Macro Roundup

While his points about fiscal austerity in the 1990s and 2013 having little if any effect on growth are noteworthy data points, it’s hard to see how monetary policy had a big impact when it’s clear that 1) the money sat in the bank unused and 2) business investment is short an accumulated $1T, according to reasonable estimates. I suspect neither fiscal or monetary policy had much effect for much the same reason: an unwillingness by the private sector to take risk that truly grow the economy and offsetting rational expectations by the small number of sophisticate companies and individual investors who matter.

He makes his case by doing little more than asserting that the US grew faster with monetary stimulus being the only difference. But there were other important differences 1) Their banks are truly bankrupt. 2) Their governments are a larger share of GDP, which contributes much less than the private sector. 3) They lack the productivity enhancing institutional capabilities of companies like Google and communities of expertise like Silicon Valley. 4) Their talented people don’t work very hard. 5) Their inflexible workforce regulations inhibit (re)hiring. 6) They don’t have as much equity per dollar of GDP to underwrite risk-taking that grows the economy. Their growth (i.e., Germany’s) is more dependent on exports—where the world’s growth is slowing—and manufacturing—where productivity gains are eating up employment growth. I call his mistake “over attributing”—i.e., he overlooks all these factors and attributes their impact to his point alone.

"...By early 2013 it was clear that if this new form of liberalism, this rejection of Clintonomics, was going to have any plausibility they needed to be able to show that the Fed could not or would not offset fiscal austerity. And calendar 2013 was the perfect test, as all sorts of austerity came together at the same time. The budget deficit fell by $400 billion in fiscal 2013, but that year begins on October 1st. The tax increases didn’t start until January 1st, 2013, and the deficit fell by an astounding $500 billion during that calendar year. A near perfect test. Some of my critics point out that GDP data is noisy, and that the speed up in growth in 2013 wasn’t particularly significant. Agreed. But the Keynesians didn’t just need a single, they needed a home run. They needed a sharp slowdown. The evidence in favor of monetary offset was becoming increasing persuasive. The Fed doesn’t stop doing monetary policy at the zero bound. If you are going to reject the previous liberal conventional wisdom, reject views held as recently as 2007, ask the public to spend a trillion dollars, you better damn well have a good reason. They desperately needed a slowdown in 2013, and got a speed up in growth instead. That’s why 2013 was so devastating. Not because it was definitive, but because fiscal stimulus was already on its last legs, increasingly rejected even by liberals such as Jeffrey Sachs. Once 2013 went against them, it was game over..."American liberalism, circa 2007

Sumner, Scott, "American liberalism, circa 2007,"The Money Illusion, December 27, 2015. Available at:http://www.themoneyillusion.com/
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Some of my critics point out that GDP data is noisy, and that the speed up in growth in 2013 wasn’t particularly significant. Agreed. But the Keynesians didn’t just need a single, they needed a home run. They needed a sharpslowdown. The evidence in favor of monetary offset was becoming increasing persuasive. The Fed doesn’t stop doing monetary policy at the zero bound. If you are going to reject the previous liberal conventional wisdom, reject views held as recently as 2007, ask the public to spend a trillion dollars, you better damn well have a good reason. They desperately needed a slowdown in 2013, and got a speed up in growth instead. That’s why 2013 was so devastating. Not because it was definitive, but because fiscal stimulus was already on its last legs, increasingly rejected even by liberals such asJeffrey Sachs. Once 2013 went against them, it was game over.

Then Keynesians claimed that even the Fed didn’t believe in monetary offset. That theory lost a bit of force when (in late 2012) Fed officials said they were doing aggressive stimulus (QE3 and forward guidance) partly to keep the recovery going as Congress moved to austerity in 2013. By early 2013 it was clear that if this new form of liberalism, this rejection of Clintonomics, was going to have any plausibility they needed to be able to show that the Fed could not or would not offset fiscal austerity. And calendar 2013 was the perfect test, as all sorts of austerity came together at the same time. The budget deficit fell by $400 billion in fiscal 2013, but that year begins on October 1st. The tax increases didn’t start until January 1st, 2013, and the deficit fell by an astounding $500 billion during that calendar year. A near perfect test.

First the Keynesians argued that monetary stimulus was ineffective at the zero bound. That’s what got me into blogging. But it soon became obvious that monetary policy was still effective. For instance, the dollar dropped 6 cents against the euro on the day QE1 was announced, in March 2009. Then after 2011 we had a controlled experiment, both the US and eurozone did roughly equal amounts of fiscal austerity. But the US did monetary stimulus and the eurozone did not. Both regions had similar unemployment rates as recently at 2010, in the 9% to 10% range. By 2014 the eurozone unemployment rate was twice that of the US (roughly 12% vs. 6%). Monetary policy made the difference.

So “obviously” more G will boost GDP. In fact, it is post-2007 liberals who are the “weirdos,” who have rejected the successful policies of Clinton and replaced them with the failed policies of Obama. (Remember, this is the president who 5 years into the recovery was arguing that unemployment was still so bad that we needed to enact an “emergency” unemployment program.)

