Clinton Plan

The WSJ asked me to review the Hillary Clinton economic plan, motivated by her August 11 speech introducing it.  The Op-Ed is here.

I read a good deal of the "plan" on hillaryclinton.com. What I discovered is that there is so much plan that there really isn't any plan at all.



For example, follow me down to the  Fact sheet at the bottom of the website to figure out just what the "infrastructure" plan is about.  Some snippets:

Clinton will make smart, targeted, and coordinated investments to increase capacity, improve road quality, and reduce congestion 

Clinton will prioritize and increase investments in public transit to connect Americans to jobs, spur economic growth, and improve quality of life in our communities. And she will encourage local governments to work with low-income communities to ensure that these investments are creating transit options that connect the unemployed and underemployed to the jobs they need. She will also support bicycle and pedestrian infrastructure 

Clinton will make smart, coordinated investments that upgrade our aging rail tunnels and bridges, expand congested highway corridors, eliminate dangerous at-grade railway crossings, and build deeper port channels to accommodate the newest and largest cargo ships. Clinton will also focus on vital “intermodal” transfer points between trucks, rail, and ships—including the “last-mile connectors” between different modes, like the local roads that connect highways to ports. She is committed to initiating upgrades of at least the 25 most costly freight bottlenecks by the end of her first term. (bold italics in the original) 

The Federal Aviation Administration is currently pursuing a “NextGen” upgrade program... But these efforts have fallen chronically behind schedule and well short of expectations. Clinton will get this crucial program back on track and ensure that it is managed effectively and with accountability. 

Clinton will also invest in building world-class American airports...with reliable and efficient connections to mass transit. ... 

committing that by 2020, 100 percent of households in America will have access to affordable broadband that delivers world-class speeds sufficient to meet families’ needs.

A wide-ranging system of advanced energy fueling stations for the 21st century fleet. A network of roadway sensors capable of alerting drivers to a dangerous icy patch a mile ahead. 

Clinton will invest in creating a world-leading passenger rail system to meet rapidly growing demand and build a more mobile America. 

...Clinton’s plan will modernize our pipeline system, increase rail safety, and enhance grid security. It will also build new infrastructure to power our economic future and capture America’s clean energy potential. ... 

We need a bold agenda to revitalize our aging water infrastructure and make it more sustainable and energy efficient. Clinton will work to harness both public and private resources to support these efforts. 

Modernizing our dams and levees ...our efforts to maintain these critical structures are haphazard and under-resourced ...We need to substantially increase funding to inspect these structures, bring them into good repair, and remove them where appropriate. ... 

Clinton will support efforts to increase dams’ capacity to deliver affordable and reliable electricity while reducing carbon pollution.

And it goes on like this.

The positive view of all this is  that someone running the vast American bureacracy should have a detailed plan for what they want that bureuacracy to do.  Well, there is plenty of detail here, and it's a good bet that Donald Trump has never thought about traffic jams at intermodal transfer facilities.

So how can I say there is no "plan?"

The other job of an Administration is to set priorities, which means something has to come second. This is what Clinton will propose in her first 100 days, and what she will accomplish in 5 years, with $50 billion a year? You must be kidding. Turning Amtrak alone into a "world-leading passenger rail system" would swallow her $275 billion

There are no numbers here anywhere. The $275 billion is clearly just a made up number that sounds sortof big but not so big as to attract tax-and-spend criticism. Because that is the last number in the whole document. In my rough calculation, she blew $275 billion by the first paragraph. As a consequence,  analysts who calculate how many "jobs" the "Clinton plan" will create are just making it up too.

There is no timeline or process The President of the US is not a King or dictator who waves her hands and upgrades at intermodal transfer facilities just happen. The president appoints cabinet secretaries, who oversee a bureaucracy, which must, by law conducts proper cost benefit analysis, follow the Administrative Procedures Act,  submit plans for EPA review, and so on.

The job of an Administration is also to understand and figure out how to surmount the institutional barriers that have stopped all of these fine and very old ideas from happening before. If Governor Brown and President Obama have not been able to lay a foot of high-speed track in 8 years, how is she going to do so much better?

As I mentioned in the oped, it fails to ask, why are these things problems in the first place? Apparently, traffic jams where trucks unload trains happen when the President is not, herself, there to run things. It's an implicitly damning condemnation of her predecessor -- he was either not studious enough to do his homework to this detail, or insufficiently "committed to initiating upgrades""at  costly freight bottlenecks"

In my world, things go wrong when markets go wrong, or the structures of government fail. In this world, things happen only on the will and attention of the President, including traffic jams. The people in charge now are either idiots, Republicans blocking progress, or just insufficiently guided by the great leader on top.  One need do not analysis of why things are going wrong, just "fight" to fix them. 

This "plan" implies a stinging rebuke of her predecessor, when you think about it. If all it takes is the force of Hllary's will to accomplish all this in 5 years for $275 billion, just why did he fail in 8 years with about $10 trillion? Maybe, just maybe, President Obama was trying darn hard, using the same methods, and came up short for a reason?


There is, literally, no plan. I looked hard through the website, and this "fact sheet" is the bottom level for infrastructure. Yet it keeps referring to what "the plan" will do, with no citations or links. That's all over the website. Thousands of pages talk about the plan, but no pages are, grammatically the plan itself.

Lost in details   And this is just one fact sheet, 6 levels deep in the website.  You get here from (click on bold) 

1) Hllaryclinton.com

2) About / Act / Issues / Shop / More / Español / Donate

3) All Issues / Economy and jobs / Education / Environment / Health / Justice and equality / National security

4) A fair tax system / Jobs and Wages /  Paid family and medical leave .../ Fixing America's infrastructure / ... (17 boxes in all)

5) As president, Hillary will:

• Repair and expand our roads and bridges....
• Lower transportation costs and unlock economic opportunity by expanding public transit options. ...
• Connect all Americans to the internet.... 
• Invest in building world-class American airports and modernize our national airspace system. ..
• Build energy infrastructure for the 21st century. ..

(Looking over all 17 tabs of the "Economy and Jobs" tab, I lost count at 139 such bullet points.)

And finally this  Fact sheet. Transport is actually one of the best thought out of all the tabs.

The point, if each such fact sheet promises that Mrs. Clinton is "committed" to details as fine as solving intermodal freight bottlenecks (the bold italics really got to me), across all 17 tabs of economic policy x 7 tabs of policy areas, she and her administration will get nothing done.

In sum, I think the picture I painted is unavoidable. Clinton and her team are well meaning, but this document (the website) displays an unbelievable naivete about how American government works. Every possible "policy solution" to every perceived problem in America got thrown in, with no thought of where the problems came from, no acknowledgement that good people have been trying hard for years, and that American government has an important set of checks and balances and a policy process. No, she will wave her hand and all will be well. 

Perhaps she and her team are wiser, and this is just a campaign document designed to please media analysts and voters. But if that is the case, it displays an unbelievable disdain for the intelligence of the media and voters she wishes to attract. 

Red Tape 

The thousands of pages of the website do address how Mrs. Clinton will succeed where President Obama failed: She will "break through washington gridlock" and get rid of "red tape." Period. 

This had me guffawing. Really? That's all it takes? Too bad President Obama never had that idea! (He did, and had an office devoted to the project. With little success.) 

Her speech made some progress on just how she will break through "gridlock": 

What we need is serious, steady leadership that can find common ground and build on it based on hard but respectful bargaining. 

Leadership that rises above personal attacks and name calling, not revels in it.... 

ogether, we'll make full use of the White House's power to convene. We'll get everyone at the table – not just Republicans and Democrats, but business and labor leaders...academics and experts... and, most importantly, all of you. I want working people to have a real say in your government again.

That means we have to get unaccountable money out of our politics, overturn Citizens United, and expand voting rights, not restrict them. 

Starting even before the election, we will bring together leaders from across our economy and our communities for meetings on jobs, American competitiveness, and working families. 

I omitted the, well, "personal attacks" on Donald Trump, so we can think about just how plausible this is once he's off the stage. And then it's just roll-your-eyes funny. The major proposal is... more Town Hall meetings and "listening" tours?  I would think, given current scandals, she'd be a little circumspect about "money in politics," and if you want to show your "listening" abilities, perhaps those who think Citizens United was a good idea might be a place to start.

If Mrs. Clinton wants to listen, and reach out to Republicans, she doesn't need to "convene" everyone at the table. And least of all, she doesn't need more policy-wonks stuffing her campaign website with every little idea that public policy schools and liberal think tanks dream up. Paul Ryan's "a better way" plan is right there on the internet. She should get a good glass of wine, sit down with that plan, pick 5 things she can live with, and go with them or see how to meet them half way.

