The euro crisis of the 2010s is well in the past now, but it remains one of the central macroeconomic events of our time.But the nature of the crisis remains widely misunderstood, not only by the mainstream but also — and more importantly from my point of view — by economists in the heterodox Keynesian tradition. In this post, I want to lay out what I think is the right way of thinking about the crisis. I am not offering much in the way of supporting evidence. For the moment, I just want to state my views as clearly as possible. You can accept them or not, as you choose.
During the first 15 years of the euro, a group of peripheral European countries experienced an economic boom followed by a crash, with GDP, employment and asset prices rising and then falling even more rapidly. As far as I can tell, there are four broad sets of explanations on offer for the crises in Greece, Ireland, Italy, Portugal and Spain starting in 2008.
(While the timing is the same as the US housing bubble and crash, that doesn’t mean they are directly linked — however different they are in other respects, most of the common explanations for the European crisis I’m aware of locate its causes primarily within Europe.s)
The four common stories are:
1. External imbalances. The fixed exchange rate created by the euro, plus some mix of slow productivity growth in periphery and weak demand growth in core led to large trade imbalances within Europe. The financial expansion in the periphery was the flip side of a causally prior current account deficit.
2. Monetary policy. Both financial instability and external imbalances were result of Europe being far from an optimal currency area. Trying to carry out monetary policy for the whole euro area inevitably produced a mix of stagnation in the core and unsustainable credit expansion in the periphery, since a monetary stance that was too expansionary for Greece, Spain etc. was too tight for Germany.
3. Fiscal irresponsibility. The root of the crisis in peripheral countries was the excessive debt incurred by their own governments. The euro was a contributing factor since it led to an excessive convergence of interest rates across Europe, as markets incorrectly believed that peripheral debt was now as safe as debt of core countries.
4. Banking crises. The booms and busts in peripheral Europe were driven by rapid expansions and then contractions of credit from the domestic banking systems, with dynamics similar to that in credit booms in other times and places. The specific features of the euro system did not play any significant role in the development of the crisis, though they did importantly shape its resolution.
In my view, the fourth story is correct, and the other three are wrong. In particular, trade imbalances within Europe played no role in the crisis. In this post, I am going to focus on why I think the external balances story is wrong, since that’s the one that people who are on my side intellectually seem most inclined toward.
As I see it, there were two distinct causal chains at work, both starting with a credit boom in the peripheral countries.
easy credit —> increased aggregate spending —> increased output and income —> increased imports —> growing trade deficit —> net financial inflows
That the two outcomes — external imbalances and banking crisis — went together is not a coincidence. But there is no causal link from the first to the second. Both rather are results of the same underlying cause.
Yes, in the specific conditions of the late-2000s euro area, a credit boom led to an external deficit. But in principle it is perfectly possible to have a a credit-financed asset bubble and ensuing crisis in a country with a current account surplus, or one with current account balance, or in a closed economy. What was specific to the euro system was not the crisis itself, but the response to it. The reason the euro made the crisis worse because it prevented national governments from taking appropriate action to rescue their banking systems and stabilize demand.
This understanding is, I think, natural if we take a “money view” of the crisis, thinking in terms of balance sheets and the relationship between income and expenditure. Here is the story I would like to tell.
Following the introduction of the euro in 1998, there were large credit expansions in a number of European countries. In Spain, for example, bank credit to the non-financial economy increased from 80 percent of GDP in 1997 to 220 percent of GDP in 2010. Banks were more willing to make loans, at lower rates, on more favorable terms, with less stringent collateral requirements and other lending standards. Borrowers were more willing to incur debt. The proximate causes of this credit boom may well have been connected to the euro in various ways. European integration offered a plausible story for why assets in Spain might be valued more highly. The ECB might have followed a less restrictive policy than independent central banks would have (or not — this is just speculation). But the euro was in no way essential to the credit boom. Similar booms have happened in many other times and places in the absence of currency unions — including, of course, in the US at roughly the same time.
In most of these countries, the bulk of the new credit went toward speculative real estate development. (In Greece there was also a big increase in public-sector borrowing, but not elsewhere.) The specifics of this lending don’t matter too much.
Now for the key point. What happens when a a Spanish bank makes a loan? In the first step the bank creates two new assets – a deposit for the borrower, and the loan for itself. Notice that this does not require any prior “saving” by a third party. Expansion of bank credit in Spain does not require any inflow of “capital” from Germany or anywhere else.
Failure to grasp is an important source of confusion. Many people with a Keynesian background talk about endogenous money, but fail to apply it consistently. Most of us still have a commodity money or loanable-funds intuition lodged in the back of our brains, especially in international contexts. Terms like “capital flows” and “capital flight” are, in this respect, unhelpful relics of a gold standard world, and should probably be retired.
Back to the story. After the deposits are created, they are spent, i.e. transferred to someone else in return, in return for title to an asset or possession of a commodity or use of a factor of production. If the other party to this transaction is also Spanish, as would usually be the case, the deposits remain in the Spanish banking system. At the aggregate level, we see an increase in bank credit, plus an increase in asset prices and/or output, depending on what the loan finances, amplified by any ensuing wealth effect or multiplier.
To the extent that the loans finance production – of beach houses in Galicia say — they generate incomes. Some fraction of new income is spent on imported consumption goods. Probably more important, production requires imported intermediate and capital goods. By both these channels, an increase in Spanish output results in higher imports. If the credit boom leads Spain to grow faster relative to its trade partners — which it will, unless they are experiencing similar booms — then its trade balance will move toward deficit.
(That changes in trade flows are primarily a function of income growth, and not of relative prices, is an important item in the Keynesian catechism.)
Now let’s turn to the financial counterpart of this deficit. A purchase of a German good by a Spanish firm requires a bank deposit to be transferred from the Spanish firm to the German firm. Since the German firm presumably doesn’t hold deposits in a Spanish bank, we’ll see a reduction in deposits in the Spanish banking system and an equal increase in deposits in the German banking system. The Spanish banks must now replace those deposits with some other funding, which they will seek in the interbank market. So in the aggregate the trade deficit will generate an equal financial inflow — or, better said, a new external liability for the Spanish banking system.
The critical thing to notice here is that these new financial positions are generated mechanically by the imports themselves. It is simply replacing the deposit funding the Spanish banks lost via payment for the imports. The financial inflow must take place for the purchase to happen — otherwise, literally, the importer’s check won’t clear.
But what if there is an autonomous inflow – what if German wealth owners really want to hold more assets in Spain? Certainly that can happen. These kinds of cross-border flows may well have contributed to the credit boom in the periphery. But they have nothing to do with the trade balance. By definition, autonomous financial flows involve offsetting financial transactions, with no implications for the current account.
Suppose you are a German pension fund that would like to lend money to a Spanish firm, to take advantage of the higher interest rates in Spain. Then you purchase, let’s say, a bond issued by Spanish construction company. That shows up as a new liability for Spain in the international investment position. But the Spanish firm now holds a deposit in a German bank, and that is an equal new asset for Spain. (If the Spanish firm transfers the deposit to a Spanish bank in return for a deposit there, as I suppose it probably would, then we get an asset for Spain in the interbank market instead.) The overall financial balance has not changed, so there is no reason for the current account to change either. Or as this recent BIS paper puts it, “the high correlations between gross capital inflows and outflows are overwhelmingly the result of double-entry bookkeeping”. (The importance of gross rather than net financial positions for crises is a pint the bIS has emphasized for many years.)
It may well happen that the effect of these offsetting financial transactions is to raise incomes in Spain (the contractor got better terms than it would at home) and/or banking-system liquidity (thanks to the fact that the Spanish banking system gets the deposits without the illiquid loan). This may well contribute to a rise in incomes in Spain and thus to a rise in the trade deficit. But this seems to me to be a second-order factor. And in any case we need to be clear about the direction of causality here — even if the financial inflows did indirectly cause the higher deficit, they did not in any sense finance it. The trade balances of Germany and Spain in no way affect the ability of German institutions to buy Spanish debt, any more than a New Yorker’s ability to buy a house in California depends on the trade balance between those states.
At this point it’s important to bring in the TARGET2 system.
Under normal conditions, when someone wants to take a cross-border position within the euro systems the other side will be passively accommodated somewhere in the banking system. But if a net position develops for whatever reason, central banks can accommodate it via TARGET2 balances. Concretely, let’s say soon in Spain wants to make a payment to someone in Germany, as above. This normally involves the reduction of a Spanish bank’s liability to the Spanish entity and the increase in a German bank’s liability to the German entity. To balance this, the Spanish bank needs to issue some other liability (or give up an asset) while the German bank needs to acquire some asset. Normally, this happens by the Spanish bank issuing some new interbank liability (commercial paper or whatever) which ends up, perhaps via various intermediaries, as an asset for a German bank. But if foreign banks are unwilling to hold the liabilities of Spanish banks (as happened during the crisis) the Spanish bank can instead borrow from its own central bank, which in turn can create two offsetting positions through TARGET2 — a liability to the euro system, and a reserve asset (a deposit at the ECB). Conceptually, rather than the transfer of the despot being offset by a liability fro the Spanish to the German bank the interbank market, it’s now offset by a debt owed by the Spanish bank to its own national central bank, a debt between the central banks in the TARGET2 system, and a claim by the German bank against its own national central bank.
In this sense, within the euro system TARGET2 balances stand at the top of the hierarchy of money. Just as non financial actors settle their accounts by transfers of deposits at commercial banks, and banks settle their balances by transfers of deposits at the central bank, central banks settle any outstanding balances via TARGET2. It plays the same role as gold in the old gold standard system. Indeed, I sometimes think it would be better to describe the euro system as the “TARGET2 system.”
