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Since Japan’s latest growth report was apparently disappointing, analysts are fretting over whether Abenomics is “working.” There was an archetypal report this morning on NPR that I cannot find a link to, sadly, but this screenshot from Google News aptly summarizes the zeitgeist:
But is this conclusion justified? Let’s ask FRED; here’s the log of Japanese NGDP-per-working-age-person (15-64):
Hey – that looks pretty good! That’s 3.5% nominal growth over the past year, which is not explosive, but at least pretty OK. But why does this look so different than the topline number? Because of reasons; demographic ones, specifically:
Japan is shrinking, and shrinking pretty quickly, in the non-retiree department, and therefore if productivity-per-worker in Japan remained constant, we would see declining topline growth numbers. Not that the actual facts on the ground are good news for Japan, per se; they’re just different news than “Abenomics isn’t working.”
Moral of the story – always try weighting economic data demographically to get actual insights. Especially Japanese data.
Let’s model a kingdom. In this model, the kingdom is a closed economy, and (very importantly) it is “well-normed” – it has strong norms relating to governance and society that tend to be widely honored and respected.
This kingdom is governed by two individuals: the king, and the wizard. Most formal power, as well as the titles of head of state and head of government, is vested with the king. The king has formally unlimited powers to tax and spend, raise armies, and adjudicate disputes, but in practice is limited by norms, sense of duty (symbolized in a sworn oath to serve in the interest of the whole kingdom and its subjects), and the patience of subjects; therefore, the king tends to maintain inherited intuitions to which their power has been delegated, like courts and military bureaucracy. The crown is hereditary – the first-born child of the king (this is a gender-progressive kingdom) inherits the crown, and in the past, though there have been occasional hiccups, most transfers of power have been peaceful and orderly.
The king must retain a wizard, who is charged in vague terms with independently securing the safety, security, and prosperity of the kingdom. The wizard bears a hat that grants them vast yet mysterious magical powers. Unlike the crown, which is symbolic, the wizard’s hat is in fact where the magical powers are vested, and is not hereditary. When the existing wizard dies, the king selects the next wizard, who receives a lifetime appointment. Extremely strong norms dictate that the king select whomever is widely acclaimed the wisest scholar in the kingdom, regardless of their personal feelings towards that individual or inclination to select an ally as wizard. Often the wizard will survive the king.
As stated above, the wizard has vast powers, but they are mysterious and to some extent ill-defined. There is no user manual for the wizard’s hat, and often throughout history wizards have surprised themselves with the consequences of exercising their powers. Therefore, norms have developed that the wizards exhibit strong restraint in exercising their powers, even in times of emergency. Extremely strong norms have also developed against the king making formal or open requests of the wizard, as well as against the wizard interfering in the quotidian or terrestrial business of the king. In the past, there have been some violations of this norm in both direction, but for the most part it tends to persist. Consequentially, the wizard tends to be reclusive, speak carefully and opaquely, and avoid commitments to use their powers. There is much dispute among the subjects of the kingdom to exactly what the wizard is doing or could be doing, and when the wizard ought to exercise their powers.
Your assignment: model the governance and economy of this kingdom.
Obviously this is kind of an allegory. And I’m going to just blow it wide open by saying the king is the fiscal authority and the wizard is the monetary authority. And while it doesn’t quite match up with how the modern world works, I think it has some implications.
Now there is great sturm und drang in the econoblogobloid about whether Keynesianism or Monetarism is “right” and what “monetary offset” is and I just don’t get it at all because to me it all makes perfect sense together.
My theory is this – monetary policy dominates fiscal policy, but doesn’t always, or even usually, exercise that dominance to determine point outcomes. Instead, it usually determines range outcomes, and within those ranges fiscal policy exerts influence.
So for example if the monetary authority declares “the rule is that inflation will never exceed 2%” that means a whole range of outcomes are possible; just not those where inflation exceeds 2%. So fiscal policy can, by being expansionary or contractionary, have a substantial influence on inflation, unemployment, and GDP, just within the range of outcomes that are possible with below-2% inflation.
If the monetary authority declares “we will print $100 billion and buy bonds with it every month until unemployment hits 3%” that means a whole range of outcomes are possible, but all those outcomes must account for an additional $100 billion of “high-powered money” in the economy every month. So fiscal policy can, by being expansionary or contractionary, have a substantial influence on inflation, unemployment, and GDP, just within the range of outcomes that are possible with regular large monetary infusions.
If the monetary authority declares “we are targeting the path of NGDP and we will never let it deviate ever ever no matter what ever” that means a whole range of outcomes are possible; just not those where NGDP deviates from its price path. So fiscal policy can, by being expansionary or contractionary, have a substantial influence on inflation, unemployment, and real GDP, just within the range of outcomes that are possible with rock-solid 5% NGDP growth.
