Wolf and Rogoff

Ken Rogoff reviews Martin Wolf's The Shifts and Shocks


Darryl FKA Ron's history:

[BIG TIME!

The end of Bretton-Woods is generally considered to have been the end of US dollar convertibility (into precious metals) and the establishment of the US dollar as the global reserve currency upon which to anchor exchange rates, trade reserves, and trading prices. Even OPEC nationalization tipped its hat to the US dollar as the global price tag.]

http://en.wikipedia.org/wiki/Bretton_Woods_system

...On 15 August 1971, the United States unilaterally terminated convertibility of the US dollar to gold, effectively bringing the Bretton Woods system to an end and rendering the dollar a fiat currency.[1] This action, referred to as the Nixon shock, created the situation in which the United States dollar became a reserve currency used by many states. At the same time, many fixed currencies (such as the pound sterling, for example), also became free-floating...

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[Meantime you had commercial banks going inter-state which broke up some of the relationships between local banks and traditional constituents in agriculture and small business when those local banks were bought. MOstly though it just positioned commercial banking for the post Glass-Steagal world of the current century, a lamb being fattened for later slaughter.

My story of the new finger on the scale of capital gains preference in 1954 is one of corporate and private equity leverage upon which investment banks grew their more speculative bond markets for buyouts and takeover financing. Schumpeter's argument against competition won the day for firm consolidation AND investment banks. Fast forwards to the end of first Bretton Woods and then the Cold War and the hegemony of multi-national corporations allied with major investment banks all resting on the shoulders of Uncle Sam's imperial dollar is a feat of global conquest that would have made Ghenghis Khan blush.]

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http://en.wikipedia.org/wiki/Nationalization_of_oil_supplies

Early nationalizations

Prior to 1970, there were ten countries that nationalized oil production: the Soviet Union in 1918, Bolivia in 1937 and 1969, Mexico in 1938, Iran in 1951, Iraq in 1961, Burma and Egypt in 1962, Argentina in 1963, Indonesia in 1963, and Peru in 1968. Although these countries were nationalized by 1971, all of the “important” industries that existed in developing countries were still held by foreign firms. In addition, only Mexico and Iran were significant exporters at the time of nationalization...

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[And then all hell broke loose. Oil shortages got us rising oil prices and by the time it all settled out global finance had its claws deep into crude. What Reagan and Thatcher did is make a narrative of all this or maybe just the backup band to Milton Fridman's narrative of all this that blame it on public spending and deficits instead of an imperialistic dollar in the hands of multinational corporations and investment banks taking advantage of financialization and globalization. Autos and steel were among the first to fall in the US because their managements were the most over-confident and unprepared to deal with change. BOth failed modernize, both in production and in marktet focus.]

The reason it is so difficult to accept that our problems originate from Ike and Nixon instead of Ronnie Rayguns is that such a narrative would not give our feeling of intellectual superiority and moral self-righteous a leg to stand on.

Rayguns was so blatantly contemptuous of liberalism that it must have been his fault. THat is like thinking that a psychopath has no guile and can easily be picked out of a crowd. It is not the guy that spits in your face that catches you unawares, but the one that puts the knife in your back while patting you on the shoulder.

Clinton probably did more to roll back the New Deal than Reagan did what with Welfare "reform" (or was that deform) and financial deregulation. Reagan screwed unions, but he was not their first time, and his recession ushered in the Great Moderation, which fathered contemporary secular stagnation. Mergers accelerated under Reagan era anti-trust "enforcement." But Reagans foulest contribution and legacy was less about legislation or administration than it was the Alfred E. Newman "Whot, me worry" attitude of the people regarding their own economic affairs. THe tonic he sold to ward off the nanny state was the individualistic patriarchal state. The public bought it and ate it up. "I got mine and screw everyone else" became the new pledge of disallegiance. Ronnie's start was as a PR man and a pitch man and he had gotten pretty good at it.

Helicopter Drop and the SecStags

William Buiter:

A permanent/irreversible increase in the nominal stock of fiat base money rate which respects the intertemporal budget constraint of the consolidated Central Bank and Treasury.... Three conditions must be satisfied for helicopter money always to boost aggregate demand. First, there must be benefits from holding fiat base money other than its pecuniary rate of return. Second, fiat base money is irredeemable – viewed as an asset by the holder but not as a liability by the issuer. Third, the price of money is positive. Given these three conditions, there always exists – even in a permanent liquidity trap – a combined monetary and fiscal policy action that boosts private demand – in principle without limit. Deflation, ‘lowflation’ and secular stagnation are therefore unnecessary. They are policy choices."

