- Paul Krugman: China, Coal, Climate
- Links for 11-14 -14
- 'Why Keynes is Important Today'
- Fed Watch: Dudley, Plosser, JOLTS, Potential Output
- 'The Number of Unemployed Exceeds the Number of Available Jobs Across All Sectors'
- 'The Mysterious Fed'
- 'The Choice of the Century'
Posted: 14 Nov 2014 12:24 AM PST
Are we finally getting somewhere in the battle against climate change?:
China, Coal, Climate, by Paul Krugman, Commentary, NY Times: It's easy to be cynical about summit meetings. Often they're just photo ops, and the photos from the latest Asia-Pacific Economic Cooperation meeting, which had world leaders looking remarkably like the cast of "Star Trek," were especially cringe-worthy. At best — almost always — they're just occasions to formally announce agreements already worked out by lower-level officials.
Once in a while, however, something really important emerges. And this is one of those times: The agreement between China and the United States on carbon emissions is, in fact, a big deal.
To understand why, you first have to understand the defense in depth that fossil-fuel interests and their loyal servants — nowadays including the entire Republican Party — have erected against any action to save the planet.
The first line of defense is denial: there is no climate change; it's a hoax concocted by a cabal including thousands of scientists around the world. ... Indeed, some elected officials have done all they can to pursue witch hunts against climate scientists.
Still, as a political matter, attacking scientists has limited effectiveness. It ... sounds like a crazy conspiracy theory, because it is.
The second line of defense involves economic scare tactics: any attempt to limit emissions will destroy jobs and end growth. ... Like claims of a vast conspiracy of scientists, however, the economic disaster argument has limited traction beyond the right-wing base. ...
Which brings us to the last line of defense, claims that America can't do anything about global warming, because other countries, China in particular, will just keep on spewing out greenhouse gases. ... But ... China has declared its intention to limit carbon emissions. ...
But consider the situation. America is not exactly the most reliable negotiating partner on these issues, with climate denialists controlling Congress ...
But the principle that has just been established is a very important one. Until now, those of us who argued that China could be induced to join an international climate agreement were speculating. Now we have the Chinese saying that they are, indeed, willing to deal — and the opponents of action have to claim that they don't mean what they say.
Needless to say, I don't expect the usual suspects to concede that a major part of the anti-environmentalist argument has just collapsed. But it has. This was a good week for the planet.
Posted: 14 Nov 2014 12:06 AM PST
Posted: 14 Nov 2014 12:06 AM PST
Peter Temin and David Vines:
Why Keynes is important today, Vox EU: The current debate on the efficacy of Keynesian stimulus mirrors the resistance Keynes met with when initially advocating his theory. This column explains the original controversy and casts today's policy debate in that context. Now that concepts of Ricardian equivalence and the fiscal multiplier are formally defined, we are better able to frame the arguments. The authors argue that a simple model of the short-run economy can substantiate the argument for stimulus.
Macroeconomists have largely failed in explaining and recommending policies since the Global Financial Crisis of 2008. Today when thinking about fiscal policy they cite Ricardian Equivalence to deny the efficacy of Keynesian analysis (which was abandoned in the turbulent 1970s that signaled the end of rapid growth). They seem unaware that they have revived the views of Montagu Norman, Governor of the Bank of England, in 1930.
Ricardian Equivalence is a theory that concludes that any expansion of public spending will be offset by an equal and opposite decline in private spending. The theory is based on a few important assumptions. It assumes forward-looking consumers who adjust their current spending in anticipation of future taxes to pay for the spending. Under these conditions, any increase in current spending leads consumers to anticipate a rise in future taxes and decrease their current spending to save for this.
This theory dominates current macroeconomic discussion. It fits into the form of current macroeconomics that assumes not just forward-looking consumers, but flexible prices as well. And if a Keynesian suggests fiscal policy in current conditions, a modern economist is likely to invoke Ricardian Equivalence.
Remembering the past
Keynes faced exactly this opposition in 1930. He was a member of the Macmillan Committee convened by the British government to analyze the worsening economic conditions of that time. His recommendation for increased government spending – what we now call expansive fiscal policy – was opposed by Norman and other representatives from the Bank of England. They did not invoke Ricardian Equivalence because it had not yet been formulated; instead they simply denied that increased government spending would have any beneficial effect.