If the monetary authority declares a whole bunch of stuff, some of which is concrete, some of which is fuzzy, and some of which is muddled, well…many outcomes become possible. But many are not!
So the story of 2013 is not one where monetarism was right because the Fed got exactly what it wanted; it’s one where fiscal contraction couldn’t generate outcomes outside the bounds set by the Fed. But it does mean that outcomes could have been better had fiscal policy been less contractionary. Counterfactuals are hard, but that’s a reasonable one.
Now, I’m a believer in the power of monetary policy, so I think it would be great if the Fed set an NGDP target and committed to not only a growth target but a path target and that they were going to overcompensate to get us back to the pre-recessionary path. I even think an optimal NGDP target is something more like 7%, not Scott Sumner’s girly-man 5%. But what I don’t believe is that absent such direct, confident, dominating policy guidance from the Fed, that Fed policy still generates pinpoint outcomes or even tight ranges of outcomes. The economy improved in 2013. It could, and should, have improved more, and that’s on both the Fed and the Congress.
Now, as much as I really, really don’t like Arnold Kling, there are also some PSST dynamics out there that constrain the power of monetary policy, which is why the auto bailout was a really good idea, but barring massive systems collapse I think monetary policy can do pretty much all the heavy lifting of macroeconomic policy but that conditional on monetary policy fiscal policy can have some room for maneuver.
Note that this is pretty much 100% what both monetarists and Keynesians think when we’re not at the ZLB; all I’m saying is that it is also true at the ZLB, and that monetary policy really doesn’t change that much. We just think it does. Which is part of the problem, because money illusion is a real and serious thing, which goes back to why our NGDP target should be higher. In general countries that are better at avoiding recessions have a somewhat higher tolerance for inflation than we do.
Miles Kimball and Yichuan Wang find that high government debt doesn’t cause low GDP growth, and Kimball says he finds that surprising, as does Matt Yglesias. But as I suggested in a post last month, I’m not really surprised by this at all.
Governments tax or borrow. The former is withdrawing money from the economy in exchange for nothing (or perhaps a promise not to sanction the taxed) while the latter withdraws money from the economy in exchange for a piece of paper. That’s debt! Evil, evil, debt! Oh, no!
Wait, let’s start over.
The goverment decides it wants to do something it isn’t already doing, and therefore needs to command a higher share of total social production going forward than it has been. Developed-world governments don’t directly commandeer social resources, they claim through the proxy of money, by spending it. Assuming an economy at full capacity (whatever that means), if the government commandeers resources by spending money without removing any money from the economy then you’d have inflation, unless the central bank raises interest rates substantially, which would likely have undesireable negative effects. So the government attempts to roughly balance the resources claims it makes using money by withdrawing an equivalent amount of money from society. Sometimes it does this through taxes, which has some desireable properties (no future obligations on the state, can be used Pigovianly) and some undesirable ones (unintended consequences, involuntary, discourages desireable activity). Borrowing also has some desireable properties (voluntary, compensates those who part with their money) and some undesireable properties (obligates the state).
Therefore, there are two key intertwined questions to be asked about this new government activity, which remember is centrally about taking some resources deployed previously to some private purpose and redirecting them to some other, presumably public purpose – is the new activity more valuable than the activity(s) it is supplanting, and how is it being financed? They are intertwined because the latter question informs the former.
Let’s say we all agree that this new government project – let’s say it’s a SUPERTRAIN, for fun – is widely considered to be of higher value than the marginal private activity it supplants regardless of how it is funded. The government could raise taxes to fund it, but unless it is taxing something undesireable (like carbon or booze or Kardashians) this would have the drawback of incurring some "deadweight loss," not to mention other unintended consequences. It could also borrow the money, which would have two consequences. Firstly, it would supplant something different – rather than raising the cost of work or carbon emissions, it would be more likely to supplant a capital investment of some kind somewhere in the economy. Secondly, it would obligate the government.
And to what would it obligate the government? Key to understanding this is that governments, unlike Lannisters, never pay their debts. They cleverly disguise this fact by paying their debts in full and on time. Huh? From the perspective of a borrower, you get your interest payments, and then your principal in full. But from the perspective of a government, you don’t pay the principal back out of tax revenue, you pay it by rolling over the debt and issuing new debt in the amount of the principal. This works because of NGDP growth (both the RGDP growth and inflationary components). In fact, we’re still likely rolling over all the debt we incurred from WWII, which back then was 110% of NGDP but today is less than 2% of NGDP.
So really what the government does when it issues a bond is issue itself a negative perpetuity. And the key to understanding the value of a perpetuity is knowing the interest rate, since the PV = C/r. Therefore, the obligation on the government is much more dependent on the interest rate path than on the nominal coupon value.