(via DeLong)

Depression is a choice as Steve Randy Waldman wrote.

Why don't the elites like helicopter drops or universal basic income? Because they don't want to provide economic and even political rights (campaign cash outweighs voting). Legal rights are okay but even there, there's two different system. 

They'd rather that campaign spending equal free speech and the banks distribute the Fed's digital money.

new normal, secstags and euthanasia of the rentier

Krugman: 

In practice the zero lower bound has huge adverse effects on policy effectiveness… [and] drastically changes the rules… [as] virtue becomes vice and prudence is folly. We want less saving, higher expected inflation, and more…. Liquidity-trap analysis has been overwhelmingly successful in its predictions: massive deficits didn’t drive up interest rates, enormous increases in the monetary base didn’t cause inflation, and fiscal austerity was associated with large declines in output and employment…. 

Secular stagnation adds… the strong possibility that this Alice-through-the-looking-glass world is the new normal….

As is the euthanasia of the rentier. As J.W. Mason put it, If credit is so cheap why do we need liquidity specialists? Mason has a new post up.

Reviewing Lawrence Summers’s et al.’s VoxEU Ebook on “Secular Stagnation”: The Honest Broker for the Week of August 23, 2014 by DeLong

Instead, I see the root causes as the confluence of an unreasonably high premium return on equities and other risky assets with a deflation or a very low inflation price trend. And where Summers sees this as operating since the mid-1990s and the start of the dot-com boom, I see it as operating since 1895, if not 1865.

SecStags

Secular Stagnation: The Book by Krugman

Secular Stagnation: Missing the Forest for the Trees by David Beckworth

There is a new VoxEU ebook on secular stagnation. The book is a collection of essays by many prominent economists, most of whom are proponents of secular stagnation. As readers know, I am not convinced that this problem lingers over the U.S. economy and have explained why at the Washington Post and on this blog. This latest book does nothing to ease my skepticism. Many of the authors continue to mismeasure the real interest rate and ignore what I see as important technology and demographic developments that undermine the case for secular stagnation. Let's review these key issues. 

First, real interest rates adjusted for the risk premium have not been in a secular decline. Everyone from Larry Summers to Paul Krugman to Olivier Blanchard ignore this point in the book. They all claim that real interest rates have been trending down for decades. The editors of the book, Coen Teulings and Richard Baldwin, even claim that this development is the 'prima facie' evidence for secular stagnation. What they are doing wrong is only subtracting expected inflation from the observed nominal interest rate. They also need to subtract the risk premium to get the natural interest rate, the interest rate at the heart of the story. For it is the natural interest rate that is affected by expected growth of technology and the labor force.

Beckworth is optimistic saying we just had a bad business cycle. Edward Lambert says we'll have a startling bad recession in the next three years with signs showing the next six months because of the "effective demand" limit.

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.

positive outlook

Here’s why Larry Summers is wrong about secular stagnation by David Beckworth

secstags and trade

Three Charts on Secular Stagnation by Krugman

Back in the Old Days, Rich Countries Were Supposed to Run Trade Surpluses by Dean Baker

Paul Krugman outlines his story of secular stagnation in a blogpost this morning. The odd part of the story is that the trade deficit is nowhere in sight. The punchline is that a slower rate of labor force growth should lead to a reduction in demand. The simple arithmetic is that if the rate of labor force growth slows by 1.0 percentage point, then this would be expected to reduce investment by 3.0 percentage points of GDP. 

This is a story of a demand gap that could be hard to fill, but how does that compare to a trade deficit that peaked at just shy of 6.0 percent of GDP in 2005 and is still close to 3.0 percent of GDP today? Why are we not supposed to be worried about this cause of a shortfall in demand? 

Back in the days before the United States began running persistent trade deficits, the standard theory held that rich countries like the United States should be running trade surpluses. The argument was that capital was plentiful in rich countries, therefore they should be exporting it to poor countries where capital is scarce. This would lead to both a better return on capital and also allow developing countries to grow more rapidly. 

We have seen the opposite story in the United States, especially after the run-up in the dollar following the East Asian financial crisis. This has contributed in a big way to the "secular stagnation" problem, but for some reason there continues to be a reluctance to talk about it. (No, being the reserve currency does not mean we have to run a trade deficit.)