There is however a critical difference between these balances and gold. Gold is an asset for central bank; TARGET2 balances are a liability. When a payment is made from country X to country Y in the euro area, with no offsetting private payment, the effect on central bank balance sheets is NOT a decrease in the assets of the central bank of X (and increase in the assets of the central bank of Y) but an increase in the liabilities of the central bank of X. This distinction is critical because assets are finite and can be exhausted, but new liabilities can be issued indefinitely. The automatic financing of payments imbalances through the TARGET2 system seems like an obscure technical detail but it transforms the functioning of the system. Every national central bank in the euro area is in effect in the situation of the Fed. It can never be financially constrained because all its obligations can be satisfied with its own liabilities.
People are sometimes uncomfortable with this aspect of the euro system and suggest that there must be some limit on TARGET2 balances. But to me, this fundamentally misunderstands the nature of a single currency. What makes “the euro” a single currency is not that it has the same name, or that the bills look the same in the various countries, or even that it trades at a fixed ratio of one for one. What makes it a single currency is that a bank deposit in any euro-area country will settle a debt in any other euro-area country, at par. TARGET2 balances have to be unlimited to guarantee the this will be the case — in other words, for there to be a single currency at all.
(In this sense, we should not have been so fixed on the question of being “in” versus “out” of the euro. The relevant question is the terms on which payments can be made from one bank account another, for settlement of which obligations.)
The view of the euro crisis in which trade imbalances finance or somehow enable credit expansion is dependent on a loanable-funds perspective in which incomes are fixed, money is exogenous and saving is a binding constraint. It’s implicitly based on a model of the gold standard in which increased lending impossible without inflow of reserves — something that was not really true in practice even in the high gold standard era and isn’t true even in principle today. What’s strange is that many people who accept this view would reject those premises – if they realized they were applying them.
Meanwhile, on the domestic side, abundant credit was bidding up asset prices and encouraging investment that was, ex post, unwise (and in some case fraudulent, though I have no idea how important this was quantitatively). When asset prices collapsed and the failure of investment projects to generate the expected returns became clear, many banks faced insolvency. There was a collapse in activity in the real-estate development and construction activity that had driven the boom and, as banks tightened credit standards across the board, in other credit-dependent activity; falling asset values further reduced private spending; all these effects were amplified by the usual multiplier. The result was a steep fall in output and employment.
I don’t believe there’s any sense in which a sudden stop of cross-border lending precipitated the crisis. Rather, the “nationalization” of finance came after. Banks tried to limit their cross-border positions came only once the crisis was underway, as it became clear that there would be no systematic euro-wide response to insolvent banks, so that any rescues or bailouts would be by national governments for their own banks.
Credit-fueled asset booms and crashes have happened in many times and places. There was nothing specific to the euro system about the property booms of the 2000s. What was specific to the euro system was what happened next. Thanks to the euro, the affected governments could not respond as developed country governments have always responded to financial crises since World War II — by recapitalizing insolvent banks and shifting public budgets toward deficit until private demand recovers.
(I write a monthly-ish opinion piece for Barron’s. This is my most recent one. You can find earlier ones here.)
Since the onset of the pandemic, policy makers in the U.S. and elsewhere have embraced a more active role for government in the economy. The extraordinary scale and success of pandemic relief, the administration’s embrace of the expansive Build Back Better program, and the revived industrial policy of the Inflation Reduction Act and the Chips and Science Act all stand in sharp contrast with the limited-government orthodoxy of the past generation.
The debt ceiling deal announced this weekend looks like a step back from this new path – albeit a smaller one than many had feared. Supporters of industrial policy and more robust social insurance have reason to be disappointed – especially since the administration, arguably, had more room for maneuver than it was willing to use.
To be fair, the agreement in part merely anticipates the likely outcome of budget negotiations. Regardless of the debt ceiling, the administration was always going to have to compromise with the House leadership to pass a budget. The difference is that in a normal negotiation, most government spending continues as usual until a deal is reached. Raising the stakes of failure to reach a deal shifts the balance in favor of the side more willing to court disaster. Allowing budget negotiations to get wrapped up with the debt ceiling may have forced the administration to give up more ground than it otherwise would.
The Biden team’s major nonbudget concession was to accept additional work requirements for some federal benefits. The primary effect of work requirements, with their often onerous administrative burdens, will be to push people off these programs. This might be welcome, if you would prefer that they not exist in their current form at all. But it’s a surprising concession from an administration that, not long ago, was pushing in the other direction.
In a bigger sense this change directly repudiates one of the main social-policy lessons of recent years. Pandemic income-support programs were an extraordinary demonstration of the value of simple, universal social insurance programs, compared with narrowly targeted ones. The expiration of pandemic unemployment benefits gave us the cleanest test we are ever likely to see of the effect of social insurance and employment. States that ended pandemic benefits early did not see any faster job growth than ones that kept it longer – despite the fact that these programs gave their recipients far stronger incentives against work than those targeted in the budget deal.
These compromises are all the more disappointing since there were routes around the debt ceiling that the administration, for whatever reason, chose not to explore. The platinum coin got a healthy share of attention. But there were plenty of others.
The Treasury Department, for example, could have looked into selling debt at a premium. The debt ceiling binds the face value, or principal, of federal debt. There is no reason that this has to be equal to the amount the debt sells for – this is simply how auctions are currently structured. For much of U.S. history, government debt was sold at a discount or premium to its face value. Fixing an above-market interest rate and selling debt at more than face value would allow more funds to be raised without exceeding the debt ceiling.
The administration might also have asked the Federal Reserve to prepay future remittances. In most years, the Fed makes a profit, which it remits to the Treasury. But it can also report a loss, as it has since September. When that happens, the Fed simply creates new reserves to make up the shortfall, offsetting these with a “deferred asset” representing future remittances. (Currently, the Fed is carrying a deferred asset of $62 billion.) The same device could be used to finance public spending without issuing debt. Ina report a decade ago, Fed staff suggested that deferred assets could be used in this way to give the Treasury department “more breathing room under the debt ceiling.” (To be clear, they were not saying that this was a good idea, just noting the possibility.)
Another route around the debt ceiling might come from the fact that about one-fifth of the federal debt – some $6 trillion – is held by federal trust funds like Social Security, rather than by the public. (Another $5 trillion is held by the Federal Reserve.) This debt has no economic function. It is a bookkeeping device reflecting the fact that trust fund contributions to date have been higher than payments. Retiring these bonds, or replacing them with other instruments that wouldn’t count against the ceiling, would have no effect on either the government’s commitment to pay scheduled benefits or its ability to do so. But it would reduce the notional value of debt outstanding.
None of these options would be costless, risk-free, or even guaranteed to work. But there is little evidence they were seriously considered. This is a bit disheartening for supporters of the administration’s program. It’s hard to understand why you would go into negotiations with one hand tied behind your backs, and not have a plan B in case negotiations break down.
Tellingly, the one alternative the Biden team did consider was invoking the 14th Amendment to justify issuing new debt in defiance of the ceiling. The amendment refers specifically to the federal government’s debt obligations. But of course, hitting the debt ceiling would not only endanger the government’s debt service. It would threaten all kinds of payments that are legally mandated and economically vital. The openness to the 14th Amendment route, consistent with other public statements, suggests that decision-makers in the administration saw the overriding goal as protecting the financial system from the consequences of a debt default – as opposed to protecting the whole range of public payments.
What looks like a myopic focus on the dangers to banks recalls one of the worst failures of the Obama administration.
In the wake of the collapse of the housing market, Congress in 2009 authorized $46 billion in assistance for homeowners facing foreclosure through the Home Affordable Modification Program. But the Obama administration spent just a small fraction of this money (less than 3%) in the program’s first two years, helping only a small fraction of the number of homeowners originally promised.
The failure to help homeowners was not due to callousness or incompetence. Rather, it was due to the overriding priority put on the stability of the banking system. As Obama’s Treasury Secretary Timothy Geithner later explained, they saw the primary purpose of HAMP not as assisting homeowners, but as a way to “foam the runway” for a financial system facing ongoing mortgage losses.
Geithner and company weren’t wrong to see shoring up the banks as important. The problem was that this was allowed to take absolute priority over all other goals — with the result that millions of families lost their homes, an important factor in the slow growth of much of the 2010s.
One wouldn’t want to push this analogy too far. The debt ceiling deal is not nearly as consequential – or as clear a reflection of administration priorities – as the abandonment of underwater homeowners was. But it does suggest similar blinders: too much attention to the danger of financial crisis on one side, not enough to equally grave threats from other directions.
It’s clear that Treasury Secretary Janet Yellen and the rest of the Biden administration are very attuned to the dangers of a default. But have they given enough thought to the other dangers of failing to reach a debt-ceiling deal — or of reaching a bad one? Financial crises are not the only crises. There are many ways that an economy can break down.
Last week, my Roosevelt colleague Mike Konczal said on twitter that he endorsed the Fed’s decision to raise the federal funds rate, and the larger goal of using higher interest rates to weaken demand and slow growth. Mike is a very sharp guy, and I generally agree with him on almost everything. But in this case I disagree.
The disagreement may partly be about the current state of the economy. I personally don’t think the inflation we’re seeing reflects any general “overheating.” I don’t think there’s any meaningful sense in which current employment and wage growth are too fast, and should be slower. But at the end of the day, I don’t think Mike’s and my views are very different on this. The real issue is not the current state of the economy, but how much confidence we have in the Fed to manage it.
