QE

A Surprising Look Back at the Fed's QE Programs by David Beckworth

You're the Worst

AV Club reviews You’re The Worst: “Insouciance”

people, Americans

Heather Boushey

Thomas Ricks

This is the reason why they hate us.

Put the Fifty Shades Of Grey trailer inside you and say you like it

They hate our decadence and freedom. Or something. Nonetheless I'm a fan of Dakota Johnson. You may remember her from 21 Jump Street and The Social Network.

Baker on housing wealth effect

The basic story is straightforward. The run-up in house prices created by the bubble created $8 trillion in housing bubble wealth. Standard estimates of the housing wealth effect suggest that this would increase annual consumption by 5-7 percent of this amount, or $400 billion to $560 billion a year. This would have been equal to 3-4 percent of GDP.

Loose macroprudential policy gave the economy about a $500 billion / year stimulus which filled the output gap left by inadequate demand from trade and government spending. It was unsustainable.

The Problem Is Not Debt: Consumption Is High Not Low by Dean Baker

Economists and economic reporters continually try to make the problem of the weak economy and prolonged downturn appear more complicated than it is. After all, if it is very simple then these people would look foolish for not having seen it coming and figuring out a way around this catastrophe. Fortunately for us, if unfortunate for them, it is simple. 

One of the efforts to make it more complex than necessary is to assign an outsized role to the debt associated with the collapse of house prices. This is the argument that we heard on Morning Edition this morning. The argument is that when house prices plunged after the housing bubble burst in 2007, homeowners were left with large amounts of debt, pushing many of them underwater. This debt supposed discouraged them from spending, leading to a sharp falloff in consumption. 

There is a big problem with this story. Consumption is not low, it is actually still quite high. The graph below shows consumption as a share of GDP. It is actually higher than during the bubble years and essentially at an all-time peak. That makes it a bit hard to explain the downturn by weak consumption. (Some folks may recall hand wringing about inadequate savings for retirement, as in this NYT column by Gene Sperling yesterday. Too little savings and too little consumption are 180 degree opposite problems, sort of like being too heavy and too thin.) 

There would be a modest decline in consumption from the peak bubble years if it was shown as a share of disposable income (tax collections are lower today than in 2004-2007), but it would stiill be unusually high by this measure. The basic story is straightforward. The run-up in house prices created by the bubble created $8 trillion in housing bubble wealth. Standard estimates of the housing wealth effect suggest that this would increase annual consumption by 5-7 percent of this amount, or $400 billion to $560 billion a year. This would have been equal to 3-4 percent of GDP.
...

anchored perceived inflation

More on Consumers' Inflation Forecasts by Robert Waldmann

My http://angrybearblog.com/2014/07/anchored-perceived-inflation-or-how-fox-news-helped-obama.html has received more attention than I would have guessed. This should be a semi-serious post on the topic.
...
In any case there is clear evidence that a sudden drop in the price of petroleum does not cause respondents to forecast extremely low inflation in the future. In constrast sudden increases in the price of petroleum correspond to unusually high forecast inflation.
...
Only later and less dramatically is there the genuinely puzzling anomaly. Median forecast inflation was consistently higher than lagged inflation for the past two and a half years. This is suprising.
...
It is not. Using all the Michigan survey data, this coefficient is almost exactly zero and, in fact, slightly positive. There is no evidence that survey respondents place more weight on food and energy prices than on other prices.

...
The indicator for 2009 and later is strongly significant and corresponds to forecast inflation being higher than expected by about 0.85%.

This is not a huge anomaly, but it is quite important. Some prominent economists feared that the extremely slack demand at a time of already low inflation would cause deflation. The fact that inflation has continued with high unemplyment suggests that at extremely low inflation rates, expected inflation ceases to affect wage bargains. The idea is that actual reductions in dollar wages are avoided. With normal pressures for variation in relative wages, this means that some nominal wages increase. This is a very old story. The continued increase in hourly wages at a an annual rate varying from about 1% to about 2.5% can be explained this way.

However, it is also possible that high unemployment has caused workers to accept a fairly rapid decline in subjectively expected real wages on the order of one to two percent a year. The systematic over estimate of future inflation would mean that this corresponds to puzzlingly stable achieved real wages.

