Making fun of people's names?

Paul Krugman is now reduced to making fun of my name.

I was alerted to the fact that we were living in a Dark Age of macroeconomics when the same cockroach put in an appearance at the University of Chicago.

Oh how clever. I haven’t heard that one since about, hmm, first grade, circa 1965. (Follow the link if you’re not sure who he’s talking about.)

Paul continues

Now, some people get all upset by this terminology. Why can’t I be serious and respectful? Well, the answer is that we’re not having a serious conversation

No, the royal “we” are not.

I suppose I should read this as a welcome sign of desperation; that Krugman, having run out of ideas, and unwilling to read the interesting “serious conversation” regarding stimulus that the rest of us are having in the academic literature (say, my own recent modest contribution), is reduced to endlessly flogging the old “Say’s law” calumny and now this.

Here are Krugman’s similarly profound thoughts about Narayana Kocherlakota’s name.

New vs. Old Keynesian Stimulus

While fiddling with a recent paper, “The New-Keynesian Liquidity Trap” (blog post), a simple insight dawned on me on the utter and fundamental difference between New-Keynesian and Old-Keynesian models of stimulus.

Old-Keynesian. The “Keynesian cross” is the most basic mechanism. (If you are worried that I’m making this up, see Greg Mankiw’s Macroeconomics, p. 308 eighth edition, “Fiscal policy and the multiplier: Government Purchases.”)

Consumption follows a “consumption function.” If people get more income Y, they consume more C

C = a + m Y.

Output Y is determined by consumption C investment I and government spending G

Y = C+ I + G.

Put the two together and equilibrium output is

Y = a + mY + I + G
Y = (a + I + G)/(1-m).

So, if the marginal propensity to consume m=0.6, then each dollar of government spending G generates not just one dollar of output Y (first equation), but $2.5 dollars of additional output.

This model captures a satisfying story. More government spending, even if on completely useless projects, “puts money in people’s pockets.” Those people in turn go out and spend, providing more income for others, who go out and spend, and so on. We pull ourselves up by our bootstraps. Saving is the enemy, as it lowers the marginal propensity to consume and reduces this multiplier.

New-Keynesian. The heart of the New-Keynesian model is a completely different view of consumption. In its simplest version

Here consumption C, relative to trend, equals the sum of all future real interest rates i less inflation π i.e. all future real interest rates. The parameter σ measures how resistant people are to consuming less today and more tomorrow when offered a higher interest rate.

(This is just the integrated version of the standard first order condition, in discrete time

People in this model think about the future when deciding how much to consume and allocate consumption today vs. tomorrow looking at the real interest rate. I’ve simplified a lot, leaving out trends, the level and variation of the “natural rate” and so on.)

In this model too, totally wasted government spending can raise consumption and hence output, but by a radically different mechanism.  Government spending raises inflation π . (How is not important here, that’s in the Phillips curve.) Holding nominal interest rates i fixed, either at the zero bound or with Fed cooperation, more inflation π means lower real interest rates. It induces consumers to spend their money today rather than in the future, before that money loses value.

Now, lowering consumption growth is normally a bad thing. But new-Keynesian modelers assume that the economy reverts to trend, so lowering growth rates is good, and raises the level of consumption today with no ill effects tomorrow. (More in a previous post here)

Comparing stories

This new-Keynesian model is an utterly and completely different mechanism and story. The heart of the New-Keynesian model is Milton Friedman’s permanent income theory of consumption, against which old-Keynesians fought so long and hard! Actually, it’s more radical than Friedman: The marginal propensity to consume is exactly and precisely zero in the new-Keynesian model.  There is no income at all on the right hand side. Why? By holding expected future consumption constant, i.e. by assuming the economy reverts to trend and no more, there is no such thing as a permanent increase in consumption.

The old-Keynesian model is driven completely by an income effect with no substitution effect. Consumers don’t think about today vs. the future at all. The new-Keynesian model based on the intertemporal substitution effect with no income effect at all.

Models and stories

Now, why is Grumpy grumpy?

Many Keynesian commentators have been arguing for much more stimulus.  They like to write the nice story, how we put money in people’s pockets, and then they go and spend, and that puts more money in other people’s pockets, and so on.

But, alas, the old-Keynesian model of that story is wrong. It’s just not economics. A 40 year quest for “microfoundations” came up with nothing. How many Nobel prizes have they given for demolishing the old-Keynesian model? At least Friedman, Lucas, Prescott, Kydland, Sargent and Sims. Since about 1980, if you send a paper with this model to any half respectable journal, they will reject it instantly.

