The Sunday New York Times has a contrast of Larry Summers and Glenn Hubbard on our collective economic future.
Summers is a past president of Harvard and economic-adviser extraordinaire to President Obama. Hubbard is the dean of the NYU Business School, and star of this ‘stinging’ sendup of Ben Bernanke.
Neither lacks confidence, that’s for sure.
This week Lawrence will be hosting a TEDx conference on re-imagining liberal education. Thanks to Professors Galambos and Gerard, and a few other colleagues from other departments, this live discussion will be video streamed for all of us to watch.
Earlier this month, another TED conference took place. This one featured economist Robert Gordon (Northwestern) and Eric Brynjolffson (MIT). Some of you will be familiar with the arguments. Those who took Capital and Growth last year read Gordon’s paper on the headwinds that will drive economic growth back to the level experienced prior to the first industrial revolution in the 18th century in England. Gordon believes that our most productive innovations are behind us and innovation will be insufficient to enable us to sustain the 2% per capita real growth of the 20th century.
Some of you may recall the discussion we had in one of our reading groups of Brynjolffson and McAfee’s book, Race Against the Machine. In his TED talk, Brynjolffson explains why innovation is far from over and that we have the potential to continue the rate of growth of economic prosperity that we experienced in the 20th century. Of course, the challenge, as he puts it is: “can we race with the machine?”
View both talks as well as a follow-up debate between these two economists here.
This view point has been recently propounded by Japanese Prime Minister Shinzo Abe and his protege (puppet?) Haruhiko Kuroda, selected to be in charge of the Bank of Japan. Japan is tired of two decades of stagnation and falling or at least not rising prices. Mr. Abe has pushed for a 2% inflation target and Mr. Kuroda will provide $77 billion worth of monthly bond purchases to achieve that goal. If that’s not enough, will more be forthcoming? Is a little good and more better?
Inflation as a cure for economic ills is not new. In fact, check out this 1933 video on the how inflation is good for everything and everyone. Clearly, proponents of Neo-classical macro beg to differ. Those in Econ 320 will have a chance to sort out the winners and losers. Indeed there will be losers, as we know that there is no free lunch. Who will the winners be?
1. lenders or borrowers
2. savers or consumers
3. labor or management
4. bond holders or stock holders
5. renters or buyers
6. government officials or Wall Street tycoons
Place your bets now or maybe just guard (cover?) your assets.
Whatever else you do watch the video? It’s a hoot.
Yesterday, Congress passed legislation designed to avoid the strictures Congress enacted in the summer of 2011 to enable the United States government to borrow in excess of the existent debt ceiling. These provisions would have allowed the income tax cuts enacted in the George W. Bush era to expire as well as imposed spending limits on defense and discretionary non-defense spending.
There are numerous provisions in yesterday’s bill, summarized by the White House here. The Congressional Joint Committee on Taxation estimates the increased revenue from the bill to yield $62o over 10 years, far short of the 4 trillion dollars some estimate will be need to generate a sustainable level of debt. Furthermore, the debt ceiling and expenditure components of the “cliff” will remain subjects of political debate for at least the next two months when further action will be required. In short, we have “kicked the can down the proverbial road” again.
Bruce Bartlett, in a New York Times Economix posting yesterday, offers little in the way of enthusiasm regarding the political feasibility of making serious headway in addressing prospective budget deficits now and in the near future. His argument parallels the time inconsistency argument that earned Edward Prescott and Finn Kydland the Nobel Prize in Economics in 2004.
The Congress that raises taxes and cuts benefits will suffer politically, while the benefits of lower deficits will accrue to future Congresses.
He goes on to argue that
Historically, what has moved Congress to enact big deficit-reduction packages was the prospect of quick improvement in terms of inflation, growth and interest rates. Given that deficit reduction today is very unlikely to improve any of these in the near term, deficit hawks lack any real payoff from a grand bargain.
Inflation has been low and stable as has expected inflation.
Even though expected inflation has been stable or declining for the past decade, real interest rates for treasuries (see chart below) – market rates minus expected inflation – has been negative for much of the past decade with the exception of the brief positive values in 2005 – 2007 and with expected deflation in late 2008. If real interests are negative, the crowding effects of public sector borrowing are non-existent; thus, the cost of running deficits has not “spooked” the markets. Of course, permanent negative real interest rates are not sustainable since few lenders will continue to offer their savings in exchange for reduced future consumption.
In the famous song from The Lion King, Hakuna Matata – there are no worries or no problem. Of course, such attitudes last only as long as those who lend money to the US government continue to do so. As Reinhart and Rogoff argue persuasively in This Time is Different: Eight Centuries of Financial Folly, this time is not different. Financial excesses and repression eventually must be paid for. We just don’t know when or how severe the price will be.