Now that I am being semi-serious, I have to admit that I can’t determine the cause of the anomalously high forecasts since 2009. In 2009 itself it is not easy to guess the effects of the then recent extreme fluctuations in the price of petroleum. More generally many things have changed. My first guess is that the combination of a Democrat in the White House and fully developed Fox News leads to high inflation illusion. However, I could fit the anomaly very well using an indicator of unconventional monetary policy — say the ratio of total Fed liabilities to GDP. It is certainly true that prominent commentators predicted that the huge expansion of high powered money would cause high inflation. There is no way to know if they would have made the same prediction with a Republican in the White House.

When discussing the effects of unconventionally monetary policy through expected inflation (the Krugman-Woodford story) I have been very skeptical for two reasons. First huge interventions were associated with tiny changes in bond prices (often of the wrong sign). Second the expectations which matter are not those of bond traders but of house builders. Bond traders pay obsessive attention to the FOMC of the Fed.

I now think these two criticisms might cancel out. Bond traders also look at official measures of inflation. This doesn’t mean they think the indices are good or correspond to the cost of living. They do this just because the Fed looks at those indices. However, this may mean that stories about how loose monetary policy is causing high inflation might have more effect on economic agents other than bond traders. This means that the loose money might have caused higher investment through lower subjective expected real interest rates even if it didn’t bring inflation up to target.

The Bridge

AV Club The Bridge: “Sorrowsworn”

With a cameo by John Cale of the Velvet Underground.

Dodd-Frank

Tightening macroprudential policy.

Ignore the Naysayers: Dodd-Frank Reforms Are Finally Paying Off by Mike Konczal

schadenfreude, The Armstrong Lie & I'm the Worst

The Armstrong Lie

Yeah, I'm the worst.

Negative Outlook?

trade deficit

Dean Baker: 

The $500 billion trade deficit, coupled with a standard multiplier of 1.5, translates into $750 billion of lost annual output (roughly 4.5 percent of GDP). This in turn would come to about 6 million jobs. That is close to enough to get us back to full employment. That would give workers enough bargaining power to secure real wages. So yes, trade is a big deal.

Investment in Equipment (and Software): What Are Neil Irwin and Tyler Cowen Thinking? Tuesday Focus: July 22, 2014 by DeLong

anchored perceived inflation

I asked in comments for DeLong to add Waldmann's post on "anchored perceived inflation" and he did.

Menzie Chinn has a related post.

And here's DeLong's post on Chris House and Krugman from a week ago.

Phillips curves with anchored expectations by Robert Waldmann (from July 1st)

Fed as Dr. Benway

Steely Dan got their name from the talking dildo that appeared in Beat writer William Burrough's Naked Lunch. The book also has a character named Dr. Benway.



In a recent post J.W. Mason quoted Dr. Benway in reference to self-induced economic problems.

“Now, boys, you won’t see this operation performed very often and there’s a reason for that…. You see it has absolutely no medical value. No one knows what the purpose of it originally was or if it had a purpose at all. Personally I think it was a pure artistic creation from the beginning. 

“Just as a bull fighter with his skill and knowledge extricates himself from danger he has himself invoked, so in this operation the surgeon deliberately endangers his patient, and then, with incredible speed and celerity, rescues him from death at the last possible split second….

He imagines Larry Summers as in the Benway role:

Interestingly, Dr. Benway was worried about technological obsolescence too. “Soon we’ll be operating by remote control on patients we never see…. We’ll be nothing but button pushers,” etc. The Dr. Benways of finance like to fret about how robots will replace human labor. I wonder how much of that is a way of hiding from the knowledge that what cheap and abundant capital renders obsolete, is the capitalist?

EDIT: I'm really liking the idea of Larry Summers as Dr. Benway. It fits the way all the talk when he was being pushed for Fed chair was about how great he would be in a financial crisis. How would everyone known how smart he was -- how essential -- if he hadn't done so much to create a crisis to solve?

but I think the Federal Reserve Bank would be more accurate. As Frances Coppola tweeted:

Working my way through FOMC minutes from 2004 to 2008. Fascinating. The FOMC members primary concern is always exactly the same.
Their concern is always that core inflation will "fail to moderate" - even when staff projections are that it will fall.
But they are always really upbeat about growth, even when staff projections are that growth will fall. They ignore their own staff.
And they ignore markets, too. Investors were pricing in lower rates due to falling growth expectations from Jan 2007 onwards.
But the FOMC? Nah. Main risk in their view was inflation (even though it was falling). They kept interest rates elevated.