But people love the story. Policy makers love the story.  Most of Washington loves the story. Most of Washington policy analysis uses Keynesian models or Keynesian thinking. This is really curious. Our whole policy establishment uses a model that cannot be published in a peer-reviewed journal. Imagine if the climate scientists were telling us to spend a trillion dollars on carbon dioxide mitigation – but they had not been able to publish any of their models in peer-reviewed journals for 35 years.

What to do? Part of the fashion is to say that all of academic economics is nuts and just abandoned the eternal verities of Keynes 35 years ago, even if nobody ever really did get the foundations right. But they know that such anti-intellectualism is not totally convincing, so it’s also fashionable to use new-Keynesian models as holy water. Something like “well, I didn’t read all the equations, but Woodford’s book sprinkles all the right Lucas-Sargent-Prescott holy water on it and makes this all respectable again.” Cognitive dissonance allows one to make these contradictory arguments simultaneously.

Except new-Keynesian economics does no such thing, as I think this example makes clear. If you want to use new-Keynesian models to defend stimulus, do it forthrightly: “The government should spend money, even if on totally wasted projects, because that will cause inflation, inflation will lower real interest rates, lower real interest rates will induce people to consume today rather than tomorrow, we believe tomorrow’s consumption will revert to trend anyway, so this step will increase demand. We disclaim any income-based "multiplier,” sorry, our new models have no such effect, and we’ll stand up in public and tell any politician who uses this argument that it’s wrong.“

That, at least, would be honest. If not particularly effective!

You may disagree with all of this, but that reinforces another important lesson. In macroeconomics, the step of crafting a story from the equations, figuring out what our little quantitative parables mean for policy, and understanding and explaining the mechanisms, is really hard, even when the equations are very simple. And it’s important. Nobody trusts black boxes. The Chicago-Minnesota equilibrium school never really got people to understand what was in the black box and trust the answers. The DSGE new Keynesian black box has some very unexpected stories in it, and is very very far from providing justification for old-Keynesian intuition.

Ferguson on Krugtron

A fun show is breaking out. Niall Ferguson on “Krugtron the invincible.”

Paul Krugman, for a while now, has been lambasting those he disagrees with by trumpeting their supposed “predictions” which came out wrong, and using words like “knaves and fools” to describe them – when he’s feeling polite. These claims often are based on a rather superficial, if any, study of what the people involved actually wrote, mirroring the sudden narcolepsy of Times fact-checkers any time Krugman steps in to the room. Niall has lately been a particular target of this calumnious campaign.

Niall’s fighting back. “Oh yeah? Let’s see how your "predictions” worked out!“ Don’t mess with a historian. He knows how to check the facts. This is only "part 1!” Ken Rogoff seems to be on a similar tear. (and a new item here.) This will be worth watching.

As regular blog readers know, I don’t think science advances by evaluating soothsaying. You make good unconditional predictions with very badly wrong structural models, and very good structural models make bad unconditional predictions.  The talent of predicting and the talent of understanding are largely uncorrelated.  The judgmental forecasts of individuals are poor ways to evaluate any serious economic or scientific theory.  I carefully don’t make “predictions” for just that reason. So, I don’t regard this cheery deconstruction effort as a useful way to show that Krugman’s “model,” whatever it is, is wrong. I also can’t see that anyone but the devoted choir of lemmings is paying much attention to Krugman’s mudslinging any more.  But it is nice that Niall and Ken are taking the effort to ask the great doctor if perhaps he also doesn’t need a bit of healing; perhaps they will force Krugman to go back to actually writing about economics. 

Update: Benn Steil Chimes in, this time on the Baltics, Iceland, and the supposed wonders of currency devaluation.

Dupor and Li on the Missing Inflation in the New-Keynesian Stimulus

Bill Dupor and Rong Li have a very nice new paper on fiscal stimulus: “The 2009 Recovery Act and the Expected Inflation Channel of Government Spending” available here.

New-Keynesian models are really utterly different from Old-Keynesian stories. In the old-Keynesian account, more government spending raises income directly (Y=C+I+G); income Y then raises consumption, so you get a second round of income increases.

New-Keynesian models act entirely through the real interest rate.  Higher government spending means more inflation. More inflation reduces real interest rates when the nominal rate is stuck at zero, or when the Fed chooses not to respond with higher nominal rates. A higher real interest rate depresses consumption and output today relative to the future, when they are expected to return to trend. Making the economy deliberately more inefficient also raises inflation, lowers the real rate and stimulates output today. (Bill and Rong’s introduction gives a better explanation, recommended.)