So: Should the Fed be raising rates to control inflation? The fact that inflation is currently high is not, in itself, evidence that conventional monetary policy is the right tool for bringing it down. The question we should be asking, in my opinion, is not, “how many basis points should the Fed raise rates this year?” It is, how conventional monetary policy affects inflation at all, at what cost, and whether it is the right tool for the job. And if not, what should we be doing instead?
What Do Rate Hikes Do?
AtPowell’s press conference, Chris Rugaber of the AP asked an excellent question: What is the mechanism by which a higher federal funds rate is supposed to bring down inflation, if not by raising unemployment?1 Powell’s answer was admirably frank: “There is a very, very tight labor market, tight to an unhealthy level. Our tools work as you describe … if you were moving down the number of job openings, you would have less upward pressure on wages, less of a labor shortage.”
Powell is clear about what he is trying to do. If you make it hard for businesses to borrow, some will invest less, leading to less demand for labor, weakening workers’ bargaining power and forcing them to accept lower wages (which presumably get passed on to prices, tho he didn’t spell that step out.) If you endorse today’s rate hikes, and the further tightening it implies, you are endorsing the reasoning behind it: labor markets are too tight, wages are rising too quickly, workers have too many options, and we need to shift bargaining power back toward the bosses.
Rather than asking exactly how fast the Fed should be trying to raise unemployment and slow wage growth, we should be asking whether this is the only way to control inflation; whether it will in fact control inflation; and whether the Fed can even bring about these outcomes in the first place.
Both hiring and pricing decisions are made by private businesses (or, in a small number of cases, in decentralized auction markets.) The Fed can’t tell them what to do. What it can do – what it is doing – is raise the overnight lending rate between banks, and sell off some part of the mortgage-backed securities and long-dated Treasury bonds that it currently holds.
A higher federal funds rate will eventually get passed on to other interest rates, and also (and perhaps more importantly) to credit conditions in general — loan standards and so on. Some parts of the financial system are more responsive to the federal funds rate than others. Some businesses and activities are more dependent on credit than others.
Higher rates and higher lending standards will, eventually, discourage borrowing. More quickly and reliably, they will raise debt service costs for households, businesses and governments, reducing disposable income. This is probably the most direct effect of rate hikes. It still depends on the degree to which market rates are linked to the policy rate set by the Fed, which in practice they may not be. But if we are looking for predictable results of a rate hike, higher debt service costs are one of the best candidates. Monetary tightening may or may not have a big effect on unemployment, inflation or home prices, but it’s certainly going to raise mortgage payments — indeed, the rise in mortgage rates we’ve seen in recent months presumably is to some degree in anticipation of rate hikes.
Higher debt service costs disposable income for households and retained earnings for business, reducing consumption and investment spending respectively. If they rise far enough, they will also lead to an increase in defaults on debt.
(As an aside, it’s worth noting that a significant and rising part of recent inflation is owners’ equivalent rent, which is a BLS estimate of how much homeowners could hypothetically get if they rented out their homes. It is not a price paid by anyone. Meanwhile, mortgage payments, which are the main actual housing cost for homeowners, are not included in the CPI. It’s a bit ironic that in response to a rise in a component of “housing costs” that is not actually a cost to anyone, the Fed is taking steps to raise what actually is the biggest component of housing costs.)
Finally, a rate hike may cause financial assets to fall in value — not slowly, not predictably, but eventually. This is the intended effect of the asset sales.
Asset prices are very far from a simple matter of supply and demand — there’s no reason to think that a small sale of, say 10-year bonds will have any discernible effect on the corresponding yield (unless the Fed announces a target for the yield, in which case the sale itself would be unnecessary.) But again, eventually, sufficient rate hikes and asset sales will presumably lead asset prices to fall. When they do fall, it will probably by a lot at once rather than a little at a time – when assets are held primarily for capital gains, their price can continue rising or fall sharply, but it cannot remain constant. If you own something because you think it will rise in value, then if it stays at the current price, the current price is too high.
Lower asset values in turn will discourage new borrowing (by weakening bank balance sheets, and raising bond yields) and reduce the net worth of households (and also of nonprofits and pension funds and the like), reducing their spending. High stock prices are often a major factor in periods of rising consumption,like the 1990s; a stock market crash could be expected to have the opposite impact.
What can we say about all these channels? First, they will over time lead to less spending in the economy, lower incomes, and less employment. This is how hikes have an effect on inflation, if they do. There is no causal pathway from rate hikes to lower inflation that doesn’t pass through reduced incomes and spending along the way. And whether or not you accept the textbook view that the path from demand to prices runs via unemployment wage growth, it is still the case that reduced output implies less demand for labor, meaning slower growth in employment and wages.
That is the first big point. There is no immaculate disinflation.
Second, rate hikes will have a disproportionate effect on certain parts of the economy. The decline in output, incomes and employment will initially come in the most interest-sensitive parts of the economy — construction especially. Rising rates will reduce wealth and income for indebted households. 2. Over time, this will cause further falls in income and employment in the sectors where these households reduce spending, as well as in whatever categories of spending that are most sensitive to changes in wealth. In some cases, like autos, these may be the same areas where supply constraints have been a problem. But there’s no reason to think this will be the case in general.
It’s important to stress that this is not a new problem. One of the things hindering a rational discussion of inflation policy, it seems to me, is the false dichotomy that either we were facing transitory, pandemic-related inflation, or else the textbook model of monetary policy is correct. But as the BIS’s Claudio Borio and coauthors notein a recent article, even before the pandemic, “measured inflation [was] largely the result of idiosyncratic (relative) price changes… not what the theoretical definition of inflation is intended to capture, i.e. a generalised increase in prices.” The effects of monetary policy, meanwhile, “operate through a remarkably narrow set of prices, concentrated mainly in the more cyclically sensitive service sectors.”
These are broadly similar results to a2019 paper by Stock and Watson, which finds that only a minority of prices show a consistent correlation with measures of cyclical activity.3 It’s true that in recent months, inflation has not been driven by auto prices specifically. But it doesn’t follow that we’re now seeing all prices rising together. In particular, non-housing services (which make up about 30 percent of the CPI basket) are still contributing almost nothing to the excess inflation. Yet, if you believe the BIS results (which seem plausible), it’s these services where the effects of tightening will be felt most.
This shows the contribution to annualized inflation above the 2% target, over rolling three-month periods. My analysis of CPI data.
The third point is that all of this takes time. It is true that some asset prices and market interest rates may move as soon as the Fed funds rate changes — or even in advance of the actual change, as with mortgage rates this year. But the translation from this to real activity is much slower. The Fed’s ownFRB/US model says that the peak effect of a rate change comes about two years later; there are significant effects out to the fourth year. What the Fed is doing now is, in an important sense, setting policy for the year 2024 or 2025. How confident should we be about what demand conditions will look like then? Given how few people predicted current inflation, I would say: not very confident.
This connects to the fourth point, which is that there is no reason to think that the Fed can deliver a smooth, incremental deceleration of demand. (Assuming we agreed that that’s what’s called for.) In part this is because of the lags just mentioned. The effects of tightening are felt years in the future, but the Fed only gets data in real time. The Fed may feel they’ve done enough once they see unemployment start to rise. But by that point, they’ll have baked several more years of rising unemployment into the economy. It’s quite possible that by the time the full effects of the current round of tightening are felt, the US economy will be entering a recession.
This is reinforced when we think about the channels policy actually works through. Empirical studies of investment spending tend to find that it is actually quite insensitive to interest rates. The effect of hikes, when it comes, is likelier to be through Minskyan channels — at some point, rising debt service costs and falling asset values lead to a cascading chain of defaults.
In and Out of the Corridor
A broader reason we should doubt that the Fed can deliver a glide path to slower growth is that the economy is a complex system, with both positive and negative feedbacks; which feedbacks dominate depends on the scale of the disturbance. In practice, small disturbances are often self-correcting; to have any effect, a shock has to be big enough to overcome this homeostasis.
Axel Leijonhufvudlong ago described this as a “corridor of stability”: economic units have buffers in the form of liquid assets and unused borrowing capacity, which allow them to avoid adjusting expenditure in response to small changes in income or costs. This means the Keynesian multiplier is small or zero for small changes in autonomous demand. But once buffers start to get exhausted, responses become much larger, as the income-expenditure positive feedback loop kicks in.
The most obvious sign of this is the saw-tooth pattern in long-run series of employment and output. We don’t see smooth variation in growth rates around a trend. Rather, we see two distinct regimes: extended periods of steady output and employment growth, interrupted by shorter periods of negative growth. Real economies experience well-defined expansions and recessions, not generic “fluctuations”.
This pattern is discussed in a very interesting recent paper by Antonio Fatas,“The Elusive State of Full Employment.” The central observation of the paper is that whether you measure labor market slack by the conventional unemployment rate or in some other way (the detrended prime-age employment-population ratio is his preferred measure), the postwar US does not show any sign of convergence back to a state of full employment. Rather, unemployment falls and employment rises at a more or less constant rate over an expansion, until it abruptly gives way to a recession. There are no extended periods in which (un)employment rates remain stable.
One implication of this is that the economy spends very little time at potential or full employment; indeed, as he says, the historical pattern should raise questions whether a level of full employment is meaningful at all.
the results of this paper also cast doubt on the empirical relevance of the concepts of full employment or the natural rate of unemployment. … If this interpretation is correct, our estimates of the natural rate of unemployment are influenced by the length of expansions. As an example, if the global pandemic had happened in 2017 when unemployment was around 4.5%, it is very likely that we would be thinking of unemployment rates as low as 3.5% as unachievable.
There are many ways of arriving at this same point. For example, he finds that the (un)employment rate at the end of an expansion is strongly predicted by the rate at the beginning, suggesting that what we are seeing is not convergence back to an equilibrium but simply a process of rising employment that continues until something ends it.