Keynes opposed this view, but he did not have an alternate theory with which to refute it. The result was confusion in which Keynes was unable to convince a single other member of the Macmillan Committee to support his conclusions. It took five years for Keynes to formulate what we now call Keynesian economics and publish it in what he called The General Theory.
He based his new theory on several assumptions, two of which are relevant here. He assumed that consumers are only forward-looking part of the time, being restrained by a lack of income at other times, and that many prices are not flexible in the short run wages in particular are 'sticky'. These assumptions give rise to involuntary (Keynesian) unemployment which expansive fiscal policy can decrease.
Which theory is relevant today? We know that wages are sticky – countries in Southern Europe have found it impossible to implement requests from their creditors that they reduce wages swiftly. And we know that not all private actors in the economy are forward-looking. Before the crisis, borrowing and spending increased in ways that could not be sustained; now consumers are not spending and business firms are not investing even though interest rates are close to zero.
Those are the conditions described by Keynes in which expansive fiscal policy works well. They also are the conditions in which monetary policy does not, even though modern macroeconomic policymakers came to rely entirely on monetary policy for stabilization. There is a disconnect between the needs of current economies and theories of current macroeconomists.
Doomed to repeat it?
What to do? In many applied disciplines, like medicine, practitioners go back to basics when the facts change. If their current practice fails to produce the desired result, they search their armamentarium for others. If their assumptions prove wrong, they look for more appropriate ones. But not modern macroeconomists – they say we must simply endure what they call secular stagnation.
This is an unhappy prediction. Monetary policy does not work today; instead, this is the perfect time for fiscal policy. There are immediate needs to repair roads and bridges, rebuild energy grids, and modernize other means of travel. Expansive Keynesian fiscal policy will benefit the economy in both the short and long run.
We argue in our new book, Keynes, Useful Economics for the World Economy, that these recommendations can be seen as inferences from a simple and effective model of the short-run economy. We show how hard it was for Keynes to break away from previous theories that work well for individual people and companies – and even for the economy as a whole in the long run – to define the short run in which we all live. We also stress Keynes' interest in the world economy, not just in isolated economies. After all, the IMF is perhaps the most enduring remnant of Keynesian thought left today.
Authors' note: Peter Temin is Elisha Gray II Professor Emeritus of Economics at MIT and the author of "Lessons from the Great Depression" (MIT Press) and other books. David Vines is Professor of Economics and Fellow of Balliol College at the University of Oxford, and joint editor of a number of books on global economic governance.
Editor's note: Temin and Vines are coauthors of "The Leaderless Economy: Why the World Economic System Fell Apart and How to Fix It".
Lucas, R (2009), "Why a Second Look Matters", Council on Foreign Relations, March 30.
Krugman, P (2011), "A Note on the Ricardian Equivalence Argument Against the Stimulus (Slightly Wonkish)", Krugman blog, The New York Times, December 26.
Barro, R (1974), "Are Government Bonds Net Wealth?", Journal of Political Economy.
Barro, R "On the Determinants of the Public Debt", Journal of Political Economy.
Poterba, J M and L H Summers (1987), "Finite Lifetimes and the Effects of Budget Deficits on National Savings", Journal of Monetary Economics.
Carroll C and L H Summers (1987), "Why Have the Private Savings Rates in the United States and Canada Diverged?", Journal of Monetary Economics.
Posted: 13 Nov 2014 11:19 AM PST
Dudley, Plosser, JOLTS, Potential Output, by Tim Duy: Not enough time to do any of these topics justice, but some quick takeaways for the last two days.
First, read today's speech by Federal Reserve President William Dudley in which he discusses the global implications of US monetary policy. Some keys points:
1. Still dismissing the recent drop in inflation expectations. Dudley says:
In assessing inflation expectations, I currently put more weight on survey-based measures of inflation expectations as opposed to market-based measures. Survey-based measures have been generally stable, consistent with inflation expectations remaining well-anchored. However, market-based measures, such as those based on breakeven inflation derived from the difference between yields on nominal versus Treasury Inflation-Protected Securities (TIPS), have registered declines over the past few months, even on a 5-years forward basis. Research done by my staff suggests that much of this decline in market-based measures of inflation compensation reflects a fall in the inflation risk premium—that is, what investors are willing to pay to protect themselves against inflation risk. Adjusting for the fall in the inflation risk premium, inflation expectations appear to have declined much less than implied by TIPS inflation breakeven measures.