So, the key proposition of new-Keynesian multipliers is that they work by increasing expected inflation. Bill and Rong look at that mechanism: did the ARRA stimulus in 2009 increase inflation or expected inflation?  Their answer: No.


This is a quantitative question. How much do the large-multiplier models say the ARRA should have increased inflation? Their answer: 4.6%. Where is it?

We know, of course, that inflation (especially core inflation) basically did nothing during the period of the ARRA, and Bill and Rong have some nice graphs. Defenders might say, aha, but except for the stimulus, we would have had a catastrophic deflation spiral. Critics might reply, that’s what George Washington’s doctors said while they were bleeding him. As always, teasing out cause and effect is hard.

Bill and Rong have a range of interesting facts that address this question. Here are two that I thought particularly clever. First, they look at the survey of professional forecasters, and examined how the forecasters changed inflation forecasts along with their changes in government spending forecasts, i.e. when they figured out a big stimulus is coming. I plotted the data from Bill and Rong’s Table 2

Dupor and Li Table 2

As you can see, in 2008Q4 and 2009Q1, many forecasters updated their views on government spending, a few by a lot.  However, there is next to no correlation between learning of a big stimulus and increases in expected inflation, especially among the forecasters who strongly update their stimulus forecasts.

Bill and Rong’s interpretation is that the stimulus failed to increase expected inflation. The main defense I can think of is to say that this evidence tells us about professional forecaster’s model, not about true inflation expectations. Professional forecasters are a bunch of old-Keynesians, not properly enlightened new-Keynesians; they don’t realize that stimulus works through inflation, they’re still thinking about a pre-Friedman consumption function. That’s probably true. But if so, it’s hard to think that everyone else in the economy does understand the new truth, and changed their inflation forecasts dramatically when they learned of the stimulus.

Another nice piece of evidence: The US had much bigger government spending stimulus than the UK. The behavior of expected inflation revealed in the real vs. nominal treasury spread was almost exactly the same. (Yes, Bill and Rong delve into the TIPS pricing in the crisis.)

Source: Dupor and Li

Finally, a key point missing in most of the stimulus debate. These models predict big multipliers not just at the zero bound, but anytime that interest rates don’t respond to inflation. We don’t have to just rely on theory, there is some experience. New-Keynesians since at least Clarida Gali and Gertler’s famous regressions have said that the Fed was not increasing interest rates fast enough in the 1970s, and the 1930s and interest-rate peg of the late 40s and early 50s are another testing ground. Using standard measures of exogenous spending increases, Bill and Rong find no impact of government spending on inflation in any of these periods.

New Keynesian stimulus analysis has been particularly slippery, on the difference between the models and the words, and on advocating the policy answers without checking or believing the mechanisms. The models are Ricardian: the same stimulus happens whether paid for by taxes or borrowing. The opeds scream that the government must borrow. The models say totally useless spending stimulates. The opeds are full of infrastructure, and roads and bridges. (At least, the “sprawl”  complaint is temporarily quiet.) The models say that spending works by creating inflation, not through a consumption function. Inflation being totally flat, and the counterfactual argument weak, you don’t hear much about that in the opeds.  The models say we should be in a huge deflation with strong expected output growth. The facts are protracted stagnation. (More in my last stimulus post.) The models are models, worthy of careful examination and empirical testing. All I ask is that their proponents take them seriously, and not as holy water for a completely different old-Keynesian agenda.

Rogoff on UK Defaults

Ken Rogoff wrote a very interesting FT oped on UK finances (FT original, Rogoff webpage if you can’t see FT.)

The issue: Should we worry about huge sovereign debts of advanced countries? Or was the only problem with fiscal stimulus that it was not big enough?


A little history:

Yes, from the 1800s until the first world war, the UK was a global superpower that commanded vast colonial resources and investments. Over long periods, these foreign assets yielded returns well in excess of interest on debt. But comparing government debt ratios back then, when the UK was a massive net creditor, to debt ratios today, when British foreign liabilities exceed foreign assets, is utterly misleading. Moreover, back in the 1820s, the UK was pioneering the industrial revolution; things are not quite the same today. Back then, the UK did not have to worry about pension liabilities or existential threats to the banking system that could require massive injections of cash to fix. …

During the 1930s, Britain defaulted on debt to the US accumulated during the first world war and its aftermath. …

It is often stated that after the second world war the UK debt reached almost 250 per cent of gross domestic product and was brought down merely through growth and inflation. This is a myth …

Then there is the high-inflation era of the 1970s – another de facto default. Last but not least, what about the UK’s serial dependence on International Monetary Fund bailouts from the mid-1950s until the mid-1970s? This is hardly a country with an indestructible credit status. …

Being a UK bondholder has had its ups and downs.