Another way of looking at this pattern is that any negative shock large enough to significantly slow growth will send it into reverse — that, in effect, growth has a “stall speed” below which it turns into recession. If this weren’t the case, we would sometimes see plateaus or gentle hills in the employment rate. But all we see are sharp peaks.
In short: Monetary policy is an anti-inflation tool that works, when it does, by lowering employment and wages; by reducing spending in a few interest-sensitive sectors of the economy, which may have little overlap with those where prices are rising; whose main effects take longer to be felt than we can reasonably predict demand conditions; and that is more likely to provoke a sharp downturn than a gradual deceleration.
Is Macroeconomic Policy the Responsibility of the Fed?
One reason I don’t think we should be endorsing this move is that we shouldn’t be endorsing the premise that the US is facing dangerously overheated labor markets. But the bigger reason is that conventional monetary policy is a bad way of managing the economy, and entails a bad way of thinking about the economy. We should not buy into a framework in which problems of rising prices or slow growth or high unemployment get reduced to “what should the federal funds rate do?”
What’s missing here is any policy action by anyone other than the Fed. It’s this narrowing of the discussion I object to, more than the rate increase as such.
Rents are rising rapidly right now — at an annual rate of about 6 percent as measured by the CPI. And there is reason to think that this number understates the increase in market rents and will go up rather than down over the coming year. This is one factor in the acceleration of inflation compared with 2020, when rents in most of the country were flat or falling. (Rents fell almost 10 percent in NYC during 2020, perZillow.) The shift from falling to rising rents is an important fact about the current situation. But rents were also rising well above 2 percent annually prior to the pandemic. The reason that rents (and housing prices generally) rise faster than most other prices generally, is that we don’t build enough housing. We don’t build enough housing for poor people because it’s not profitable to do so; we don’t build enough housing for anyone in major cities because land-use rules prevent it.
Rising rents are not an inflation problem, they are a housing problem. The only way to deal with them is some mix of public money for lower-income housing, land-use reform, and rent regulations to protect tenants in the meantime. Higher interest rates will not help at all — except insofar as, eventually, they make people too poor to afford homes.
Or energy costs. Energy today still mostly means fossil fuels, especially at the margin. Both supply and demand are inelastic, so prices are subject to large swings. It’s a global market, so there’s not much chance of insulating the US even if it is “energy independent” in net terms. The geopolitics of fossil fuels means that production is both vulnerable to interruption from unpredictable political developments, and subject to control by cartels.
The long run solution is, of course, to transition as quickly as possible away from fossil fuels. In the short run, we can’t do much to reduce the cost of gasoline (or home heating oil and so on), but we can shelter people from the impact, by reducing the costs of alternatives, like transit, or simply by sending them checks. (The California state legislature’s plan seems like a good model.) Free bus service will help both with the short-term effect on household budgets and to reduce energy demand in the long run. Raising interest rates won’t help at all — except insofar as, eventually, they make people too poor to buy gas.
These are hard problems. Land use decisions are made across tens of thousands of local governments, and changes are ferociously opposed by politically potent local homeowners (and some progressives). Dependence on oil is deeply baked into our economy. And of course any substantial increase in federal spending must overcome both entrenched opposition and the convoluted, anti-democratic structures of our government, as we have all been learning (again) this past year.
These daunting problems disappear when we fold everything into a price index and hand it over to the Fed to manage. Reducing everything to the core CPI and a policy rule are a way of evading all sorts of difficult political and intellectual challenges. We can also then ignore the question how, exactly, inflation will be brought down without costs to the real economy, and how to decide if these costs are worth it. Over here is inflation; over there are the maestros with their magic anti-inflation device. All they have to do is put the right number into the machine.
It’s an appealing fantasy – it’s easy to see why people are drawn to it. But it is a fantasy.
A modern central bank, sitting at the apex of the financial system, has a great deal of influence over markets for financial assets and credit. This in turn allows it to exert some influence — powerful if often slow and indirect — on production and consumption decisions of businesses and households. Changes in the level and direction of spending will in turn affect the pricing decisions of business. These effects are real. But they are no different than the effects of anything else — public policy or economic developments — that influence spending decisions. And the level of spending is in turn only one factor in the evolution of prices. There is no special link from monetary policy to aggregate demand or inflation. It’s just one factor among others — sometimes important, often not.
Yes, a higher interest rate will, eventually reduce spending, wages and prices. But many other forces are pushing in other directions, and dampening or amplifying the effect of interest rate changes. The idea that there is out there some “r*”, some “neutral rate” that somehow corresponds to the true inter temporal interest rate — that is a fairy tale.
Nor does the Fed have any special responsibility for inflation. Once we recognize monetary policy for what it is — one among many regulatory and tax actions that influence economic rewards and incomes, perhaps influencing behavior — arguments for central bank independence evaporate. (Then again, theydid not make much sense to begin with.) And contrary to widely held belief, the Fed’s governing statutes do not give it legal responsibility for inflation or unemployment.
That last statement might sound strange, given that we are used to talking about the Fed’s dual mandate. But as Lev Menand points out in an important recent intervention, the legal mandate of the Fed has been widely misunderstood. What the Federal Reserve Act charges the Fed with is
maintain[ing the] long run growth of the monetary and credit aggregates commensurate with the economy’s long-run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.
There are two things to notice here. First, the bolded phrase: The Fed’s mandate is not to maintain price stability or full employment as such. It is to prevent developments in the financial system that interfere with them. This is not the same thing. And as Menand argues (in the blog post and at more lengthelsewhere), limiting the Fed’s macroeconomic role to this narrower mission was the explicit intent of the lawmakers who wrote the Fed’s governing statutes from the 1930s onward.
Second, price stability, maximum employment and moderate interest rates (an often forgotten part of the Fed’s mandate) are not presented as independent objectives, but as the expected consequences of keeping credit growth on a steady path. As Menand writes:
The Fed’s job, as policymakers then recognized, was not to combat inflation—it was to ensure that banks create enough money and credit to keep the nation’s productive resources fully utilized…
This distinction is important because there are many reasons that, in the short-to-medium term, the economy might not achieve full potential—as manifested by maximum employment, price stability, and moderate long-term interest rates. And often these reasons have nothing to do with monetary expansion, the only variable Congress expected the Fed to control. For example, supply shortages of key goods and services can cause prices to rise for months or even years while producers adapt to satisfy changing market demand. The Fed’s job is not to stop these price rises—even if policymakers might think stopping them is desirable—just as the Fed’s job is not to … lend lots of money to companies so that they can hire more workers. The Fed’s job is to ensure that a lack of money and credit created by the banking system—an inelastic money supply—does not prevent the economy from achieving these goals. That is its sole mandate.
As Menand notes, the idea that the Fed was directly responsible for macroeconomic outcomes was a new development in the 1980s, an aspect of the broader neoliberal turn that had no basis in law. Nor does it have any good basis in economics. If a financial crisis leads to a credit crunch, or credit-fueled speculation develops into an asset bubble, the central bank can and should take steps to stabilize credit growth and asset prices. In doing so, it will contribute to the stability of the real economy. But when inflation or unemployment come from other sources, conventional monetary policy is a clumsy, ineffectual and often destructive way of responding to them.
There’s a reason that the rightward turn in the 1980s saw the elevation of central banks as the sole custodians of macroeconomic stability. The economies we live in are not in fact self-regulating; they are subject to catastrophic breakdowns of various forms, and even when they function well, are in constant friction with their social surroundings. They require active management. But routine management of the economy — even if limited to the adjustment of the demand “thermostat,” in Samuelson’s old metaphor — both undermine the claim that markets are natural, spontaneous and decentralized, and opens the door to a broader politicization of the economy. The independent central bank in effect quarantines the necessary economic management from the infection of democratic politics.
The period between the 1980s and the global financial crisis saw both a dramatic elevation of the central bank’s role in macroeconomic policy, and a systematic forgetting of the wide range of tools central banks used historically. There is a basic conflict between the expansive conception of the central bank’s responsibilities and the narrow definition of what it actually does. The textbooks tell us that monetary policy is the sole, or at least primary, tool for managing output, employment and inflation (and in much of the world, the exchange rate); and that it is limited to setting a single overnight interest rate according to a predetermined rule. These two ideas can coexist comfortably only in periods of tranquility when the central bank doesn’t actually have to do anything.
What has the Fed Delivered in the Past?
Coming back to the present: The reason I think it is wrong to endorse the Fed’s move toward tightening is not that there’s any great social benefit to having an overnight rate on interbank loans of near 0. I don’t especially care whether the federal funds rate is at 0.38 percent or 1.17 percent next September. I don’t think it makes much difference either way. What I care about is endorsing a framework that commits us to managing inflation by forcing down wages, one that closes off discussion of more progressive and humane — and effective! — ways of controlling inflation. Once the discussion of macroeconomic policy is reduced to what path the federal funds rate should follow, our side has already lost, whatever the answer turns out to be.
It is true that there are important differences between the current situation the end of 2015, the last time the Fed started hiking, that make today’s tightening more defensible. Headline unemployment is now at 3.8 percent, compared with 5 percent when the Fed began hiking in 2015. The prime-age employment rate was also about a point lower then than now. But note also that in 2015 the Fedthought the long-run unemployment rate was 4.9 percent. So from their point of view, we were at full employment. (The CBO, which had the long-run rate at 5.3 percent, thought we’d already passed it.) It may be obvious in retrospect (and to some of us in the moment) that in late 2015 there was still plenty of space for continued employment growth. But policymakers did not think so at the time.
