Krugman on 2013 vs 1958 macro

by John Quiggin on January 9, 2013

At the recent American Economic Association meeting in San Diego, Brad DeLong chaired a panel on ” Stimulus or Stymied?: The Macroeconomics of Recessions“, and has posted a transcript. Paul Krugman was there and picked up my claim that macroeconomics has, on balance, gone backwards since 1958. I’ve extracted his section here. Lots of useful stuff, but I’d stress this:

the whole basis on which we constructed monetary policy during the Great Moderation, which is that stabilizing inflation and stabilizing output are the same thing, is all wrong: you can have a sustained period of low but not negative inflation consistent with an economy operating far below its potential productive capacity. That is what I believe is happening now. If so, we are failing dismally in responding to this economic crisis. This is in contrast to what some central bankers are saying—that we have done well because inflation has stayed relatively stable.
To push this a bit further, I’d argue that there will be no real recovery as long as central banks continue to treat the inflation-targeting polices of the (spurious) Great Moderation as the pre-crisis normal to which we should strive to return

Krugman remarks to panel on The Macroeconomics of Recessions

Let me try to talk about where I think we stand and what the fiscal-policy issues ought to be.

The basic story—at least as many of us see it—is that we had this really, really dramatic shock to private spending. This is the private-sector financial deficit: gross private domestic investment minus gross private domestic saving as a share of potential GDP as estimated by the CBO. This is not the first time in the post-WWII era we have had a big drop, but it is the biggest: 10% of potential GDP. [30:00] The previous ones in the mid-1970s and early-1980s were associated with tight monetary policy, very high interest rates, and collapses in housing investment driven by tight monetary policy—which, of course, sprang back as soon as the Federal Reserve decided that the American economy had suffered enough.

This time is different. This time it came spontaneously. This time it came in spite of drastic cuts in interest rates to essentially zero.

The question is: “What do we do?”

There is an interesting debate: “When did economics go all wrong? When did macroeconomics go all wrong?” Bob Gordon has rather persuasively made the case that it went all wrong about 1978—that we would have done a better job at macro policy if we had met this crisis with the intellectual panoply we had then and had not had the thirty years since. I saw John Quiggin just made the argument that things actually went all wrong about 1958.

If an economist from 1958 had seen what is going on now, he—and back in 1958 it would have been “he”—would have said: “OK. Private sector does not want to spend. The government should spend. This is a powerful case for fiscal stimulus to prevent this from causing a persistent slump.” We have not done that. We had some fiscal stimulus delivered for a brief period of time in 2009. We have had a fair bit of allowing automatic stabilizers to operate. But at the same time we have had quite a lot of policy austerity. We had a worldwide or at least an advanced-world turn to austerity in 2010 inspired to some extent by the lessons that were drawn—I would say mostly wrongly—from the story of Greece but then applied across the board, and also from a reversion to pre-Keynesian modes of thinking about the macroeconomy. Whatever the reasons—and there are a mixture of political-economy reasons and just plain bad-economics reasons—we made a big turn to austerity. Now we debate: “Was that wrong? How wrong was it? Should we really be doing as much fiscal stimulus as the man from 1958 would say?”

Think about the objections to stimulus. I would put them into three categories:

First, perhaps we do not have nearly as much economic slack as people like—well—me say. Perhaps there is something much more structural going on, and we do not have that much room to expand. We have a huge economic failure, but the failure is not for the most part a simple failure of aggregate demand.

Second—you do not hear this story that much, but it is important to set up the third—is that we should not be using fiscal policy but should instead by using monetary policy. That is a more popular argument in the more informal discussion in the econoblogosphere than it is in academia. But there is the question of what you can do.

Third, even though we are at the zero lower bound, fiscal policy is a lot less effective than the man from 1958 would say it is, and that multipliers are quite low even under urgent conditions.

About limited economic slack:

There is a whole literature trying to identify structural issues—what does the shift in the Beveridge Curve mean—that would be an entirely different discussion. I think the most important argument that has the biggest impact is the argument: “If we have all that economic slack, where is the deflation?” When we look at core inflation, it dropped a lot in the crisis, but has been fluctuating in a 1-2%/year range since then and has not been declining. You will see the argument, which is consistent with what most Principles of Economics or Intermediate Macroeconomics textbooks say or would have said before the crisis, that if we really had a large output gap we should be seeing not just low but declining inflation. The stability of the core inflation rate is an indication that there is not a lot of economic slack. The most recent speech by James Bullard makes that case. The San Francisco Fed has a nice updated chart estimating the output gap by backing it out of a linear expectational Phillips Curve and comparing it to the CBO output gap which is a gussied-up trend. The difference is striking. The stability of inflation says that there is hardly any output gap. Comparing us to the pre-crisis trend says that there is still a very large output gap: $900 billion/year of potential non-inflationary production of goods and services is simply not happening.

Brad asked: “What have we changed our views about?” The inflation process is one area in which I have changed my views. It has become much more apparent that downward nominal rigidity—not just stickiness but people don’t like to cut nominal prices and wages—is a very significant factor. When you have a depressed economy in a state of initially low inflation the zero bound not just on interest rates but on wage changes becomes a really big deal. Again, more San Francisco Fed stuff: they have tried to back out how many people are literally getting zero wage change. The answer is: “a lot”. That suggests that we are indeed an economy in its depressed state, and that the reason that average wages continue to rise is that we have truncated the left edge of the distribution, not that we have anything close to full employment.

That is very important, if true. Among other things, it means that the whole basis on which we constructed monetary policy during the Great Moderation, which is that stabilizing inflation and stabilizing output are the same thing, is all wrong: you can have a sustained period of low but not negative inflation consistent with an economy operating far below its potential productive capacity. That is what I believe is happening now. If so, we are failing dismally in responding to this economic crisis. This is in contrast to what some central bankers are saying—that we have done well because inflation has stayed relatively stable.