Looking forward, an important point: a country needs to be substantially below its ultimate borrowing limit, or it loses its ability to fight crises going ahead.

..a euro collapse would have triggered a stampede out once investors realised that the UK banks and trade would be savaged, a flexible currency notwithstanding. In that scenario, UK leaders would have been forced to close massive budget deficits almost overnight. That would have been truly catastrophic austerity. …

We now know the euro did not collapse. [yet – JC] With 20-20 hindsight, yes, the UK could have borrowed more. But we do not have hindsight at the moment decisions have to be taken. 

Kan and Carmen Reinhart have been at the receiving end of Paul Krugman’s tender commentaries lately, and I’m interested to see Ken taking up the issue. Krugman likes to lambaste people for “predictions” that he imagines they made which didn’t come out. On the euro blowing up, Ken seems to be offering a taste of his own medicine, made more bitter by the fact that Krugman actually did say what Ken says he said:

…This was the big call – the one that everyone was focusing on. To state that credit risk was gone by 2010 is ludicrous. None other than The New York Times columnist Paul Krugman prognosticated the euro’s early demise regularly from April 2010 to July 2012. His big call has turned out – so far – to be dead wrong.

I will be curious if we see more of that from Ken. Stay tuned.

The New-Keynesian Liquidity Trap

I just finished a draft of an academic article, “The New-Keynesian Liquidity Trap"  that might be of interest to blog readers, especially those of you who follow the stimulus wars. 

New-Keynesian models produce some stunning predictions of what happens in a "liquidity trap” when interest rates are stuck at zero.  They predict a deep recession. They predict that promises work: “forward guidance,” and commitments to keep interest rates low for long periods, with no current action, stimulate the current level of consumption.  Fully-expected future inflation is a good thing. Growth is bad. Deliberate destruction of output, capital, and productivity raise GDP. Throw away the bulldozers, let them use shovels. Or, better, spoons. Hurricanes are good. Government spending, even if financed by current taxation, and even if completely wasted, of the digging ditches and filling them up type, can have huge output multipliers.

Even more puzzling, new-Keynesian models predict that all of this gets worse as prices become more flexible.  Thus, although price stickiness is the central friction keeping the economy from achieving its optimal output, policies that reduce price stickiness would make matters worse.

In short, every law of economics seems to change sign at the zero bound. If gravity itself changed sign and we all started floating away, it would be no less surprising.

And of course, if you read the New York Times, people like me who have any doubts about all this are morons, evil, corrupt, and paid off by some vast right-wing conspiracy to transfer wealth from the poor to the secret conspiracy of hedge fund billionaires.

So I spent some time looking at all this.

It’s true, the models do make these predictions. However, there is a crucial step along the way, where they choose one particular equilibrium. There is another equilibirum choice, where all of normal economics works again: no huge recession, no huge deflation, and policies work just as they ought to.

I took a setup from Ivan Werning’s really nice 2012 paper: There is a negative “natural rate” from time 0 to time T, and the interest rate is stuck at zero. After that, the natural rate becomes positive again, and everyone expects the actual interest rate to follow. I solved the standard new-Keynesian model in this circumstance – forward-looking “IS” and Phillips curves.

This is Werning’s “standard” equilibrium choice, which shows all the new-Keynesian predictions. The liquidity trap lasts until T=5, shown as the vertical line in the middle of the graph.

The thick red line is inflation. As you see, there is huge deflation during the liquidity trap, though deflation is steadily decreasing.

The dashed blue line is output (deviation from  "potential".) As you see, there is a huge output gap, though strong expected output growth as it comes back to “trend” at the end of the trap. This is why growth is bad – in these models you always come back to trend, so if you can lower growth, that raises today’s level.

The thin red dashed lines marching toward the vertical axis show what happens as you reduce price stickiness. (I only showed inflation, output does the same thing.) As you reduce price stickiness, it all gets worse – output at any given date falls dramatically. For price stickiness epsilon away from a frictionless market, output falls to zero and inflation to negative infinity.