This should be taken as constructive and nonpartisan criticism. Do not mistakenly imply anything about Mr. Trump in here.  Mrs. Clinton is daily more likely to be our next president. I hope dearly that she could make some progress in coming to compromise on some of the simple and obvious steps that our country needs to take, steps pretty much every bipartisan commission agrees on -- tax and immigration reform, yes, infrastructure, reform of much regulatory process, and so on. She doesn't have to agree on policy, but an approach much more like the famous Shultz memo to Reagan -- written in November! -- is much more likely to succeed.

Sadly, though, this seems like a road to four more years of gridlock.

Summers on growth and stimulus

Larry Summers has an important, and 95% excellent, Financial Times column. Larry is especially worth listening to. I can't imagine that if not a main Hilary Clinton adviser he will surely be an eminence grise on its economic policies. He's saying loud and clear what they are, so far, not: Focus on growth.


The title "the progressive case" for growth, is interesting enough. Perhaps Larry now uses the word "progressive" to describe himself. More importantly, Larry's audience here is the Clinton campaign and the Democratic party. He's saying loud and clear: you're not paying enough attention to growth, and growth ought to be at the center of the party, and the new Administration's, economic plans.

...many people, in their eagerness to focus on fairness, neglect the single most important determinant of almost every aspect of economic performance: the rate of growth of total income,

Hooray. Not only is this vitally important and factually correct, a growth oriented policy, if sold without the usual demonization, could well attract bipartisan support. That sentence could come from Paul Ryan's a better way

Alas, Larry blows that spirit right off the bat with a sentence that take a gold medal for convoluted calumny and bombastic bulverism:

Because those who champion strategies that centre on business tax-cutting and deregulation and favour the wealthy have placed the most emphasis on growth over the past 35 years, the objective of increasing growth has been discredited in the minds of too many progressives.

Translated into something approximating English: because people whose only and base motive was "favoring the wealthy" happened to advocate growth to sell their (as later described) useless tax-cutting and deregulation strategies, the goal of growth has become tarnished in the minds of good progressives.

This is below Larry -- in person I have always known him to recognize that conservatives and free-marketers have exactly the same dispassionate goal, advocate growth primarily to help the less well off, and tax-cutting and deregulation as time-proven policies that improve growth.  But, again, his audience is to the left, so perhaps one can excuse some I-hear-you agreeing with common demonizations.

But then he gets to well written and praiseworthy work, so good I must quote it in entirety:  

It can hardly be an accident that the decades of maximum growth, the 1960s and 1990s, also saw the most rapid job growth and most rapid increase in middle-class living standards.

Growth provides the wherewithal for increased federal revenue and so encourages the protection of vital social insurance programmes such as Social Security and Medicare.... 

Tight labour markets are the best social programme, as they force employers to hire and mentor inexperienced people in order to be adequately staffed. Some years ago, I estimated that for each 1 per cent point increase in adult male employment, the employment of young black men rose 7 per cent. More recent research confirms economic growth has an outsized benefit for younger people and minorities.

Rising growth has other benefits, as well. It strengthens the power of the American example in the world. It obviates the need for desperation monetary policies that risk future financial stability. Greater growth also has historically operated to reduce crime, encourage environmental protection and contributes to public optimism about the country that our children will inherit.

The reality is that if American growth continues to have a 2 per cent ceiling, it is doubtful that we will achieve any of our major national objectives.

If, on the other hand, we can boost growth to 3 per cent, interest rates will normalise, middle-class wages will rise faster than inflation, debt burdens will tend to melt away and the power of the American example will be greatly enhanced.

...the vast majority of job creation and income growth comes from the private sector. If the next president is lucky enough to oversee the creation of 10m jobs from 2017-20, more than 8m of them will surely come from businesses hiring in response to profit opportunities. 

All true, excellent, well-stated, and bipartisan (at least for the pre-Trump era). Jeb Bush's 4%, Paul Ryan's opportunity society agree totally. Heck, even Gary Johnson might find little to quibble with here. If growth could be the mantra for the Hilary Clinton administration, and if Larry can persuade his fellow "progressives," great things could follow.

And now to the remaining 5%:

There is no case for reducing already low corporate taxes or removing regulations unless it can be shown that these have costs in excess of benefits.

What is needed is more demand for the product of business. This is the core of the case for policy approaches to raising public investment, increasing workers’ purchasing power and promoting competitiveness.

No case? Really? The higher taxes, steadily more convoluted tax code, vast expansion of regulation (Dodd-Frank, Obamacare are just the start) that coincided with our epic slow growth, have nothing at all to do with that sorry experience?   There is absolutely nothing wrong with the microeconomics of the American economy and its vast administrative, judicial and regulatory state, we just need a bit more "demand?"

Leave aside the last 30 years of growth theory, which is silent on "demand," we can do nothing better than move around 1970s era IS and LM curves, and revive ideas from the 1930s?

Read the second paragraph carefully. "More demand" is the ""core of the case for policy approaches to raising public investment, increasing workers’ purchasing power and promoting competitiveness."

That "more demand" is the "core of the case" for (The Federal Government to borrow a lot of money and spend it on things labeled as) "public investment" admits up front that the actual value of such investment is at best secondary. Public investment in a great Ice Wall of Westeros on the southern border, or for high-speed trains from Tonopah to Winemucca, do just as well in boosting "demand."

What is needed is a serious negotiation: Fund needed infrastructure investment, but put in serious cost-benefit analysis,  buy it at reasonable prices, and so forth. That negotiation should start by abandoning the whole idea that we're doing it to provide "jobs" and "demand." If you're not wiling to do that, at least be honest and state that Mr. Trump's wall provides the same "demand."

Then explain to us how Japan has been at this for 20 years, producing no great shakes of growth.

"policy-approaches to... increasing worker's purchasing power" is another classic hidden-subject clause. I presume it means [The Federal Government, by legislation, regulation, or threat, will force companies to pay workers more, and then control employment to make sure those companies don't just fire workers or select better ones in order to ] increase [some] worker's purchasing power." Gary Johson's program also increases worker's purchasing power, and I don't think that's what Larry has in mind. I'm also curious where in modern economics forced transfers increase employment and long-run growth.

But in context, this is a small complaint. If Larry can persuade Mrs. Clinton and the "progressives" in the Democratic Party to focus on growth, to state goals for growth, and to hold themselves accountable for growth, then we can have an honest and very productive conversation about what's stopping growth and what steps can further it.

WSJ growth oped -- full version

WSJ Oped. Now that 30 days have passed, I can post the whole thing. Previous post.

Ending America’s Slow-Growth Tailspin

Sclerotic growth is America’s overriding economic problem. From 1950 to 2000, the U.S. economy grew at an average rate of 3.5% annually. Since 2000, it has grown at half that rate—1.76%. Even in the years since the bottom of the great recession in 2009, which should have been a time of fast catch-up growth, the economy has only grown at 2%. Last week’s 0.5% GDP report is merely the latest Groundhog Day repetition of dashed hopes.

The differences in these small percentages might seem minor, but over time they have big consequences. By 2008, the average American was more than three times better off than in 1952. Real GDP per person rose from $16,000 to $49,000. And those numbers understate the advances in the quality of goods, health and environment that came with growth. But if U.S. growth between 1950 and 2000 had been the 2% of recent years, instead of 3.5%, income per person in 2000 would have risen to just $23,000, not $50,000. That’s a huge difference.

Looking ahead, solving almost all of America’s problems hinges on re-establishing robust economic growth. Over the next 50 years, if income could be doubled relative to 2% growth, the U.S. would be able to pay for Social Security, Medicare, defense, environmental concerns and the debt. Halve that income gain, and none of those spending challenges can be addressed. Doubling income per capita would help the less well off far more than any imaginable transfer scheme.


Why is growth slowing down? One camp says that we’ve run out of ideas. We were supposed to have flying cars and all we got was Twitter. Get used to it, the thinking goes, and start fighting over the shrinking pie.

Another camp holds that the culprit is “secular stagnation,” a “savings glut” demanding sharply negative interest rates that the Federal Reserve cannot deliver. That outlook attracts clever new economic theories and promotes vast new stimulus spending of the sort that Japan has fruitlessly followed.

The third camp (mine) holds that the U.S. economy is simply overrun by an out-of-control and increasingly politicized regulatory state. If it takes years to get the permits to start projects and mountains of paper to hire people, if every step risks a new criminal investigation, people don’t invest, hire or innovate. The U.S. needs simple, common-sense, Adam Smith policies.