 Investors were rational in 2007, but turned irrational in the face of Obama. As Robert Waldmann writes:

I am assuming that, like inflation expectations, inflation perceptions have delinked from reality recently. I really really should find data on perceived inflation (which is out there somewhere). I also have to come up with a story for why this happened just in time to save us from deflation. 

I give the credit to Fox news. A large fraction of people in the US rely on Fox News (often indirectly as repeated by friends and relatives). They are out of touch with reality — there expectations and perceptions are what Roger Ailes wants them to be. He thinks inflation is bad even though in a depressed economy in the liquidity trap it is good. Therefore Fox News convinces people that inflation has been and will be high. The representative consumer is only partly living in the Fox bubble so perceived and expected inflation are moderate. Then finally actual inflation is low but positive.

federal exchanges set up for the states' benefit or state exchanges run by the feds

THE 4TH CIRCUIT BIGFOOTS THE REPUBLICAN DC PANEL'S ATTEMPT TO WIN THE DAY WITH ITS ANTI-OBAMACARE DECISION... by DeLong

Sarah Kliff: Separate circuit court rules in favor of Obamacare subsidies: "The Fourth Circuit Court of Appeals...

ruled Tuesday afternoon that Obamacare subsidies could be offered through federally-run insurance marketplaces.

It is... clear that widely available tax credits are essential to fulfilling the Act’s primary goals and that Congress was aware of their importance when drafting the bill," the Fourth Circuit Court ruled. 

We'll have more coverage soon...."

Keynesians

Aggregate Demand, Aggregate Supply, and What We Know (Wonkish) by Krugman

Still, we try. New Keynesians do stuff like one-period-ahead price setting or Calvo pricing, in which prices are revised randomly. Practicing Keynesians have tended to rely on “accelerationist” Phillips curves in which unemployment determined the rate of change rather than the level of inflation. 

So what has happened since 2008 is that both of these approaches have been found wanting: inflation has dropped, but stayed positive despite high unemployment. What the data actually look like is an old-fashioned non-expectations Phillips curve. And there are a couple of popular stories about why: downward wage rigidity even in the long run, anchored expectations. 

The point, however, is that the price-setting side of the models has never been an integral part of Keynesian doctrine, and the surprising resilience of inflation hasn’t undermined the core insights. 

And it remains true that Keynesians have been hugely right on the effects of monetary and fiscal policy, while equilibrium macro types have been wrong about everything.

And Robert Waldmann's Fox News inflation-distortion bubble which isn't exactly anchored expectations. It boosts expected inflation rates.

fiscal stimulus

More Monetarism and the Great Depression.

The “spending hypothesis” attributes the Great Depression to a sudden collapse of spending which, in turn, is attributed to a collapse of consumer confidence resulting from the 1929 stock-market crash and a collapse of investment spending occasioned by a collapse of business confidence. The cause of the collapse in consumer and business confidence is not really specified, but somehow it has to do with the unstable economic and financial situation that characterized the developed world in the wake of World War I. In addition there was, at least according to some accounts, a perverse fiscal response, cuts in government spending and increases in taxes to keep the budget in balance. The latter notion that fiscal policy was contractionary evokes a contemptuous response from Scott, more or less justified, because nominal government spending actually rose in 1930 and 1931 and spending in real terms continued to rise in 1932. But the key point is that government spending in those days was too low to have made much difference; the spending hypothesis rises or falls on the notion that the trigger for the Great Depression was an autonomous collapse in private spending.

Glasner on market monetarism

Monetarism and the Great Depression by David Glasner

...
Scott is totally right, of course, to point out that the fall in interest rates and the increase in the real quantity of money do not contradict the “money hypothesis.” However, he is also being selective and unfair in making that criticism, because, in the three slides immediately following the one to which Scott takes such offense, Foote actually explains that the simple IS-LM analysis presented in the previous slide requires modification to take into account expected deflation, because the demand for money depends on the nominal rate of interest while the amount of investment spending depends on the real rate of interest. Here are the slides: 

Thus, expected deflation raises the real rate of interest and causes the IS curve to shift to the left but leaves the LM curve where it was. Thus, expected deflation explains a fall in both nominal and real income as well as in the nominal rate of interest; it also explains an increase in the real rate of interest. Scott seems to be emotionally committed to the notion that the IS-LM model must lead to a misunderstanding of the effects of monetary policy, but Foote actually shows that it can accommodate a correct understanding of the role of monetary policy in the Great Depression. 