The Secstags

A Model of Secular Stagnation by Gauti Eggertsson Neil Mehrotray

Krugman

What It Would Have Taken by Krugman 

Brad DeLong is wrong. He thinks we have a disagreement, but he’s misinterpreting what I said when I argued that the Fed’s 2008 inflation phobia wasn’t responsible for the Great Recession and the Lesser Depression that have followed and continue to this day. 

What Brad says — and I agree with — is that there is no economic necessity behind our ongoing employment and output disaster. We could and should have moved the resources employed in the housing boom to other uses, and needn’t have paid this immense cost. 

But what would it have taken — what would it take now — to have maintained or restored full employment? My argument is that it would have required more radical, aggressive policies than anyone close to the levers of power has been willing to contemplate, at any point along the way. So the fact that the Fed was wrongly obsessed with inflation for most of 2008, the original subject of my post, was just a contributing factor; things would have been a bit better, but nowhere near OK, if the Fed had stayed focused on underlying inflation and ignored the effects of the commodity-price blip. 

Think of it this way: what would a really effective set of policies be right now? First of all, we should aggressively reverse the fiscal austerity of the last few years, getting government at all levels spending several points of GDP more to boost demand. 

Monetary policy should accommodate that boost; interest rates should not go up even if inflation goes somewhat above 2 percent. In fact, there’s an overwhelming prudential case for raising the inflation target — even if we’re not sure about secula(r) stagnation, it might be true, and we definitely know that the risk of hitting the zero lower bound is much higher than Fed officials imagined when they settled on 2 percent as the magic number. 

I’m not totally wedded to these particular numbers, but let’s say for the sake of argument that the right policy is two years of fiscal expansion amounting to 3 percent of GDP each year, plus a permanent rise in the inflation target to 4 percent. These wouldn’t be radical moves in terms of Econ 101 — they are in fact pretty much what textbook models would suggest make sense given what we have learned about macroeconomic vulnerabilities. But they are completely outside the bounds of respectable discussion. 

That’s the sense in which we are “doomed” to long-term stagnation. We have met the enemy, and it’s not the economic fundamentals, it’s us.

Stanley Fischer

The Root of Many U.S. Economic Problems Lie In Stanley Fischer's East Asian Bailout by Dean Baker

Morning Edition engaged in ritualistic praise of Stanley Fischer, in discussing his prospects for approval as President Obama's pick to be vice-chair of the Federal Reserve Board. It accurately reported that economists on both the left and right of the political mainstream respect Fischer and see him as central to shaping the current state of macroeconomics. 

The small point left out of this discussion is that this macroeconomics led us into the worst economic downturn since the Great Depression, giving the country and the world a slump from which we have not yet recovered. Tens of millions of people have seen their lives ruined as a result of failed economic management. 

Fischer personally played a direct role in creating the imbalances that led to the crisis. As first managing director at the I.M.F., he played a central role in directing the bailout from the East Asian financial crisis. The harsh conditions imposed by the I.M.F. led the countries of the region, along with countries throughout the developing world, to begin to accumulate massive amounts of reserves (dollars) in order to avoid ever being in the same situation as the East Asian countries. 

This led to a huge rise in the value of the dollar and an explosion in the size of the U.S. trade deficit. The trade deficit created a huge gap in demand. This gap in demand was filled in the late 1990s with the demand generated by the stock bubble. The demand gap was filled in the last decade by the housing bubble. This is not a stable mechanism for generating demand. 

In standard textbook economics capital is supposed to flow from rich countries to poor countries where in principle it will derive a higher rate of return. Fischer's policies at the I.M.F. led to a reversal of this pattern in a very big way. The consequences for the world economy have been disastrous. This point could have been made to NPR's audience if it had spoken to anyone who was not complicit in this momentous mistake.

The Great Clusterfuck

Macroeconomics and the Crisis by DeLong

secstags and demand management*

What Market Failures Underlie Our Fears of "Secular Stagnation"? by DeLong

What Policy Conclusions Follow from Our Fears of “Secular Stagnation”? by DeLong

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*supply can also be managed of course.

Attention Must Be Paid: The Big (Structural) Jobs Question by Bernstein

4 percent employment growth in 2000-2007. And yet unemployment was low until the financial panic. What does that mean? Fewer job losses? Growth of the labor force is about 1 percent.

There's a scene in Ron Suskind's book where Obama is talking to Summers and Romer and mentions structural problems regarding jobs growth. Summers and Romer tell him no that the job losses are cyclical. Maybe Obama was referring to this.