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November 11, 2014

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Posted: 11 Nov 2014 12:06 AM PST

FRBSF Economic Letter: Does Slower Growth Imply Lower Interest Rates?

Posted: 10 Nov 2014 10:00 AM PST

Sylvain Leduc and Glenn Rudebusch of the Federal Reserve Bank of San Francisco.

The aging of the labor force, weak productivity growth, and possible long-run supply-side damage from the Great Recession have all suggested recently that the potential growth rate of the U.S. economy may be lower in the years ahead. According to standard economic theory, such slower growth would push down the level of the natural rate of interest. This natural rate, also called the neutral or equilibrium real interest rate, is the risk-free short-term interest rate adjusted for inflation that would prevail in normal times with full employment (Williams 2003). 
Moreover, a decline in the natural rate of interest would tend to lower every other real and nominal interest rate in the economy. Therefore, understanding the linkage between economic growth and the natural rate is crucial for forecasting all types of interest rates. Indeed, this linkage has been at the center of recent fiscal and monetary policy forecasts. The Congressional Budget Office (CBO 2014) noted that its lower projections of U.S. Treasury yields and the federal government's future debt servicing costs partly reflected reductions in its forecast for potential output. In addition, earlier this year, some Federal Open Market Committee (FOMC) participants appeared to reduce their estimates of the natural rate of interest because of an expectation of slower growth ahead for potential output. 
This Economic Letter examines the linkage between growth and interest rates as embodied in recent projections by FOMC participants, the CBO, and private-sector forecasters. Although forecasts of potential growth or the natural rate are rarely reported, we can construct reasonable proxies from long-run forecasts of GDP growth, the short-term interest rate, and inflation. In essence, the long-run nature of these forecasts strips out cyclical variation and reveals the fundamental secular trends that underlie the concepts of potential growth and the natural rate of interest. 
Although in the CBO and FOMC policy projections long-run forecasts of growth and the real interest rate have fallen together, private-sector forecasters do not anticipate a similar dual drop. In particular, the recent downward revisions in private-sector expectations for long-run growth have been associated with no change in their long-run projections of the real short-term interest rate. If the private-sector forecasters are correct, this would raise a concern that the CBO and FOMC may have overestimated the effects of slower potential growth toward reducing interest rates, which may introduce some upside risk to CBO and FOMC interest rate projections. ...

Skipping to the conclusions:

In this Letter, we document a range of views about the link between potential growth and the natural interest rate. In particular, while the CBO and many FOMC participants expect weaker long-run growth to translate into lower interest rates, private-sector forecasts do not seem to share this view. Thus, future downward pressure on interest rates may be more muted than indicated by current monetary and fiscal policy projections, which would translate into an upside risk to these longer-term interest rate forecasts.

'Honest Abe Was a Co-op Dude: How the G.O.P. Can Save Us from Despotism'

Posted: 10 Nov 2014 09:50 AM PST

Stephen Ziliak emails:

Dear Mark:
I thought you and readers of Economist's View would like to know about an essay, "Honest Abe Was a Co-op Dude: How the G.O.P. Can Save Us from Despotism", hot off the press. Here is the abstract:
Abstract: Abraham Lincoln was a co-op dude. He had a hip neck beard, sure. Everyone knows that. But few have bothered to notice that the first Republican President of the United States was an economic democrat who put labor above capital. Labor is prior to and independent of capital, Lincoln believed, and "deserves much the higher consideration", he told Congress in his first annual address of 1861. Capital despotism is on the rise again, threatening the stability of the economy and union. The biggest problem of democracy now is not the failure to fully extend political rights, however important. The bigger problem is economic in nature. The threat today is from a lack of economic democracy—a lack of ownership, of self-reliance, of autonomy, and of justice in the distribution of rewards and punishments at work. From the appropriation of company revenue to lack of protection against pension raids, capital despotism is rife. "The road to serfdom" has many paths to choose from, Hayek warned in his important book of 1944. But too many Americans—including economists and policymakers—are neglecting the economic path, the road to serfdom caused by a lack of economic democracy. Cooperative banks and firms can help.
And here are a few excerpts:
"Labor is prior to and independent of capital. Capital is only the fruit of labor, and could never have existed if labor had not first existed. Labor is the superior of capital, and deserves much the higher consideration."
—Abraham Lincoln
"Economists in the know have acknowledged that the worker owned cooperative firm is the most perfect model of economic democracy and rational business organization dreamed up so far. That is true around the world, from Springfield all the way back to Shelbyville, economists who've examined such co-ops agree. Co-ops are more productive. And every worker is an owner."
"From the Dutch blossoming of commerce in the 1600s to the Asian Spring of the 2000s, socialists and capitalists alike have not produced, it seems, a better, more efficient and democratic form of economic production and distribution. Co-ops win. Not everyone is convinced."
"If co-ops are so great, why don't they dominate the economy? Negligence and ignorance, more than any other possible cause, it would seem.
 For example, the infamous "socialist calculation debate" in economics dragged on for two decades before a single word was said by either side, from Lange and Lerner to von Mises and Hayek, about the nature of the firm. Nary a peep from economists about how or even why firms choose to organize into production units of a certain scale, large or small. Ronald Coase's article on "The Nature of the Firm" (1937) was good enough to fetch him a Nobel Prize. But Coase did not bring as much clarity to the debate as most economists believe.
 Coase was vague and conventional to point of embarrassment. He made straw man assumptions about the firm being a hierarchical-capitalistic entity. Coase's firm, though more "tractable" and "realistic" than previous notions, is assumed to be run by a "master" or masters, by capitalists who seek to maximize profit by bossing around "servants"—that is, wage earners possessing little autonomy, little or no ownership, and no voting rights on capital, their sole purpose being assumed to serve the "masters" of capital.
 Said Coase, "If a workman moves from department Y to department X, he does not go because of a change in relative prices, but because he is ordered to do so." But if Coase (himself a lovely man in person) would have taken a closer look at the real world, he could have found cooperative firms succeeding in stark contrast to the anti-democratic firms of his imagination."
Stephen T. Ziliak

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