America is middle-aged and overweight. The first camp says, well, that’s nature, stop complaining. The second camp looks for the latest miracle diet—try the 10-day detox cleanse! The third camp says get back to the tried, true and sometimes painful: eat right and exercise.

The first two camps are doubtful. How much more growth is really possible from better policies? To get an idea, see the nearby chart plotting 2014 income per capita for 189 countries against the World Bank’s “Distance to Frontier” ease-of-doing-business measure for the same year. The measure combines individual indicators, including starting a business, dealing with construction permits, protecting minority investors, paying taxes and trading across borders. Unlike the more popular ease-of-doing business rankings, this is a measure of how good or bad things are with 100 being the best observed so far, or “Frontier,” score.

In general, the higher a country’s score, the higher its per capita income. The Central African Republic scores a dismal 33, and has an annual per capita income of just $328. Compare that to India (50.3, $1,455), China (61, $7,000) and the U.S. (82, $53,000).

The U.S. scores well, but there is plenty of room for improvement. A score of 100 unites the best already-observed performance in each category. So a score of 100—labeled Frontier—is certainly possible. And, following the fitted line in the chart, Frontier generates $163,000 of income per capita, 209% better than the U.S., or 6% additional annual growth for 20 years. If America could improve on the best seen in other countries by 10%, a 110 score would generate $400,000 income per capita, a 650% improvement, or 15% additional growth for 20 years.

If you think these numbers are absurd, consider China. Between 2000 and 2014, China averaged 15% growth and a 700% improvement in income per capita. This growth did not follow from some grand stimulus or central plan; Mao tried that in the 1960s, producing famine, not steel. China just turned an awful business climate into a moderately bad one.

It is amazing that governments can do so much damage. Yet the evidence of the graph is strong. The nearly controlled experimental comparison of North Korea versus South Korea, or East Germany versus West Germany, is stronger. But if bad institutions can do such enormous harm, it follows inescapably that better institutions can do enormous good.

A growth agenda doesn’t fit neatly into current policy debates. This is fortunate, as new ideas are easier to swallow than defeats.

Parties argue over tax rates, but what’s really needed is deep tax reform, cleaning out the insane complexity and cronyism.

Parties argue over how much to raise or cut spending for social programs, but what’s needed is a thorough overhaul of the programs’ pernicious incentives. For example, Social Security disability needs to remove its disincentives to work, move or change careers.

Parties argue about education spending, but America needs the better schools that come from increased choice and competition.

Most of all, the country needs a dramatic legal and regulatory simplification, restoring the rule of law. Middle-aged America is living in a hoarder’s house of a legal system. State and local impediments such as occupational licensing and zoning are also part of the problem.

Growth-oriented policies will be resisted. Growth comes from productivity, which comes from new technologies and new companies. These displace the profits of old companies, and the healthy pay and settled lives of their managers and workers. Economic regulation is largely designed to protect profits, jobs and wages tied to old ways of doing things. Everyone likes growth, but only in someone else’s backyard.

There is hope. Washington lawmakers need to bring about a grand bargain, moving the debate from “they’re getting their special deal, I want mine,” to “I’m losing my special deal, so they’d better lose theirs too.” While the current presidential front-runners are not championing economic growth, House Speaker Paul Ryan (R., Wis.) and other House members are. And if economic-policy leadership moves from a chaotic presidency to a well-run Congress, that may be healthy for America’s political system as well as for the economy.

Update: response to some criticis

Summers on roadblocks to infrastructure

The bureaucrats of Massachusetts have done the nation a wonderful service, by parking an abject lesson in America's infrastructure sclerosis right in front of Larry Summers' office.

Summers and Rachel Lipson have written a remarkable Op-Ed in the Boston Globe, and Larry a deeper follow-on piece on the Washington Post Wonkblog, detailing the 5 year struggle to repair a bridge that took 11 months to build in 1911.

The narrow story:

How, we ask, could our society have regressed to the point where a bridge that could be built in less than a year one century ago takes five times as long to repair today?

In order to adhere to strict historical requirements overseen by the Massachusetts Historical Commission, the Massachusetts Department of Transportation had to order special bricks, cast by a company in Maine, to meet special size and appearance specifications from the bridge’s inception in 1912.

...extensive permitting and redesigns haven’t helped. 

And the rest reads like a typical Wall Street Journal oped anecdote of regulatory incompetence, fodder for my next weekly summary.

Larry's Post follow on is deeper:

Investigating the reasons behind the bridge blunders have helped to illuminate an aspect of American sclerosis — a gaggle of regulators and veto players, each with the power to block or to delay, ...

At one level this explains why, despite the overwhelming case for infrastructure investment, there is so much resistance from those who think it will be carried out ineptly. 

Stop for a moment here. This sentence is a watershed moment. Larry is one of our foremost public-intellectual economists. He's been arguing for years for infrastructure spending, first as "shovel-ready" stimulus to fight the recession, lately as the remedy for "secular stagnation." So far, he's been arguing mostly for more money, and not highlighting regulatory roadblocks. The Democratic party (not Larry) line is that infrastructure is the fault of stingy Republicans who won't spend the money.

But here is Larry, listening, and urging his readers to listen. Savor the sentence: "This explains why.. there is so much resistance from those who think it will be carried out ineptly." How often, in American public life these days, do we see a prominent, party-aligned, public intellectual listen hard and understand what's bothering the other side? No, it's not that they are stingy, mean-hearted, evil, or whatever. It's that they don't trust the money to be spent on the right thing, in the right place, in finite time. They have a point.

(I had a conversation with Larry a while ago, that went something like this: Larry: We need more infrastructure, and borrowing money is really cheap right now! John: Yeah, but they'll just blow the money on a high-speed rail line from Tonopah to Winnemucca, and even that will be held up for 10 years of EPA reviews and lawsuits. Larry: Oh, John, there you go again exaggerating how bad regulations are... Maybe I can flatter myself that I nudged him a little here.)

The right response is to advocate for reforms in procurement policies, regulatory policies and government procedures to make the investment process more efficient and effective.

This is a watershed. Here is the kind of reach out for middle ground that could unlock our political and economic sclerosis.  Larry is likely to be in government again sooner or later, and I hope he will push hard for this -- and with more effect than the last hundred or so anti-red-tape and regulatory reform commissions.

Larry's change of heart, or at least change of emphasis, seems deeper:

I'm a progressive, but it seems plausible to wonder if  government can build a nation abroad, fight social decay, run schools, mandate the design of cars, run health insurance exchanges, or set proper sexual harassment policies on college campuses, if it can't even fix a 232-foot bridge competently. Waiting in traffic over the Anderson Bridge, I've empathized with the two-thirds of Americans who distrust government.

It's not about who cares. It's about competence. We can work together to fix this. Wow. Thank you, Massachusetts Historical Commission.

More than questions of personality or even those of high policy, the question of how to escape this trap should be a central issue in this election year

That is not likely to happen in our Presidential race, but it surely should be a focus of Congressional elections, and the realignments happening now in Congress to try to escape paralysis.

In that context, I heard recently of one lovely small proposal to help "escape this trap." If you're fixing a bridge that is already there, you are exempt:

Amendment 4065 Mr. SULLIVAN [Senator Dan Sullivan, Alaska] (for himself and Mr. King [Angus King, Maine] submitted an amendment ....to the bill H.R. 2577... as follows:

Any bridge eligible for assistance under title 23, United States Code, that is structurally deficient and requires construction, reconstruction, or maintenance--

(1) may be reconstructed in the same location with the same capacity and dimensions as in existence on the date of enactment of this Act; and

(2) if the environmental impacts of the construction, reconstruction, or maintenance are not substantially greater than the environmental impacts of the original structure, as determined by the applicable State environmental authority, shall be considered to be compliant with the environmental reviews, approvals, licensing, and permit requirements under--

(A) the National Environmental Policy Act of 1969 (42 U.S.C. 4321 et seq.);

(B) sections 402 and 404 of the Federal Water Pollution Control Act (33 U.S.C. 1342, 1344);

(C) division A of subtitle III of title 54, United States Code;

(D) the Migratory Bird Treaty Act (16 U.S.C. 703 et seq.);

(E) the Wild and Scenic Rivers Act (16 U.S.C. 1271 et seq.);

(F) the Fish and Wildlife Coordination Act (16 U.S.C. 661 et seq.);

(G) the Endangered Species Act of 1973 (16 U.S.C. 1531 et seq.), except when the reconstruction occurs in designated critical habitat for threatened and endangered species;

(H) Executive Order 11990 (42 U.S.C. 4321 note; relating to the protection of wetland); and

(I) any Federal law (including regulations) requiring no net loss of wetland.

