The Grumpy Economist

By the standards of mainstream media coverage of technical economics, Peter Coy's coverage of HANK (Heterogeneous Agent New Keynesian) models in the New York Times was actually pretty good. 

1) Representative agents and distributions. 

Yes, it starts with the usual misunderstanding about "representative agents," that models assume we are all the same. Some of this is the standard journalist's response to all economic models: we have simplified the assumptions, we need more general assumptions. They don't understand that the genius of economic theory lies precisely in finding simplified but tractable assumptions that tell the main story. Progress never comes from putting more ingredients and stirring the pot to see what comes out. (I mean you, third year graduate students looking for a thesis topic.) 

But in this case many economists are also confused on this issue. I've been to quite a few HANK seminars in which prominent academics waste 10 minutes or so dumping on the "assumption that everyone is identical." 

There is a beautiful old theorem, called the "social welfare function." (I learned this in graduate school in fall 1979, from Hal Varian's excellent textbook.) People can have almost arbitrarily different preferences (utility functions), incomes and shocks, companies can have almost arbitrarily different characteristics (production functions),  yet the aggregate economy behaves as if there is a single representative consumer and representative firm. The equilibrium path of aggregate consumption, output,  investment, employment, and the prices and interest rates of that equilibrium are the same as those of an economy where everyone and every firm is the same, with a "representative agent" consumption function and "representative firm" production function.  Moreover, the representative agent utility function and representative firm production function need not look anything like those of any particular individual person and firm. If I have power utility and you have quadratic utility, the economy behaves as if there is a single consumer with something in between. 

Defining the job of macroeconomics to understand the movement over time of aggregates -- how do GDP, consumption, investment, employment, price level, interest rates, stock prices etc. move over time, and how do policies affect those movements -- macroeconomics can ignore microeconomics. (We'll get back to that definition in a moment.) 

Larry Summers wrote an interesting oped at the Washington Post. Mostly, he still is of the adaptive-expectations ISLM view that interest rates must exceed current inflation before inflation will decline. (The issue here (blogpost) and here (paper).) But listen to this:

Questions of macroeconomic policy are not about values but judgments about the ultimate effects of various actions. As Fed chair during the early 1980s, Paul Volcker famously tamed out-of-control inflation at the cost of a severe recession. But he did so not because he cared less about unemployment or worker incomes than his predecessors did but because he rightly recognized that delay in containing inflation would only mean more pain down the road.

Would we all recognize common goals, but differences on cause and effect to get there.  

That’s why it’s vital that the Federal Reserve not waver. Chair Jerome H. Powell has vowed to impose sufficiently restrictive monetary policy to return inflation to within range of the Fed’s 2 percent target. The more confident that workers, businesses and markets are that the Fed will follow through on that, the less painful the process will be.

Within the conventional monetary policy community, praise for Volcker and the view, basically, that the Fed should focus on inflation and the labor market will take care of itself is sensible, but remarkably Reaganish. 

The tidbit that I found most interesting

Finally, the crisis of inflation should not be wasted. A bright spot in the dismal inflation period of the 1970s was the collaboration of Stephen G. Breyer (then counsel to the Senate Judiciary Committee), Sen. Edward M. Kennedy (D-Mass.) and the Carter administration on airline deregulation. In this era, high inflation should be a spur to regulatory changes — from addressing Jones Act increases in shipping costs, to strategic tariffs, to rules that force oil and gas to be transported via truck rather than pipeline, to punitive zoning restrictions — that will both reduce prices and make the economy work better.

As you know I've been preaching that "supply side" growth is the central problem and also the key to reducing inflation. Larry hasn't quite gotten to the latter, but this is the economist most identified with "secular stagnation," "hysteresis" and the view that all we need to do is borrow or print more money and hand it out to create growth. Now deregulation and the supply side is the key to growth. 

Larry is starting to sound like a Reagan Republican!  I'm sure he would say circumstances have changed -- that was ZLB (zero lower bound on interest rates), this is inflation. That's a consistent view. But inflation should wake us all up as it has Larry: All the old verities are over, there is only supply now, and that comes mostly from getting out of the way, as Larry recommends, not new "investments" of more borrowed money thrown down ratholes. 

*** 

Pierre Poilievre, the leader of Canada's Conservative party, wrote a great Oped in the National Post. Now that Liz Truss has imploded, perhaps Poilievre will become the international hope for a successful free market libertarian politician. 