I verify in the paper that all the claimed policy magic works in this equilibrium.  Even a small amount of “forward guidance” can dramatically raise output, wasted-spending multipliers can be as large as you like, and those policies get more effective as price stickiness gets smaller.

However, for the same interest rate path, there are lots and lots of equilibria.

This graph shows a different equilibrium. I call it the “local-to-frictionless” equilibrium. Again, the thick  red line is inflation. Now, during the liquidity trap, there is steady, mild inflation. The inflation pretty much matches the negative natural rate, so the zero interest rate during the trap (from t=0 to t=T=5) produces a the real interest rate near the natural rate.

As the trap ends, inflation slowly declines and then takes a “glide path” to zero – i.e. zero deviation from trend, or back to the Fed’s long-run target.

In this equilibrium, there is a small increase in potential output, shown in the dashed blue output line. The new-Keynesian Phillips curve says that when inflation today is higher than inflation tomorrow, output is above potential.

As we turn down price stickiness, the thin red lines show that inflation smoothly approaches the totally frictionless case, positive inflation from 0 to T and zero inflation immediately thereafter. I didn’t have room to show it, but  output smoothly approaches a flat line as well.

The paper shows that all the magical policies are absent in this equilibrium: The multiplier is always negative, announcements about the far off future do no good, and deliberately making prices sticker doesn’t help.

These are not different models. These are not different policies or different expected policies. Interest rates follow exactly the same path in each case, zero from t until T=5, and following the natural rate thereafter. These are different equilibrium choices of the same model. Each choice is completely valid by the rules of new-Keynesian models. I don’t here challenge any of the assumptions, any of the model ingredients, any of the rules of the game for computation. Which outcome you choose is completely arbitrary.

The difference between the calamitous equilibrium and the mild local-to-frictionless equilibirum, in this model, is just expectational mulitple equilibria (with an implicit Ricardian regime.) If people expect the inflation glide path, we get the benign equilibrium. If they expect inflation to be zero the minute the trap ends, we get the disaster.

The paper goes on to compute all the magical policies, consider Taylor rules, and every other objection I can think of. So far.

What do I make of all this? Well obviously, maybe one isn’t so dumb, evil, or corrupt for having doubts about changing the sign of all economic principles when interest rates hit zero.

Let me just quote from the conclusion

At a minimum, this analysis shows that equilibrium selection, rather than just interest rate policy, is vitally important for understanding these models’ predictions for a liquidity trap and the effectiveness of stimulative policies. In usual interpretations of new-Keynesian model results, authors feel that interest rate policy is central, and equilibrium-selection policy by the Fed, or equilibrium-selection criteria, are details relegated to technical footnotes (as in Werning 2012), game-theoretic foundations, or philosophical debates, which can all safely be ignored in applied research. These results deny that interpretation.

….there really are multiple equilibria and choosing one vs. another is simply an arbitrary choice. Since there is an equilibrium with no depression and deflation, and no magical policy predictions, one cannot say that the new-Keynesian model makes a definite prediction of depression and policy impact.

I have not advocated a specific alternative equilibrium selection criterion. Obviously, the local-to-frictionless equilibrium has some points to commend it: It is bounded in both directions, it produces normal policy predictions, it has a smooth limit as price stickiness is reduced, and it does not presume an enormous fiscal support for deflation. But this is not yet economic proof that it is the “right” equilibrium choice.

We might consider which equilibrium choice is more consistent with the data. The US economy 2009-2013 features steady but slow growth, a level of output stuck about 6-7% below the previous trendline and the CBO’s assessment of “potential,” a stagnant employment-population ratio, and steady positive 2-2.5% inflation.

The local-to-frictionless equilibrium as shown in my second Figure can produce this stagnant outcome, but only if one thinks that current output is about equal to potential, i.e. that the problem is “supply” rather than “demand,” and that the CBO and other calculations of “potential” or non-inflationary output and employment are optimistic, as they were in the 1970s, and do not reflect new structural impediments to output.

The standard equilibrium choice as shown in my first Figure cannot produce stagnation. It counterfactually predicts deflation, and it counterfactually predicts strong growth. One would have imagine a steady stream of unexpected negative shocks – that each year, the expected duration of the negative natural rate increases unexpectedly by one more year – to rescue the model. But five tails in a row is pretty unlikely.