More to the point, inflation then was much lower. If inflation control is the Fed’s job, then the case for raising rates is indeed much stronger now than it was in December 2015. And while I am challenging the idea that this should be the Fed’s job, most people believe that it is. I’m not upset or disappointed that Powell is moving to hike rates now, or is justifying it in the way that he is. Anyone who could plausibly be in that position would be doing the same.
So let’s say a turn toward higher rates was less justified in 2015 than it is today. Did it matter? If you look at employment growth over the 2010s, it’s a perfectly straight line — an annual rate of 1.2 percent, month after month after month. If you just looked at the employment numbers, you’d have no idea that the the Fed was tightening over 2016-2018, and then loosening in the second half of 2019. This doesn’t, strictly speaking, prove that the tightening had no effect. But that’s certainly the view favored by Occam’s razor. The Fed, fortunately, did not tighten enough to tip the economy into recession. So it might as well not have tightened at all.
The problem in 2015, or 2013, or 2011, the reason we had such a long and costly jobless recovery, was not that someone at the Fed put the wrong parameter into their model. It was not that the Fed made the wrong choices. It was that the Fed did not have the tools for the job.
Honestly, it’s hard for me to see how anyone who’s been in these debates over the past decade could believe that the Fed has the ability to steer demand in any reliable way. The policy rate was at zero for six full years. The Fed was trying their best! Certainly the Fed’s response to the 2008 crisis was much better than the fiscal authorities’. So for that matter was the ECB’s, once Draghi took over from Trichet. 4 The problem was not that the central bankers weren’t trying. The problem was that having the foot all the way down on the monetary gas pedal turned out not to do much.
As far as I can tell, modern US history offers exactly one unambiguous case of successful inflation control via monetary policy: the Volcker shock. And there, it was part of a comprehensive attack on labor.
It is true that recessions since then have consistently seen a fall in inflation, and have consistently been preceded by monetary tightenings. So you could argue that the Fed has had some inflation-control successes since the 1980s, albeit at the cost of recessions. Let’s be clear about what this entails. To say that the Fed was responsible for the fall in inflation over 2000-2002, is to say that the dot-com boom could have continued indefinitely if the Fed had not raised rates.
Maybe it could have, maybe not. But whether or not you want to credit (or blame) the Fed for some or all of the three pre-pandemic recessions, what is clear is that there are few if any cases of the Fed delivering slower growth and lower inflation without a recession.
According to Alan Blinder, since World War II the Fed has achieved a soft landing in exactly two out of 11 tightening cycles, most recently in 1994. In that case, it’s true, higher rates were not followed by a recession. But nor were they followed by any discernible slowdown in growth. Output and employment grew even faster after the Fed started tightening than before. As for inflation, it did come down about two years later, at the end of 1996 – at exactly the same moment as oil prices peaked. And came back up in 1999, at exactly the moment when oil prices started rising again. Did the Fed do that? It looks to me more like 2015 – a tightening that stopped in time to avoid triggering a recession, and instead had no effect. But even if we accept the 1994 case, that’s one success story in the past 50 years. (Blinder’s other soft landing is 1966.)
I think the heart of my disagreement with progressives who are support tightening is whether it’s reasonable to think the Fed can adjust the “angle of approach” to a higher level of employment. I don’t think history gives us much reason to believe that they can. There are people who think that a recession, or at least a much weaker labor market, is the necessary cost of restoring price stability. That’s not a view I share, obviously, but it is intellectually coherent. The view that the Fed can engineer a gentle cooling that will bring down inflation while employment keeps rising, on the other hand, seems like wishful thinking.
That said, of the two realistic outcomes of tightening – no effect, or else a crisis – I think the first is more likely, unless they move quite a bit faster than they are right now.
So what’s at stake then? If the Fed is doing what anyone in their position would do, and if it’s not likely to have much impact one way or another, why not make some approving noises, bank the respectability points, and move on?
Four Good Reasons to Be Against Rate Hikes (and One that Isn’t)
I think that it’s a mistake to endorse or support monetary tightening. I’ll end this long post by summarizing my reasons. But first, let me stress that a commitment to keeping the federal funds rate at 0 is not one of those reasons. If the Fed were to set the overnight rate at some moderate positive level and then leave it there, I’d have no objection. In the mid-19th century, the Bank of France kept its discount rate at exactly 4 percent for something like 25 years. Admittedly 4 percent sounds a little high for the US today. But a fixed 2 percent for the next 25 years would probably be fine.
There are four reasons I think endorsing the Fed’s decision to hike is a mistake.
First, most obviously, there is the risk of recession. If rates were at 2 percent today, I would not be calling for them to be cut. But raising them is a different story. Last week’s hike is no big deal in itself, but there will be another, and another, and another. I don’t know where the tipping point is, where hikes inflict enough financial distress to tip the economy into recession. But neither does the Fed. The faster they go, the sooner they’ll hit it. And given the long lags in monetary transmission, they probably won’t know until it’s too late. People are talking a lot lately about wage-price spirals, but that is far from the only positive feedback in a capitalist economy. Once a downturn gets started, with widespread business failures, defaults and disappointed investment plans, it’s much harder to reverse it than it would have been to maintain growth.
I think many people see trusting the Fed to deal with inflation as the safe, cautious position. But the fact that a view is widely held doesn’t mean it is reasonable. It seems to me that counting on the Fed to pull off something that they’ve seldom if ever succeeded at before is not safe or cautious at all.5 Those of us who’ve been critical of rate hikes in the past should not be too quick to jump on the bandwagon now. There are plenty of voices calling on the Fed to move faster. It’s important that there also be some saying, slow down.
2. Second, related to this, is a question I think anyone inclined to applaud hikes should be asking themselves: If high inflation means we need slower growth, higher unemployment and lower wages, where does that stop? Inflation may come down on its own over the next year — I still think this is more likely than not. But if it doesn’t come down on its own, the current round of rate hikes certainly isn’t going to do it. Looking again at the Fed’s FRB/US model, we see that a one point increase in the federal funds rate is predicted to reduce inflation by about one-tenth of a point after one year, and about 0.15 points after two years. The OECD’s benchmark macro model make similar predictions: a sustained one-point increase in the interest rate in a given year leads to an 0.1 point fall in inflation the following year, an 0.3 fall in the third year and and an 0.5 point fall in the fourth year.
Depending which index you prefer, inflation is now between 3 and 6 points above target.6 If you think conventional monetary policy is what’s going to fix that, then either you must have have some reason to think its effects are much bigger than the Fed’s own models predict, or you must be imagining much bigger hikes than what we’re currently seeing. If you’re a progressive signing on to today’s hikes, you need to ask yourself if you will be on board with much bigger hikes if inflation stays high. “I hope it doesn’t come to that” is not an answer.
3. Third, embracing rate hikes validates the narrative that inflation is now a matter of generalized overheating, and that the solution has to be some form of across-the-board reduction in spending, income and wages. It reinforces the idea that pandemic-era macro policy has been a story of errors, rather than, on balance, a resounding success.
The orthodox view is that low unemployment, rising wages, and stronger bargaining power for workers are in themselves serious problems that need to be fixed. Look at how the news earlier this week of record-low unemployment claims got covered: It’s a dangerous sign of “wage inflation” that will “raise red flags at the Fed.” Or the constant complaints by employers of “labor shortages” (echoed by Powell last week.) Saying that we want more employment and wage growth, just not right now, feels like trying to split the baby. There is not a path to a higher labor share that won’t upset business owners.
The orthodox view is that a big reason inflation was so intractable in the 1970s was that workers were also getting large raises. From this point of view, if wages are keeping pace with inflation, that makes the problem worse, and implies we need even more tightening. Conversely, if wages are falling behind, that’s good. Alternatively, you might think that the Powell was right before when he said the Phillips curve was flat, and that inflation today has little connection with unemployment and wages. In that case faster wage growth, so that living standards don’t fall, is part of the solution not the problem. Would higher wages right now be good, or bad? This is not a question on which you can be agnostic, or split the difference. I think anyone with broadly pro-worker politics needs to think very carefully before they accept the narrative of a wage-price spiral as the one thing to be avoided at all costs.
Similarly, if rate hikes are justified, then so must be other measures to reduce aggregate spending. The good folks over at the Committee for a Responsible Federal Budget just put out a piece arguing that student loan forbearance and expanded state Medicare and Medicaid funding ought to be ended, since they are inflationary. And you have to admit there’s some logic to that. If we agree that the economy is suffering from excessive demand, shouldn’t we support fiscal as well as monetary measures to reduce it? A big thing that rate hikes will do is raise interest payments by debtors, including student loan debtors. If that’s something we think ought to happen, we should think so when it’s brought about in other ways too. Conversely, if you don’t want to sign on to the CFRB program, you probably want to keep some distance from Powell.
4. Fourth and finally, reinforcing the idea that inflation control is the job of the Fed undermines the case for measures that actually would help with inflation. Paradoxical as it may sound, one reason it’s a mistake to endorse rate hikes is precisely because rising prices really are a problem. High costs of housing and childcare are a major burden for working families. They’re also a major obstacle to broader social goals (more people living in dense cities; a more equal division of labor within the family). Rate hikes move us away from the solution to these problems, not towards it. Most urgently and obviously, they are entirely unhelpful in the energy transition. Tell me if you think this is sensible: “Oil prices are rising, so we should discourage people from developing alternative energy sources”. But that is how conventional monetary policy works.