I kept the long list as a reminder of just how many laws and regulations are in the way of fixing a bridge. Alas, the Senators forgot about the National Historic Preservation Act of 1966, which seems to be mainly behind Larry's traffic jam.

I gather this amendment provoked a  specific veto threat. Well, maybe next time.

Global Imbalances

I gave some comments on “Global Imbalances and Currency Wars at the ZLB,” by Ricardo J. Caballero, Emmanuel Farhi, and Pierre-Olivier Gourinchas at the conference, “International Monetary Stability: Past, Present and Future”, Hoover Institution, May 5 2016. My comments are here, the paper is here 

The paper is a very clever and detailed model of "Global Imbalances," "Safe asset shortages" and the zero bound. A country's inability to "produce safe assets" spills, at the zero bound, across to output fluctuations around the world. I disagree with just about everything, and outline an alternative world view.

A quick overview:

Why are interest rates so low? Pierre-Olivier & Co.: countries can't  “produce safe stores of value”
This is entirely a financial friction. Real investment opportunities are unchanged. Economies can’t “produce” enough pieces of paper. Me: Productivity is low, so marginal product of capital is low.

Why is growth so low? Pierre-Olivier: The Zero Lower Bound is a "tipping point." Above the ZLB, things are fine. Below ZLB, the extra saving from above drives output gaps. It's all gaps, demand. Me: Productivity is low, interest rates are low, so output and output growth are low.

Data: I Don't see a big change in dynamics at and before the ZLB. If anything, things are more stable now that central banks are stuck at zero. Too slow, but stable.  Gaps and unemployment are down. It's not "demand" anymore.


Exchange rates. Pierre-Olivier  "indeterminacy when at the ZLB” induces extra volatility. Central banks can try to "coordinate expectations." Me: FTPL gives determinacy, but volatility in exchange rates. There is no big difference at the ZLB.

Safe asset Shortages. Pierre-Olivier: driven by a large mass of infinitely risk averse agents. Risk premia are therefore just as high as in the crisis. Me: Risk premia seem low. And doesn't everyone complain about "reach for yield" and low risk premia?

Observation. These ingredients are plausible about fall 2008. But that's nearly 8 years ago! At some point we have to get past financial crisis theory to not-enough-growth theory.

But, finally, praise. This is a great paper. It clearly articulates a world view, and you can look at the assumptions and mechanisms and decide if you think they make sense. I am in awe that Pierre-Olivier & Co. were able to make a coherent model of these buzzwords.

But great theory is great theory. To a critic, the assumptions are necessary as well as sufficient. I  read it as a brilliant negative paper, almost a parody: Here are the extreme assumptions that it takes to justify all the policy blather about "savings gluts" "global imbalances" "safe asset shortages" and so on. To me, it shows just how empty the idea is, that our policy-makers understand any of this stuff at a scientific, empirically-tested level, and should take strong actions to offset the supposed problems these buzzwords allude to.

I hope this taste gets you to read  my comments and the paper. 

Next Steps for FTPL

Last Friday April 1, Eric Leeper Tom Coleman and I organized a conference at the Becker-Friedman Institute,  "Next Steps for the Fiscal Theory of the Price Level." Follow the link for the whole agenda, slides, and papers.

The theoretical controversies are behind us. But how do we use the fiscal theory, to understand historical episodes, data, policy, and policy regimes? The idea of the conference was to get together and help each other to map out this the agenda. The day started with history, moved on to monetary policy, and then to international issues.

A common theme was various forms of price-related fiscal rules, fiscal analogues to the Taylor rule of monetary policy. In a simple form, suppose primary surpluses rise with the price level, as
\[ b_t = \sum_{j=0}^{\infty} \beta^j \left( s_{0,t+j} + s_1 (P_{t+j} - P^\ast) \right) \]
where \(b_t\) is the real value of debt, \(s_{0,t}\) is a sequence of primary surpluses budgeted to pay off that debt, \(P^\ast\) is a price-level target and \(P_t\) is the price level. \(b_t\) can be real or nominal debt \( b_{t}= B_{t-1}/P_t\), but I write it as real debt to emphasize the point: This equation too can determine price levels \(P_t\). If inflation rises, the government raises taxes or cuts spending to soak up extra money. If inflation declines, the government does the opposite, putting extra money and debt in the economy but in a way that does not trigger higher future surpluses, so it does push up prices.

(Note: this post has embedded figures and mathjax equations. If the last paragraph is garbled or you don't see graphs below, go here.)

That idea surfaced in many of the papers.


The morning had several papers studying the gold standard and related historical arrangements. To a fiscal theorist the gold standard is really a fiscal commitment. No gold standard has ever backed its note issue 100%; and none has even dreamed of backing its nominal government debt 100%. If a government had that much gold, there would be no point to borrowing.

So a gold standard is a  commitment to raise taxes, or to borrow against credible future taxes, to get enough gold should it ever be needed. The gold standard says, we commit to pay off this debt at one, and only one, price level. If inflation gets big, people will start to want to exchange money for gold, and we'll raise taxes. If inflation gets too low, people wills tart to exchange gold for money, and we'll print it up as needed. Usually, in the fiscal theory,
\[ \frac{B_{t-1}}{P_t} = E_t \sum_{j=0}^{\infty} \beta^j s_{t+j}\]
the expectation of future surpluses is a bit nebulous, so inflation might wander around a lot like stock prices. The gold standard is a way to commit to just the right path of surpluses that stabilize the price level.

A summary, with apologies in advance to authors whose points I missed or misunderstood:

Part I: History

George Hall presented his work with Tom Sargent on the history of US debt limits, together with a fantastic new data set on US debt that will be very useful going forward.

Price of a Chariot Horse: 100,000 Denarii

François Velde and Christophe Chalmley took us on a lighting tour of monetary arrangements across history, prompting a thoughtful discussion on just where Fiscal theory starts to matter and where it really is not relevant. (François easily gets the prize for the best set of slides. Picking just one was hard.)

Michael Bordo and Arunima Sinha presented an analysis of suspensions of convertibility: Governments temporarily abandon the gold standard during war, then go back at parity afterward. Maybe. By going back afterward, people are willing to hold a lot of unbacked debt and currency during the war. But sometimes the fiscal resources to go back afterward are tough to get, the benefits of establishing credibility so you can borrow in the next war seem further off. When people are unsure whether the country will go back, the wartime inflation is worse, and the cost of going back on parity are heavier. They analyze France vs. UK after WWI.

Martin Kleim took us on a tour of a big inflation in a previous European currency union, the Holy Roman Empire in the early 1600s. Europe has had currency union without fiscal union for a long time, under various metallic standards and coinages.  In this case small states, under fiscal pressure from the 30 years' war, started to debase small coins, leading to a large inflation. It ended with an agreement to go back to parity, with the states absorbing the losses. (In my equation, they needed a lot of surpluses to match \(P\) with \(P^\ast\)). We had an interesting discussion on just where those funds came from. Disinflation is always and everywhere a fiscal reform.

Margaret Jacobson presented her work with Eric Leeper and Bruce Preston on the end of the gold standard in the US in the 1930s. (Eric modestly stated his contribution to the paper as finding the matlab color code for gold, as shown in the graph.)  Margaret and Eric interpret the fiscal statements of the Roosevelt Administration to say that they would run unbacked deficits until the price level returned to its previous level, the \(P^\ast\) in my above equation.  Much discussion followed on how governments today, if they really want inflation, could achieve something similar.

 Part II Monetary Policy 

Chris Sims took on that issue directly. If you want inflation, just running big deficits might not help. Hundreds of years in which governments built up hard-won reputations that when they borrow money, they pay it off, are hard to upend immediately. Even if you want to break that expectation -- all our governments have mixed promises of stimulus now with deficit reduction later.  A devaluation would help, but we don't have a gold standard against which to devalue, and not everyone can devalue relative to each other's currency.

Chris' bottom line is a lot like Margaret and Eric's, and my fiscal Taylor rule,

Coordinating fiscal and monetary policy so that both are explicitly contingent on reaching an inflation target — not only interest rates low, but no tax increases or spending cuts until inflation rises. 

But,

• This might work because it would represent such a shift in political economy that people would rethink their inflation expectations.

Chris led a long discussion including thoughts on rational expectations -- it's a stretch to impose rational expectations on policies that have never been tried before (though our history lesson reminded us just how few genuinely novel policies there are!)

