Category Archives: PSST and Macro

Consumer Spending and the Stimulus

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Jonathan A. Parker, et al, find a strong effect.

on average households spent about 12-30% of their stimulus payments, depending on the specification, on non-durable consumption goods and services (as defined in the CE survey) during the three-month period in which the payments were received. This response is statistically and economically significant. Although our findings do not depend on any particular theoretical model, the response is inconsistent with both Ricardian equivalence, which implies no spending response, and with the canonical life-cycle/permanent income hypothesis (LCPIH), which implies that households should consume at most the annuitized value of a transitory increase in income like that induced by the one-time stimulus payments. We also find a significant effect on the purchase of durable goods and related services, primarily the purchase of vehicles, bringing the average response of total consumption expenditures to about 50-90% of the payments during the three-month period of receipt.

Their approach uses cross-section analysis, with differences across households in the timing of receipt of stimulus payments as the identification strategy.

The Voice of Authority

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Either Google “Charlie Rose Stanley Fischer” or try this link.

I am particularly interested in Fischer’s view that (a) the financial crisis had the potential to cause another Great Depression and (b) that the policy responses of the United States worked quite well and (c) fiscal expansion was needed, because monetary policy could not do enough. He does not offer a list of evidence on these points. Instead, he says, in effect, that experts agree on these points. Some possibilities:

1. There is a lot of evidence, but in an oral interview he could not give footnotes.

2. Fischer’s circle is an echo chamber that takes these views, without much need for evidence.

3. Fischer formulated an opinion early on in the crisis, and he has seen no need to change his views, because hypotheses about the financial crisis are untestable (we cannot undertake controlled experiments in macro).

I am particularly curious about (1), and where one could find the list of observations that supports the view that we were headed toward another Great Depression without the bank bailouts and fiscal stimulus.

The New Keynesian Model: Who Believes It?

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John Cochrane has been going after the New Keynesian model. The other day, he linked to a paper by Bill Dupor and Rong Li. They argue that the stimulus did not increase expected inflation, which is a channel by which fiscal policy is supposed to create an expansion in the New Keynesian model.

My question is whether anyone really believes the New Keynesian model. I know that for twenty years, it’s what every graduate student was taught. I know that everyone thinks that writing down a dynamic optimization problem counts as microfoundations.

But when it comes to interpreting the stimulus, my sense is that most economists revert to the old Keynesian model. If they believed the New Keynesian model, I think they would be using the language of intertemporal substitution and expectations more frequently. Instead, what I keep reading is more along the lines of spending creates jobs and jobs create spending.

Money, Finance, and Nominal GDP

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Scott Sumner writes, among other things,

there is utterly no reason to presume that “the financial markets will evolve ways to insulate the economy from what the Fed does.” Indeed so far as I know no economist has ever even proposed a model where this is true. And that’s because it would have to be a very strange model.

This puts me in an awkward position. Either I say that this is my own model, in which case I think I am taking more credit than I should. Or I say that it is implicit in the writings of some other economists, in which case Scott is going to argue that I am misinterpreting them. When in doubt, I will commit the first error.

However, I am not totally daft. Jeffrey Rogers Hummel has just posted an excellent tour of monetary theory. It serves as a very useful reference. Read the whole thing. He concludes,

As I conceded at the outset, central banks can affect interest rates somewhat. What is incorrect is the now-common but simplistic belief that the liquidity effect is so powerful that it allows the Fed to put interest rates wherever it wants, irrespective of underlying real demands and supplies in the economy. Nor do I deny that central banks have other far-reaching economic repercussions, often detrimental. But in a globalized world of open economies, the tight control of central banks over interest rates is a mirage. Central banks remain important enough players in the loan market that they can push short-term rates up or down a little. But in the final analysis, the market, not central banks, determines real interest rates.

If you take Hummel’s tour, pay attention to the McCloskey-Fama challenge. Also, pay attention to this point:

As the Fed increased bank reserves and currency in circulation by $2.5 trillion over the five years since, it also was, for the first time, paying banks interest on their reserves deposited at the Fed. Although the 0.25 percent rate it pays is quite low, it has consistently exceeded the yield on Treasury bills, one of the primary securities in the Fed’s balance sheet. Thus, at least $2 trillion of the base explosion represents interest-bearing money that, in substance, is government or private debt merely intermediated by the Fed…The Fed can have no more impact on market rates through pure intermediation—borrowing with interest-earning deposits in order to purchase other financial assets—than can Fannie Mae or Freddie Mac. The remaining $500 billion increase in non-interest-bearing money (what economists call “outside money”) represents only a slightly more rapid increase than in the decade before the crisis, and nearly all of that has been in the form of currency in the hands of the public.