The Federal Reserve Bank of the US has followed a zero interest rate policy (ZIRP) since fall 2008. It has employed a variety of mechanisms to lower not only overnight loans between banks (the Federal Funds rate – its usual target) but also to lower the entire yield curve. (See the details at the Federal Reserve Bank of St. Louis.) Previous postings here and here have addressed some of the costs of this approach.
Yesterday’s Financial Times contains some historical evidence consistent with the idea that ZIRPS are not free. John Plender argues that experience in Japan over two decades indicates that very low interest rate monetary policy did significant structural damage to the Japanese economy. In addition to creating a very low cost of capital, excessive monetary ease tends to lock-in the existing industrial structure or as he argues
“…from the Austrian perspective of Von Mises, Schumpeter, and Hayek, the Japanese bubble that burst in 1990 fostered economic distortions they dubbed ‘malinvestments’ – credit driven investments in real capital that prove loss making when a credit bubble implodes.”
As a consequence, Japan impeded “creatively destructive” economic activity since “zombie” companies were kept alive by cheap credit that was not available to new entrants. Capital allocation became very distorted; hence, many profitable opportunities were foregone and low return (perhaps even negative return) activities remained in existence.
Of course, that was Japan. Not the U.S. That couldn’t happen here, could it?
Much political debate – more appropriate described as hot or even toxic air – attempts to address how poorly the economy has recovered from what Reinhardt and Rogoff call The Great Contraction. As noted in Professor Gerard’s recent post, R and R argue- as they have done many times before – that recoveries from balance sheet or financial crisis recessions are much slower than those related to “garden variety” declines in aggregate demand. So what does the current recovery look like? One way to answer this is to view the four major indicators that the National Bureau of Economic Research’s Business Cycle Dating Committee uses to identify the beginning and ending points for recessionary and expansionary periods. Fortunately, our friends at the Federal Reserve Bank of St. Louis have done all the hard work. As can readily be seen below (or more clearly here), industrial production and real retail sales have grown roughly in line with the average of past recessions. Real income started to grow similar to past history, but for the past 18 months growth has slowed markedly. The employment growth pattern, however, has shown the least responsiveness to the medicinal help provided by the Federal Reserve and other governmental policies. This suggests that “financial crisis” related recessions require both more time and different policies than demand deficient recessions not induced by too much debt. I will have more to say about why in future posts.
Lawrence alum Elijah Brewer will address the above question in the next Economics Colloquium. It will take place next Monday, October 8th, in Steitz Hall 102 at 4:30. We encourage all to attend.
Brewer characterizes what he will argue as follows:
The causes of the financial crisis of 2007-09 are many and varied. Indeed, the crisis may be viewed as the product of a perfect storm. This address will discuss many of the popular causes of the U.S. crisis and enumerate their more important sins. It then presents the traditional way we like to think about commercial banks, and how that had changed leading up to the financial crisis. Indicators of stress in the financial system, and commercial banks in particular, are presented. What you will see is that many of these indicators were flashing red well before regulators got their hands around the problem. I will argue that it was not the lack of regulation, but a lack of will by regulators to enforce the rules that were already on the books. Thus, the government’s and Congress’s desire to regulate Wall Street is mis-placed. The banking industry does not need more regulation for the regulators to ignore when it’s convenient for them to do so, but we need a greater will by regulators to enforce the regulations that they do have. I will conclude by offering an assessment of the Dodd-Frank Act.
Everyone knows that the Dodd-Frank law passed in 2010 to regulate the financial industry is incredibly complex. As those who took Money and Monetary Policy last fall learned from alum Jim Lyon, it will take years just to write the implementation provisions. Furthermore, these provisions will be influenced significantly by those (especially in the banking industry) whose behavior will be affected.
Andrew Haldane, in the most recent Kansas City Federal Reserve Bank symposium in an article entitled “The Dog and the Frisbee”, argues that such complexity is far from optimal in an economic environment in which uncertainty prevails. He uses the concept of uncertainty in the same way that Frank Knight and John Maynard Keynes did almost a century ago; that is, situations in which assessing the probability of different outcomes is quite low and that risk cannot be easily measured and therefore, hedged against. Haldane argues for simple rules, such as existed under the Glass-Steagall Act which forbids the mixing of commercial and investment banking.