Steve Williamson followed with a thoughtful model full of surprising results. The stock of money does not matter, but fed transfers to the treasury do. (I hope I got that right!)

My presentation (slides also  here  on my webpage) took on the "agenda" question. The basic fiscal equation is
\[\frac{B_{t-1}}{P_t} = E_t \sum M_{t,t+j} s_{t+j} \]
For the project of matching history, data, analyzing policy and finding better regimes, I opined we have spent too much time on the \(s\) fiscal part, and not nearly enough time on the \(M\) discount rate part, or the \(B\) part, which I map to monetary policy.

I argued that in order to understand the cyclical variation of inflation -- in recessions inflation declines while \(B\) is rising and \(s\) is declining -- we need to focus on discount rate variation. More generally, changes in the value of government debt due to interest rate variation are plausibly much bigger than changes in expected surpluses. As interest rates rise, government debt will be worth a lot less, an additionan inflationary pressure that is often overlooked.

Then I presented short versions of recent papers analyzing monetary policy in the fiscal theory of the price level. Interest rate targets with no change in surpluses can determine expected inflation, but the neo-Fisherian conundrum remains.

Harald Uhlig presented a skeptical view, provoking much discussion.  Some main points: large debt and deficits are not associated with inflation, and M2 demand is stable.

I found Harald's critique quite useful. Even if you don't agree with something, knowing that this is how a really sharp and well informed macroeconomist perceives the issues is a vital lesson. I answered somewhat impertinently that we addressed these issues 15 years ago: High debt comes with large expected surpluses, just as in financing a war, because governments want to borrow without creating inflation. The stability of M2 velocity does not isolate cause and effect. The chocolate/GDP ratio is stable too, but eating more chocolate will not increase GDP.

But Harald knows this, and his overall point resonates: You guys need to find something like MV=PY that easily organizes historical events. The obvious graph doesn't work. Irving Fisher came up with MV=PY, but it took Friedman and Schwartz using it to make the idea come alive. That is the purpose of the whole conference.

Francesco Bianchi presented his work with Leonardo Melosi on the Great Recession. New Keynesian models typically predict huge deflation at the zero bound. Why didn't this happen? They specify a model with shifting fiscal vs money dominant regimes. The standard model specifies that once we leave the zero bound we go right back to a money-dominant, Taylor-rule regime with passive fiscal policy. However, if there is a chance of going back to a fiscal-dominant regime for a while, that changes expectations of inflation at the end of the zero bound. Even small changes in those expectations have big effects on inflation during the zero bound (Shameless plug for the New Keynesian Liquidity Trap which explains this point very simply.) So, as you see in the graph above, the "benchmark" model which includes a probability of reverting to a fiscal regime after the zero bound, produces the mild recession and disinflation we have seen, compared to the standard model prediction of a huge depression.

Fiscal policy is political of course. Campbell Leith presented, among other things,  an intriguing tour of how political scientists think about political determinants of debt and deficits. My snarky quip, we learned with great precision that political scientists don't know a heck of a lot more than we do! But if so, that is also wisdom.

Part III International

red line regime switching probability of 30%, blue line 0 % 

Alexander Kriwoluzky presented thoughts on a fiscal theory of exchange rates, applying it to the US vs. Germany, the abandonment of the gold standard and switch to floating rates in the early 1970s. An exchange rate peg means that Germany must import US fiscal policy as well, importing the deficits that support more inflation. Germany didn't want to do that.  People knew that, so a shift to floating rates was in the air. Expectations of that shift can explain the interest differential and apparent failure of uncovered interest parity.

Last but certainly not least, Bartosz Maćkowiak presented a thoughtful analysis of "Monetary-Fiscal Interactions and the Euro Area’s Malaise" joint work with Marek Jarosińsky.

Echoing the fiscal Taylor rule idea running through so many talks, they propose a fiscal rule
\[ S_{n,t} = \Psi_n + \Psi_B \left( B_{n,t-1} - \sum_n \theta_n B_{n,t-1} \right) + \psi_n (Y_{n,t}-Y_n) \]
In words, each country's surplus must react to that country's debt \(B_n\), but total EU surpluses do not react to total EU debt. In this way, the EU is "Ricardian" or "fiscal passive" for each country, but it is "non-Ricardian" or "fiscal active" for the EU as a whole. In their simulations, this fiscal commitment has the same beneficial effects running through Leeper and Jabcobson, Bianchi and Melosi, Sims, and others -- but maintaining the idea that individual countries pay their debts.

A big thanks to the Harris School and the Becker-Friedman Institute who sponsored the conference.

Deflation Puzzle

Larry Summers writes an eloquent FT column "A world stumped by stubbornly low inflation"

Market measures of inflation expectations have been collapsing and on the Fed’s preferred inflation measure are now in the range of 1-1.25 per cent over the next decade.

Inflation expectations are even lower in Europe and Japan. Survey measures have shown sharp declines in recent months. Commodity prices are at multi-decade lows and the dollar has only risen as rapidly as in the past 18 months twice during the past 40 years when it has fluctuated widely

And the Fed is forecasting a return to its 2 per cent inflation target on the basis of models that are not convincing to most outside observers. 

Central bankers [at the G20 meeting] communicated a sense that there was relatively little left that they can do to strengthen growth or even to raise inflation. This message was reinforced by the highly negative market reaction to Japan’s move to negative interest rates.

So why is inflation slowly declining despite our central banks' best efforts? Here is a stab at an answer. I emphasize the central logical points with bullets.

• Interest rates have two effects on inflation: a short-run "liquidity" effect, and a long-run "expected inflation" or "Fisher" effect.  

In normal times, to raise interest rates, the central bank sells bonds, which soaks up money. Less money drives up interest rates as people bid to borrow a smaller supply, and less money also reduces "demand," which reduces inflation.  In the long run, higher inflation and higher interest rates go together, as they did in the 1980s.

However, we are now in a classic "liquidity trap." Interest rates have been zero since 2008. Money and bonds are perfect substitutes. The proof of that is in the pudding: the Fed massively increased excess reserves from less than $50 billion to almost $3,000 billion, and inflation keeps trundling down.

• In a liquidity trap, the liquidity effect is absent. 

The liquidity effect will remain absent as the Fed starts raising interest rates, and would remain absent if the Fed were to cut rates or reduce them below zero as other central banks are doing. You can't have more than perfect liquidity.

The Fed isn't even planning to try. It plans to keep the $3,000 billion of excess reserves outstanding and raise interest rates by raising the interest rate on reserves. There will be no open market operations, no "tightening" associated with this interest rate raise.  But even if it did, we're $2,950 billion of excess reserves away from any liquidity effect, so it wouldn't matter.

• When the liquidity effect is absent, the expected inflation effect is all that remains. Inflation must follow interest rates. 

Central banks thought they were raising inflation by lowering interest rates, following experience from the normal-times liquidity-effect correlation between lower interest rates and higher inflation. But that experience does not apply when its liquidity effect is turned off.

With no liquidity effect, lowering interest rates further below zero can only, slowly, lower inflation further. Central banks desiring inflation may have followed a classic pedal mis-application.

Do I "believe" this story? Belief has no place in science. It is the simplest coherent story that explains the last few years, not needing lots of frictions, irrationalities, and other assumptions. I have some equations to back it up. But we don't "believe" anything at least until it's published and has survived critical examination, replication and dissection. Still, I think it merits consideration.

Shh. I like zero inflation. If central banks have the wrong pedal but are driving the right speed anyway, why wake them up? Even Larry seems to have given up on the Phillips curve:

...suppose that officials were comfortable with current policy settings based on the argument that Phillips curve models predicted that inflation would revert over time to target due to the supposed relationship between unemployment and price increases.

There is no sign of the dreaded "deflation vortex," any more than there is any sign of dreaded monetary hyperinflation. We're drifting down to the Friedman rule. As Larry emphasizes, don't get excited over forecasts from models that rather spectacularly did not forecast where we are today. 
Central banks' desire for 2% inflation, and the Fed's rather puzzling interpretation of its "price stability" mandate to mean perpetual 2% inflation may also be relics of the bygone liquidity-effect regime. 

Appreciate the first half of the column which turns the signs around. It's a great bit of rhetoric.

I have to register mild disagreement with Larry's "solution" to the supposed "problem," 

In all likelihood the important elements will be a combination of fiscal expansion drawing on the opportunity created by super low rates and, in extremis, further experimentation with unconventional monetary policies.

He doesn't say which monetary policies would work, given they have not done so yet. But these are topics for another day.