The Fed is not taking the market-based measured of inflation expectations at face value, especially now that the Fed is closer to its employment objectives and they are increasingly confident that the recovery is more likely than not to strengthen further.
2. Cautious about prematurely raising rates. Dudley on the implications of his outlook for monetary policy:
In considering the appropriate timing of lift-off, there are three important reasons to be patient. First, the Committee is still undershooting both its employment and inflation objectives...Second, when interest rates are at the zero lower bound, the risks of tightening a bit too early seem considerably greater than the risks of tightening a bit too late. A premature tightening might lead to financial conditions that are too tight, resulting in a weaker economy and an aborted lift-off...Finally, given the still high level of long-term unemployment, there could be a significant benefit to allowing the economy to run "slightly hot" for a while in order to get these people employed again. If they are not employed relatively soon, their job skills will erode further, reducing their long-term prospects for employment and, therefore, the productive capacity of the U.S. economy.
Hence, no need for a rate hike now. But...
3. Rate hikes are coming. Dudley continues:
All that said, I hope the economic outlook evolves so that it will be appropriate to begin to raise interest rates sometime next year. While raising interest rates is often portrayed as a difficult task for central bankers, in fact, given the events since the onset of the financial crisis, it would be a development to be truly excited about. Raising interest rates would signal that the U.S. economy is finally getting healthier, and that the Fed is getting closer to achieving its dual mandate objectives of maximum employment and price stability. That would be very good news, even if it were to cause a bump or two in financial markets.
The economy is improving, hence normalization is coming. And note he does not specify any time frame other than next year. Based on previous comments we might reasonably conclude that he thinks mid-year, but it is a data-dependent decision. I think his is "patient" in the sense that it is not going to happen this year (which really isn't a question to begin with). But I doubt he has ruled out the end of the first quarter of next year. And again, don't expect the Fed to change course on the basis of some market turbulence. They expect it as part of the policy transition.
Outgoing Philadelphia Federal Reserve President Charles Plosser, in contrast, is looking for action sooner than later. While Dudley sees the risks of premature tightening, Plosser thinks the risk of wanting too long before normalization are higher:
First, we do not know how to confidently determine whether the labor market is fully healed or when we have reached full employment...Second, if we wait until we are certain that the labor market has fully recovered before beginning to raise rates, policy will be far behind the curve. One risk of waiting is that the Committee may be forced to raise rates very quickly to prevent an increase in inflation...This would represent a return of the so-called "go-stop" policies of the past...A third risk to waiting is that the zero interest rate policy has generated a very aggressive reach for yield as investors take on either credit or duration risk to earn higher returns...For these reasons, I would prefer that we start to raise rates sooner rather than later. This may allow us to increase rates more gradually as the data improve rather than face the prospect of a more abrupt increase in rates to catch up with market forces, which could be the outcome of a prolonged delay in our willingness to act. Of course, financial markets are not always patient, so some volatility will be unavoidable.
Still a minority position on the FOMC, but eventually hawks (or those that remain, see below) and doves will converge. I still think that convergence will happen in the middle of next year with the risks weighted more on the second than the third quarter. Indeed, the JOLTS report for September suggests the labor market improvement is accelerating as we head into the final months of the year. Notably, the quits rates spiked:
I suspect that a faster quit rate will force employers to step up the pace of higher out of necessity. Moreover, unemployment below 6% and heading south and quit rates heading north to pre-recession levels suggests that wage growth is coming. And that wage growth will push FOMC moderates toward the "hike sooner than later" side of the debate. Call me an optimist on the near-term outlook.
Finally, via Mark Thoma, researchers at the Federal Reserve are questioning the ability of the economy to regain anything like what we thought was potential output prior to the recession:
The economic collapse in the wake of the global financial crises (GFC) and the weaker-than-expected recovery in many countries have led to questions about the impact of severe downturns on economic potential. Indeed, for several major economies, the level of output is nowhere near returning to pre-crisis trend (figure 1). Such developments have resulted in repeated downward revisions to estimates of potential output by private- and public-sector forecasters. In addition, this disappointment in post-recession growth has contributed to concerns that the U.S. economy, among others, is entering an era of secular stagnation. However, the historical experience of advanced economies around recessions indicates that the current experience is less unusual than one might think. First, output typically does not return to pre-crisis trend following recessions, especially deep ones. Second, in response, forecasters repeatedly revise down measures of trend......Although these calculations are simple, they raise deeper questions about the impact of recessions on trend output. The finding that recessions tend to depress the long-run level of output may imply that demand shocks have permanent effects. The sustained deviation of the level of output from pre-crisis trend points to flaws in the way the economics profession models the recovery of output to economic shocks and raises further doubts about the reliance on measures of output gaps to determine economic slack. For policymakers, the results also point to the cost of recessions, especially deep and long ones, and provide a rationale for strong and rapid policy responses to economic downturns.