But that interest rate path isn’t just some made-up thing – it’s fundamentally related to NGDP growth. Don’t believe me? Here’s the fed funds rate divided by the NGDP growth rate:
So when recessions happen, the ratio spikes (and whether it spikes up or down is very interesting), but otherwise it’s very steady; if you exclude just the 12 of 223 periods where the absolute value of the ratio is greater than 3, you get an average of 0.8 and a standard deviation of 0.6.
So what does that mean? As interest rates grow, so does the obligation on the government – but it also implies that the government’s ability to meet that obligation is growing in tandem. Which suggests that, while governments cannot borrow limitlessly, the pain point at which government indebtedness begins to inflict structural economic harm is vastly higher than previous assumptions.
Japan, for example, is often cited as an example of government debt creating a huge drag/time bomb/giant vengeful lizard that is harming Japan’s economy. But since 1990, Japan’s debt/GDP ratio increased from 67% to 211% and GDP-per-capita…grew! Significantly! Not awesomely, not enough to catch-up with the US (in fact, it fell behind), but grow it did. Certainly more than you might think it would if the 90% monster were real and starting smashing major cities or something.
Many people have begun to worry whether the seemingly-inevitable Japanese debt crisis is nearing as yield have crept up. But yields have crept up because NGDP-growth-expectations have crept up. As long as they increase in tandem, contra Noah Smith, Japan should always be able to pay its debts.
And I’d be willing to put money/my reputation on this point. While Noah Smith is 100% right that bets != beliefs, I am nonetheless willing to agree in principle to any reasonably-valued bet that neither Japan nor the United States will default over any arbitrary time period. Any takers?
David Andolfatto and Tyler Cowen are confused:
In grandma’s liquidity trap, the real interest rate is too high because of the zero lower bound. Steve argues that in our current liquidity trap, the real interest rate is too low, reflecting the huge world appetite for relatively safe assets like U.S. treasuries.
If this latter view is correct, then "corrective" measures like expanding G or increasing the inflation target are not addressing the fundamental economic problem: low real interest rates as the byproduct of real economic/political/financial factors.
My reaction to this is two-fold:
2) OK, here’s how it goes – there are two interest rates at work here, the "true" interest rate, ie, the rate at which people would be willing to invest; and the "prevailing" interest rate, what you’re actually getting in the market. The former reflects the sum of underlying preferences, the latter a mix of the expression of those preferences along with a helping dose of central bank regulation. A liquidity trap is when the former is less than zero. That’s it. What is the difference between the two liquidity traps they discuss? In the former scenario, the prevailing rate cannot be brought below zero to match the true rate, and therefore: liquidity trap. In the latter scenario…the true rate is lower than zero, and the prevailing rate is stuck at zero. Same scenario. In both scenarios, the key is low growth expectations and low inflation expectations means a flight to safe, liquid assets with a low real rate. When the prevailing rate is 5%, and the true rate declines to 3%, then the Fed cuts their rate to 3% and everything is fine. When the true rate goes below zero, though, then the central bank’s ability to guide the economy through the signal of the prevailing interest rate is handicapped and therefore you need something else (debt-financed public spending, QE, NGDPLT, whatever).
I really don’t get this. If I’m missing something, please tell me.
Cantankerous archetype Don Boudreaux has apparently abandoned his job and family in order to rail full–time against the minimum wage, writing no fewer than nineteen posts on the subject since the SOTU speech. There is a lot I could say about the subject – about the economics, about the social and political impacts of the policy, and about the patronizing and condescending way Boudreaux concludes that anyone who disagrees with him is an idiot trying to destroy the poor – but instead I’ll just post the below graph, which is the ratio of one hour worked at the minimum wage to NGDP-per-capita (log scale)*:
Firstly – note how awesomely the log trendline fits the data. Secondly, note that the last point, Obama’s proposal (assuming full implementation at $9/hr on Jan 1 2014) does “hop” outside the trendline a little, but still is below the level observed in 1991.
One of my firmest belief is that most differences in kind are really differences in degree, and thus the answer to the question “is raising the minimum wage a good idea?” is another question – namely, “by how much?” I am exceedingly doubtful that Obama’s proposal will have any substantial disemployment effects.
Lastly, note that I only used “new” minimum wages, so I’m really only tracking the politically-decided minimum wage at the moment of impelmenetation, not at every moment in time. Here’s the chart for the latter:
*The future data points for NGDP/POP were projected forward by Excel using…whatever it felt like using, I guess? Kind of magic. Anyway, the numbers didn’t seem absurd so I kept them.