Finance Minister Chrystia Freeland wants us to believe she has had an epiphany. After years of ignoring my warnings that Liberal deficit spending would cause inflation to balloon, followed by interest rates, she now claims to agree with me in a leaked letter to fellow ministers. Even her boss, Prime Minister Justin Trudeau, is uttering words unthinkable to him not long ago: “fiscal responsibility.”

The cost of government is driving up the cost of living. A half-trillion dollars of inflationary deficits have sent more dollars chasing fewer goods, which always leads to higher prices. 

We're all FTPLers (fiscal theory of the price level) now, some sooner than others. A clear explanation of how central banks create money and buy treasury debt follows. Then

 the Bank of Canada must pay interest — at the going rate. Because rates are now rising, the central bank is now losing money and will need a bailout from the federal government for the first time in history — something I predicted would happen two years ago. 

Fiscal constraints on monetary policy. Nice. 

Liberals like to say that all this inflation is the result of the Russian invasion of Ukraine. But less than 0.3 per cent of Canada’s trade is with those two countries, and the things that they produce are things we already have — food and energy. In fact, the higher commodity prices should have helped our resource-heavy economy, but for the fact that the Trudeau government has hit farmers with fertilizer tariffs and carbon taxes and blocked or bungled every single pipeline or LNG export terminal proposed in seven years.

Beside my thread, but an important point. His bottom line 

Instead of creating more cash, we need our economy to produce more of what cash buys: more food, energy and homes. That means removing gatekeepers that have made Canada the second slowest country in all the OECD to get a building permit. As prime minister I would challenge all three levels of government to work together to offer the fastest building permits in the OECD. This would mean going from 250 days to 28 days to beat the now first-placed South Korea....We would remove taxes and tariffs on farmers’ fuel and fertilizer....Finally, we would reform our taxes to reward work, savings, and investment so our workers and businesses can produce more of the goods we need. 

Simply put, we would stop creating cash and start creating more of what cash buys: food, homes, energy, manufactured goods and more. That is the only path to bigger buying power for paycheques and savings.

FTPL and deregulation-focused supply side growth. Well, us free market libertarians are like Chicago Cubs fans, there's always hope!

(at Project Syndicate)

The Liz Truss Tragedy

The former British prime minister’s downfall holds important lessons for growth-minded policymakers in the United States, Europe, and elsewhere. While her diagnosis of the country’s economic problem was spot on, she fatally mismanaged both the politics and the messaging of her policy response.

STANFORD – Liz Truss’s stint as British prime minister is over, but she was right that the United Kingdom needs growth. Her downfall is tragic, because growth is the only path out of the country’s economic dilemma. 

The UK is surprisingly poor. Its GDP per capita is just $43,000, compared to $60,000 in the United States. The average British home is one-third the size of the average US home. Worse, the country’s economy is not growing. Its GDP per capita is lower than it was in 2007. Productivity – the underlying source of economic growth – has been flat for over a decade. 

The UK desperately needs supply-side reforms. Surging inflation tells us that demand-side stimulus is a spent force. 

The Revenge of Supply, at Project Syndicate

Surging inflation, skyrocketing energy prices, production bottlenecks, shortages, plumbers who won’t return your calls – economic orthodoxy has just run smack into a wall of reality called “supply.” 

Demand matters too, of course. If people wanted to buy half as much as they do, today’s bottlenecks and shortages would not be happening. But the US Federal Reserve and Treasury have printed trillions of new dollars and sent checks to just about every American. Inflation should not have been terribly hard to foresee; and yet it has caught the Fed completely by surprise. 

The Fed’s excuse is that the supply shocks are transient symptoms of pent-up demand. But the Fed’s job is – or at least should be – to calibrate how much supply the economy can offer, and then adjust demand to that level and no more. Being surprised by a supply issue is like the Army being surprised by an invasion. 

The current crunch should change ideas. Renewed respect may come to the real-business-cycle school, which focuses precisely on supply constraints and warns against death by a thousand cuts from supply inefficiencies. Arthur Laffer, whose eponymous curve announced that lower marginal tax rates stimulate growth, ought to be chuckling at the record-breaking revenues that corporate taxes are bringing in this year. 

Equally, one hopes that we will hear no more from Modern Monetary Theory, whose proponents advocate that the government print money and send it to people. They proclaimed that inflation would not follow, because, as Stephanie Kelton puts it in The Deficit Myth, “there is always slack” in our economy. It is hard to ask for a clearer test. 