In a recent blog entry on the EconoMonitor, Ed Dolan analyses this argument in terms of Goodhart’s Law, which suggests that as soon as a particular indicator becomes an explicit policy variable, it loses its predictive power because economic agents change their actions in response to expectations of the authorities using this indicator for policy action. Some of you might recall this as a variation of the Lucas critique of traditional monetary and fiscal policy actions.
All of the above is prologue for our next Economics Colloquium to be held next Monday. Our visitor, 1971 Lawrence alum, Elijah Brewer, will address the topic “Regulating Wall Street: Did We Go Too Far?“ Be sure to come to his talk at 4:30 PM, Monday, October 8th in Steitz Hall 102.
In a recent article in Forbes, contributor Nick Shulz asks what the “new normal” for economic growth in the U.S. will be. On one side, we find Tyler Cowen (The Great Stagnation) and Robert Gordon (“Is U.S. Economic Growth Over?…”) arguing that the technological low hanging fruit have been picked and that the future will feature economic growth similar to what existed before the industrial revolution (that is, well below 1% per year.)
On the other side of the debate, Race Against the Machine authors Bryjolfsson and McAfee and authors of the new volume The 4% Solution, published by the Bush Institute, suggest that the future will be brighter than the past.
Which do you believe? On which future would you bet? Why?
In Monday’s Financial Times – of course, no US newspaper would publish it - Stephen Roach, former chair of Morgan Stanley Asia and present senior fellow at Yale University, describes a scenario that might take place if 1) Mitt Romney is elected and 2) he follows through on what he said would be his first order of business. I encourage you to read this opinion piece in full. Here are the pertinent details.
1. Romney declares China guilty of currency manipulation.
2. Romney proposes and Congress passes the Defend America Trade Act of 2013 (DATA2013 for short.)
3. Negotiations between the US and China fail so the US slaps a 20% tariff on all Chinese products entering the US.
4. Beijing interprets this action as economic warfare and files a complaint with the WTO.
5. Not willing to wait until the WTO dispute process plays out and given the large number of plants closed in China, China’s Ministry of Commerce introduces a 20% tariff on all U.S. exports (roughly $104B worth in 2011.)
6. Walmart announces average price increases of 5% and other retailers follow suit.
7. The Fed extends its commitment to zero interest rate policies to 2015 (ZIRP.)
8. Financial market swoon, and Romney and Congress up the tariffs on China by another 10%.
9. China publicly announces it will no longer buy US treasuries.
10. Both the US and Chinese economies tank.
Is this scenario just the ghosts of Smoot and Hawley (authors of the infamous Tariff Act of 1930) arising to exhort their contemporary counterparts in Congress or is this just a nightmare that will fade when Stephen Roach and I wake up?
This is clearly the “dark” side of public policy making. But, where’s the “light” or enlightened side? I don’t see any.
For most of his editorial postings, Paul Krugman’s opinions are political in character and offer limited if any economic analysis. In today’s posting in The Conscience of a Liberal , Krugman demonstrates why his insights are worthy of a Nobel laureate in economics. In particular, he discusses what the literature on optimal currency unions has to contribute to discussion of the Eurozone. He draws insights from economists of various stripes regarding the necessary criteria for a successful currency union and how the Euro falls well short of what’s needed.
In summary, optimum currency area theory suggested two big things to look at – labor mobility and fiscal integration. And on both counts it was obvious that Europe fell far short of the U.S. example, with limited labor mobility and virtually no fiscal integration. This should have given European leaders pause – but they had their hearts set on the single currency.
He notes that most economists forecast that the Eurozone would have problems holding together given the above criteria.
So optimum currency area theory was right to assert that creating a single currency would bring significant costs, which in turn meant that Europe’s lack of mitigating factors in the form of high labor mobility and/or fiscal integration became a very significant issue. In this sense, the story of the euro is one of a crisis foretold.
Krugman does provide some options for Europeans to consider but isn’t optimistic that this political project will succeed. In short political will or perhaps wishing thinking is not enough. The economic fundamentals can’t be ignored.
The creation of the euro involved, in effect, a decision to ignore everything economists had said about optimum currency areas. Unfortunately, it turned out that optimum currency area theory was essentially right, erring only in understating the problems with a shared currency. And now that theory is taking its revenge.
No, this is not a question on the final exam for Money and Monetary Policy; however, it has been. It’s also a question that pervades contemporary political economy in the US and Europe.
Federal Reserve Chair, Ben Benanke continues to be criticized from both those who advocate aggressive monetary policy and those who argue that the Fed has been too aggressive. For example, today’s Wall Street Journal features “Fed bashing” from the House Financial Services Committee.