GDP = C + I + G

As recently as 2007, the conventional wisdom of American liberals (on fiscal policy) was essentially market monetarist—they believed in monetary offset. The fiscal multiplier is close to zero. Deficits are bad. And yet I get many Keynesian commenters who don’t know this. They act like I’m propounding some sort of weird theory. They tell me that:

Recall that unemployment was pretty high when Clinton took office, much higher than today. Of course today’s liberals would point to one key difference, interest rates were not stuck as zero. (But that’s also true of the eurozone, circa 2008-12.)

Clinton’s 1993 budget bore out these tenets in their purest practical form. Its overall framework was deficit reduction, with the purpose of reducing interest rates and promoting economic health. It also had a strongly progressive tilt, raising the tax rate on the highest earners while expanding low-income subsidies such as the Earned Income Tax Credit (EITC) and Head Start. Six years later, Clinton and his advisers—and even like-minded economists outside the administration—continue to hold up the 1993 budget as their pinnacle achievement.

That intellectual breakthrough forms the bedrock of progressive fiscal conservatism. The principles of this economic synthesis are eminently clear. It begins with a recognition that the Federal Reserve and the bond market wield an effective control over the economy and that these instruments, rather than deficit spending, have become the most effective levers available to government for promoting economic growth. At the same time, there is an understanding among liberals that the burdens of fiscal restraint should fall primarily upon those most able to bear it and that the government should make a special effort to ensure that the benefits of economic growth also flow to those at the bottom.

The question that so bedeviled the White House in 1993——can the Fed and the bond market overcome the effects of tight budgets?——is no longer in doubt, and therein lies the great transformation of liberal economics. Previously, even liberals who favored deficit reduction considered it a painful trade-off: Reducing government borrowing would free up more savings for private investment and, in the long run, improve productivity, but in the short run, it would slow or even halt economic growth and throw millions out of work. The White House accepted this bargain in 1993 and hoped it would work out for the best. Now fiscal restraint is seen not even as a trade-off but, rather, as a way of getting the best of both worlds. This does not mean that forbearance is the one true answer, now and forever. It merely suggests that, under the present economic and political circumstances, the interests of current and future prosperity both argue for reducing deficits or expanding surpluses.

All of these developments were known at the time, but they had not fully cohered when Clinton began to construct his first economic plan. The key decision was not whether to reduce the deficit——given its size, the White House had no other realistic option——but rather what effect this would have upon the economy. Everyone present assumed that raising taxes or cutting spending would, at least in the short run, dampen economic growth. White House economists gave serious consideration to the possibility that their plan would throw the economy into recession. The only way to avoid this dismal fate was if the Federal Reserve or the bond market would lower interest rates to spur economic activity and make up for the depressing effects of deficit reduction. According to Bob Woodward’s account in The Agenda, Clinton replied to this news in a half whisper: “You mean to tell me that the success of my program and my reelection hinges on the Federal Reserve and a bunch of fucking bond traders?”

Marcus Nunes directed me to a very interesting piece by Jonathan Chait in theAmerican Prospect,from 2001. It begins by pointing out that by the early 1990s American liberals had turned against the deficit spending policy of Ronald Reagan. Then it moves on to the Clinton Administration:

Cochrane on that UI paper quotes Bob Hall, "In words, is there something else about state policies that changed at the same time in the "generous" vs. "stingy" states? And are counties really small enough to capture only the border effects? The deeper issue in evaluating this paper, I think, comes from blowing the county results up to the aggregate, as Bob but it "The authors conclude that, absent the increase in UI benefits, unemployment in 2010 would have been about 3 percentage points lower." Unemployment insurance and unemployment "The Impact of Unemployment Benefit Extensions on Employment: The 2014 Employment Miracle" by Marcus Hagedorn, Iourii Manovskii and Kurt Mitman is making waves.NBER working paper here.Kurt Mitman's webpagehas an ungated version of the paper, and a summary of some of the controversy. It's part of a pair, with "Unemployment Benefits and Unemployment in the Great
Recession: The Role of Macro Effects" also including Fatih Karahan.

Acritical reviewby Mike Konczal at the Roosevelt Institute blog, and amore positive reviewby Patrick Brennan at National Review Online are both interesting. Both are thoughtful reviews that get at facts and methods. Maybe the tone of the economics blogoshpere is improving too.Bob Hall's commentsandresponseon the earlier paper are also worth reading. This is a bit deja-vu from the observation that North Carolina experienced a large drop in unemployment when it cut benefits.My post here, WSJ coverage, and I think there are some papers which google isn't finding fast enough at the moment.

The basic issue: I think it's widely accepted, if sometimes grudgingly, that unemployment insurance increases unemployment. If you pay for anything, you get more of it. People with unemployment insurance can hold out for better jobs, put off moving or other painful adjustments, and so on. The earlier paper points out that there are important general equilibrium effects as well. We should talk about how UI affects labor markets, not just job search.

Quick disclaimer. Let's not jump to "good" and "bad." Searching too hard and taking awful jobs in the middle of a depression might not be optimal. Pareto-optimal risk sharing with moral hazard looks a lot like unemployment insurance. Perhaps that disclaimer can settle down the tone of the debate.