But the US shouldn’t be in a supply crunch. Real (inflation-adjusted) per capita US GDP just barely passed its pre-pandemic level this last quarter, and overall employment is still five million below its previous peak. Why is the supply capacity of the US economy so low? Evidently, there is a lot of sand in the gears. Consequently, the economic-policy task has been upended – or, rather, reoriented to where it should have been all along: focused on reducing supply-side inefficiencies. 

One underlying problem today is the intersection of labor shortages and Americans who are not even looking for jobs. Although there are more than ten million listed job openings – three million more than the pre-pandemic peak – only six million people are looking for work. All told, the number of people working or looking for work has fallen by three million, from a steady 63% of the working-age population to just 61.6%. 

We know two things about human behavior: First, if people have more money, they work less. Lottery winners tend to quit their jobs. Second, if the rewards of working are greater, people work more. Our current policies offer a double whammy: more money, but much of it will be taken away if one works. Last summer, it became clear to everyone that people receiving more benefits while unemployed than they would earn from working would not return to the labor market. That problem remains with us and is getting worse. 

Remember when commentators warned a few years ago that we would need to send basic-income checks to truck drivers whose jobs would soon be eliminated by artificial intelligence? Well, we started sending people checks, and now we are surprised to find that there is a truck driver shortage. 

Practically every policy on the current agenda compounds this disincentive, adding to the supply constraints. Consider childcare as one tiny example among thousands. Childcare costs have been proclaimed the latest “crisis,” and the “Build Back Better” bill proposes a new open-ended entitlement. Yes, entitlement: “every family who applies for assistance … shall be offered child care assistance” no matter the cost. 

The bill explodes costs and disincentives. It stipulates that childcare workers must be paid at least as much as elementary school teachers ($63,930), rather than the current average ($25,510). Providers must be licensed. Families pay a fixed and rising fraction of family income. If families earn more money, benefits are reduced. If a couple marries, they pay a higher rate, based on combined income. With payments proclaimed as a fraction of income and the government picking up the rest, either prices will explode or price controls must swiftly follow. Adding to the absurdity, the proposed legislation requires states to implement a “tiered system” of “quality,” but grants everyone the right to a top-tier placement. And this is just one tiny element of a huge bill. 

Or consider climate policy, which is heading for a rude awakening this winter. This, too, was foreseeable. The current policy focus is on killing off fossil-fuel supply before reliable alternatives are ready at scale. Quiz: If you reduce supply, do prices go up or go down? Europeans facing surging energy prices this fall have just found out. 

In the United States, policymakers have devised a “whole-of-government” approach to strangle fossil fuels, while repeating the mantra that “climate risk” is threatening fossil-fuel companies with bankruptcy due to low prices. We shall see if the facts shame anyone here. Pleading for OPEC and Russia to open the spigots that we have closed will only go so far. 

Last week, the International Energy Agency declared that current climate pledges will “create” 13 million new jobs, and that this figure would double in a “Net-Zero Scenario.” But we’re in a labor shortage. If you can’t hire truckers to unload ships, where are these 13 million new workers going to come from, and who is going to do the jobs that they were previously doing? Sooner or later, we have to realize it’s not 1933 anymore, and using more workers to provide the same energy is a cost, not a benefit. 

It is time to unlock the supply shackles that our governments have created. Government policy prevents people from building more housing. Occupational licenses reduce supply. Labor legislation reduces supply and opportunity, for example, laws requiring that Uber drivers be categorized as employees rather than independent contractors. The infrastructure problem is not money, it is that law and regulation have made infrastructure absurdly expensive, if it can be built at all. Subways now cost more than a billion dollars per mile. Contracting rules, mandates to pay union wages, “buy American” provisions, and suits filed under environmental pretexts gum up the works and reduce supply. We bemoan a labor shortage, yet thousands of would-be immigrants are desperate to come to our shores to work, pay taxes, and get our economy going. 

A supply crunch with inflation is a great wake-up call. Supply, and efficiency, must now top our economic-policy priorities.

*********

Update: I am vaguely aware of many regulations causing port bottlenecks, including union work rules, rules against trucks parking and idling, overtime rules, and so on. But it turns out a crucial bottleneck in the port of LA is... Zoning laws! By zoning law you're not allowed to stack empty containers more than two high, so there is nowhere to leave them but on the truck, which then can't take a full container. The tweet thread is really interesting for suggesting the ports are at a standstill, bottled up FUBARed and SNAFUed, not running full steam but just can't handle the goods. 