The Fed’s easy-money policy and actions taken to boost economic growth have prevented lawmakers from taking responsibility for shoring up the economic recovery and reducing the deep federal budget deficit, some Republicans said Tuesday at a hearing of a panel of the House Financial Services Committee.
“As the Fed does more, Congress is doing less and in the long term that slows our recovery,” said Rep. Kevin Brady (R., Texas).
How are we to interpret this? Mr. Bernanke, since you did your job appropriately, we won’t (can’t?) do ours?? Of course, many pundits, especially those who fear a tripling of the Fed’s balance sheet since 2008, believe that the world would be better without the Fed. Anyone ever heard of Ron Paul?
At the other extreme, Paul Krugman, not to be outdone in the world of political rhetoric Earth to Bernanke, has accused Fed Chair Bernanke of not following the advice that Professor Bernanke gave the Japanese in a 2000 paper. He and others such as Scott Sumner of the Modern Monetarist Movement argue that the Fed should target nominal GDP and make monetary policy as expansionary as needed to reach that target.’
Where’s the center or at least some non-extreme view? I suggest one look to Raghuram Rajan who yesterday posted “Central Bankers Under Siege” and for the current issue of Foreign Affairs wrote “True Lessons of the Recession.” In these articles, Rajan argues that various versions of demand stimulus through credit creation will not address fundamental structural problems in the US economy. He concludes the latter article as follows:
The industrial countries have a choice. They can act as if all is well except that their consumers are in a funk and so what John Maynard Keynes called “animal spirits” must be revived through stimulus measures. Or they can treat the crisis as a wake-up call and move to fix all that has been papered over in the last few decades and thus put themselves in a better position to take advantage of coming opportunities. For better or worse, the narrative that persuades these countries’ governments and publics will determine their futures — and that of the global economy.
So, what should Central Bankers do? In my view, they should recognize that monetary policy has its limits and that using monetary policy as a means to generate sustained employment won’t work. Longer term structural adjustments are required. Such adjustments will be the subject of another blog posting.
Quotation of the Day… from Cafe Hayek
Posted: 29 Apr 2012 05:01 AM PDT
… is from page 134 of Deirdre McCloskey’s 2010 Bourgeois Dignity:
During the 1930s and early 1940s the prospect of diminishing returns deeply alarmed economists such as the British economist John Maynard Keynes and the American follower of Keynes at Minnesota and Harvard, Alvin Hansen. They believed that the technology of electricity and the automobile were exhausted, and that sharply diminishing returns to capital were at hand, especially in view of declining birthrates. People would save more than could be profitably invested, the “stagnationists” believed, and the advanced economies would fall into chronic unemployment. In line with the usual if doubtful claim that spending on the war had temporarily saved the nonbombed part of the world’s economy, they believed that 1946 would see a renewal of the Great Depression.
But it didn’t. Stagnationism proved false.
Yes, trumpets Lawrence Summers in today’s Financial Times. Presumably, anyone who pays any attention to the Washington scene knows Larry Summers. Just in case you haven’t been paying any attention for the past 20 years, the bullet point version of Summers’ CV might read as follows:
Few people – economists, policy analysts, or politicians – defend the current tax codes filled with huge inequities in both horizontal and vertical directions (as argued here.) Tax “loopholes,” tax expenditures (CBO estimates), or societal preferences – if you care to be generous – reduce taxable income by at least $800 billion per year. Stated differently, if all special provisions (i.e., everything but the personal exemption) of the U.S. tax code were eliminated, income tax revenue would rise to at least $2 trillion and cover about two-thirds of the estimated U.S. Federal deficit for 2012.
So what makes 2013 so special? Summers gives a variety of intriguing answers including the following:
As Summers argues,equity, efficiency, and budgetary reasons all dictate that we need to fundamentally reform the tax structure. The longer we wait, the more difficult the choices will be. If (when?) the rest of the world decides it no longer has a voracious appetite for U.S. Treasuries, our choices will be much more painful. He argues, and I agree, a good place to start would be the recommendations of the Simpson-Bowles Commission appointed by President Obama, which unfortunately in my view, he chose not to back vigorously.
This week many of you are reading Brynjolfsson and McAfee’s book Race Against the Machine. The authors make reference to a September 28, 2011 Wall Street Journal article by Kathleen Madigan entitled “It’s Man vs. Machine and Man is Losing.” Madigan provides the chart below to illustrate the relative growth of equipment and software in comparison with payroll employment since the trough of the recession in June 2009.
As I have previously argued here and here, Madigan notes how the relative price of labor compared to capital is consistent with the pattern shown in the above chart. Again, job creation clearly is quite difficult if the incentives are perverse.