Monetary policy: When I arrived at Princeton in 2000 there was a group of us—“Japan worriers”. I am the only one still there. Mike Woodford, Lars Svensson, who is now run off to the Riksbank, me, and Ben Bernanke—I wonder what happened to him? All of us were very concerned by what was happening to Japan in the 1990s. Some people looked at it and said: “That just shows how messed up the Japanese are.” Some of us looked at us and said: “Surface differences apart, Japan looks a lot like us: big advanced country, lots of room to maneuver, government officials who might not be the most brilliant but who were not complete idiots, and if they could get trapped in this sort of deflationary stagnation then it could happen to us.” Sure enough, it did.

At the time, all of the discussion was about what you could do by way of monetary policy. Could the central bank by unconventional purchases of non-standard assets move expectations? The simple fact is that dramatic changes in the simplest measures of what central banks are doing—the size of the monetary base—have been invisible in their effect on either inflation or output. I think we have to say that at this point to make the argument that if only the central bank really wanted to we would be doing much better needs to be accompanied by a very clear explanation of how that it is supposed to work and why the effects of monetary policy to date have been so limited. There is in principle the expectations channel. If a central bank can credibly promise that it will allow a higher inflation rate over the medium term then it ought to be able to reduce real interest rates and have a significant expansionary effect on the economy. The problem is how do you in fact make that promise credible. There are multiple hurdles that you have to cross. First, you have to cross the threshold of the political acceptability of the policy of changing the inflation target, which has proved virtually impossible to tackle in part because people do not think that this is a permanent crisis. They may be right. But that means that it is then very very hard to say that we should change the price-level target for five or ten years in the future to deal with a crisis that everybody expects will be over in a year .

Then, how do you make it credible? Why will the people running the central bank five or ten years from now—who are not the people running it now—go through with it? In an unfortunate phrase I used back in 1998 about Japan, they have to credibly promise to be irresponsible. That is the issue. It has turned out, I think, that, as Michael Woodford says, while in principle unorthodox monetary policy can deal with a situation like what we have now, in practice it is really really hard to see how this could work. And that makes you lean on fiscal policy.

Last comes the question about the effectiveness of fiscal policy. Valerie Ramey will present evidence on the size of multipliers. What are multipliers? That is a critical issue. The trouble is that fiscal policy is very hard to assess econometrically from the historical record. The basic rule is that when all is said and done, no matter how much effort we put it and in spite of all the valid work we do, unless you can show clear natural experiments people are not convinced. Even with natural experiments people are often not convinced, but it is your best chance. And convincing natural experiments are hard to come by. The clearly-exogenous changes in government spending are pretty much those associated with wars. This is just the very simple stuff that Bob Hall did just a little while back. They clearly show that expansionary policy is expansionary. They also show that the multiplier is less than one, which is not what an enthusiastic advocate of Keynesian fiscal stimulus would like to see. Again, the IMF tried recently very carefully to tease out the answer, and again found that expansionary policy is expansionary and contractionary policy is contractionary, but once again multipliers are less than one.

The IMF has changed its mind, or at least Oliver has changed his mind. But that’s where we are.

The question then becomes: is this historical evidence relevant for what we face now? The historical evidence incorporates a lot of crowding-out. The question is then: where is this crowding-out coming from? One answer is the old textbook crowding-out: crowding-out via rising interest rates. That is clearly relevant to the historical cases but not relevant now. A second answer is that in wartime other things are happening. I believe that a lot of the literature on this understates the seriousness of this issue. It’s not just that the multiplier is lower at full employment. During World War II there was severe rationing of consumer goods. During World War II—I have not seen this mentioned at all—there was essentially a prohibition on private construction. You look at World War II and say “private spending fell”. What relevance does that have? We are not about to have such controls on private investment. [45:00]

We can look at periods that do not have war complicating the picture, and the problem is that there is not a lot of that. For the U.S., the World War II period before wartime controls come in is about a year and a half, six quarters. If you are going to use VAR time-series methods, you can look at quarters that have both high unemployment and large changes or news of large changes in military spending, the problem is that the impulse response period extends well into the period of wartime controls. It is not at all easy to get past that.

Finally, Ricardian effects. It is really important to understand how many people misunderstand that. There are many people who believe that higher government spending now means higher taxes later and this will crowd-out private spending now. But higher spending now means higher incomes now as well. In the simplest Ricardian setup, if you believe that resources are unemployed and if interest rates are zero, the multiplier is not zero but one. It is very difficult to come up with a story in which the current multiplier would be less than one. Invoking the expectation of future tax increases as a reason for a multiplier less than one is a much more difficult story to tell than people seem to imagine.

Our evidence is not great. The closest thing to a really good natural experiment is what is happening now—the scary policies of recent years. It is not perfect. But look at the euro area countries—we talk about the great mistake of 1937, Roosevelt’s turn to austerity, but his turn to austerity was less than 3% of GDP. Compare that to what is happening to Greece or Ireland now, that is nothing. In Greece, if the whole program is implemented, we are talking about austerity on the order of 16% of GDP. These are enormous shocks. And if you do a simple regression it looks like a multiplier of 1.3.

The immediate objection is that causation is not reversed? This is where the Blanchard-Leigh stuff comes in: They look at forecast errors in output growth and forecast errors in future policy, and find that their forecasts of output growth which assumed a multiplier of 0.5 underestimated the true multiplier by about 1.0, systematically understating economic contraction in countries with larger-than-expected degrees of austerity.

I think their work is good. Of course, it fits what I wanted to believe, so you have to be careful. But very important stuff, if true.

The final point is policy: Are we sure that expansionary fiscal policy is the right thing to be doing and that austerity is a terrible, terrible mistake? No. We are absolutely sure of nothing. But the consequences, if that is the truth, and I think the evidence tilts that way, is that what we are doing right now is absolutely disastrous. And that is where we are right now.

{ 58 comments }

1

hidflect 01.09.13 at 11:36 am

It is a bit hard to write an article and not appear to be name dropping but I think you pulled it off… It mus be a bit galling when someone “famous” rips off your musings.

2

Martin Bento 01.09.13 at 12:13 pm

OK, maybe I’m johnny-one-note on this, but shouldn’t we at least ask how things are different for monetized debt?