The Great Depression was triggered by a deflationary scramble for gold associated with an uncoordinated restoration of the gold standard by the major European countries in the late 1920s, especially France and its insane central bank. On top of this, the Federal Reserve, succumbing to political pressure to stop stock market speculation, raised its discount rate to a near record 6.5%, adding to the pressure on gold reserves, thereby driving up the value of gold, and leading to expectations of further deflation. It was thus a rise in the value of gold, not a reduction in the money supply (and thus no shift in the LM curve), which was the source of the monetary shock that produced the Great Depression. IS-LM is not necessarily the best model with which to describe this monetary shock, but the basic story can be expressed in terms of the IS-LM model. 

So you may be asking yourself why, if I don’t think that Foote’s exposition of the IS-LM model seriously misrepresents what happened in the Great Depression, did I say at beginning of this post that Foote’s slides really annoy me? Well, the reason is simply that Foote seems to think that the only monetary explanation of the Great Depression is that of Milton Friedman: that the Great Depression was caused by an exogenous contraction in the US money supply. That is totally wrong. What caused the Great Depression was an international disturbance to the value of gold, caused by the independent actions of a number of central banks, most notably the insane Bank of France, which was maniacally trying to convert all its foreign exchange reserves into gold, and the Federal Reserve, which was obsessed with the suppression of a non-existent stock market bubble on Wall Street. It was a bubble only because the combined policies of the Bank of France and Fed wrecked the world economy and drove into Depression. The decline in the nominal quantity of money in the US, the great bugaboo of Milton Friedman, was truly an epiphenomenon. But as Ron Batchelder and I have shown, Gustav Cassel and Ralph Hawtrey had already diagnosed and explained the causes of the Great Depression fully a decade before it happened. Unfortunately whenever people think of a monetary explanation of the Great Depression, they think of Milton Friedman, not Hawtrey and Cassel. Scott Sumner understands all this, he’s even written a book – a wonderful book – about it. But he’s gets all worked up about IS-LM. I could not care less about IS-LM, it’s idea that monetary cause of the Great Depression was discovered by Milton Friedman that annoys the [redacted] out of me.

Blair

Blair's Legacy by Chris Dillow

Pam from True Blood

"Oh. My. God. I’m a Republicunt.”

Pam in last night's True Blood.

anchored perceived inflation

Anchored Perceived Inflation or How Fox News Helped Obama by Robert Waldmann

I am assuming that, like inflation expectations, inflation perceptions have delinked from reality recently. I really really should find data on perceived inflation (which is out there somewhere). I also have to come up with a story for why this happened just in time to save us from deflation. 

I give the credit to Fox news. A large fraction of people in the US rely on Fox News (often indirectly as repeated by friends and relatives). They are out of touch with reality — there expectations and perceptions are what Roger Ailes wants them to be. He thinks inflation is bad even though in a depressed economy in the liquidity trap it is good. Therefore Fox News convinces people that inflation has been and will be high. The representative consumer is only partly living in the Fox bubble so perceived and expected inflation are moderate. Then finally actual inflation is low but positive.

secstags

Follow up to My Washington Post Piece on Secular Stagnation by David Beckworth

I have an new article in the Washington Post where I make the case against secular stagnation. My argument is based on three observations. The details of these arguments and evidence for them are spelled out in the piece, but here is a quick summary.

First, the prima-facie evidence most secular stagnation advocates point to is misleading. They see the long-decline of real interest rates since the early 1980s as supporting their view. Their real interest rate measures, however, do not account for a trend decline in the risk premium.* Once that is done there is no downward trend in real interest rates. And this measure--the 10-year real risk-free interest rate--is the one at the heart of the secular stagnation story. 

This long-run measure of the natural interest rate is currently negative, but only because of the current slump--its deviations tracks the CBO's output gap--and appears to be simply deviating around a roughly 2% trend. Based on this evidence, there is no reason to believe it has permanently turned negative.

Second, claims about a trend decline in technical innovation and productivity growth are overstated. It is getting increasingly hard to measure economic activity with GDP in an increasingly digitized economy. This means productivity gets under measured. Moreover, there is reason to be believe we are on the cusp of a rapid growth spurt as noted by Erik Brynjfolsson and Andrea McAfee in The Second Machine Age: Work, Progress, and Prosperity in a Time of Brilliant Technologies. If so, the return to capital will rise and so will investment demand This should put upward pressure on the natural interest rate.