In some sense, quantitative easing consists of the Fed borrowing at 0.25 percent to buy Treasury securities. It is engaged in debt management, converting the long-term obligations of the Treasury into short-term obligations of the Fed/Treasury. As other economists have pointed out, the Treasury could cut out the middle man by buying back long-term obligations and borrowing more at the short end of the market.

Hummel does not depart from the standard theoretical assumption that there is an equilibrium “real” money supply, which ultimately ties the price level to the supply of money. That means that when the Fed raises the money supply, eventually the economy must adjust with higher prices. If you take that view, then the question of whether or not the Fed can affect interest rates may not matter. If the Fed can force prices higher, then it can raise nominal GDP, and we have something.

However, I take the view that the McCloskey-Fama challenge means that in fact that the Fed cannot force prices higher, because there is little adjustment needed in the economy when the Fed does something. The Fed is dipping its little cup in and out of a sea of financial assets. Right near the cup, you can observe water move, but viewed from overhead, the sea seems to have its own tides and storms.* As Fischer Black wrote in “Noise,” this leads to the upsetting and heretical conclusion that there is no equilibrium “real” money supply that ties down the price level. Instead, prices evolve higgledy-piggledy, based on habits and expectations.

*If the Fed used a really huge pitcher, big enough to raise the sea level by several meters, then I think we would see an effect. I only think that will happen if we run into a government debt crisis and the option of sudden monetization is adopted.

PSST, Youth Unemployment, and Internships

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From the book-in-progress, a draft of a dialogue in which a character representing my views is speaking.

In the Schumpeterian story, jobs are always being created and destroyed. Sometimes, though, new opportunities appear before old firms realize that they are in trouble. Lots of people try to come up with new ways to deliver news on the Internet, but old-fashioned newspapers are slow to close down. That is Schumpeter’s model of a boom.

Eventually, the obsolete firms get the memo. Perhaps they get it during a financial crisis, when it becomes clear that they are no longer viable. As a result, a lot of workers are let go at the same time.

Now the entrepreneurs have to figure out what to do with these unemployed workers. The challenge is that these are likely to be the workers whose skills have the least value in the contemporary workplace. They are not likely to be computer programmers, or effective project managers, or persuasive salespeople.

Moderator: But in today’s economy, the people that seem to be having the hardest time finding a job are younger workers. You would think that if technological obsolescence is the problem, it should be the older workers having problems, and young people should be doing okay.

Schumpeterian Adjustment: That is a bit of a puzzle. One factor at work is that a lot of older people work in occupations that are protected in one way or another. In government, they are not going to fire a 50-year-old in order to hire a 25-year-old, even if the younger worker has better computer skills and requires lower compensation.

Something like one-third of the labor force is working in occupations that require licenses, and one thing that people in those fields can do is make it harder to get a license. They require a new entrant to obtain a doctorate (this happened several years ago in Maryland in physical therapy), but existing practitioners are grandfathered in.

However, I think that the biggest reason that young people tend to have lower rates of employment than older workers is that young people have not been able to settle on their comparative advantage. Young people today do not go to trade school. Most of them get general degrees, and they have very little experience in actual work environments, so they do not know the best way to use their talents. Neither do employers.

We are seeing an economy with fewer well-defined jobs. If it’s well-defined, it can be automated. Instead, businesses have projects to try to create new capabilities or solve problems. It is harder to fit inexperienced workers into that framework. You cannot just give them a couple days of training and have them be productive. Overall, the up-front cost of bringing on a new worker has been going up, particularly for young people with no work experience.

Moderator: Shouldn’t the wage rate take care of that? Young workers will have to accept lower wages.

Schumpeterian Adjustment: In fact, what we are seeing is a different path for young workers into the workplace. Consider the phenomenon of internships, many of which are unpaid. I think that internships are a response to the high fixed cost associated with hiring a new worker. You have to put so much effort into training and acclimating a new hire before the person becomes productive that it does not work just to pay a low wage or to hire people that you will have to fire later. Instead, the internship works as a sort of trial period. By creating an internship path into the business, the firm cuts down on its up-front hiring costs. The intern bears more of those costs.

The Fiscal Multiplier

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An IMF paper writes,

there is even stronger evidence than before that fiscal multipliers are larger when monetary policy is constrained by the zero lower bound (ZLB) on nominal interest rates, the financial sector is weak, or the economy is in a slump.

Reading further, it turns out that some of the “evidence” consists of simulations of macroeconometric models, which I personally do not find convincing. Also, I would have liked to see more discussion of the the “monetary offset” issue.

The main point of the paper is that although the pre-crisis conventional wisdom was that discretionary countercyclical fiscal policy was not necessary, the post-crisis conventional wisdom is that it is a good idea. What I suggest in the book that I am writing is that this is normal in macroeconomics. That is, the conventional wisdom at time t always seems to be that the conventional wisdom at time t-1 is wrong. Yet if you think about what this model implies for the conventional wisdom at time t as viewed in time t+1, it is quite subversive.