The Biden administration has been strikingly consistent in articulating an alternative vision of inflation control – what some people call a progressive supply-side vision. In the State of the Union, for example, we heard:
We have a choice. One way to fight inflation is to drive down wages and make Americans poorer. I think I have a better idea … Make more cars and semiconductors in America. More infrastructure and innovation in America. …
First, cut the cost of prescription drugs. We pay more for the same drug produced by the same company in America than any other country in the world. Just look at insulin. … Insulin costs about $10 a vial to make. … But drug companies charge … up to 30 times that amount. …. Let’s cap the cost of insulin at $35 a month so everyone can afford it.7
Second, cut energy costs for families an average of $500 a year by combating climate change. Let’s provide investment tax credits to weatherize your home and your business to be energy efficient …; double America’s clean energy production in solar, wind and so much more; lower the price of electric vehicles,…
Of course weatherizing homes is not, by itself, going to have a big effect on inflation. But that’s the direction we should be looking in. If we’re serious about managing destructive price increases, we can’t leave the job to the Fed. We need to be looking for a mix of policies that directly limit price increases using administrative tools, that cushion the impact of high prices on family budgets in the short run, and that deal with the supply constraints driving price increases in the long run.
The interest rate hike approach is an obstacle to all this, both practically and ideologically. A big reason I’m disappointed to see progressives accepting the idea that inflation equals rate hikes, is that there has been so much creative thinking about macroeconomic policy in recent years. What’s made this possible is increasing recognition that the neoliberal, central bank-centered model has failed. We have to decide now if we really believed that. Forward or backward? You can’t have it both ways.
The previous post got quite a bit of attention — more, I think, than anything I’ve written on this blog in the dozen years I’ve been doing it.
I would like to do a followup post replying to some of the comments and criticisms, but I haven’t had time and realistically may not any time soon, or ever. In the meantime, though, here is some existing content that might be relevant to people who would like to see the arguments in that post drawn out more fully.
Here is a podcast interview I did with some folks from Current Affairs a month or so ago. The ostensible topic is Modern Mone(tar)y Theory, but the conversation gave me space to talk more broadly about how to think about macroeconomic questions.
Here is a piece I wrote a couple years ago on Macroeconomic Lessons from the Past Decade. Bidenomics could be seen as a sort of deferred learning of the lessons from the Great Recession. So even though this was written before the pandemic and the election, there’s a lot of overlap here.
This report from Roosevelt, What Recovery? is an earlier stab at learning those lessons. I hope to be revisiting a lot of the topics here (and doing a better job with them, hopefully) in a new Roosevelt report that should be out in a couple of months.
If you like podcast interviews, here’s one I did with David Beckworth of Macro Musings following the What Recovery report, where we talked quite a bit about hysteresis and the limits of monetary policy, among other topics.
And here are some relevant previous past posts on this blog:
(A couple days ago I gave a talk — virtually, of course — to a group of activists about the state of the economy. This is an edied and somewha expanded version of what I said.)
The US economy has officially been in recession since February. But what we’ve seen so far looks very different from the kind of recessions we’re used to, both because of the unique nature of the coronavirus shock and because of the government response to it. In some ways, the real recession is only beginning now. And if federal stimulus is not restored, it’s likely to be a very deep and prolonged one.
In a normal recession, the fundamental problem is an interruption in the flow of money through the economy. People or businesses reduce their spending for whatever reason. But since your spending is someone else’s income, lower spending here reduces incomes and employment over there — this is what we call a fall in aggregate demand. Businesses that sell less need fewer workers and generate less profits for their owners. That lost income causes other people to reduce their spending, which reduces income even more, and so on.
Now, a small reduction in spending may not have any lasting effects — people and businesses have financial cushions, so they won’t have to cut spending the instant their income falls, especially if they expect the fall in income to be temporary. So if there’s just a small fall in demand, the economy can return to its old growth path quickly. But if the fall in spending is big enough to cause many workers and businesses to cut back their own spending, then it can perpetuate itself and grow larger instead of dying out. This downward spiral is what we call a recession. Usually it’s amplified by the financial system, as people who lose income can’t pay their debts, which makes banks less willing or able to lend, which forces people and businesses that needed to borrow to cut back on their spending. New housing and business investment in particular are very dependent on borrowed money, so they can fall steeply if loans become less available. That creates another spiral on top of the first. Or in recent recessions, often it’s the financial problems that come first.
But none of that is what happened in this case. Businesses didn’t close because there wasn’t enough money flowing through the economy, or because they couldn’t get loans. They closed because under conditions of pandemic and lockdown they couldn’t do specific things — serve food, offer live entertainment, etc. And to a surprising extent, the stimulus and unemployment benefits meant that people who stopped working did not lose income. So you could imagine that once the pandemic was controlled, we could return to normal much quicker than in a normal recession.
That was the situation as recently as August.
The problem is that much of the federal spending dried up at the end of July. And that is shifting the economy from a temporary lockdown toward a self-perpetuating fall in incomes and employment.
One way we see the difference between the lockdown and a recession is the industries affected. The biggest falls in employment were in entertainment and recreation and food service, which are industries that normally weather downturns pretty well, while construction and manufacturing, normally the most cyclical industries, have been largely unaffected. Meanwhile, employment in health and education, which in previous recessions has not fallen at all, this time has declined quite a bit.8
If we look at employment, for instance which is normally our best measure of business-cycle conditions, we again see something very different from past recessions. Total employment fell by 20 million in April and May of this year. In just two months, 15 percent of American workers lost their jobs. There’s nothing remotely comparable historically — more jobs were lost in the Depression, but that was a slow process over years not just two months. The post-World War II demobilization was the closest, but that only involved about half the fall in employment. So this is a job loss without precedent.
Since May, about half of those 20 million people have gone back to work. We’re about 10 million jobs down from a year ago. Still, that might look like a fairly strong recovery.
But in the spring, the vast majority of unemployed people described themselves as on temporary layoff — they expected to go back to their jobs. The recovery in employment has almost all come from that group. If we look at people who say they have lost their jobs permanently, that number has continued to grow. Back in May, almost 90 percent of the people out of work described it as temporary. Today, it’s less than half. Business closings and layoffs that were expected to be temporary in the spring are now becoming permanent. So in a certain sense, even though unemployment is officially much lower than it was a few months ago, unemployment as we usually think of it is still rising.
We can see this even more dramatically if we look at income. Most people don’t realize how large and effective the stimulus and pandemic unemployment insurance programs were. Back in the spring, most people — me included — thought there was no way the federal government would spend on the scale required to offset the hob losses. The history of stimulus in this country — definitely including the ARRA under Obama — has always been too little, too late. Unemployment insurance in particular has historically had such tight eligibility requirements that the majority of people who lose their jobs never get it.
But this time, surprisingly, the federal stimulus was actually big enough to fill the hole of lost incomes. The across-the-board $600 per week unemployment benefit reached a large share of people who had lost their jobs, including gig workers and others who would not have been able to get conventional UI. And of course the stimulus checks reached nearly everyone. As a result, if we look at household income, we see that as late as July, it was substantially above pre-recession levels. This is a far more effective response than the US has made to any previous downturn. And it’s nearly certain that the biggest beneficiaries were lower-wage workers.
We can see the effects of this in the Household Pulse surveys conducted by the Census. Every week since Mach, they’ve been asking a sample of households questions about their economic situation, including whether they have enough money to meet their basic needs. And the remarkable thing is that over that period, there has been no increase in the number of people who say they can’t pay their rent or their mortgage or can’t get enough to eat. About 9 percent of families said they sometimes or often couldn’t afford enough to eat, and about 20 percent of renters said they were unable to pay the last month’s rent in full. Those numbers are shockingly high. But they are no higher than they were before the pandemic.
To be clear – there are millions of people facing serious deprivation in this country, far more than in other rich countries. But this is a longstanding fact about the United States. It doesn’t seem to be any worse than it was a year ago. And given the scale of the job loss, that is powerful testimony to how effective the stimulus has been.
But the stimulus checks were one-off, and the pandemic unemployment insurance expired at end of July. Fortunately there are other federal unemployment supplements, but they are nowhere as generous. So we are now seeing the steep fall in income that we did not see in the first five months of the crisis.
That means we may now be about to see the deep recession that we did not really get in the spring and summer. And history suggests that recovery from that will be much slower. If we look at the last downturn, it took five full years after the official end of the recession for employment to just get back to its pre-recession level. And in many ways, the economy had still not fully recovered when the pandemic hit.
One thing we may not see, though, is a financial crisis. The Fed is in some ways one of the few parts of our macroeconomic policy apparatus that works well, and it’s become even more creative and aggressive as a result of the last crisis. In the spring, people were talking about a collapse in credit, businesses unable to get loans, people unable to borrow. But this really has not happened. And there’s good reason to think that the Fed has all the tools they need if a credit crunch did develop, if some financial institutions to end up in distress. Even if we look at state and local governments, where austerity is already starting and is going to be a big part of what makes this recession severe, all the evidence is that they aren’t willing to borrow, not that they can’t borrow.
Similarly with the stock market — people think it’s strange that it’s doing well, that it’s delinked from the real economy, or that it’s somehow an artificial result of Fed intervention. To be clear, there’s no question that low interest rates are good for stock prices, but that’s not artificial — there’s no such thing as a natural interest rate.
More to the point, by and large, stocks are doing well because profits are doing well. Stock market indexes dominated by a small number of large companies, and many of those have seen sales hold up or grow. Again, so far we haven’t seen a big fall in total income. So businesses in general are not losing sales. What we have seen is a division of businesses into winners and losers. The businesses most affected by the pandemic have seen big losses of sales and profits and their share prices have gone down. But the businesses that can continue to operate have done well. So there’s nothing mysterious in the fact that Amazon’s stock price, for instance, has risen, and there’s no reason to think it’s going to fall. If you look at specific stocks, you see that by and large the ones that are doing well, the underlying business is doing well.