Third, the demographic outlook is not so dire. Baby boomers are no longer the largest U.S. cohort and around the globe the outlook for the prime-age working population is improving. This too implies a higher return to capital, more investment spending, and upward pressure on the natural interest rate.

One thing I did not get to fully explain in the article is why the growth of productivity and the labor force should affect the natural interest rate. To do this, we need to first recognize there was a trend and cyclical component to the 10-year real risk-free interest rate. This is equivalent to saying there is a long-term and short-term natural interest rate, with the latter gravitating around the former. So we need to distinguish how these different components are determined. Also, I left out a third determinant of the natural interest rate: household time preferences. My assumption in the article is that this part is relatively steady and all the interesting developments come from changes in productivity and labor force growth.

So with all that said, below is an explanation of long-term and short-term natural interest rate determinants. It is drawn from an earlier post:

[T]he long-term nominal natural interest rate is determined by trend changes in the expected productivity growth rate, the population growth rate, and household time preferences... Productivity matters because it affects the expected return to capital and expected household income. Faster productivity growth, for example, translates into a higher expected return on capital and higher expected household incomes. In turn, these developments should lead to less saving/more borrowing by firms and households and put upward pressure on the natural interest rate. The opposite would happen with slower productivity growth. Population growth matters because it too affects the expected return to capital. More people means more workers and output per unit of capital. For example, the opening up of China and India's labor supply to the global economy, meant a higher expected return to the global stock of capital over the past decade. That should put upward pressure on interest rates and vice versa. Finally, for a given level of expected income, a change in households time preferences means a change in their desire for present consumption over future consumption. This, in turn, affects households' decision to save and borrow. If households, say, start living more for the moment there would be less saving, more borrowing, and upward pressure on the natural interest rate. 

Some like Paul Krugman and Larry Summers believe these determinants have changed enough such that the long-term nominal natural interest rate has been negative. I am not convinced and hope to explain why in a subsequent post (if you cannot wait, see my views in this twitter discussion). In my view, then, the important question is whether the short-run nominal natural interest rate has been negative since the crisis started. 

So what do we know about the short-run nominal natural interest rate? It is shaped by aggregate demand shocks that create temporary deviations of the economy above or below its full-employment level (i.e. output gaps). For example, a large negative aggregate demand shock that temporarily weakens the economy will put downward pressure on interest rates. This happens because firms do less investment spending and therefore less borrowing in anticipation of lower future profits. It also happens because households, particularly credit and liquidity constrained ones, save more and borrow less in anticipation of lower future incomes. In short, aggregate demand shocks that create output gaps will also push the short-run nominal natural interest rate in a procyclical direction. This is a natural process that allows the economy to heal itself. What is not natural is when interest rates are prevented from fully adjusting to their market-clearing levels. That happens when interest rates are pinned down at the ZLB. See this earlier postfor a graphical representation of this ZLB problem.

I hope that helps. Be sure to read the article at the Washingont Post.

PS. Josh Hendrickson and John Cochrane provide critiques of the formal modeling of secular stagnagtion by Gautti Eggertson and Neil Mehrotra.

"Good I'm sick of running from these wimps."

[The street gang The Warriors are running from the Baseball Furies as they make their way home to Coney Island.]

Ajax: "Did we lose these fucking clowns or what?"

Swan: "Look."

Ajax: "Holy shit."

[More running.]

Swan: "Cochise with me."

[Cochise and Swan split off from Ajax and Cowboy. The Furies follow the latter. Cochise and Swan circle back around the Furies and chase them from behind.]

Cowboy: "I can't make it."

Ajax: "Are you sure."

Cowboy: "Yeah I'm sure."

Ajax: "Good, I'm sick of running from these wimps."

FOMC during the bubble defltation

Frances Coppola tweets:

Working my way through FOMC minutes from 2004 to 2008. Fascinating. The FOMC members primary concern is always exactly the same.

Their concern is always that core inflation will "fail to moderate" - even when staff projections are that it will fall.

But they are always really upbeat about growth, even when staff projections are that growth will fall. They ignore their own staff.

And they ignore markets, too. Investors were pricing in lower rates due to falling growth expectations from Jan 2007 onwards.

But the FOMC? Nah. Main risk in their view was inflation (even though it was falling). They kept interest rates elevated.