1) It is both a fiscal and monetary stimulus.
2) Promise to be irresponsible? Heck, be irresponsible now.
3) The multiplier would have to be greater than financed debt.
4) Crowding out? Seems unlikely, no?
5) Moderate but higher inflation sounding good now, right? It’s a way around the stickiness of nominal wages and prices.

What are the objections? OMG! Wiemar, Zimbabwe! Is it really impossible to imagine utilization of a tool without leaping to the most extreme possible applications? Especially since both those governments were strapped by foreign debts not payable in their own currencies? The US is much luckier in this.

3

Rob 01.09.13 at 12:54 pm

“Why will the people running the central bank five or ten years from now—who are not the people running it now—go through with it? In an unfortunate phrase I used back in 1998 about Japan, they have to credibly promise to be irresponsible. That is the issue. It has turned out, I think, that, as Michael Woodford says, while in principle unorthodox monetary policy can deal with a situation like what we have now, in practice it is really really hard to see how this could work. And that makes you lean on fiscal policy.”

“…promise to be irresponsible” is an unfortunate phrase, because it rests on the assumption that any excess (greater than 2%?) inflation is, by definition, irresponsible; that any central banker committing to this (or to a policy which may allow or encourage it) is de facto irresponsible. It is correct to say that if we charge a central banker with achieving a 2% inflation target, and she delivers 3% inflation, then she has been irresponsible (has failed in her responsibility), not because 3% inflation is necessarily worse than 2% inflation but because we have given the central banker a responsibility to hit a target of our choosing, and we chose 2%. I guess that for economists of Krugman’s generation, the notion that “inflation greater than 2% is irresponsible” is a firmly-held belief, rooted in the experience of the 1970s. (Krugman himself can probably see this, but not everyone can).

First, you have to cross the threshold of the political acceptability of the policy of changing the inflation target, which has proved virtually impossible to tackle in part because people do not think that this is a permanent crisis.

The longer the crisis goes on, the less effective that counter-argument will be. Also, Michael Woodford and Frederic Mishkin are clearly still trying to find a way of making the policy change acceptable (from the WSJ):

Instead, the Fed’s new approach is a temporary policy to keep interest rates low for longer, to make up for the inadequate nominal GDP growth that has occurred since 2008. Once the nominal GDP growth shortfall has been eliminated, it will be appropriate to again conduct policy much as was done before the crisis. That means ensuring a long-run inflation rate of 2% in terms of the PCE (personal consumption expenditure) deflator, and an average unemployment rate that is consistent with price stability.

Unless I’m misreading them, they actually want to eliminate the entire NGDP shortfall since 2008 (check the graph here for an idea of how big this is), on the promise that once the crisis is over, we can return to 2% inflation targeting. This is simultaneously very aggressive (returning to the pre-2008 NGDP trend line is hugely expansionary) but also potentially appealing to small-c conservatives in that the objective in doing so is to get back to 2% inflation targets. Of course, if this actually works then it will teach us that 2% inflation targets are not inviolable, and that we might be better on using a price level target rather than a growth rate target, so we might get a permanent switch to a policy stance that is much more capable of monetary stimulus when it proves to be needed again in future.

As a neutral spectator, I’m curious about whether or not people would regard the above scenario as desirable if it were to happen.

4

Alex 01.09.13 at 2:32 pm

What’s the magic behind 2% anyway? Everyone with an inflation target seems to pick 2%. Not 2.2% or 3.5% or zero. 2.

5

MPAVictoria 01.09.13 at 3:36 pm

“What’s the magic behind 2% anyway? Everyone with an inflation target seems to pick 2%. Not 2.2% or 3.5% or zero. 2″

That is a great question! Why 2%?

6

sherparick 01.09.13 at 3:37 pm

Well, if you have been following his blog, Krugman has been musing on these things for the last five years. And he did drop John Quiggin’s name in his talk.

What I find missing in both Professor Krugman and John Quiggin is an appreciation of what Peter Dorman calls the “Political Economy” behind all of the bad ideas of the last 40 years. These ideas have promoted the interests, income, and wealth, of a particular group of people, usually linked by Finance and Energy investments, the last 40 years. This group is now effectively are rulers. All you have to do is read Anders Ausland and the others at Petersen Institute, University of Chicago, Casey Mulligan, Richard Fisher, ECB, David Brooks, the German Finance Ministry, etc. have to say about how wonderful the Lativia is doing and how it proves “Austerity Works” (and the “bad” the effects of social welfare and insurance are on workers’ “incentives” to take the lowest possible pay to work in the worse possible conditions) to know that for these folks high unemployment, declining median real wages, and decimation of the welfare state (so that the proles will be soon so be terrified of starving that they will accept declining nominal median wages and we can get some old fashion deflation going!) are features, not bugs. As Dorman wrote in August 2011, the principles that guide our ruling elite are: “From what we (you and me) can see from our vantage point, the ruling demands are to make sure my bonds are serviced, my counterparties pony up, the markets I invest in stay liquid, and expenditures for public welfare (i.e. the losers and chiselers) are slashed.” http://econospeak.blogspot.com/2011/08/its-political-economy-stupid.html

(By the way, I note that the leading Republican tea partiers, for instance Ted Cruz and Pat Toomey for one, are advocating that President should use tax revenue to continure servicing all Government bonds if the debt ceiling is not raise. Just stop paying Medicare and Social Security. See the point about “bonds being serviced above.”)

And hence, even the current Democratic Administration’s Treasury Department will welcome Valerie Ramey’s arguments against the usefulness of the Fiscal multipliers and reject Krugman’s, because they fit better with what they, as members of that Financial ruling elite, feel is “sound,” and that the debt limit fight with the Republicans is an opportunity to slash and reduce Social Security and Medicare and the “long term deficit.” (The difference between them and the Republicans is that they would preserve a small amount of social insurance to avoid complete immiseration of the masses, while the Republicans would like the programs abolished and immiseration adopted as a goal “to encourage the others.”)

7

Niall McAuley 01.09.13 at 3:43 pm

they have to credibly promise to be irresponsible.