The problem in generating stagnation is central to the new-Keynesian model. The “IS” curve and the assumption that we return to trend means that we can only have a low level of output and consumption if we expect strong growth. The Phillips curve says that to have a large output gap, we must have inflation today much below expected inflation tomorrow and thus growing inflation (or declining deflation). Thus if we are to return to a low-inflation steady state, we must experience sharp deflation today.  If one wants a model with stagnation resulting from perpetual lack of “demand,” this model isn’t it. Static old-Keynesian models produce slumps, but dynamic intertemporal new-Keynesian models do not.
….
I close with a few kinds words for the new-Keynesian model. This paper is really an argument to save the core of the new-Keynesian model – proper, forward-looking intertemporal behavior in its IS and price-setting equations – rather than to attack it. Inaccurate predictions for data (deflation, depression, strong growth), crazy-sounding policy predictions, a paradoxical limit as price stickiness declines, and explosive off-equilibrium expectations, are not essential results of the model’s core ingredients.  A model with the core ingredients can give a very conventional view of the world, if one only picks the local-to-frictionless equilibrium. That model will build neatly on a stochastic growth model, represented here in part by the forward-looking “IS” equation and changes in “potential.” Its price stickiness will modify dynamics in small but sensible ways and allow a description of the effects of monetary policy. This was the initial vision for new-Keynesian models, and it remains true.

Really, the fault is not in the core of the new-Keynesian model. The fault is in its application, which failed to take seriously the fundamental problem of nominal indeterminacy…. Interest rate targets, even those that vary with output and inflation, or money supply control with interest-elastic demand, simply do not determine the price level or inflation.  In a model with price stickiness, nominal indeterminacy spills over in to real indeterminacy.

In that context, this paper shows there is an equilibrium choice that leads to sensible results. Alas, those sensible results are non-intoxicating. In that equilibrium, our present (2013) economic troubles cannot be chalked up to one big simple story, a “negative natural rate” (whatever that means) facing a lower bound on short term nominal rates; and our economic troubles cannot be solved by promises, or a sign reversal of all the dismal parts of our dismal science. Technical regress, wasted government spending, and deliberate capital destruction do not work. Growth is good, not bad. That outcome is bad news for those who found magical policies an intoxicating possibility, but good news for a realistic and sober macroeconomics.
    

If all this just whets your appetite, I hope you will read the paper. Similarly, if you’re brimming with objections, take a look at my attempts to anticipate most objections – what about the Taylor rule, etc. – in the paper.

(This follows an earlier paper in the JPE (online appendix) looking deeply at multiple equilibria in new-Keynesian models. In that paper, I questioned whether ruling out multiple explosive equilibria made sense. In this paper, I accept that part of the rules of the game, and think about the mulitple non-explosive equilibria.)

Job market doldrums

Three recent views on the dismal labor market pose an interesting contrast.

Alan Blinder wrote a provocative WSJ piece on 6/11, Fiscal Fixes for the Jobless Recovery. A week prviously, 6/5, Ed Lazear wrote about The Hidden Jobless Disaster. And John Taylor has a good short blog post Job Growth–Barely Keeping Pace with Population

All three authors emphasize that the unemployment rate is a poor measure of the labor market. Unemployment counts people who don’t have a job but are actively looking for one. People who give up and leave the labor force don’t count. Employment is a more interesting number, and the employment-population ratio a better summary statistic than the unemployment rate. After all, if unemployment falls because everyone who is looking for a job gives up, I don’t think we’d see that as a good sign.

Source: Wall Street Journal

Ed Lazear made this interesting chart. As he explains,

Every time the unemployment rate changes, analysts and reporters try to determine whether unemployment changed because more people were actually working or because people simply dropped out of the labor market entirely… The employment rate—that is, the employment-to-population ratio—eliminates this issue by going straight to the bottom line, measuring the proportion of potential workers who are actually working.

While the unemployment rate has fallen over the past 3½ years, the employment-to-population ratio has stayed almost constant at about 58.5%, well below the prerecession peak. Jobs are always being created and destroyed, and the net number of jobs over the last 3½ years has increased. But so too has the size of the working-age population. Job growth has been just slightly better than what it takes to keep the employed proportion of the working-age population constant. That’s why jobs still seem so scarce.

The U.S. is not getting back many of the jobs that were lost during the recession. At the present slow pace of job growth, it will require more than a decade to get back to full employment defined by prerecession standards….

Why have so many workers dropped out of the labor force and stopped actively seeking work? Partly this is due to sluggish economic growth. But research by the University of Chicago’s Casey Mulligan has suggested that because government benefits are lost when income rises, some people forgo poor jobs in lieu of government benefits—unemployment insurance, food stamps and disability benefits among the most obvious. The disability rolls have grown by 13% and the number receiving food stamps by 39% since 2009.
….