Disclaimer: To my economist friends, yes, using the word "supply" here is not really accurate. "Aggregate supply" is different from the supply of an individual good. Supply of one good increases when its price rises relative to other prices. "Aggregate supply" is the supply of all goods when prices and wages rise together, a much trickier and different concept. What I mean, of course, is something like "the amount produced by the general equilibrium functioning of the economy, supply and demand, in the absence of whatever frictions we call low 'aggregate demand', but as reduced by taxes, regulations, and other market distortions." That being too much of a mouthful, and popular writing using the word "supply" and "supply-side" for this concept, I did not try to bend language towards something more accurate. 

 

 Source Stephan Schubert

Source: Chad Jones "straight out of the Penn World Tables, and I first learned about it from Lee Ohanian and Jesus Fernandez-Villaverde"

In the top graph you get the impression that German and French workers are using up to date technology, including both machines, firm organization,  opportunities to trade in a wide market, etc. but that they simply choose to, are incented to, or forced to work fewer hours than US workers. Italy and UK are still plodding along 20% or so inside the frontier.

The bottom graph points a bleaker picture. I'm not an expert, but if labor productivity is high and total productivity is low, that means that the productivity of other inputs must be atrocious.  Chad (amazing expert on all things growth) "It is stunning to me that Spain and Italy have had negative TFP growth for 20 years." 

I remember when real business cycles came out, and many were incredulous at the idea of negative productivity shocks. How can you forget how to do things? Well, maybe not for business cycles, but a society clearly can forget, and retrench. For centuries, remember, Italians looked up in wonder at the cupola of the Pantheon, the arches of the dry aqueducts, and wondered how they had been built. 

Source: Eli Dourado.  

Before you get all "go USA", let us not forget the largest economic disaster of our own times. These are all relative to the US. How is the US doing? Productivity slowed down suddenly, sharply, and it seems permanently around 2000. 

In the long run, nothing else matters. GDP buys you health, advancement of the disadvantaged, social programs, international security, and climate if you are so inclined. Without GDP, you get less of all.  Economic policy should have one central goal -- get productivity growing again, or (in my view) get out of the way of its growth. This is the one little hope that has not been let out of the policy Pandora's box, focused on everything else right now. 

Update: 

John Fernald and Bing Wang date the recent slowdown at 2003. The end of the first tech boom has something to do with it -- but why hasn't the second tech boom shown up in more productivity? 

Ed Prescott's famous Ely Lecture* looked at US vs. France and concluded high marginal tax rates reduced French working hours. 

Many commenters chalk it up to culture and a preference for leisure. I'm old enough to remember when French people worked Saturday mornings and chuckled at the lazy English who took the whole weekend off. An important work of social science on this question here.  

An excellent Vox Post by Fadi Hassan and Gianmarco Ottaviano on Italian productivity. Too much investment in the wrong places, not enough computers. I speculate also too-small companies. Labor laws, regulations and taxes make it desirable to stay small, private, family-run -- and thus local, non-financialized. 

*BTW, looking up the citation, I learned that the AEA canceled Ely of the Ely lecture, and renamed the lecture series. 

Should the government make unemployment insurance more generous and easier to get in the pandemic recession? Well, yes, but it's not ideal, and a good point on which to ponder the difference between a pandemic recession and a conventional recession.

To get unemployment insurance, you have to actually lose a job (in most cases) and you are supposed to be looking for a new job. In the pandemic recession, lots of people will be temporarily furloughed - -think airline pilots or flight attendants. But assuming, and helping to ensure, that the economy comes roaring back, we don't want airlines to fire pilots and flight attendants, and we don't want them walking around looking for new jobs at other shut down businesses. It would be  much harder for airlines to get going again; the employees lose health insurance (!) and other benefits, and people out looking for work are spreading viruses around.

Yes, there are some open jobs now. Amazon is looking for workers, as much activity moves online. Anyone with medical skills should be helping at hospitals. And face-mask and sanitizer companies are hiring. But this cannot make up for the large number of Americans who will be sitting on the sidelines for a few months.

So, we want unemployment and other benefits for people who aren't technically unemployed, but whose companies are shut down for the virus and can't afford to keep paying them.

Why don't we always have that, you might ask? Well, our social programs have a lot of rules and for good reasons -- to manage the inevitable unintended consequences and moral hazards of normal times and normal recessions. Government paying salary and health benefits of furloughed workers would give companies a big incentive to routinely furlough employees instead of giving them vacations. Around the world, unemployment insurance and many other benefits are  coupled with job search or training requirements, to avoid the massive overuse experienced before those requirements were put in place. But we don't want them now.

So our problem is that a pandemic shutdown requires a different set of detailed micro rules and regulations about who get what when. Good old Keynesian stimulus and standard automatic stabilizers are completely inappropriate. Incentives matter, now as much as ever, not just cash.