But the question remains. How much? How much does unemployment insurance increase unemployment? And the related macro question, just why did unemployment in the US suddenly drop coincident with sequester and the end of 99 week unemployment benefits?

Method is important. Too much media coverage starts and stops with "study finds unemployment insurance raises unemployment." And then the next day "study finds unemployment insurance crucial to stopping people from dying in gutters." If we focused on the facts, we'd all get along better.

In macro, we always are faced with the problem that interpreting time series, we never know what else changed. Sure, congress lowered unemployment benefits and the economy took off. But lots of other stuff happened. Maybe it's "despite" not "because."

This paper is part of a new breed trying to get around this problem by looking at cross-sectional evidence. Roughly, the evidence in this paper builds on the fact that Congress' action had different effects in different states.

Bob Halldescribed the strategy compactly:

They compare labor markets with arguably similar conditions apart from the UI benefits regime. In their work, the markets are defined as counties and the similarity arises because they focus on pairs of adjacent counties. The difference in the UI regimes arises because the two counties are in different states and UI benefits are set at the state level and often differ across state boundaries. The research uses a regression-discontinuity design, where the discontinuity is the state boundary and the window is the area of the two adjacent counties....

We find that a 1% drop in benefit duration leads to a statistically significant increase of employment by 0.0161 log points. In levels, 1.8 million additional jobs were created in 2014 due to the benefit cut.

Column (1) of Table 3 contains the results of the estimation of the effect of unemployment benefit duration on employment using the baseline specification in Equation (6).

Bob Hall echoes standard but important complaints.

The issues that arise in evaluating the paper are those for any regression-discontinuity research design: (1) Are there any other sources of discontinuous changes at the designated discontinuity points that might be correlated with the one of interest? (2) Is the window small enough to avoid contamination from differences that do not occur at the discontinuity point but rather elsewhere in the window?

The deeper issue in evaluating this paper, I think, comes from blowing the county results up to the aggregate, as Bob but it

The authors conclude that, absent the increase in UI benefits, unemployment in 2010 would have been about 3 percentage points lower.

This is a small nitpick. The basic fact is interesting, and I think a lot harder to dismiss.

It's interesting that so much of the pushback, both from Bob and from Mike Konczal'scritical reviewcomes down to theory, not the fact.

Update:Wednesday's Wall Street Journal covers the paper. The WSJ spends more time on the macro question, the claim that unemployment insurance actually boosts the economy via stimulus.
Cochrane, John, "Unemployment insurance and unemployment,"The Grumpy Economist, January 28, 2015. Available at:http://johnhcochrane.blogspot.com/2015/01/unemployment-insurance-and-unemployment.html

you will hate their takeaway from their data (Dalioesque/Mian and Sufi) but it really is the perfect paper for illustrating your point about what the financial system does. Jorda, Oscar and Moritz Schularick and Alan Taylor, "The Great Mortgaging: Housing Finance, Crises, and Business Cycles," NBER, September 2014. Available at:http://www.frbsf.org/economic-research/publications/working-papers/wp2014-23.pdf"...To a large extent the core business model of banks in advanced economies today resembles that of real estate funds; banks are borrowing (short) from the public and capital markets to invest (long) into assets linked to real estate...looking more deeply at the composition of bank credit, it becomes clear thatthe rapid growth of mortgage lending to households has been the driving force behind this remarkable change in the composition of banks' balance sheets....We found that in the second half of the 20th century, banks and households have been heavily leveraging up through mortgages. Mortgage credit on the balance sheets of banks has been the driving force behind the increasingly financialization of advanced economies. In relation to GDP, non-mortgage bank lending to companies and households has remained stable, with virtually all the increase in the size of the financial sector stemming from a boom in mortgage lending to households. Household leverage ratios (mortgage debt divided by the value of the housing stock) have increased substantially in many economies over the 20th century.About two thirds of the business of banking today consists of the intermediation of savings to the household sector for the purchase of real estate. At the beginning of the 20th century mortgage lending accounted for less than a third of the typical bank’s loan book....we showed thatthe growth of mortgage credit has important implications for the sources of financial fragility in advanced economies, and hence for macroeconomic policies. Mortgage booms are an important source of financial instability in the post-WWII era, and mortgages have growing weight in total financial sector activity. We present evidence that the changing nature of financial intermediation has shifted the locus of crisis risk towards mortgage lending booms....we demonstrated that mortgage credit has also increasingly left its mark on business cycle dynamics. In the post-WWII period the aftermath of mortgage boomsgone bust is marked by considerably slower growth rates, irrespective of whether a financial crisis occured or not. Non-mortgage credit no longer appears to have such an effect. Contemporary business cycles seem to be increasingly shaped by the dynamics of mortgage credit, with non-mortgage lending playing only a minor role...Overall, the findings of this paper call for a differentiated perspective on credit growth and on the implications that this differentiation has for financial stability, macroeconomic policies, and financial regulation. Important insights into the sources of financial fragility and the role of credit in the business cycle would be missed without a disaggregated perspective on the various types of credit and their development over the course of modern macroeconomic history..."