John Taylor makes the point nicely with another graph, which contrasts the labor force participation rate to the BLS’ forecast of what should have happened from demographic effects.

The graph comes from a recent paper Chris Erceg and Andrew Levin.

I part company a bit with Lazear on his conclusions

… the various programs of quantitative easing (and other fiscal and monetary policies) have not been particularly effective at stimulating job growth. Consequently, the Fed may want to reconsider its decision to maintain a loose-money policy until the unemployment rate dips to 6.5%.

If low employment is “structural,” resulting from the worker-side disincentives as well as employer-side disincentives – policy uncertainty, regulatory threats, NLRB, Obamacare, Dodd-Frank, EPA, and so on – then the problem isn’t lack of “demand” in the first place. If the problem has nothing to do with the Fed, and if $2 trillion of QE didn’t do anything to help it, why does the solution have anything to do with the Fed?

The greater surprise is to hear so much agreement from Alan Blinder:

The Brookings Institution’s Hamilton Project, with which I am associated, estimates each month what it calls the “jobs gap,” defined as the number of jobs needed to return employment to its prerecession levels and also absorb new entrants to the labor force. The project’s latest jobs-gap estimate is 9.9 million jobs. At a rate of 194,000 a month, it would take almost eight more years to eliminate that gap.

…. policy makers should be running around like their hair is on fire.

Lazear said “a decade."  More suprising agreement on the impotence of monetary policy:

The Federal Reserve has worked overtime to spur job creation, and there is not much more it can do.

As you might imagine, I’m not such a fan of Blinder’s suggested fixes. He starts with traditional simple Keynesian recommendations that  the government should hire people and "spend” more. No need to refight that here. The more interesting recommendations follow as he warms up to his latest clever scheme.

… the basic idea is straightforward: Offer tax breaks to firms that boost their payrolls.

For example, companies might be offered a tax credit equal to 10% of the increase in their wage bills over the previous year. …

Another sort of business tax cut may hold more political promise….Suppose Congress enacted a partial tax holiday that allowed companies to repatriate profits held abroad at some bargain-basement tax rate like 10%. The catch: The maximum amount each company could bring home at that low tax rate would equal the increase in its wage payments as measured by Social Security records.

For example, if XYZ Corporation paid wages covered by Social Security of $1 billion in 2012 and $1.1 billion in 2013, it would be allowed to repatriate $100 million at the superlow tax rate. The reward for boosting its payroll by $100 million would thus be a $25 million tax saving. That looks like a powerful incentive.

…companies could claim the tax benefit only for individual earnings below the Social Security maximum ($113,700 in 2013). No subsidies for raising executive pay.

I find this most interesting at the level of basic philosophy; how we think about economic policy.

There are huge, longstanding, tax and regulatory disincentives to hiring people. Income tax, payroll taxes, health care and other mandates, and NLRB, OSHA, and so on. There are the high marginal taxes to labor implied by social insurance programs, as Mulligan points out.  If we want to increase the incentive for companies to hire people and people to take the jobs, why add another tax break to an obscenely complex tax code, rather than fix some of the existing disincentives? 

Is this really the right way to run a country? When “policy makers” want more employment, they slap on a complex, tax break on top of a mountain of disncentives. Presumably they then will remove this tax break, and pages 536,721 to 621,843 of the tax code describing it, despite the lobbying by large corporations who have figured out how to exploit it for billions of dollars, once the Brookings Institution decides that there is “enough” employment (!), and “policy-makers” no longer need to encourage it? 

How are the existing hundreds of bits of social engineering in the tax code working out? Do we really need more of this?  Isn’t it time to return to a tax code that raises money for the government at minimal distortion?

The contrast between the benevolent “policy-maker” (no dictator ever had such power) and the reality of how the tax code in this country is actually enacted is pretty striking.

I have to say, I’m a bit disappointed in the end by both. They agree that the US economy is about 10 million jobs short. Something big is in the way. Lazear at least mentions some candidates, though many are long-standing. But the stirring conclusion from Lazear is only to continue a loose monetary policy that he says has been ineffective so far, and the conclusion from Blinder is the sort of clever scheme that economists cook up in late-night cocktail parties piling one more quickly-exploitable bit of social engineering on top of a tax code rife with them. Neither recommendation comes close to 10 million jobs, or addressing any sort of clear story why those jobs have vanished.

