full-employment equilibrium, and, after a shock, do so fairly quickly if not impeded by misguided government action. This is why they are fierce opponents of Keynesian interventionism.

U.S. Second-Quarter Growth Now Looks Likely to Be at a Pace That Puts Downward Pressure on the Employment-to-Adult-Population Ratio...

Not too Late for the Social Credit Helicopters!

Duncan Black:

Eschaton: Not Too Late For The Helicopters: A big tragedy of the last few years is the failure to recognize that being in a low inflation world at the zero lower bound was a tremendous opportunity to massively enhance human welfare in this country. Mailing out 10 grand checks to everyone would have been an egalitarian massive boost to the economic well-being of huge numbers of people. Instead, the Fed has goosed asset prices, mostly benefiting the rich. Trickle down through another means, but still trickle down. Better than doing nothing, probably, but there were other ways.

How can you oppose a social-democratic economic policy that had the endorsement of Robert A. Heinlein?

Brad DeLong (Summer 2010): It Is Far too Soon to End Expansion: Wednesday Hoisted from Three Years Ago

Brad DeLong: It is far too soon to end expansion:

It was in 1829 that John Stuart Mill made the key intellectual leap in figuring out how to fight what he called “general gluts”: he saw that what had happened was an enormous excess demand for particular financial assets was driving an enormous excess supply of goods and services – and if you relieved the excess demand in finance you would cure the excess supply of labour. When the government relieves an excess demand for liquid money by printing up cash and swapping it out for government bonds, we call that expansionary monetary policy. When the government relieves an excess demand for bonds by printing up more Treasuries and selling them to finance its own purchases of goods and services, we call that expansionary fiscal policy. And when it prints up cash and bonds and swaps them for risky private financial assets, or when it guarantees private assets and so raises the supply of high-quality and reduces the supply of low-quality bonds, we call that banking policy. 

Exchequer Chancellor Osborne Braced for IMF Verdict

An Article IV consultation for a reserve-currency sovereign that might actually matter:

Rachel Cooper:

Osborne braced for IMF verdict on UK economy: George Osborne is braced for the International Monetary Fund's verdict on Britain's economic prospects amid speculation it will urge him to change course. On Wednesday, the IMF presents its annual healthcheck on the UK and the international body is expected to suggest that deficit reduction should be slowed amid anaemic growth. The “Article IV” report is expected to recommend Mr Osborne change his plans and borrow more to invest in infrastructure or cut taxes. Previously, the IMF was among the strongest backers of the Chancellor's economic strategy, but has gradually changed its tone in response to dwindling growth forecasts.

Jeffrey Frankel: "[It Is] Alberto Alesina [Who] Has Not Been Receiving His 'Fair Share of Abuse'”

Jeff Frankel:

On Whose Research is the Case for Austerity Mistakenly Based?: Several of my colleagues on the Harvard faculty have recently been casualties in the cross-fire between fiscal austerians and stimulators…. Carmen Reinhart and Ken Rogoff… the statistical relationship between debt and growth…. Niall Ferguson… “suggested that Keynes was perhaps indifferent to the long run because he had no children, and that he had no children because he was gay.”

Ryan Avent: "Mr Cowen's posts, and many other like them by other authors, sometimes look like elaborate efforts to avoid concluding that German inflation-phobia, while totally understandable and rational, looks like a grave moral error in the current econ

Ryan Avent watches Karl Smith remind Tyler Cowen that people respond to market prices, and piles on himself:

The euro crisis: Der Elefant im Raum: TYLER COWEN writes on the euro-zone economy:

Would the new helicopter drop money be kept in periphery banks and lent out to stimulate business investment? Or does the new money flee say Portugal because Portuguese banks are not safe enough, Portuguese loans are not lucrative and safe enough, and Portuguese mattresses are too cumbersome? The former scenario implies that monetary policy should be potent. The latter scenario implies that the helicopter drop will be for naught and the fiscal policy multiplier also will be low, on the upside at the very least (fiscal cuts still might cause a lot of damage on the downside). I call this the liquidity leak, rather than the liquidity trap.

Karl Smith gives the correct response:

What Tyler calls a liquidity leak, I call markets at work. The ECB provides enough stimulus to get all of the Eurozone going but it all leaks to Germany. Fine. The German market heats up. German wages and rents rise. Retired German doctors start considering the virtues of a flat in Lisbon overlooking the harbor. German consultancies hold seminars on “How to make your Mediterranean town competitive in the new German Outsourcing Model.” This is the way things are supposed to work. The idea that a more competitive and efficient Germany should not command higher wages and rents is bizarre; and is only called inflation because the Eurozone, in its heart-of-hearts, doesn’t actually believe its one monetary union where the richer parts are distinguished principally by the fact that they have more money.

Paul Krugman: One of Michael Kinsley's Problem Is That He Is Not Living in the Real 1970s

Paul Krugman:

The Mythical 70s: It’s actually even worse than Matt [O'Brien] says. For the 1970s such people remember as a cautionary tale bears little resemblance to the 1970s that actually happened. In elite mythology, the origins of the crisis of the 70s, like the supposed origins of our current crisis, lay in excess: too much debt, too much coddling of those slovenly proles via a strong welfare state. The suffering of 1979-82 was necessary payback. None of that is remotely true. There was no deficit problem: government debt was low and stable or falling as a share of GDP during the 70s… a runaway welfare state more broadly just wasn’t an issue — hey, these days right-wingers complaining about a nation of takers tend to use the low-dependency 70s as a baseline.

What we did have was a wage-price spiral… exacerbated by big oil shocks… a case of self-fulfilling expectations, and the problem was to break the cycle.

So why did we need a terrible recession? Not to pay for our past sins, but simply as a way to cool the action…. Was there a better way? Ideally, we should have been able to get all the relevant parties in a room and say, look, this inflation has to stop; you workers, reduce your wage demands, you businesses, cancel your price increases, and for our part, we agree to stop printing money so the whole thing is over. That way, you’d get price stability without the recession. And in some small, cohesive countries that is more or less what happened. (Check out the Israeli stabilization of 1985). But America wasn’t like that, and the decision was made to do it the hard, brutal way. This was not a policy triumph! It was, in a way, a confession of despair….

No, America didn’t return to vigorous productivity growth — that didn’t happen until the mid-1990s. 60-year-old men should remember that a decade after the Volcker disinflation we were still very much in a national funk; remember the old joke that the Cold War was over, and Japan won? So it would be bad enough if we were basing policy today on lessons from the 70s. It’s even worse that we’re basing policy today on a mythical 70s that never was.

One thing going on is that the 1980s did see (a) a reduction in the progressively of taxation and (b) the start of the huge surge in overclass income. For overclass people--or people who are now part of the overclass and who then identified with the overclass like Michael Kinsley--the 1980s were pretty good (as, by the way, were the 2000s up until 2007).

Ken Rogoff (1998) on Optimal Policy in a Liquidity Trap

Ken Rogoff: Comment on Paul Krugman: "It's Baaack: Japan's Slump and the Returnof the LiquidityTrap":

Kenneth Rogoff: This is a truly inspired paper on Japan's ongoing "Great Recession," although I have to keep pinching myself to ask if its main thesis can really be true. Is the equilibrium (full-employment) medium-term real interest rate for Japan actually negative, so that un- less the Bank of Japan (BOJ) resigns itself to sustained inflation, the zero bound on nominal interest rates will present serious problems? Has the BOJ so thoroughly convinced the public of its anti-inflation credibility that it has lost the power to rekindle inflation now that Japan needs it?