Those of us concerned by the risk that the lengthy cyclical downturn would yield structural damage would not be surprised by this conclusion. Note that the more the Fed believes output is close to potential, the less patient they will be in holding rates low. And note that the have already pretty much given up on the CBO potential output numbers:
If he don't get back to that estimate of potential output by 2017, that estimate just isn't going to hold. Call me a pessimist on this point. I think it more likely than not that the CBO estimate of potential is revised downward again. I suspect the Fed has already done so.
And in a late-breaking development, Dallas Federal Reserve President Richard Fisher announced his retirement today, effective March 19, 2015. Another hawk down.
Bottom Line: Watch the data. In my opinion, the pessimistic focus from both the left and the right risks underestimating the degree of economic improvement. The Fed's patience will wane in the face of further improvement in the pace of activity.
Posted: 13 Nov 2014 10:29 AM PST
About that skills mismatch story:
The Number of Unemployed Exceeds the Number of Available Jobs Across All Sectors, by Elise Gould, EPI: The figure below shows the number of unemployed workers and the number of job openings in September, by industry. This figure is useful for diagnosing what's behind our sustained high unemployment. If today's labor market woes were the result of skills shortages or mismatches, we would expect to see some sectors where there are more unemployed workers than job openings, and others where there are more job openings than unemployed workers. What we find, however, is that unemployed workers exceed jobs openings across the board. ...
This demonstrates that the main problem in the labor market is a broad-based lack of demand for workers—not, as is often claimed, available workers lacking the skills needed for the sectors with job openings. ...
Posted: 13 Nov 2014 09:39 AM PST
Dear Fed hawks. Please listen:
The Mysterious Fed, by Paul Krugman: As usual, my inbox is full of speculations about when the Fed will raise interest rates. June 2015? Earlier? Has it already waited too long?
And as usual, I wonder why anyone is talking about this at all. Yes, unemployment has fallen. But there is huge ambiguity about what level of unemployment is sustainable given changing demography, the uncertain degree to which people might return to the work force given better job availability, and so on. There's also a huge asymmetry in risks between raising rates too soon — which can leave us stuck in a low inflation or deflation trap for a very long time — and raising rates a bit too late, which at worst means temporarily overshooting an inflation target that's arguably too low anyway.
Meanwhile, both the Fed's preferred measure of inflation and wages are showing no hint of an overheating economy...
So what the heck is going on? Maybe it's just pluralistic ignorance?
Dallas Fed president Richard Fisher said recently that the failure to raise interest rates soon enough could cause the economy to go into a recession. Because inflation. He wants interest rates to go up sooner rather than later, which I think would be a mistake.
[See also Dan Alpert: Why the Fed is Flummoxed by the U.S. Labor Market.]
Update: "Federal Reserve Bank of Dallas President and CEO Richard W. Fisher today announced that he will retire from his position on March 19, 2015."
Posted: 13 Nov 2014 09:19 AM PST
Do you agree with Robert Reich?:
The Choice of the Century: The President blames himself for the Democrat's big losses Election Day. "We have not been successful in going out there and letting people know what it is that we're trying to do and why this is the right direction," he said Sunday.
In other words, he didn't sufficiently tout the Administration's accomplishments.
I respectfully disagree.
If you want a single reason for why Democrats lost big on Election Day 2014 it's this: Median household income continues to drop. This is the first "recovery" in memory when this has happened. ...
It's hard for me to believe that people think Republican economic policies are the solution to this problem. As Paul Krugman says, "So if Republicans are gaining from public frustration here, it is ironic. After all, the GOP is systematically opposed to anything that would increase workers' bargaining power, and bitterly opposed to any suggestion that inequality is an issue — what we need, they say, is growth, which will raise all incomes (even though it hasn't)." I'm all for growth, but the increase in income needs to be distributed equitably, and in recent years (decades actually) it hasn't been. It's hard to see how Republican policies will change that rather than make the problem worse.
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