Many commentators have highlighted one thing as the most significant in the Euro crisis mayhem of 2012. It is Mario Draghi saying:

“Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”

8

themgt 01.09.13 at 3:59 pm

The one concept I almost never see penetrating economic thought on the crisis is peak oil and demand destruction. Back since 2005 at least, experts at places like theoildrum.com have been predicting production peak and then rising liquid prices and subsequent demand destruction, where the high fuel pricing percolating through the economy act as a tax on everything, pushing down consumption and resulting in a price roller coaster/head against a ceiling effect.

This now seems very similar to what we’ve seen since 2007, perhaps slightly moderated by a desperate global effort to drill, frack or strip mine every last ounce of useable carbon from the earth’s crust as production of crude oil stalls.

If the demand destruction acts as a negative feedback loop when costs rise, it seemingly prevent inflation. Under this scenario it would be simply impossible to re-inflate the global economy back to where it “should” be, drawing a straight-line project out from 2007, because we don’t have the energy resources needed to build and fuel all the cars and food and stuff.

9

reason 01.09.13 at 4:07 pm

Martin Bento @2
You have my vote!

10

reason 01.09.13 at 4:11 pm

themgt
mmmm.
But we should be seeing some substition and efficiency gains shouldn’t we? This works up a point, but the effect should get less over time. I’m not actually convinced. How can you explain Germany and Australia – to name a couple – based on this idea? This effect is (outside of oil rich countries) universal, yet the severity of the de(re)cession is not.

11

Sebastian H 01.09.13 at 5:20 pm

“First, you have to cross the threshold of the political acceptability of the policy of changing the inflation target, which has proved virtually impossible to tackle in part because people do not think that this is a permanent crisis.”

I think the real worry we should have is that the banking class will decide this is the new and totally acceptable normal.

12

ponce 01.09.13 at 6:50 pm

@11

“I think the real worry we should have is that the banking class will decide this is the new and totally acceptable normal.”

Corporate profits are at record levels.

Where’s the crisis?

13

Tim Wilkinson 01.09.13 at 9:20 pm

What’s the magic behind 2% anyway? Everyone with an inflation target seems to pick 2%. Not 2.2% or 3.5% or zero. 2

For that matter, why is the value 1 seen as particularly salient vis-à-vis fiscal multipliers, as in Krugman’s the multiplier is less than one, which is not what an enthusiastic advocate of Keynesian fiscal stimulus would like to see? I recognise there may be a good reason, but can’t see what it could be.

(I’m emboldened to question this since on the Jacobin thread, similar skepticism – that 1. there’s some non-convoluted specification of the rate of ‘normal profit’, 2. markets-as-we-know them are required to produce relative valuations, 3. good production decisions can only be elicited by the promise of capitalistic profit – seems not to have been effectively countered.)

14

Alex 01.09.13 at 9:39 pm

Germany. or China. or Brazil. or India. or Sweden.

15

Bruce Wilder 01.09.13 at 11:33 pm

themgt @ 8

I’m with ya.

One interpretation of U.S. policy is to use high unemployment and falling wages to put a ceiling on U.S. domestic consumption, and to give greater room, globally, to MNCs. If you look at, say, vehicle miles travelled, you can see it’s been pretty effective.

The energy companies want to export petroleum product, and there’s talk of building the capacity to export liquefied natural gas, which has to be among the most insane policies ever proposed. Most U.S. news and public affairs teevee programming is sponsored by oil companies, so little notice will be given to the insanity of it.

16

Gotchaye 01.10.13 at 12:43 am

Tim @ 13: Isn’t it that a value of 1 means that stimulative effects are cancelled out by “crowding out” effects? A multiplier of 1 is just what you would expect if the spending didn’t have any broader impact – you spend $100 and GDP goes up $100. That’s not really stimulating anything. If there’s something to the idea that fiscal policy can be stimulative, then the stimulative effect has to exceed the “crowding out” effect – the stimulus is the extra impact that your spending has in excess of its face value.

17

Barry 01.10.13 at 1:36 am

I second Rob about the ‘irresponsibility’ argument, but I disagree with ‘The longer the crisis goes on, the less effective that counter-argument will be. ‘. The Chicago Mafia probably figures that they’ll have the White House again in 2016, and can pull things even further worse. At that point (as pointed out), things will definitely be ‘the new normal’.

BTW, I repeat my statement that things went wrong when the Chicago Mafia refused to accept the lessons of the Great Depression and the New Deal.

18

ezra abrams 01.10.13 at 1:56 am

As an ordinary concerned citizen, with no special knowledge of econ other then reading a couple of popular books,

can some one tell me

If diff top level economists are at logger heads, how and why should I bother to pay attention, and why should I believe Krugman that debt is ok, or UChicago that debt is bad ?

As a liberal, I take the view that we should confiscate money from the rich; it might not help big picture, but it will help a lot of kids who need new clothes to go to school, and food at school cause their parents can’t afford food.

As a liberal, I take the view tht economic factors are much, much less important then technological progress, and that a consistent doubling of hte NIH, and creation of a similar NIMS (nat institute material science) will lead to technology like artificial hearts that will result in greatly lowering the cost of healthcare (there really isn’t any reason we can’t lower the cost of, say drug development, 100X – and yes, i can do basic math, I know what that means)

technological chest pounding: drug development is a decade long process that is end weighted – the $ stuff, clinical trials, occurs at the end, so you would like to be able to avoid new chemicals that cause problems in clinical trials.
one thing that would help a lot would be the ability to dock nce’s against hi res nmr and xray structures – this is not that far off

19

derrida derider 01.10.13 at 2:13 am

I, too, have long been puzzled by the choice of a 2% inflation target; even if you believe in inflation targeting 2% seems too low a level.

There are two well known (and empirically tested) arguments for making the longrun target higher. Firstly, there’s Bob Solow’s one about easing relative wage adjutment in the face of nominal wage stickiness, which creates an upward sloping region of the longrun Phillips curve at low inflation levels. Secondly there’s Blanchard’s one about keeping well clear of the ZLB in the face of exogenous output variations.

Both the papers making these points were put out a while ago – before the GFC – so its not as though its something we should just have learned from recent experience. But even those who think (sensibly) that temporary inflation would be a small price to pay to get us out of this mess don’t seem to realise that permanent inflation should be higher anyway.