(Note: If quote and bullet formatting doesn't show up, come back to the original.)

Sanders multiplier magic

The critiques of Gerald Friedman's analysis of the Sanders economic plan  continue. The latest and most detailed and careful so far is by David and Christina Romer.

Bottom line:

1. The central idea in Friedman's analysis is that taking $1 from Peter to give to Paul raises overall income by 55 cents.  From this, you get multipliers from raising taxes and spending, from higher minimum wages, more unions, and so forth. 
2. I chuckle a little bit that so many economists who previously liked multipliers now don't like their logical conclusions. 
3. The Romers charge a serious, elementary arithmetic mistake in treating levels vs. growth rates. If they're right Friedman's whole analysis is just wrong on arithmetic.

The analysis

One might have expected that a sympathetic analysis of the Sanders plan would say, look, this is going to cost us a bit of growth, but the fairness and (claimed) better treatment of disadvantaged people are worth it.

Friedman's having none of that. In his analysis, the Sanders plan will also unleash a burst of growth, claims for which would make a fervent supply-sider like Art Laffer blush.

"The Sanders program... will raise the gross domestic product by 37% and per capita income by 33% in 2026; the growth rate of per capita GDP will increase from 1.7% a year to 4.5% a year." And, apparently, raise the growth rate permanently.

More stunning still are Friedman's claims about employment, shown at left here

and here.

Multipliers

So, where does this spurt of growth come from? The answer is the magic of multipliers.

But it's not just run of the mill fiscal stimulus multipliers.  After all, Friedman also says that the Sanders program would reduce the deficit, and by 2025 turn the Federal Budget to surplus!

How are multipliers so strong?

There seem to be two basic answers. First, Sanders assumes that there is a large multiplier from income transfers.

If the government takes $1 from rich Peter, and gives that $1 to poor Paul, overall income rises 55 cents! The one quote that makes this clearest is

The stimulus from regulator[y] changes is in Table 9. In general, the assumption is that wages have a multiplier of 0.9 compared with a multiplier of 0.35 for profits accruing to high-income persons. A wage increase coming out of profits, therefore, has a multiplier of 0.55.

It's also visible here explaining how a balanced budget still has a multiplier

the average value of the (governent spending) multiplier from 2017-26 is 0.89, falling from 1.25 to 0.87 as the output gap closes 

Other taxes are assumed to reduce effective demand with a multiplier of 0.35

[The] balance of revenue and spending programs will increase employment and economic growth because the spending program has a larger fiscal multiplier than do progressive tax increases. 

So tax $1 and spend $1 raises GDP by 54 cents.

He cites many standard sources for multipliers. He does not give a theory.  The standard story is that poor Paul consumes a lot more of his income, while rich Peter was investing it all in venture capital startups.  Consumption is good, savings is bad, so GDP rises.

From this central assumption, the rest of the magic follows.  Friedman creatively goes far beyond conventional deficit multipliers, to conjure multipliers out of tax increases, raises in the minimum wage, greater unionization, increased social program spending, and so forth. For example

 I assume that the Paycheck Fairness Act will raise women’s wages by 1% relative to men’s, and there will be an increase of 0.2% a year for the next decade.  I assume that 50% of the increased cost goes to higher prices and 50% comes from profits, and these are assumed to lower spending by higher income people with a multiplier of 0.35.

This, I think, is the central case. Admire it for its courage, and creative use of Keynesian arguments. These are the kind of interventions that most economists admit reduce growth, but some argue for on other grounds. But in Keynesian economics, taking money from low marginal propensity to consume people, and giving it to high marginal propensity to consume people raises GDP.

Snark

At this point, I stop in a bit of amusement at all the criticism. After all, these are just standard Keynesian arguments. The individual multipliers in Friedman's analysis are all conservative, and cite standard middle-of-the-road sources. The economists now so critical of this analysis, including the Romers, former democratic administration CEA chairs who wrote the open letter from past CEA chairs, and Paul Krugman, have been making big multiplier arguments for years to argue for more spending.  The "new Keynesian" academic literature includes multipliers far above two, so one can point to "science" if you wish. (Gauti Eggertsson, Christiano, Eichenbaum and Rebelo ; a simple example with multipliers as large as you want.)

The Romers are right to emphasize that multipliers only operate where "demand" is slack, and monetary policy doesn't steal the show. But the asterisks about fixed interest rates and output below "capacity" have been overlooked by the mainstream many times before. It's a rare Keynesian economist who ever thinks the economy is operating at full capacity. And Friedman has the former monetary asterisk, and he addresses the latter by claiming a large return to the labor force and increased productivity.

Even that view is not so out of the mainstream. For example,  Brad DeLong and Larry Summers wrote an influential Brookings paper arguing for very large fiscal multipliers, with some of the same flavor. There is hysterisis; a multiplier will bring people back to the labor market (as Friedman claims), those people will regain skills, productivity will increase; higher investment will give us better capital and also increase productivity. Demand creates its own supply.

Friedman is apparently just taking the consumption-first, poor-people-spend-more-than-rich-people, undergraduate ISLM analysis, with a bit of Delong-Summers hysterisis, to its logical conclusion. I agree in a way: take those ideas to their logical conclusion and you get silly propositions (old essay on that). Robbing Peter to pay Paul raises income; wasted government spending is good; theft improves the economy, transfers even from thrifty poor to spendthrift rich improve the economy, hurricanes are good for us, social programs, unions, minimum wages raise GDP, and so forth. Well, if the logical conclusions are patently silly, maybe one shouldn't have been making small versions of those arguments all along. Economic Homeopathy is not wisdom. 

Arithmetic 

But the Romers uncover a deeper puzzle. Even with these assumptions -- government spending multipliers around 0.8, and a transfer multiplier of around 0.55 -- you still don't get the wild increase in growth that Friedman claims. So how does he do it? Their answer: 

We have a conjecture about how Friedman may have incorrectly found such large effects. Suppose one is considering a permanent increase in government spending of 1% of GDP, and suppose one assumes that government spending raises output one-for-one. Then one might be tempted to think that the program would raise output growth each year by a percentage point, and so raise the level of output after a decade by about 10%. In fact, however, in this scenario there is no additional stimulus after the first year. As a result, each year the spending would raise the level of output by 1% relative to what it would have been otherwise, and so the impact on the level of output after a decade would be only 1%.

If this is right, it's absolutely damning. This is a question of arithmetic, not economics. (And I would have to swallow some of my above snark!) 

A clearer (maybe) example: The government spends an extra $1 for one year.  With a 1.0 multiplier GDP goes up $1 that year, period. If the government stops spending next year, GDP goes back to where it was. That's the conventional definition of multiplier, and the one that all Fridman's cited sources have in mind. Per Romers, Friedman misread that calculation and assumed the first $1 of spending raises GDP by $1 forever. In 10 years, you have a multiplier of 10! 

The Romers are cautious, and don't directly make this charge. It's not my job to get into the Hilary vs. Bernie whose-numbers-add-up fight. (At least someone here actually seems to care about numbers and economic plans!) But whether the spreadsheets make this arithmetic mistake or not is an answerable question. I hope to inspire someone with a spreadsheet and a nose for such things to check. This is a great time for a replication exercise! 

(Note: This post has pictures and quotes, which don't translate well when the post is picked up elswhere. If you're not seeing them, come back to the original.)

Update: Joakim Book tries to reproduce the numbers and comes up way short.

Update 2: Justin Wolfers at the New York Times did some old-fashioned journalism: He called up Friedman for a reaction.  The article is great, and clear. Yes, Friedman did the calculation as the Romers allege: An extra dollar of government spending today raises GDP permanently; an extra dollar of permanent government spending raises GDP growth permanently. That is at least not what the cited sources have in mind.

Negative rates and FTPL

I've devoted most of my monetary economics research agenda to the Fiscal Theory of the Price Level in the last two decades (collection here). This theory says, fundamentally, that money has value because the government accepts it for taxes, and inflation is fundamentally a fiscal phenomenon over which central banks' conventional tools -- open market operations trading money for government bonds -- have limited power.

Since I grew up in the 1970s, I figured the FTPL would have its day when inflation unexpectedly broke out, again, and central banks were powerless to stop it. I figured that the spread of interest-paying electronic money would so clearly undermine the foundations of MV=PY that its pleasant stories would be quickly abandoned as no longer relevant.

I may have been  exactly wrong on both points: It seems that uncontrolled disinflation or deflation will be the spark for adoption of FTPL ideas; that the equivalence of money and bonds at zero interest rates,  and central banks powerless to create inflation will be the trigger.