This doesn’t mean that what’s good for the stock market is good for ordinary workers. But again, that’s always been true. Shareholders don’t care about workers, they only care about the flow of profits their shares entitle them to. And if you’re a shareholder in a company that makes most of its sales online, that flow of profits is looking reasonably healthy right now.
So going forward, I think the critical question is whether we see any kind of renewed stimulus. If we do, it’s still possible that the downward income-expenditure spiral can be halted. At some point soon that will be much harder.
I haven’t been able to write as much about the current situation as I would like to.
Personally, I am doing fine. My wife and I are lucky to have some of the most secure jobs in the country – we are both public university professors — and we’re all healthy and as comfortable as can be expected under the circumstances, and we have access to outdoor space. But we also have two children who are now home all day, both of them young enough to need more or less constant attention. And I’m teaching three classes this semester, and the transition to teaching online, which I’ve never before done, has been challenging. And of course there is work already in the pipeline that has to be completed, like my project with Andrew Bossie on the economic mobilization of World War as a model for today. (The first part is here and the second should be out soon.)
I don’t mean to complain. Again, my personal situation under the lockdown is fine. But I do feel bad about not being more present in the important moment for economic debate since 2008-2009, if not longer.There’s an endless number of urgent, challenging, and profound economic questions to be wrestled with. I’m a bit jealous of people like my associates Nathan Tankus and Jacob Robbins, who are in a position to give the economic situation the attention it deserves and putting out a steady stream of excellent posts on their respective blogs.
And to be fair, it’s not just a matter of time. Like, I suppose, most people, I don’t feel any confidence about how this situation will develop, or what the right framework is to think about it through. I feel I’ve spent many years developing a set of economic ideas and arguemnts with, and within, certain positions, that may not be relevant here. I find it hard to gather enough thoughts together to be worth writing down.
If I did feel able to blog regularly about the economics of the coronavirus, here are some of the posts I might write. I don’t claim these are the most important topics, just ones that I would like to blog about.
Taking the money view. Our economy consists of a network of money payments and commitments, many of them corresponding to some concrete activity. What’s unique about this crisis is that the initial interruption is to the concrete activities rather than the money payments. This complicates the policy response: It’s not enough to inject more spending in the economy somewhere, on the assumption that it will diffuse through the normal circuits of income and expenditure, we have to think about maintaining the payments, and social relations, associated with various specific activities while the activities themselves can’t take place.
Paging Henry George. While much of the concrete activity we think of as “consumption” is on hold, much of consumption spending is various forms of social overhead that has to happen regardless; housing is far the most important category here, with a large fraction of mortgage and especially rent payments already not being made. We urgently need to replace these payments with public money, or else suspend (not just defer) them in a controlled way; the flipside of this is that here as elsewhere, where private payments are replaced with public ones, there’s an opportunity to transform the social relations structured by those payments. In this case, that could mean not just replacing rent paymentsbut buying out properties, so as to replace private ownership of rental housing with public or resident ownership.
Crying “fire, fire” in Noah’s flood. Despite the uniqueness of the current crisis, I still think one important dimension is a shortfall of demand. While many businesses have been directly shut down by coronavirus restrictions, it’s clear that many others are limited by a lack of customers – airlines traffic are down by 95% not because airlines can’t find people to staff the planes, but because no one is buying tickets. (The planes that do fly are empty, not full.) As incomes continue to fall from unemployment — and only a fraction are replaced by UI and other forms of public assistance — the demand shortfall is only going to get deeper, so I’m a bit puzzled when people like Dean Baker say that the problemin the coming year might be too much spending rather than too little.
The skeleton of the state. One reason I’m confident that the economy is going to need more demand, is that recessions always involve a downward spiral between income and expenditure; once economic units have run through their reserves of liquidity, and/or start changing their beliefs about future income, the fall in spending will continue under its own power, regardless of what started it. One important area where this process is already underway is state and local governments; thanks to a combination of institutional constraints political culture, spending here is even more closely linked to current income than it is for households and businesses. In the last recession state and local spending continued to fall for a full five years after the official recovery.
Credit contraction? Adam Tooze, in the LRB, describes the economic crisis as “a shockwave of credit contraction,” which sounds to me like an uncritical updating of the 2008-2009 script for 2020. Is there any evidence that limits on borrowing are currently playing an independent role in reducing activity, or are likely to in the future? The problem seems obviously to be a collapse in current income, not a sudden unwillingness of banks to lend.
Send in the Fed. Even if a credit contraction is not a factor in the crisis, it doesn’t follow that efforts to boost the supply the of credit are irrelevant. Easing credit conditions can help offset declining demand from other sources — that’s monetary policy 101, and especially true in the current crisis, where so many incomes need to be temporarily replaced. It’s very important, for example, that the Fed support borrowing by state and local governments, partly because they may be finding it harder to borrow, but mainly because they should be borrowing much more.
Pay as you go vs prefunding. As everyone knows, state and local governments face many constraints on their ability to borrow, which the Fed can relieve only some of. But another important margin for state and local government is on the asset side; it’s not widely recognized, but in the US, subnational governments are substantial net creditors, which in principle allows them to fund current spending by reducing net asset acquisition. One important way that they can do this is by suspending pension fund contributions — this may sound crazy, but what’s really crazy is that they prefund pension expenditure in the first place.
Can we blame the shareholders? A number of us have observed over the past decade have observed that the marginal use of both corporate profits and borrowing now is payouts to shareholders; this, along with the activities of private equity, have left a number of corporations with high debt and weak balance sheets even after years of high profits. There’s an argument that this has left them more vulnerable to the crisis than they needed to be. I’m not entirely convinced on this, especially given that the relevant counterfactual seems to be higher real investment and/or higher wages rather than simply accumulating liquid assets, but it’s a question very much worth exploring.
Seasonal disorder. One technical but, I think, important point about all kinds of economic data right now is that we should not be using seasonally adjusted numbers. Seasonal adjustment for unemployment claims, and for many other economic variables, is based on the percentage change from the previous month, whichproduces totally spurious results in the face of the kinds of moves we are seeing. For example, new unemployment claims rose by 3 percent, from 6 million to 6.2 million, from the week ending April 7 to the week ending April 14; but since claims normally increase by 7 percent between the first and second week of April, this was misleadingly reported as a decrease of 4 percent.
The opportunity to be lazy. This fascinating review of a book on the plague in 17th century Florence quotes a wealthy Florentine who opposed the city’s policy of delivering food to those under quarantine, because it “would give [the poor] the opportunity to be lazy and lose the desire to work, having for forty days been provided abundantly for all their needs”. It’s striking how widespreadsimilar worries are today among our own elite. It seems like one of the deepest lessons of the crisis is that a system organized around the threat of withholding people’s subsistence will deeply resist measures to guarantee it, even when particular circumstances make that necessary for the survival of the system itself.
Brian Nichols of the essential Employ America has a useful, if depressing, roundup of the coming wave of state-local austerity. Some highlights: Ohio, Nevada and Pennsylvania have already announced hiring freezes; Ohio is also looking at a 20 percent across the board cut in state spending, while Virginia has canceled planned raises for teachers. Many cities, including New York, St. Paul and New Orleans, are laying off public employees. And as I noted in my last post, New YorkState is planning to slash $400 million from the hospitals at the front line of the crisis.
This isn’t new. One of the many drawbacks of American federalism is that state and local government spending — which includes the great majority of public sevices that people use on a day to day basis — is distinctly procyclical. Following the 2007-008 crisis, austerity at the state and local level more than offset stimulus at the federal level. And it lasted much longer than the recession itself.
In fact, as my colleague Amanda Page-Hoongrajok points out, inflation-adjusted state and local final expenditure did not return to its 2009 level until 2019.9 On a per-capita basis, real state and local final expenditure is 5 percent lower today than it was at the bottom of the last recession.
As we face the rising wave of public-service cutbacks, we need to be fighting on all levels. We need to demand a massive package of aid to state and local govrnments as part of Stimulus IV. We need to be pushing the Fed to do more to support municipal finances. We need to keep the pressure up on mayors and governors not to throw their hands up and wait for the feds, but to be creative in working around their fiscal constraints.10 And also, we need to keep in mind: As far as state and local spending is concerned, the Great Recession never ended.
(My Roosevelt colleague Naomi Zewde and I have an op-ed in the March 26 Daily News, criticizing Governor Cuomo’s plans to push ahead with cuts to state Medicaid spending despite the epidemic.)
Last week, as the coronavirus shut down much of New York, the state announced a bold plan to drastically cut funding for the state’s hard-pressed health care providers.
That’s right: As the coronavirus crisis escalates across New York State, Gov. Cuomo is proposing to slash funding for those at the frontlines.
Specifically, the cuts come via the Medicaid Redesign Team, appointed last month by the governor with the charge of cutting $2.5 billion from the state’s annual health spending. These cuts will not only mean an even more overstretched health care system; they will mean lost jobs.
For example, $200 million is slated to be cut from Consumer Directed Personal Assistance (CDPA), which allows elderly or disabled New Yorkers to hire their own home care assistants. As a Daily News editorial recently noted, CDPA was responsible for 36,000 new private-sector jobs in New York City in 2019, a lion’s share of all such jobs.
The biggest savings come from across-the-board cuts to health care providers, including $400 million from the state’s hospitals.
Cutting health spending in an epidemic seems like obvious lunacy. But it’s even worse than it seems.
Since the start of this epidemic, nearly one in five American households have had their hours cut or been laid off due to the virus. In New York, Cuomo said that the state has “never seen such volume” of unemployment claims.
As the economy slides over a cliff, we desperately need to keep people employed so that they can pay their bills and keep local businesses running. The proposed cuts will not only kneecap our health care system, but they will also deepen the coming recession.