20

Main Street Muse 01.10.13 at 2:23 am

To Barry @ 17. When did Tim Geithner & Ben Bernanke live in Chicago? Or do the Fed Chair & Treasury Secretary have no power at all when confronted by this band of Windy City brothers?

Want to point out that things went terribly awry prior to Obama’s election to office (even though McCain felt the “pillars of our economy were sound.”) As much as people like to blame Obama for the crash, he did not drive that bus over the cliff….

Seems obvious to me that the lower taxes of the Bush years did not accomplish the planned goal of growing the economy.

From Krugman: “If an economist from 1958 had seen what is going on now, he—and back in 1958 it would have been “he”—would have said: “OK. Private sector does not want to spend….”

I want macro experts to focus on WHY private sector does not “want” to spend. There’s meaning in that answer that is being ignored by those who feel all is well because inflation is controlled. It’s as if they’re stuck in the 1970s.

21

Omega Centauri 01.10.13 at 2:45 am

Like themgt and Bruce, I think that the various limits to growth issues are biting, and those headwinds are part of the overall picture. Oil is now fize times the price of just a few years ago. many other commodities, including food are also becoming a lot more expensive. If I postulate that these LTG/commodity price effects are giving us a delta of say 2% inflation per year, than maybe that 1-2% inflation we are observing is really 0-1% deflation? Would that change the picture?

22

The Tragically Flip 01.10.13 at 4:27 am

By no means an expert, but my read on 2% is this:

- it’s just high enough to give some breathing room to avoid going into deflation because of some short term shock, which everyone short of gold bugs agrees is bad and might not be easily stopped once it starts (e.g. Why buy a new fridge or car today when it will be cheaper tomorrow, and everyone says the same thing…)

- it’s as low as possible which is what the monied class likes – their assets stay as valuable as possible with as little work as possible on their part. A lot of their “assets” are of course debts for middle and lower class people, higher inflation would be good for those of us who have more debt than income, and ergo, bad for them. I don’t think we can ignore the Fed’s basic abandonment of its unemployment mandate in this analysis. Who are they serving when they fixate on inflation at the direct expense of dealing with massive unemployment?

Why exactly 2%? It’s just a round number. People like those in the absence of some very specific reason to use a non-round number.

23

The Tragically Flip 01.10.13 at 4:31 am

^^^^

“have more debt than income,”

That probably makes more sense if I say “have more debt than assets” though I haven’t really thought through at what point one is more likely to benefit from higher inflation than suffer it – anyway, I think there clearly are people who owe a lot more than they earn or are worth and for whom, inflation is actually good. And those who own a lot of stuff, for whom inflation makes their stuff worth less in real terms over time.

24

gordon 01.10.13 at 6:23 am

From the post: “we have truncated the left edge of the distribution”

Much as I respect Prof. Krugman, this has got to be one of the worst pseudo-scientific euphemisms for “we have impoverished an awful lot of people” I have ever seen.

And if they are poor, then rising petroleum product prices (themgt at 8) will mean more and more of their tiny budgets are consumed by heating and transport. Households don’t have many choices here; there are minimum requirements for health and travel which mean that consumption of some petroleum products can’t be reduced below a certain minimum. Of course that means there are other things they can’t buy, hence the “demand destruction”. But it’s the poverty, not the oil shortage that is to blame.

25

gordon 01.10.13 at 7:14 am

Re: inflation target of 2% (Alex at 4 and others), I note that the Californian Proposition 13 (1978) included a ceiling of 2% on annual inflation adjustments of property values for rating purposes. I have no idea whether that was the origin of the US National number or just a coincidence.

26

anon/portly 01.10.13 at 8:04 am

From the post: “we have truncated the left edge of the distribution”

Much as I respect Prof. Krugman, this has got to be one of the worst pseudo-scientific euphemisms for “we have impoverished an awful lot of people” I have ever seen.

Krugman is referring to the distribution of wage changes – the idea is that many workers are getting wage changes of zero instead of the negative wage changes that would happen if wages were more flexible or less sticky. Those workers not getting pay cuts explains why it can be so that we don’t have “anything close to full employment” even if “average wages continue to rise.”

27

anon/portly 01.10.13 at 8:06 am

Sorry, second paragraph in above should be in italics, quoting gordon at 6:23.

28

reason 01.10.13 at 8:48 am

MainStreetMuse @20
“From Krugman: “If an economist from 1958 had seen what is going on now, he—and back in 1958 it would have been “he”—would have said: “OK. Private sector does not want to spend….”

I want macro experts to focus on WHY private sector does not “want” to spend. There’s meaning in that answer that is being ignored by those who feel all is well because inflation is controlled. It’s as if they’re stuck in the 1970s.”

I think here I should echo Dean Baker – seen from the point of view of historical averages, it is a misrepresentation to say that “the private sector does not want to spend”. Even at current levels, household savings levels are not extraordinarily high. You cannot really understand the current crisis (and I think the Great Depression either) without noticing large and persistant trade deficits. US based economists have a tendency to ignore the foreign sector – which may have some historical validity – but is not valid now. Krugman has also at times noted the necessity of addressing external balances as a long term concern (but like budget balances – not now Josephine!).

Ultimately, the disfunctional international financial system should be a major concern, to be addressed internationally. Unfortunately, it is not even on the radar.

29

Curmudgeon 01.10.13 at 8:52 am

#22 et el:

The level of expected inflation has no impact on the balance of power between lenders and borrowers. Unexpected changes in the level of inflation impact the balance of power between lenders and borrowers.

If the expected level of inflation was, for example, eight percent higher than it currently is, the spread between the central bank rate and consumer credit rates would be eight percent higher. Lenders would extract the same rate of real return regardless.

In contrast, if the expected rate of inflation unexpectedly jumped from %2 to %10, every lender which was a party to fixed rate loan contracts, or contracts where the lender was unable to alter the spread between the bank rate and the rate extracted from the borrower, would lose their shirt.

As this relates to American monetary policy, the prevalence of fixed-rate mortgages in the US banking system would make it very costly to the financial sector for the Fed to raise its inflation target significantly. Raising the inflation target, therefore, will remain off the table regardless of unemployment levels.