These thoughts are prodded by two pieces in the Economist, "Out of Ammo:" and "Unfamiliar Ways Forward" (HT and interesting discussion by Miles Kimball)

If you want inflation (a big if -- I don't, but let's go with the if) how do you get it? Ultra-low rates, huge bond purchases, and lots of talk (forward guidance, higher inflation targets) seem to have no effect. What can governments actually do?


"Out of ammo" explains

... At least some of them [politicians] have failed to grasp the need to have fiscal and monetary policy operating in concert....

... One such option is to finance public spending (or tax cuts) directly by printing money—known as a “helicopter drop”. Unlike QE, a helicopter drop bypasses banks and financial markets, and puts freshly printed cash straight into people’s pockets. The sheer recklessness of this would, in theory, encourage people to spend the windfall, not save it. 

The "recklessness" part is crucial. "Unfamiliar ways" has a more intricate scheme to communicate that recklessness

..a central bank and its finance ministry ... collude in printing money to pay for public spending (or tax cuts). ...the government announces a tax rebate and issues bonds to finance it, but instead of selling them to private investors swaps them for a deposit with the central bank. The central bank proceeds to cancel the bonds, and the government withdraws the money it has on deposit and gives it to citizens. “Helicopter money” of this sort—named in honour of a parable told by Milton Friedman, a famous economist—is as close as you can get to raining cash from a clear blue sky like manna from heaven, untouched by banks and financial markets.

Such largesse is, in effect, fiscal policy financed by money instead of bonds... But the unaccustomed drama—indeed, the apparent recklessness—of helicopter money could increase the expected inflation rate, encouraging taxpayers to spend rather than save.

Simpler, in my mind, the Treasury borrows and sends checks to voters. The Fed buys the bonds and then cancels them.

In addition to rather convoluted scheme, the pieces are not quite clear why the fiscal counterpart is necessary -- or why money has to be involved with fiscal policy.  That was not a central part of Friedman's helicopters. Miles is clearer about this:

the government give[s] away so much money that people would be convinced there was no way the government could ever sell enough bonds to soak that money up. 

This is clear and good FTPL thinking. The value of money is set by how much there is vs how much people expect the government to soak up via taxes -- or bond sales, backed by credible promises of future taxes.

If the government drops $100 in every voter's pocket but simultaneously announces "austerity" that taxes are going up $100 tomorrow, even helicopter drops would have no effect.

Helicopter drops are a clever fiscal signaling device. Canceling the bonds in the Economists plan is the crucial signaling device. They say "we are really going to be reckless."  When governments sell a lot of bonds, people think  the government is sooner or later going to soak up these bonds with taxes, and do not spend. That's the whole point -- bond sales are set up to raise revenue, not to create inflation.  The whole canceling the bonds thing in the Economists's plan, or the helicopter drama in Friedman's, is a clever psychological device, to convince people that no, the government is not going to raise taxes to soak money or underlying bonds up, so you'd better spend it now before it loses value.

Well if (if) our central banks want inflation, why not get out the helicopters?

Such shenanigans are not possible in the euro zone, where the ECB is forbidden by treaty from buying government bonds directly. Elsewhere they might work as follows: 

monetary financing is prohibited by the treaties underpinning the euro, for example

The US Federal reserve is similarly constrained to always buy something in return for creating money -- it can't send checks to voters.

Why?  The people who set up our monetary systems understood all this very well. Their memories were full of disastrous inflations, and they understood that printing money without clear promises that taxes would eventually soak up that money would lead quickly to inflation. So, yes, central banks are prohibited from doing the one thing that would most quickly produce inflation! For about the same reason that wise parents don't keep the car keys in the liquor cabinet.  (There are also all sorts of good political economy reasons that an independent central bank should not lend to specific businesses or send checks to voters.)

The Economist articles are also quite good at the evidence that current monetary policy is essentially powerless.

If policymakers appear defenceless in the face of a fresh threat to the world economy, it is in part because they have so little to show for their past efforts. The balance-sheets of the rich world’s main central banks have been pumped up to between 20% and 25% of GDP by the successive bouts of QE with which they have injected money into their economies (see chart 1). The Bank of Japan’s assets are a whopping 77% of GDP. Yet inflation has been persistently below the 2% goal that central banks aim for.

The power of open market operations -- buying bonds in return for money - is just dramatically refuted, at least at zero interest rates, by recent experience.

One way to get them back up might be to set a higher inflation target. But when inflation sits so persistently below today’s targets, persuading people that higher targets would produce higher rates will require action, not just words.

Or as I call it, the speak loudly because you have no stick policy. If central banks announce a 5% inflation target, and inflation goes down anyway, now what? Announce a 10% target?

Miles goes on about the power of negative interest rates to stoke inflation, which will be a topic for another day. If negative 2% real rates (2% inflation, 0% interest) didn't stoke "demand" and revive the extinct Phillips curve,  I don't see how negative 3% (2% inflation  -1% interest rate) or negative 5% will finally do the trick. In the standard models I've been playing with,  raising nominal interest rates, and committing to keep them there, is the way for central banks to raise expected inflation. That action would, however, also cool the economy, producing stagflation, and thus be particularly pointless.

I also fully admit that I'm cherry-picking the things I like from the Economist article, and ignoring all sorts of things that seem pretty silly to me. The point: I'm glad to see fiscal-theory thinking making its way out of academic debate into real-world commentary, if only in the "radical ideas" section.  Now, on to the "conventional wisdom" section!

Greece and Taxes

An interview for the Greek Reporter, in English, perhaps cheering the like-minded and sure to infuriate some conventional wisdom.

I agree with the "anti-austerians" on one point: Raising taxes was a bad idea. In my emphasis what counts are marginal tax rates on growth-producing activities, rather than Keynesian pump-priming, however, which is an important distinction.

The article says "A recently released study by the Economics Department at the National Kapodistrian University of Athens revealed that Greece has the third highest taxation rate among 21 European countries." If anyone has a link, especially if it's in English, send it in the comments.

Small shoes and headroom

I talked with Kathleen Hays and Michael McKee on Bloomberg Radio last week, and they asked (twice!) a question that comes up often in thinking about Fed policy: shouldn't the Fed raise rates now, so it has some "headroom" to lower them again if another recession should strike?

I could only answer with my standard joke: That's like the theory that you should wear shoes two sizes too small because it feels so good to take them off at the end of the day.

But the question comes up so often, it's worth thinking about a little more seriously. Under what views about the economy does this common idea make any sense?

One way to think about the question: is the effect of interest rates on the economy path-dependent, so that a given level of short-term interest rates has more "stimulative" effect if it comes from a previously high value than if short-term interest rates were zero all along?

The usual answer is no. The model is usually a linear system, in which lowering the rate from a high value has the same effect as raising to the same rate coming from a low value.  In fact, the usual model goes the other way:  If, say, a new recession hits in June 2017 and you want more stimulus then,  having had rates at zero all along is more "stimulative" than having raised them to 3% between now and then, and lowering rates all of a sudden.  In equations, if \(y_t = \sum \theta_j i_{t-j} + \varepsilon_{t} \) with \(\theta_j \ge0 \) then the partial derivative of any \(y_t\) with respect to any \(i_{t-j}\) is the same no matter what the path of interest rates before time \( t-j\), and raising \( i_t \) today lowers future \( y_{t+j} \) given any set of shocks \(\{\varepsilon_t\}\)  You need some sort of nonlinear system where a higher interest rate today \(i_t\)  makes \( y_{t+j}\) more sensitive to some future rate  \(i_{t+k} \).

Another way to think about this question is to think about what sort of state variables the interest rate affects. If the Fed raises rates now, the economy will be in a different state in June 2017. So in what view of things does raising rates now put the economy in state such that the economy can better weather a shock, or, more to the point, a state in which lowering rates back to zero will be more "stimulative" than if rates were zero all along? People usually think that raising rates between now and May 2017 would lower inflation, output and employment over what they would have been otherwise. Then, once rates go to zero again in June 2017, inflation, output, and employment will be lower than if interest rates had been zero all along.

If the economy were to boom on its own, with inflation, output and employment rising, and the Fed were to follow that good news by raising rates, then yes the Fed would have more "headroom." But that's not an argument that the Fed can get the "headroom" by acting now.

In fact, the opposite  story has been told by those who advocate forward guidance and raising the inflation target. They argue that the Fed should keep rates lower and for longer, in order to raise inflation (the "state variable"). Higher inflation then indeed gives the Fed "headroom" to lower real rates by lowering nominal rates in the next recession.