Here we economists are very clever. Marginal revolution links to many clever ideas to get us through the crisis, new programs and new rules and new ways of getting money to where it is needed. I've blogged a few dozen clever ideas too.

But it is nearly impossible to ask bureaucracies to make things up on the fly in a crisis, and invent an implement new rules in a matter of weeks, even if politicians could agree what those programs should look like. This is the lesson of Graham Allison's Essence of Decision masterpiece on the Cuban missile crisis. (If you're looking for good self-isolation reading this is a great one. It also shows how important it is to have a President who can make cool decisions in a crisis, when all his or her advisers are screaming nonsense. The many pandemic books are also great reading. We have been here many times before and it's always the same chaos.) That is the lesson of 2001, when we discovered that half the emergency responders didn't have the other half's phone numbers. That's why when this is over, we need a serious pandemic economic plan, one that gets practiced and refined, and not just another big report that gets shelved and forgotten.

At the cost of repetition, there will be other pandemics.

Larry Summers has an interesting tweet stream (HT Marginal Revolution) on the state of monetary policy. Much I agree with and find insightful:

Can central banking as we know it be the primary tool of macroeconomic stabilization in the industrial world over the next decade?...There is little room for interest rate cuts..QE and forward guidance have been tried on a substantial scale....It is hard to believe that changing adverbs here and there or altering the timing of press conferences or the mode of presenting projections is consequential...interest rates stuck at zero with no real prospect of escape - is now the confident market expectation in Europe & Japan, with essentially zero or negative yields over a generation....The one thing that was taught as axiomatic to economics students around the world was that monetary authorities could over the long term create as much inflation as they wanted through monetary policy. This proposition is now very much in doubt.

Agreed so far, and well put. "Monetary policy" here means buying government bonds and issuing reserves in return, or lowering short-term interest rates. I am still intrigued by the possibility that a commitment to permanently higher rates might raise inflation, but that's quite speculative.

and later

Limited nominal GDP growth in the face of very low interest rates has been interpreted as evidence simply that the neutral rate has fallen substantially....We believe it is at least equally plausible that the impact of interest rates on aggregate demand has declined sharply, and that the marginal impact falls off as rates fall.  It is even plausible that in some cases interest rate cuts may reduce aggregate demand: because of target saving behavior, reversal rate effects on fin. intermediaries, option effects on irreversible investment, and the arithmetic effect of lower rates on gov’t deficits

Central banks are a lot less powerful than everyone seems to think, and potentially for deep reasons. File this as speculative but very interesting. Larry has many thoughts on why lowering interest rates may be ineffective or unwise.

The question is just how bad this is? The economy is growing, unemployment is at an all time low, inflation is nonexistent, the dollar is strong. Larry and I grew up in the 1970s, and monetary affairs can be a lot worse.

Yes, the worry is how much the Fed can "stimulate" in the next recession. But it is not obvious to me that recessions come from somewhere else and are much mitigated by lowering short term rates as "stimulus." Many postwar recessions were induced by the Fed, and the Great Depression was made much worse by the Fed. Perhaps it is enough for the Fed simply not to screw up -- do its supervisory job of enforcing capital standards in booms (please, at last!) do its lender of last resort job in financial crises, and don't make matters worse.

But how bad is it now? Here Larry and I part company. Larry is, surprisingly to me, still pushing "secular stagnation"

Call it the black hole problem, secular stagnation, or Japanification, this set of issues should be what central banks are worrying about...We have come to agree w/ the point long stressed by Post Keynesian economists & recently emphasized by Palley that the role of specific frictions in economic fluctuations should be de-emphasized relative to a more fundamental lack of aggregate demand. 

The right issue for macroeconomists to be focused on is assuring adequate aggregate demand.  

My jaw drops.


The unemployment rate is 3.9%, lower than it has ever been in a half century. It fell faster after about 2014 than in the last two recessions.



Labor force participation is trending back up.



Wages are rising faster and faster, especially for less skilled and education educated workers.



 There are 8 million job openings in the US.

Why in the world are we talking about "lack of demand?

Ricardo Reis has an excellent essay on the state of macroeconomics. "Is something really wrong with macroeconomics?"

In substantive debates about actual economic policies, it is frustrating to have good economic thinking on macro topics being dismissed with a four-letter insult: it is a DSGE. It is worrying to see the practice of rigorously stating logic in precise mathematical terms described as a flaw instead of a virtue. It is perplexing to read arguments being boxed into macroeconomic theory (bad) as opposed to microeconomic empirical work (good), as if there was such a strong distinction. It is dangerous to see public grant awards become strictly tied to some methodological directions to deal with the crisis in macroeconomics.