Thanks to Timothy Taylor for the pointer.

The Macro Book: An Update

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I think that the basic approach is now stable. I might have a draft completed by the end of October. It is now a drama in four acts (have I said that before?). I have no idea how it will work for readers, but if I try appealing to an imaginary reader, I can’t write the book at all. As Ricky Nelson sang, “you can’t please everyone, so, you’ve got to please yourself.”

The “drama” approach allows me to speak favorably of points of view that I do not really share. I make a case for DSGE models. I try to make Scott Sumner’s case. Below the fold are some excerpts from the current version of the book.
Continue reading →

The Labor Share of Income

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Has fallen and it can’t get up, according to Michael Elsby, Bart Hobijn, and Aysegul Sahin.

the decline of the labor share, which has been driven by a decline in the share of payroll compensation in national income over the last 25 years, is likely due to the offshoring of the labor-intensive component of the U.S. supply chain.

Pointer from Tyler Cowen. I have called this the Great Factor-price Equalization.

If your model of a recession is that it is caused by sticky wages, then as far as I can tell labor’s share of income should rise during a recession. Or, to put it another way, if labor’s share falls (as it has during this recession), then makes the sticky-wage story less attractive. Labor’s share of income can be written as WL/PY, where w is the wage, L is employment, P is the price level, and Y is real GDP. We can re-write this as (W/P)(L/Y), or the real wage times the average productivity of labor. I labor’s share falls, then either real wages have fallen or productivity has risen. If real wages have fallen, then this directly contradicts the sticky-wage story. If real wages have risen, then productivity has risen faster, and I still have doubts about the sticky-wage story.

Fischer Black on PSST

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Comments on this post reminded me that I need to re-read Fischer Black’s famous address, Noise. He writes,

The costs of shifting real resources are clearly large, so it is plausible that these costs might play a role in business cycles. The costs of putting inflation adjustments in contracts or of publicizing changes in the money stock or the price level seem low, so it is not plausible that these costs play a significant role in business cycles.

Tyler Cowen and I both credit Fischer Black with influencing our views on macro. More from Black:

I cannot think of any conventional econometric tests that would shed light on the question of whether my business cycle theory is correct or not. One of its predictions, though, is that real wages will fluctuate with other measures of economic activity. When there is a match between tastes and technology in many sectors, income will be high, wags will be high, output will be high, and unemployment will be low. Thus real wages will be procyclical.

I am pretty sure that the ratio of wages to nominal GDP has been falling as the labor market has weakened over the past dozen years. So procyclical real wages are still with us.

And then:

I believe that monetary policy is almost completely passive in a country like the U.S. Money goes up when prices go up or when incomes goes up because demand for money goes up at those times. I have been unable to construct an equilibrium model in which changes in money cause changes in prices or income, but I have not trouble constructing an equilibrium model in which changes in prices or income cause changes in money.

Similarly, I also think that it is at least as plausible that causality runs from the long-term bond market to the Fed funds market as the reverse.

Finally:

I think that the price level and the rate of inflation are literally indeterminate. They are whatever people think they will be. They are determined by expectations, but expectations follow no rational rules.

Keep in mind that he is talking about a country without an insane fiscal/monetary nexus. I am sure he would grant that you can have hyperinflation by running ridiculously large deficits and printing money to fund them.

Narrative Wars on the State of the Economy.

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John B. Taylor and Lee Ohanian write,

why is the current recovery so weak? It is not because of the aftermath of the 2007-08 financial crisis. U.S. Financial markets began to recover in late 2008, more than four and a half years ago.

I am just starting to write in my book about the aftermath of the financial crisis (which means I am on the home stretch, although I am not sure that I might not try one more major re-write of the whole book). Like Ohanian and Taylor, I find it striking that he employment/population ratio today is actually lower than it was during the official “recession.” (See also Stephen Bronars on a careful calculation that adjusts the employment/population ratio for demographic trend factors. Bottom line: it still looks awful.)

My take on that is that the NBER dating of the end of the recession is a distortion of reality. Yes, GDP started to rise in the middle of 2009, but otherwise, things do not look very good.

Why is the economy not doing well? I would suggest the the latest Economic Freedom indexes might have part of the answer. Since the year 2000, we have fallen on a 10-point scale from 8.65 to 7.74.

The left’s counter-narrative is that the financial crisis blew a deep hole in the economy, and we needed bailouts and Keynesian stimulus do dig us out. We had about the right amount of bailouts, but not enough stimulus. And anyone who believes anything different is anti-science and defiant of the facts.