30

reason 01.10.13 at 8:53 am

MainStreetMuse @20
btw I think Barry was speaking of the UofC Economics Department when he referred to the “Chicago Mafia”, not the Hawaiian import who happened to win the Presidency.

31

reason 01.10.13 at 8:59 am

Curmudgeon @29
Yes, this is generally correct.

It seems to me to be a common misconception that the financial sector cares about the real value of loans. The financial sector cares about margins and default rates. They make margin, not the principal of the loans.

I think the fact that Australia has mostly variable interest mortgages explains why monetary policy still has bite there. With variable interest mortgages, and high rates of home ownership, monetary policy works almost as directly as fiscal policy. RBA ups the rates, disposable income goes down. RBA lowers the rates, disposable income goes up.

32

John Quiggin 01.10.13 at 9:21 am

@26 It’s not the clearest thing he’s ever said, but I think Krugman actually means “We have (very modestly) increased minimum wages.

As an aside, based on a 35-hour week, the US Federal Minimum wage yields almost exactly the same income* as the Australian basic unemployment benefit for a single person (Orwellian name Newstart). There was a big fuss here recently when the relevant minister was asked the “gotcha” question: Could you live on $35/week and she answered “I could”

* Admittedly that’s at current exchange rates, well above purchasing power parity. But a Newstart recipient gets a variety of concessions and additional allowances for children, which aren’t available to minimum wage earners in the US AFAIK.

33

Rob 01.10.13 at 9:58 am

There was a big fuss here recently when the relevant minister was asked the “gotcha” question: Could you live on $35/week and she answered “I could”

At the risk of going off-topic, I’m always annoyed when people try to use this as a “gotcha” question. Any middle-class-or-above person can live on $35/week for one or two, maybe more, weeks because they have many material and social advantages that make them more resilient to shocks than poor people. If they own a car, or a computer, it is more likely to be in good working order (and owned outright rather than rented). They’re likely to be in better health. They’re likely to have friends and family who are also economically self-sufficient and who will not show up needing to borrow money for some unexpected emergency.

Every so often some Tory back-bencher or Daily Mail columnist will run this experiment themselves to “prove” how generous benefits are, ignoring the fact that people on benefits are often starting from a much different, and much more precarious, position. $35/week is survivable for a person with no dependants, good health and no unexpected expenses, but nobody can live that kind of life indefinitely. The real question should always be “how will you cope if you get sick, or your car/computer/washing machine/etc. breaks down, or your brother needs to borrow money for rent, if you’re on $35/week and you have no savings and nobody to bail you out?” I think this captures the challenges much more clearly than trying to work out what the cheapest basket of groceries for a week could be.

34

Mao Cheng Ji 01.10.13 at 10:12 am

$35/week seems to be much less than the US minimum wage, and not nearly enough to survive, if you have to pay rent. Could it be $35/week-day, $175/week?

35

reason 01.10.13 at 11:10 am

Mao Cheng Ji @34
Wikipedia to the rescue:
“Newstart allowance as at the 12th January 2010 for single people without children is A$228 per week”
– so of the order of A$35 a day.

36

Alex 01.10.13 at 11:13 am

Newstart, for one person, is A$492/fortnight = A$246/week or US$260/week. (I was wondering about that figure too.)

http://www.humanservices.gov.au/customer/enablers/centrelink/newstart-allowance/payment-rates-for-newstart-allowance

37

SJ 01.10.13 at 12:49 pm

Yes, the actual figure is $35/day, obviously a typo from John Quiggin.

See here for example:

http://www.skynews.com.au/politics/article.aspx?id=833073

There’s another useful US/Australian comparison I posted here back in July 2012:

“The median wage in the US is about $26,000. The minimum wage in Australia is about $31,000.”

I think that comparison does a lot of damage to claims in the US that raising the minimum wage must lead to higher unemployment. (In case anyone doesn’t know, unemployment in Australia is lower than that in the US).

38

Metatone 01.10.13 at 12:55 pm

I think it was Nick Rowe that suggested the fashion for a 2% target (with due respect to the antecedents noted by gordon @25) came from the choice of that target by the Bank of New Zealand, who were the first of the new-fashioned “independent” central banks.

As far as I remember, the evidence from policy documents of the time was that the 2% figure was rather plucked out of thin air. I’d go with Tragically Flip @22 on the heuristics involved, above 0 to give some breathing room over deflation, but not high enough to scare people with lots of money…

39

SJ 01.10.13 at 12:59 pm

John Quiggin does note that “Admittedly that’s at current exchange rates, well above purchasing power parity.”

I’ll repeat another comment I made back in July 2012, about the usefulness of PPP when comparing (ostensibly) first world countries like the US and Australia:

“PPP is very useful when comparing, for example, poverty levels. It really does make a difference if rice costs 1.0 USD/kilogram in the US but only 0.25 USD/kilogram in India.

It’s not so useful higher up the income scale, nor for internationally traded goods. If a burger flipper at McDonalds in Australia is in the market for, say, an iPod, a camera, a TV, a refrigerator, a Toyota, a washing machine, an iPad, etc, she’s in a much better position than the median USican.

There’s also another aspect to the World Bank’s PPP that seems to work in the US’s favor, but really doesn’t if you think about it a bit. The PPP adjustment also includes the cost of labor. It does not help the average working slob in the US that she gets paid less than the average working slob in Australia.”

40

Metatone 01.10.13 at 1:18 pm

Glad to see someone of Krugman’s stature thinking harder about inflation.

Quick notes I’d hope he gets to thinking/talking about:

1) Imported inflation from inelastic commodities hasn’t proved to be easily controlled by austerity.

2) There doesn’t appear to be good agreement about the relationship between inflation and asset prices. As a result, strawmen straight lines are drawn between money supply and wage inflation, leading to a lot of misunderstandings. Further, wage inflation (and indeed labour productivity) are used as proxies for all sorts of economic effects without proper mechanisms/linkages being delineated.