Just a quick observation: for the past couple of days I’ve been seeing in a lot of places, including comments on this blog, the assertion that federal spending has risen 37 percent under Obama — that specific number. Does anyone know where it’s coming from? Because if I look at the actual data, I see federal spending rising from $3.475 trillion in fourth-quarter 2008 to $3.917 trillion in fourth-quarter 2012 — a rise of 12.7 percent.
Obviously this is coming from somewhere, and being broadcast by Rush or somebody. But it’s still kind of amazing how a totally wrong number can become part of what everyone on the right just knows to be true.
Not only that – look at this:
That’s the natural log of federal spending per-capita. As you can see, it grows slowly, then a little more quickly, then back to slowly, then aaaaaalmost flatlines during the Clinton administration, then takes off during the Bush administration. When the recession hits it accelerates before hitting a total wall. That’s what austerity looks like.
You can also see this as a percentage change:
That’s the first instance of federal spending per-capita shrinking in…well, how long?
Looks like the answer is “since Eisenhower got us out of Korea.”
A simple problem – let’s say the central bank has a 2% inflation ceiling. Ergo, if it records inflation expectations as over 2%, it will take action to lower those expectations, usually raising interest rates as a way of draining the money supply, which also has the effect of decreasing total economic activity. Additionally, everyone knows this, so when some activities or events occur that would ceteris paribus increase inflation expectations markets presume the central bank will act to quash inflation and therefore adjust their overall expectations of economic activity. This will probably manifest itself as a reluctance to invest.
Let’s say unemployment is 10%, inflation is 1%, and real GDP growth is 1%. Let’s further say that the central bank is willing to tolerate an unlimited amount of RGDP growth but refuses to budget on its inflation ceiling. Let’s further say that any activation of idle labor will necessitate some inflation due to short-to-medium-run supply inelasticities. And let’s say everyone knows all of this.
Let’s say some large positive exogenous shock causes a boom in labor demand in some sector or another. This model would predict a largely zero-sum net gain in employment or economic growth, as the increase in activity in that sector will be offset by a decline elsewhere. The only net increase would be that commensurate with accommodating short-to-medium run supply inelasticities – that is, there can be some net gain every period, but only enough that it doesn’t push up prices very much.
Consequently, the Committee anticipates that the unemployment rate will decline only slowly toward levels that it judges to be consistent with its dual mandate.
I always enjoy going to zerohedge for the most intelligent, compelling, and engaging iteration of the sociopathic perspective on events. I was disappointed, however, to see Tyler Durden submit this guest post from Bill Buckler, who is apparently of this publication. Anyway, in the course of writing some positive things about Ron Paul, Buckler writes:
The root of the problem is perfectly illustrated in the fact that since August 1971, the funded debt of the US government has risen from $US 400 Billion to $US 15,236 Billion. The severity of the problem is illustrated by the fact that with Mr Obama having yet to complete his third full year as President, he has presided over $US 4,600 Billion (or almost one-third) of that increase. The root of the problem is the abandonment of money – the final legal connection between Gold and the US Dollar was ended in August 1971. The severity of the problem is the grotesque expansion of what has taken its place.
Of course this is a giant stink bomb of the “correlation
equals causation” fallacy. But beyond that this is a comparison equivalent to comparing apples to zebras. This may be painfully obvious to most people, but let’s examine some other things that happened between 1971 and the present.
Firstly, we went from having 200mm people to 300mm. Secondly, NGDP went from $1.1 trillion to $14.6 trillion. And lest hard-money types wave that all away as ruinous inflation, the Inflation Calculator says that $1 in 1971 is equivalent to $5.32 today, which if you take it purely at face leaves today’s RGDP relative to 1971 at $2.7 trillion, a nearly three-old increase even though population increased 50%, leaving per-capita GDP much higher, which can be confirmed by looking at all kinds of measurements of quality of life in the United States over the last 40 years and seeing them all rise. So we are a much wealthier country now than we have been, and we have experienced a decent amount of inflation, so it makes no sense whatsoever to just throw up the nominal gross national debt numbers from 1971 and today and call it “the root of the problem.”
And look – the debt-to-GDP ratio, which is a very useful measurement since it complete controls for any nominal growth that isn’t reflected in real standards, has tripled! In 1971 it was below 40%, now it’s over 100%! If you wanted to push the idea that we are dangerously indebted (we aren’t, but if you did), that’s all you have to say. You don’t have to make grossly misleading comparisons to prove that point.
FWIW, I’m not even mentioning how deeply unfair this is specifically to the President, who was handed a $500b structural deficit and an economic implosion worthy of the Great Depression by his successor. I’m not sure it’s really possible to stabilize debt-to-GDP in those conditions unless you unilaterally abolish most government functions.