Local Austerity

The Wall Street Journal had a really heart-warming article, Europe’s Recession Sparks Grass-Roots Political Push  about groups taking over local governments in southern Europe, and cleaning out years of mismanagement. An excerpt

At her inauguration Ms. Biurrun [the new mayor of Torroledones, Spain] choked up before a jubilant crowd.

Then she began slashing away. She lowered the mayor’s salary by 21%, to €49,500 a year, trimmed council members’ salaries and eliminated four paid advisory positions.

She got rid of the police escort and the leased car, and gave the chauffeur a different job. She returned a carpet, emblazoned with the town seal, that had cost nearly €300 a month to clean. She ordered council members to pay for their own meals at work events instead of billing the town.

“I was so indignant seeing what these people had been doing with everyone’s money as if it were their own,” Ms. Biurrun said.

Those cuts, combined with savings achieved by renegotiating contracts for garbage pickup and other services, helped give a million-euro boost to the city treasury in her first year in office.

Great, no?

But wait, isn’t this all “austerity?” Isn’t cutting spending  exactly the kind of thing that Keynesian macroeconomists, as well as the reigning IMF-style policy consensus decries, saying we need stimulus now, austerity later?

Keynesian, and especially new-Keynesian economics wants more government spending, even if completely wasted. Those trimmed salaries, fired “advisers,” cleaning bills, restaurant spending, overpaid contracts are, in the standard mindset, all crucial for “demand” and goosing GDP.  If stimulus advocates were at all honest, they would be writing blog posts decrying Ms. Birrun and her kind.

Of course they don’t. Abstract “spending” sounds good, and touting abstract “topsy-turvy” model predictions sounds fine.  But when it is concrete, it’s so patently absurd that you don’t hear it.

The Greek city of Thessaloniki cut costs after Yannis Boutaris, a businessman-turned-politician, took office in late 2010 and ended City Hall’s relationship with a few selected providers. Competitive bidding has saved the city 80% of its previous spending on accounting, 25% on waste disposal trucks and 20% on printer paper. The savings have allowed Mr. Boutaris to spend more on social services, even while cutting taxes and paying down City Hall’s debt to suppliers.

How sad. So much “demand”-destroying “austerity.”

(Of course, the main point of the articles is about a political realignment, in which local governments are becoming responsive to local voters, transparent, and efficient, rather than being cronyist machines of national political parties. I can’t imagine anyone not feeling warm about that!)

Update: Courtesy Marginal Revolution, I found this nice story about the new Spanish $680 million submarine that will sink if put in water.  MR snarkily asks “did this help Spain or hurt Spain.” $680 million of government spending raises Spanish GDP by nearly $1 billion, so this is great, right?

Debt and growth in 10 minutes

This is a short video from last year. I only just found out it exists. It still seems pretty topical, and (for once) condensed because Lars Hansen really forced me to obey the 10 minute time limit!

There is a better link here from the BFI page here that covers the whole event, but I couldn’t figure out how to embed those.

Growth in the UK?

I thought European “austerity,” meaning mostly large increases in marginal tax rates on anyone daring  to work, save, invest, start a company or hire people, while spending stays north of 50% of GDP, was a pretty bad idea.

So I was glad to read the tiltle, when a friend sent me a link to the Telegraph, announcing Osborne to unleash raft of policies to kick-start growth. Great, I thought, after trying everything else, the British will finally try the one thing that will work.


The byline was only a bit disappointing

The Government is to reveal a series of major new measures to boost national and regional growth ahead of the Budget to show its “pro-business” strategy is working

Pro-business is usually a code word for protection and subsidy. But there are plenty of worse code words.

And then it all falls apart

The measures will include:

• Billions of pounds of central government funding directed at boosting regional growth and a backing for Michael Heseltine’s plans for new local spending powers;

• The planning go-ahead for the Hinkley Point C nuclear power station;

• Support for housebuilders and for first-time buyers trying to get mortgages;

• A push on major infrastructure projects, including the Merseyside Gateway and the “super-sewer” in London, and more government guarantees for such projects;

… The Bank of England could also be given a broader mandate to support growth.

…billions of pounds of central government funds should be made directly available to the regions and cities such as Birmingham…

Lord Heseltine’s report made far-reaching recommendations for stimulating economic growth. The Government will unveil plans enabling Local Enterprise Partnerships and businesses to bid regionally for money that is now allocated centrally.

It’s not all bad. Allowing a nuclear power plant to operate is nice, and some plans to lower corporate taxes a bit. But the blossoming of free enterprise in the land of Adam Smith, alas, this is not. Keynes still rules.