There have been lots of essays lately bemoaning the state of macroeconomics. Most of these essays are written by people not actively involved in research, or by older members of the profession who seem tired when faced with the difficulty of understanding what the young whippersnappers are up to, or by economic journalists who don't really understand the models they are criticizing. I am old enough to feel this temptation and have to fight it.

Many bemoan the simplifications of economic models, not recognizing that good economic models are quantiative parables. Models are best when they isolate a specific mechanism in a transparent way.

Critics usually conclude that we need to add the author's favorite ingredients -- psychology, sociology, autonomous agent models, heterogeneity, learning behavior, irrational expectations, and on and on -- stir the big pot, and somehow great insights will surely come. This is the standard third-year PhD student approach to writing a thesis, and explains why it takes five years to get a PhD.

I did an EconTalk Podcast with Russ Roberts. The general subject is economic growth, the reasons it seems to be slipping away from us and policies (or non-policies) that might help.

As in other recent projects (growth essay, testimony) I'm trying to synthesize, and also to find policies and ways to talk about them that avoid the stale left-right debate, where people just shout base-pleasing spin ever louder. "You're a tax and spend socialist" "You just want tax cuts for your rich buddies" is getting about as far as "You always leave your socks on the floor" "Well, you spend the whole day on the phone to your mother."

We did this as an interview before a live audience, at a Chicago Booth alumni event held at Hoover, so it's a bit lighter than the usual EconTalk. This kind of thought helps the synthesis process a lot for me.  Russ' pointed questions make me think, as did the audience in follow up Q&A (not recorded). Plus, it was fun.

I always leave any interview full of regrets about things I could have said better or differently. The top of the regret pile here was leaving a short joke in response to Russ' question about what the government should spend more on. Russ was kindly teeing up the section of the growth essay "there is good spending" and perhaps "spend more to spend less" ideas in several other recent writings. It would have been a good idea to go there and spend a lot more time on the question.

I was invited to testify at a hearing of the House budget committee on Sept 14. It's nothing novel or revolutionary, but a chance to put my thoughts together on how to get growth going again, and policy approaches that get past the usual partisan squabbling. Here are my oral remarks. (pdf version here.) The written testimony, with lots of explanation and footnotes, is here. (pdf) (Getting footnotes in html is a pain.)

Chairman Price, Ranking Member Van Hollen, and members of the committee: It is an honor to speak to you today.

Sclerotic growth is our country’s most fundamental economic problem. If we could get back to the three and half percent postwar average, we would, in the next 30 years, triple rather than double the size of the economy—and tax revenues, which would do wonders for our debt problem.

Why has growth halved? The most plausible answer is simple and sensible: Our legal and regulatory system is slowly strangling the golden goose of growth.

How do we fix it? Our national political and economic debate just makes the same points again, louder, and going nowhere. Instead, let us look together for novel and effective policies that can appeal to all sides.

Regulation:

The cause of sclerotic growth is the major economic policy question of our time. The three big explanations are 1) We ran out of ideas (Gordon); 2) Deficient "demand," remediable by more fiscal stimulus (Summers, say) 3); Death by a thousand cuts of cronyist regulation and legal economic interference.

On the latter, we mostly have stories and some estimates for individual markets, not easy-to-use  government-provided statistics. But there are lots of stories.

Here is one day's Wall Street Journal reading while waiting for a plane last Saturday:

1) Holman Jenkins,

... unbridled rent seeking.  That’s the term economists use for exercising government power to create private gains for political purposes. 

Channelling Jefferson,

Mr. Obama’s bank policy dramatically consolidated the banking industry, which the government routinely sues for billions of dollars, with the proceeds partly distributed to Democratic activist groups. 

His consumer-finance agency manufactured fake evidence of racism against wholesale auto lenders in order to facilitate a billion-dollar shakedown.

I did an interview with Cloud Yip at Econreporter, Part I and Part II, on various things macro, money, and fiscal theory of the price level. It's part of an interesting series on macroeconomics. Being a transcript of an interview, it's not as clean as a written essay, but not as incoherent as I usually am when talking.

On the same topics, I will be giving a talk at the European Financial Association, on Friday, titled  "Michelson-Morley, Occam and Fisher: The radical implications of stable inflation at the zero bound," slides here. (Yes, it's an evolution of earlier talks, and hopefully it will be a paper in the fall.)