41

Tim Wilkinson 01.10.13 at 3:16 pm

Gotchaye @16 – thanks; the idea was that if generating a net total of $100 worth of ripples in the national output pool isn’t ‘stimulative’, then why is generating say $150 worth? Both are presumably meant to specify the total effect all down the line – not leave some further stimulus effect unaccounted for. I guess the idea is that these are not in fact net effects, but leave out of account the GDP hit of taking a matching $100 out of circulation by some means or other. I don’t see that this should be assumed always necessary, still less that the resulting GDP hit will necessarily amount to $100 (isn’t there some multiplier for that effect too?). I may just be publicly miring myself further in my own ignorance here, and in any case should probably not clutter the thread further with this stuff.

42

Omega Centauri 01.10.13 at 4:59 pm

Curmudgen @29. That interest rates (usually) move with inflation doesn’t effect all the outstanding fixed rate loans. These were agreed to often years ago. So an uptick in inflation decrease the real value of a loan/debt portfolio. If loans have to be renegotiated, or are indexed to inflation that would apply.

43

js. 01.10.13 at 5:55 pm

Gotchaye@16: Wouldn’t “crowding out” imply a multiplier of 0? As in: the govt. spends $100, which *if the govt. had not spent it* would have been spent by some private actor. With exactly the same effects etc. So govt. spending has no net effect. Or something. Whereas a multiplier of 1 implies that there is a stimulative effect—there’s a $100 floating around now that wouldn’t have been otherwise—but there’s no *multiplier* effect. Or something. Or I guess if you take “stimulative effect” to mean something stimulate further growth/spending/etc., then there is indeed no stimulative effect.

(I should note that I really don’t know what I’m talking about, but this is what I gleaned from JQ/Bruce Wilder on JQ’s fiscal multiplier thread.)

44

mpowell 01.10.13 at 6:16 pm


There’s also another aspect to the World Bank’s PPP that seems to work in the US’s favor, but really doesn’t if you think about it a bit. The PPP adjustment also includes the cost of labor. It does not help the average working slob in the US that she gets paid less than the average working slob in Australia.”

What in the world are you talking about? If my haircuts cost less because labor costs are lower, that most certainly helps lower my cost of living. Now of course this also implies that certain workers may be paid less, but that’s the whole point of the comparison! You take median wages and then apply the appropriate PPP adjustment as best you can to really see which country is doing better. It might be a high cost, high wage economy or a low cost, low wage economy and you are trying to find the answer! Depending on the particular basket of goods that any given consumer wants, some PPP adjustments will work better than others but there are two points to make here: 1) Services are 70% of GDP so PPP matters a lot and 2) even internationally traded goods like phones and cars have different prices in different local markets.

45

Trader Joe 01.10.13 at 6:50 pm

“There is in principle the expectations channel. If a central bank can credibly promise that it will allow a higher inflation rate over the medium term then it ought to be able to reduce real interest rates and have a significant expansionary effect on the economy. The problem is how do you in fact make that promise credible”

It seems to me Krugman’s above quoted passage on ‘expectations’ is really the core flaw with a monetary solution. As an investor when I see “0%” interest rates I don’t think “gee we must be in a great economy lets do projects” I see we’re in a lousy economy with lots of uncertainty – better hunker down.

That then implies a fiscal approach has a better chance of success – if indeed there is a macro response that can provide some cure.

The difficulty I find with fiscal solutions, particularly for an economy that is already borrowing to fund spending is a matter of degree – $1T of incremental spending is only an 8% additional to a $15T economy multiplelier or not…considering borrowing is already running >$1T annually to simply fund existing spending (very little of which is directly stimulative) .

High levels of borrowing heavily influence expectations about future taxation, which in turn doesn’t foster an environment conducive to capital investment. This isn’t “crowding out” in the literal sense, more an expectations theory of current economic actions.

Bottom line, in my view, is we’re in relatively uncharted territory for macro response. Like a complex disease I’m doubtful that a ‘silver bullet’ response would be as effective as a ‘cocktail’ response…so would sooner see policy conducted using multiple mid-sized vector than making big bets on one theory or another.

46

Rob 01.10.13 at 7:04 pm

js. @43

Gotchaye@16: Wouldn’t “crowding out” imply a multiplier of 0? As in: the govt. spends $100, which *if the govt. had not spent it* would have been spent by some private actor. With exactly the same effects etc. So govt. spending has no net effect.

$100 * 0 = 0, so there’s a net loss of $100 in that scenario – equivalent to setting your $100 bill on fire.

47

js. 01.10.13 at 8:20 pm

Rob @46:

I’m just going to quote Bruce Wilder from the fiscal multiplier thread, which still makes a lot of sense to me, and which is what I was trying to get at. This is BW’s #31 (01.04.13 at 6:21 pm):

“The multiplier is the ratio of the incremental government expenditure to the expected or resulting increase in national income. If the government borrows an additional $1 from me, private citizen, and I spend $1 less (since I lent it to the government), at the same time as the government spends the additional $1 it borrowed, national income (the total expenditure on production in the economy) hasn’t changed. Hence, a multiplier of zero.”

Maybe “crowding out” refers to something else, but in JQ in the same post suggests that crowding out implies at least that the multiplier is < 1.

48

Tim Wilkinson 01.10.13 at 8:42 pm

49

John Quiggin 01.10.13 at 9:23 pm

A few quick response

1. Sorry, everyone, I meant to type $35/day. Also sorry for derailing my own thread. SJ’s point is valid if you look at PPP adjustments for GDP/person, since a lower wage share will increase measured purchasing power, but not the PP of workers. But, if we look directly at incomes, as in this case, PPP works fine (at least in this respect).

2. Crowding out implies a multiplier between 0 and 1. Complete crowding out implies a multiplier of zero. That doesn’t mean the money was wasted, just that public expenditure has displaced an equal amount of private

3. NZ started with a very low target (1-2 per cent IIRC), had disastrous results and raised the target. The ground lost then, relative to Oz, has never been regained, though.

50

Michael H Schneider 01.10.13 at 10:43 pm

Forgive me if I’m about to lower the median comment quality, but I’m confused.