But don’t we have to do something about out-of-control Medicaid spending? No, we do not. Medicaid spending is already under control.
Over the past five years, Medicaid spending in New York has risen by a steady 4% a year — exactly the same growth rate the state’s economy has had as a whole. And thanks to the Affordable Care Act, the share of total Medicaid costs paid by the state has gone down.
The apparent Medicaid crisis is entirely of the governor’s own making. When an arbitrary “global cap” on Medicaid spending turned out to be unachievable, instead of accepting reality, the state shifted a portion of the bill from fiscal year 2019-2020 to 2020-2021. This created the illusion of a big rise in this year’s costs.
Not only are there no runaway costs to rein in, but health spending is also an important economic stimulus. About 13% of New Yorkers work in health care — more than in manufacturing and finance combined. New York’s hospitals are stable sources of employment in many communities where good jobs are scarce. While many of the state’s traditional industries are in decline, health care promises to be a growth industry in the 21st century — if its growth isn’t cut off by shortsighted cutbacks.
Cutting state Medicaid spending today would be especially perverse, as the federal government appears poised to pick up a larger share of the program’s spending, just as it did in the last recession.
When private sector spending falls in a recession, the role of government is to lean against the wind, and boost public spending to fill the gap. Fiscal stimulus is primarily the responsibility of the federal government, but a state as large and rich as New York should also do its part — especially if leadership in Washington is lacking.
In normal times, trying to balance the budget through Medicaid cuts would be a mistake. Today, it is economic malpractice.
(Cross-posted from the Roosevelt Institute blog. I am hoping to start doing these kinds of posts on new economic data somewhat regularly.)
On Friday, the the Bureau of Labor Statistics released the unemployment figures for May. As expected, the reported unemployment rate was very low—3.6 percent, the same as last month. Combined with the steady growth in employment over the past few years, this level of unemployment—not seen since the 1960s—suggests an exceptionally strong labor market by historical standards.On one level this really is good news for the economy. But at the same time it is very bad news for economic policy: The fact that employment this low is possible, shows that we have fallen even farther short of full employment in earlier years than we thought.
Some skeptics, of course, will cast doubts on how meaningful the BLS numbers are. The headline unemployment rate, they will argue, understates true slack in the labor market; many of the jobs being created are low-wage and insecure; workers’ overall position is still weak and precarious by historical standards.
This is all true. But it is also true that the unemployment numbers are not an isolated outlier. Virtually every other measure also suggests a labor market that is relatively favorable to workers, at least by the standards of the past 20 years.
The broader unemployment measures published by the BLS, while higher than the headline rate, have come down more or less in lockstep with it. (The new release shows that the BLS’s broadest measure of unemployment, U-6, continued to decline in May, thanks to a steep fall in the number of people working part-time because they can’t find full-time work.) The labor force participation rate, after declining for a number of years, has now started to trend back upward, suggesting that people who might have given up on finding a job a few years ago are once again finding it worthwhile to look for one. The fraction of workers voluntarily quitting their jobs, at 2.3 percent, is now higher than it ever got during the previous business cycle. The quit rate is a good measure of labor market tightness—one of former Fed chair Janet Yellen’s preferred measures—because it shows you how people evaluate their own job prospects; people are much more likely to quit their current job if they expect to get a better one. Reported job openings, a longstanding measure of labor market conditions, are at their highest level on record, with employers reporting that nearly 5 percent of positions are unfilled. Wage growth, which was nowhere to be seen well into the official recovery, has finally begun to pick up, with wage growth noticeably faster since 2016 than in the first six years of the expansion. In the nonfinancial business sector—where the shares of labor and capital are most easily measured—the share of value added going to labor has finally begun to tick up, from a steady 57 percent from 2011 to 2014 up to 59 percent by 2017. Though still far short of the 65 percent of value added claimed by labor at the height of the late-1990s boom, the recent increase does suggest an environment in which bargaining power has at last begun to shift in favor of workers.
For progressives, it can be a challenge to talk about the strengthening labor market. Our first instinct is often to call attention to the ways in which workers’ position is still worse than it was a generation ago, and to all the ways that the labor market is still rigged in favor of employers. This instinct is not wrong, but it is only one side of the picture. At the same time, we need to call attention to the real gains to working people from a high-pressure economy—one where aggregate demand is running ahead of available labor.
A high-pressure economy is especially important for those at the back of the hiring queue. People sometimes say that full employment is fine, but that it doesn’t help people of color, younger people, or those without college degrees. This thinking, however, is backwards. It is educated white men with plenty of experience whose job prospects depend least on overall labor market conditions; their employment prospects are good whether overall unemployment rates are high or low. It is those at the back of the hiring queue—Black Americans, those who have received less education, people with criminal records, and others discriminated against by potential employers—who depend much more on a strong labor market. The Atlanta Fed’s useful wage tracker shows this clearly: Wage growth for lower-wage, non-white, and less-educated workers lagged behind that of college-educated white workers during the high-unemployment years following the recession. Since 2016, however, that pattern has reversed, with the biggest wage gains for nonwhite workers and those at the bottom of the wage distribution. This pattern has been documented in careful empirical work by Josh Bivens and Ben Zipperer of the Economic Policy Institute, who show that, historically, tight labor markets have disproportionately benefited Black workers and raised wages most at the bottom.
Does this mean we should be satisfied with the state of macroeconomic policy—if not in every detail, at least with its broad direction?
No, it means just the opposite. Labor markets do seem to be doing well today. But that only shows that macroeconomic performance over the past decade was even worse than we thought.
This is true in a precise sense. Macroeconomic policy always aims at keeping the economy near some target. Whether we define the target as potential output or full employment, the goal of policy is to keep the actual level of activity as close to it as possible. But we can’t see the target directly. We know how high gross domestic product (GDP) growth is or how low unemployment is, but we don’t know how high or how low they could be. Everyone agrees that the US fell short of full employment for much of the past decade, but we don’t know how far short. Every month that the US records an unemployment rate below 4 percent suggests that these low unemployment rates are indeed sustainable. Which means that they should be the benchmark for full employment. Which also means that the economy fell that much further short of full employment in the years after the 2008-2009 recession—and, indeed, in the years before it.
For example: In 2014, the headline unemployment rate averaged 6.2 percent. At that time, the benchmark for full employment (technically, the non-accelerating inflation rate of unemployment, or NAIRU) used by the federal government was 4.8 percent, suggesting a 1.4 point shortfall, equivalent to 2.2 million excess people out of work. But let’s suppose that today’s unemployment rate of 3.6 percent is sustainable—which it certainly seems to be, given that it is, in fact, being sustained. Then the unemployment rate in 2014 wasn’t 1.4 points too high but 2.6 points too high, which is nearly twice as big of a gap as policymakers thought at the time. Again, this implies that the failure of demand management after the Great Recession was even worse than we thought.
And not just after it. For most of the previous expansion, unemployment was above 5 percent, and the labor share was falling. At the time, this was considered full employment – indeed, the self-congratulation over the so-called Great Moderation and “amazing success” of economic policy reached a crescendo in this period. But if a perofrmance like today’s was possible then — and why shouldn’t it have been? — then what policymakers were actually presiding over was an extended stagnation. As Minnesota Fed chair Narayan Kocherlakota – one of the the few people at the economic-policy high table who seems to have learned something from the past decade – points out, the US “output gap has been negative for almost the entirety of the current millenium.”
These mistakes have consequences. For years now, we have been repeatedly told that the US is at or above full employment—claims that have been repeatedly proved wrong as the labor market continues to strengthen. Only three years ago, respectable opinion dismissed the idea that, with sufficient stimulus, the unemployment could fall below 4 percent as absurd. As a result, we spent years talking about how to rein in demand and bring down the deficit, when in retrospect it is clear that we should have been talking about big new public spending programs to boost demand.
This, then, is a lesson we can draw from today’s strong unemployment numbers. Strong economic growth does improve the bargaining position of workers relative to employers, just as it has in the past. The fact that the genuine gains for working people over the past couple years have only begun to roll back the losses of the past 20 doesn’t mean that strong demand is not an important goal for policy. It means that we need much more of it, sustained for much longer. More fundamentally, strong labor markets today are no grounds for complacency about the state of macroeconomic policy. Again, the fact that today’s labor market outcomes are better than people thought possible a few years ago shows that the earlier outcomes were even worse than we thought. The lesson we should take is not that today’s good numbers are somehow fake; they are real, or at least they reflect a real shift from the position of a few years ago. Rather, the lesson we should take is that we need to set our sights higher. If today’s strong labor markets are sustainable—and there’s no reason to think that they are not—then we should not accept a macroeconomic policy consensus that has been willing to settle for so much less for so long.
On May 30, I did a “webinar” with INET’s Young Scholar’s Intiative. The subject was central banking since the financial crisis of a decade ago, and how it forces us to rethink some long-held ideas about money and the real economy — the dstinction between a demand-determined short run and a supply-determined long run; the neutrality of money in the long run; the absence of tradeoffs between unemployment, inflation and other macroeconomic goals; the reduction of monetary policy choices to setting a single overnight interest rate based on a fixed rule.My argument is that the crisis — or more precisely, central banks’ response to it — creates deep problems for all these ideas.
The full video (about an hour and 15 minus, including Q&A) is on YouTube, and embedded below. It’s part of an ongoing series of YSI webinars on endogenous money, including ones by Daniela Gabor, Jo Mitchella nd Sheila Dow. I encourage you, if you’re interested, to sign up with YSI — anyone can join — and check them out.
I didn’t use slides, but you can read my notes for the talk, if you want to.