What does it take to turn this around, and to justify the idea that raising rates gives "headroom" to lower them in the future? The main answer I can think of is to turn the conventional stories around. Suppose that raising interest rates raises inflation, as I have speculated before (here). The desired "headroom" is the desire to raise inflation, so that when June 2017 comes around the same nominal rate (0) corresponds to a lower real rate. I doubt many people articulating the policy view want to travel to Fisher-land and reverse the effect of interest rates on inflation.

You still need a second belief: that despite the wrong sign on inflation the conventional theory has the right sign on output: That lowering rates in June 2017 will fight that recession, even as it will lower inflation again. My little model didn't deliver that. Maybe other models do.

Loud disclaimer: I'm not advocating any position here. I'm just thinking out loud about what kind of views, if any, lie behind this common idea that raising rates now gives the Fed some sort of "headroom" to stimulate the economy in the event of a future recession.

This is a good case for real economic models. There is a lot of cause and effect chat surrounding monetary policy and financial policy that is way ahead of (if you're being polite) or outside of (if you're being accurate) any well-understood or even well-articulated economic model. By tying ideas together, perhaps a policy belief ("headroom") can open one's mind to an interesting causal channel (Fisher equation), or perhaps seeing that channel needed can reverse a policy belief.

Blanchard on Countours of Policy

Olivier Blanchard, (IMF research director) has a thoughtful blog post, Contours of Macroeconomic Policy in the Future. In part it's background for the IMF's upcoming conference with the charming title Rethinking Macro Policy III: Progress or Confusion?” (You can guess my choice.)

Olivier cleanly poses some questions which in his view are likely to be the focus of policy-world debate for the next few years.  Looking for policy-oriented thesis topics? It's a one-stop shop.

Whether these should be the questions is another matter. (Mostly no, in my view.)

As a blogger, I can't resist a few pithy answers. But please note, I'm mostly having fun, and the questions and essay are much more serious.

Financial regulation

... Where do we stand? Are some dimensions of systemic risk easier to measure (e.g., leverage in the banking sector vs. interconnectedness of banks and non-banks or risks outside the banking sector)? How should we assess the experience with stress-tests?  And have we made enough progress in reducing systemic risk since the crisis, e.g., with Dodd-Frank, the Vickers commission, the Financial Stability Board, etc?

Answer: "Systemic risk" is barely defined. The idea that regulators will, this time, really really, understand risks taken by the big banks, see trouble ahead, and stop the banks from failing, is a triumph of hope over repeated experience.
The only progress -- and it's big -- is the slow realization that banks can and should issue lots more equity.

Macro Prudential Policies

... Do we have or can we develop tools to deal with the different types of risk, from high housing prices, to insufficient capital in some financial institutions, to sudden drops in liquidity in some financial markets?

Using these tools ...raises political economy issues.  In a housing boom, increasing the loan to value ratio may be politically difficult.  Questions:  Given these issues, when should we use macro prudential tools, or should we use tougher, non contingent financial regulation? To be concrete, should we aim for variable capital ratios and decide when to adjust them, or just give up on the variable part, and aim for high but constant capital ratios?

Answer: The hubris that the Davos set will be able to figure out just the right amount of capital, and then fine-tune that month-to-month and bank-to-bank is astounding. "Political economy concerns" is putting it mildly. The IMF's "bubble" or "imbalance" is the local Congressman's boom, and he or she will be hopping mad if the Fed restricts credit to his district or pet industry in favor of another. 

The fact that our regulators are still talking about liquidity betrays a fundamental confusion of individual vs. systemic risks. Liquidity is the plan, "if we lose money we'll sell assets." To who? Regulators demanding liquidity to plan for a financial crisis is like the FAA making sure everyone on the plane has enough money to buy a parachute in case of engine failure.  

Finally, it is clear that both financial regulation and macro prudential tools are likely to lead financial actors to adjust and explore ways of getting around them. Questions:  In this game of cat and mouse, can the macro prudential regulators hope to win?  Or will regulation and tools become increasingly complex and possibly counterproductive?

That's easy. No and Yes. Actually I'm being too pessimistic. Regulatory capture works both ways. An easy forecast: Stress-testers at the Fed will be getting lucrative salary offers to move to the private sector and help pass stress tests. Which they will increasingly do. 

Monetary Policy 

...  Questions:  Under the highly realistic assumption that financial regulation and macroprudential tools do not fully take care of financial stability, [Highly realistic indeed! You just answered the first set of questions as I did!] should monetary policy take financial stability into account?  And if so, how?  Can the interest rate or other monetary policy tools reduce financial risk?   How should macro prudential tools and monetary policy be coordinated?  Should they both be under the responsibility of the central bank?

 Let's remember that the crash of 1929 was, at least in the standard history, sparked by the Fed trying to restrain what they saw as the bubble in the stock market.

If this is the case, and central banks have tools which can have effects on very specific sectors of the economy, can they retain full independence?

No. In a democracy, independence comes with limited authority. The financial central planner cannot and will not long stay independent.   

The zero ... lower bound on the  interest rate set by central banks was thought to be a theoretical curiosum, unlikely to happen, and, in any case, easy to combat if reached.   If reached, central banks could, through announcements of future monetary policy, increase expected inflation and achieve large negative interest rates.  We have learned that this was simply wishful thinking.  The zero lower bound could be reached, inflation expectations are not easy to manipulate, and it may take a very long time to exit.

Three cheers. Wow, Olivier, who wrote one of the most influential calls for announcements of higher inflation targets, looks at the data and calls it "wishful thinking." Bravo. 

.. Quantitative Easing,... Questions:  ...should central banks eventually return to the traditional mode of intervening at the short end of the market, or should they continue to buy and sell longer maturity sovereign or corporate bonds?   Should the balance sheets of central banks return to their pre-crisis size, or remain permanently larger?  If the central bank intervenes along the yield curve, how should monetary policy and debt management by the Treasury be combined?

Large balance sheet, interest-paying reserves, open to everyone. Some crisis interventions reveal very desirable permanent states of affairs. Stop fooling around with direct intervention in long-term debt, mortgage-backed security markets, and don't follow other central banks to buying and selling stocks, foreign exchange, etc.

Fiscal Policy

... Questions: What is a dangerous level of debt? That which markets doubt you can repay. Seriously, if you're growing fast with a good long run plan for containing expenditures and raising revenue without ruinous taxation, a lot. If not, a lot less. ... What do we know about confidence effects?  You mean statements by officials that "engender confidence?" Go back to the Romans, burn incense at the Temple of Jupiter. More seriously, we've learned that speaking loudly with no stick doesn't work. ...Should the old idea of the fiscal golden rule, the separation of a current and of a capital account, be resurrected? Separating two sides of an accounting identity sounds like an interesting golden rule. I think it would be golden to separate the current account and capital account I run down at the apple store -- they give me stuff, I don't have to give them money. Olivier surely has something more sophisticated in mind, and I'm revealing I'm a rube at this policy-speak coded language. 

Most observers agree that the fiscal stimulus early in the crisis was instrumental in limiting the decrease in output.   I'm glad he said "most" not "all"....

Capital inflows, exchange rate management and capital controls

The crisis has reinforced the notion that international capital flows can be very volatile, with emerging markets being particularly vulnerable.  Back to previous comment. Capital can try to flow, but unless goods flow in the other direction, all it does is to lower prices. Unless you can pass a rule to get rid of accounting identities. See above.  Policy makers have responded with a panoply of tools, from capital controls A polite word for expropriation to macro prudential measures aimed at shaping flows, What a lovely little policy-ese phrase  and FX intervention. .... And what does the experience since the crisis say about the optimal opening of the capital account, even in the long run? Translated to English, back to the de-globalized protectionist world. If capital can't flow, neither can goods. 

The International Monetary and Financial System

.... Questions: ... Should we reexamine the rules of the game for exchange rates?   How can we improve on the process of sovereign debt restructuring?

As Olivier's essay moves on, and gradually reverts to the  obfuscatory Orwellian prose of the international policy world, I get more and more animated. I mean just who is this "we?" Who is going to tell you you're not allowed to buy euros for your vacation this summer ("capital controls"), tell your bank not to give you a loan ("macro-produential policy"), decide how many billions to siphon from your pocket to the owners of large banks ("recapitalization" "process of sovereign debt restructuring"), not allowed to expand your business in a new country ("macro prudential measures aimed at shaping flows") and so forth? When there even is a "we," unlike most sentences with no subjects, like "the optimal opening of the capital account."

What should be the role of international forums such as the G20?

Aha, now I get it.