And, also on the same topic, you might find useful a set of slides for a 1.5 hour MBA class covering all of monetary economics from Friedman to Sargent-Wallace to Taylor to Woodford to FTPL.  That too should get written down at some point.

The talk incorporates something I just figured out last week, namely how Sims' "stepping on a rake" model produces a temporary decline in inflation after an interest rate rise. Details here. The key is simple fiscal theory of the price level, long-term debt, and a Treasury that stubbornly keeps real surpluses in place even when the Fed devalues long-term debt via inflation.

Here is really simple example.

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

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

Ending America’s Slow-Growth Tailspin

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

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

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

The WSJ has a nice article showing just how hard it has been for many people who lost jobs in the recession to get back to work. Their profile is typical of what I have read and not the typical picture of unemployment: Middle age middle managers. The paper by Steve Davis and Till von Wachter is here. They present the fact largely as a puzzle, which it is:  "losses in the model vary little with aggregate conditions at the time of displacement, unlike the pattern in the data."

As the story makes clear, the problem is really not unemployment. There are lots of jobs available. The jobs just don't pay much, and don't use the specialized skills that the workers have to offer. The problem is wages at the jobs they can get.

This is a very interesting fact, with many less than obvious interpretations. It strikes me as a good teaching moment for economics classes.

The natural interpretation of all correlations is causal: There are  two identical workers in two identical jobs at two identical companies. One worker happened to lose his or her job in a recession, and so faces a harder climb back. We learn about the difference in job markets over time.

Maybe, but the job of being an economist is to recognize lots of other possibilities for a correlation. So the proposed discussion question: what else might this mean? How does taking averages reflect selection rather than cause?

Perhaps not all workers are the same. The conventional view of recessions is that companies fire people from lack of "aggregate demand," or shocks external to the firm.  In good times, companies fire people when those people aren't very good. Then, you would think, being laid off in a recession is better than being laid off in good times. If you're laid off in good times that is a signal you're not a great worker. In a recession, everybody got laid off, so there is not any particular stigma in it.  Well, so much for that story.

A contrary story is that it's easier to get rid of people in a recession. The head of a large business once told me how useful the last recession was, as he could plead financial problems and finally get rid of the army of unionized workers that were playing solitaire all day. Guido Menzio  and Mikhail Golosov have a model that (I think!) formalizes this story. (Menzio was recently in the news, as an idiot fellow passenger thought he was a terrorist because he was doing algebra on a plane, a different sad commentary on contemporary America.)

Perhaps not all businesses are the same. Businesses and occupations that get hit in recessions are different from those that get hit in booms...

Perhaps times are not the same. Recessions are pretty much by definition a time when different sorts of shocks hit the economy. If recession shocks require bigger changes in specialized human capital than normal-times (more idosyncratic shocks), or people to move industries and cities more, then you'll see this pattern.

And so on. Interesting facts, not so obvious interpretations, averages that don't always mean what you think they mean, that's why economics is so fun.

Update:  Steve Davis writes to explain that job losses in recessions are concentrated in specific industries:

You write: "...If recession shocks require bigger changes in specialized human capital than normal-times (more idiosyncratic shocks), or people to move industries and cities more, then you'll see this pattern.” 

Here’s a modified version of this story that has more promise in my view.  First, an under appreciated empirical observation: The cross-industry (cross-firm, cross-establishment) distribution of employment growth rates becomes more negatively skewed in recessionary periods.  Job loss is also concentrated in industries (firms, establishments) that experience relatively large net and gross job destruction rates.  Taken together, these two observations tell us that, in recessions, a larger share of job losers hail from industries (firms, establishments) that get hit by especially large negative shocks (even compared to the average), reducing the value of skills utilized by workers in those industries (firms, establishments).  I conjecture that negative skewness in the cross-occupation distribution of employment growth rates is also counter cyclical, but I don’t recall any direct and convincing evidence on that score. 

Restating, the setting in which job loss occurs worsens for the average job loser in recessions, because (1) overall economic conditions worsen in recessions, AND (2) conditions worsen especially for industries (occupations, etc.) with a disproportionate share of job loss. Many models consider the effects of (1), but there is little work on (2).  Testing hypotheses and building theories related to (2) requires good measures of the individual-specific “setting” in which individual job losses occur.  One of my PhD students, Claudia Macaluso, is making good progress on that front in her dissertation.

William Carrington and Bruce Fallick have a review paper on why earnings fall with job displacement.

I did an oped on growth in the Wall Street Journal, titled "Ending America’s Slow-Growth Tailspin." I'll post the full thing here in 30 days.