There’s been talk about the work of Valerie Ramey, and how her work supports the conclusion that fiscal stimulus won’t work (or is a bad idea), so I’ve been trying to understand what she said last Sunday as reported by Delong. I find her reaching this conclusion:

Thus to answer one of Brad’s questions, yes, the government could adopt a policy that would quickly reduce unemployment: large-scale military conscription. If the problem is with employment rates for young males, this is a great way to do something about that, but I don’t think anybody thinks that policy would be welfare-improving.

First, let’s ignore the qualifier about young males, because we all know that we have females in the US armed forces, and I do seem to recall that when I registered for the draft 35 year olds were still draftable. While 35 is obviously quite young, surely we could draft 50 year olds for clerical positions.

Second, I don’t see that it would make any difference if people chose to sign up in exchange for good pay rather than being conscripted, it would still get them out of the pool of job seekers.

Third, I don’t see that it would make a difference if people were to join, say, the National Park Service and get a dark green uniform rather than the Marines and get a blotchy uniform.

So isn’t this an agreement that increased government spending certainly could bring down unemployment?

Then she goes on to say:

I think a key structural reform that would significantly help the economy—the labor market and also the long-run budget deficit—would be to reform the health-care sector.

One of the problems of health care in the US is that we are spending more and getting less. Suppose we were to replace our inefficient private sector health care system with a more efficient single payer government system – and let’s suppose we get equally good results while spending only 70% as much (because we’ve eliminated that 30% in overhead imposed by the private system).

Doesn’t that mean that by increasing government spending by 70 cents we’ve eliminated (crowded out?) 100 cents of private spending? Doesn’t that give us a net reduction in GDP of 30 cents, and thus a negative multiplier? So while she thinks increasing government spending is a bad idea because the multiplier might only be a positive .5, she favors policies having a multiplier of negative .3?

51

Tim Wilkinson 01.10.13 at 10:55 pm

Crowding out implies a multiplier between 0 and 1. Complete crowding out implies a multiplier of zero. That doesn’t mean the money was wasted

OK, so >0 means worth doing, not >1, which thus has no salience unless one has other prejudices which lead to opposing any degree of ‘crowding out’ at all, ‘on principle’, correct?

But even then (and without accepting that a private-sector fetish should be catered to at all, particularly in constructing econ. theory), isn’t the multiplier still an all-things-considered thing, so that looked at in detail, the effects of spending whose multiplier ends up being 1 could still include some crowding out component, just not a big enough one to drive the multiplier below one overall?

Assuming that’s right, then if one has an overriding aversion to government ‘getting in the way of business’ to any extent at all, a multiplier value of >1 still won’t guarantee that the spending plan in question is acceptable, though <1 will apparently be sufficient to make it unacceptable (is there really no realistic, not-gratuitously-wasteful, way of ending up with a multiplier <1 without crowding out being involved?).

52

gordon 01.10.13 at 10:57 pm

Anon/portly (at 26)

You may be right. It’s a bit obscure, as Prof. Quggin notes at 32. My reading was that mass impoverishment meant that a rising average wage represented actual rises only among the not-impoverished, ie. that the “average” isn’t in this case a good measure of what is going on for most people. The distribution is strongly skewed, so that the
“average” number doesn’t tell you much. But the big deal is the mass impoverishment, without which a rise in the average wage would actually be a good thing, indicating good National economic health.

Your reading is, I think, that if mass impoverishment was even worse than it already is (because of people taking wage cuts) there wouldn’t have been any rise in the “average” wage number, so that wage movement as an index of economic health would then unambiguously have shown recession/depression.

But on either reading, I still think Prof. K’s “truncated the left edge of the distribution” is remarkably cold-blooded. I suppose I won’t hold it against him too much; it’s a technical argument for a technical audience, and he has pointed to impoverishment often enough in other places. I think he should have pointed to it at the Conference, too. There are people there with blood on their hands, and they should be told so.

53

anon/portly 01.11.13 at 9:11 am

JQ: @26 It’s not the clearest thing he’s ever said, but I think Krugman actually means “We have (very modestly) increased minimum wages.

The minimum wage is obviously a factor in wage stickiness, but “not the clearest thing he’s ever said” would be something of an understatement if workers getting a very modest increase in their nominal wage due to an increase in the minimum wage were what Krugman meant by “a lot” of people “literally getting zero wage change” or for that matter “people don’t like to cut … wages.”

PK: It has become much more apparent that downward nominal rigidity—not just stickiness but people don’t like to cut nominal prices and wages—is a very significant factor. When you have a depressed economy in a state of initially low inflation the zero bound not just on interest rates but on wage changes becomes a really big deal. Again, more San Francisco Fed stuff: they have tried to back out how many people are literally getting zero wage change. The answer is: “a lot”. That suggests….

54

anon/portly 01.11.13 at 9:43 am

gordon, just above: Your reading is, I think, that if mass impoverishment was even worse than it already is (because of people taking wage cuts) there wouldn’t have been any rise in the “average” wage number, so that wage movement as an index of economic health would then unambiguously have shown recession/depression.

No, this isn’t my reading. My reading is that Krugman is saying that the truncation of the wage distribution is what is showing that we have recession/depression. In the preceding paragraph, he brings up someone like James Bullard, who thinks that we don’t have a lot of economic slack. So Krugman is explaining why that view is wrong, that unemployment is cyclical not structural, and therefore we should be doing a lot more to eliminate it.

55

gordon 01.11.13 at 9:54 am

Anon/portly (at 54)

Well, have you got Prof. K’s phone number? I don’t, unfortunately.

56

dax 01.11.13 at 12:21 pm

““If we have all that economic slack, where is the deflation?”

” ‘…if they could get trapped in this sort of deflationary stagnation then it could happen to us.’ Sure enough, it did.”

When one of the participants in the discussion doesn’t notice that he has contradicted himself three paragraphs on, perhaps that is the best indication why macro is in worse state now than it was in 1958?

57

Walt 01.11.13 at 12:56 pm

Your typo-free world must be beautiful, dax.

58

dax 01.11.13 at 2:44 pm

Typos aren’t essential blocks to an argument, Walt.

Comments on this entry are closed.