Blog readers will recognize a distilled version of my longer essay on growth (blog post here, html here,   pdf here), and the graph from Smith v. Jones blog post. I think out loud. The growth essay is much more detailed on diagnosis and especially on policy.

There are three basic ideas (two too many for a good oped).

1) Growth is everything. Increasing growth will do way more for every problem you can name than anything else on the economic agenda. Even if workers in 1910 could have taken all of Rockefeller's wealth, they would have been disastrously poor compared to today.

2) Can policies actually improve growth? The tut-tutters mocked Jeb Bush's 4% aspiration. I outline the "we've run out of ideas" school of thought, most recently in Bob Gordon's thoughtful book; the "everything is right but the zero bound" secular-staglation school, and the view that the growth giant is being held back by a liliputian army of politicized regulators.

As evidence,  I improved on the graph from an earlier post of the World Bank's ease of doing business score vs. GDP per capita,

Marty Feldstein has a very interesting opinion piece on Project Syndicate. His main point is that micro distortions from social programs (and taxes, labor laws, regulations etc.) are leading many people not to work, and is well stated.

An introductory paragraph poses a puzzle to me, however,

Consider this: Average hourly earnings in May were 2.3% higher than in May 2014; but, since the beginning of this year, hourly earnings are up 3.3%, and in May alone rose at a 3.8% rate – a clear sign of full employment. The acceleration began in 2013 as labor markets started to tighten. Average compensation per hour rose just 1.1% from 2012 to 2013, but then increased at a 2.6% rate from 2013 to 2014, and at 3.3% in the first quarter of 2015.

These wage increases will soon show up in higher price inflation. 

This is a common story I hear. However I hear another story too -- the puzzle that the share of capital seems to have increased, and that real wages have not kept up with productivity.

So, maybe we should cheer -- rising real wages means wages finally catch up with productivity, and do not signal inflation. The long-delayed "middle class" (real) wage rise is here.

I'd be curious to hear opinions, better informed than mine, about how to tell the two stories apart.  

I attended the NBER EFG (economic fluctuations and growth) meeting a few weeks ago, and saw a very nice paper by Rabah Arezki, Valerie Ramey, and Liugang Sheng, "News Shocks in Open Economies: Evidence from Giant Oil Discoveries" (There were a lot of nice papers, but this one is more bloggable.)

They look at what happens to economies that discover they have a lot of oil.

An oil discovery is a well identified "news shock."

Standard productivity shocks are a bit nebulous, and alter two things at once: they give greater productivity and hence incentive to work today and also news about more income in the future.

An oil discovery is well publicized. It incentivizes a small investment in oil drilling, but mostly is pure news of an income flow in the future. It does not affect overall labor productivity or other changes to preferences or technology.
Rabah,Valerie, and Liugang then construct a straightforward macro model of such an event.

Rüdiger Bachmann, Tim Berg, and Eric Sims have an interesting article, "Inflation Expectations and Readiness to Spend: Cross-Sectional Evidence" in the American Economic Journal: Economic Policy.

Many macroeconomists have advocated deliberate, expected inflation to "stimulate" the economy while interest rates are stuck at the lower bound. The idea is that higher expected inflation amounts to a lower real interest rate. This lower rate encourages people to spend today rather than to save, which, the story goes, will raise today's level of output and employment.

As usual in macroeconomics, measuring this effect is hard. There are few zero-bound observations, fewer still with substantial variation in expected inflation.  And as always in macro it's hard to tell causation from correlation, supply from demand, because from despite of any small inflation-output correlation we see.

This paper is an interesting part of the movement that uses microeconomic observations to illuminate such macroeconomic questions, and also a very interesting use of survey data. Bachman, Berg, and Sims look at survey data from the University of Michigan. This survey asks about spending plans and inflation expectations. Thus, looking across people at a given moment in time, Bachman, Berg, and Sims ask whether people who think there is going to be a lot more inflation are also people who are planning to spend a lot more. (Whether more "spending" causes more GDP is separate question.)

The answer is... No. Not at all. There is just no correlation between people's expectations of inflation and their plans to spend money.

In a sense that's not too surprising. The intertemporal substitution relation -- expected consumption growth = elasticity times expected real interest rate -- has been very unreliable in macro and micro data for decades. That hasn't stopped it from being the center of much macroeconomics and the article of faith in policy prescriptions for stimulus. But fresh reminders of its instability are welcome.

At first blush, this just seems great. Finally, micro data are illuminating macro questions.