I am now using Disqus to manage blog comments. Disqus should allow embedded urls and I am hoping it will be a significant improvement. Unfortunately, the move appears to have caused comments that were posted under the previous format to evaporate into cyberspace. I am working to see if I can recover them. Stay tuned.
Property Rights, the Income Distribution and China
In my post, The UK and Europe: The Way Forward, I say that
"A persistent free fall in the financial markets will, if allowed to occur, cause a major recession. [ ... ] My recommendation is based on empirical research that shows a stable persistent connection between the value of financial assets and the unemployment rate."
Commenting on this blog, Blissex Walex replies,
"This seems to me the best and clearest yet expression of the neoliberal trickle-down policies aimed at redistribution from workers to asset owners.
It even goes further than B DeLong "suggestion" that Keynes would have added a fourth, one known to us today as the “Greenspan put" – using monetary policy to validate the asset prices reached at the height of the bubble"
There are two issues here that should not be confounded.
First: Can central banks and national treasuries intervene in either asset markets or goods markets, or both, in a way that improves upon unregulated private markets? By 'improves upon' I mean: is there a feasible policy that can make everyone better off; both workers and capital owners? Keynes thought so. So do I, for the reasons I explain in my forthcoming book, Prosperity for All.
Second: why has the distribution of income, in the United States and Europe, tilted towards capital and away from labor over the past few decades? There is growing evidence that this redistribution is connected with the opening of trade with China. Globalization has lifted a billion Chinese workers out of poverty and it has led to huge income gains for Americans and Europeans at the top of the income and wealth distributions. These gains have not been shared with middle class and working class people in the US and Europe. This second issue is hugely important, but it is distinct from the question of asset price stabilization. Nobody will gain from a global depression.
My own view is that solving the first issue at a national level will lead to a reformation of world capital markets and a redesign of global financial institutions. It is also possible to conceive of alternative forms of democracy that would provide greater rights to workers. Workers councils, for example, have proved to be relatively successful in Germany.
The concept of private property is contingent on rights that are defined and enforced by national governments. Those rights are constantly evolving. When the US founding fathers signed the Declaration of Independence, it was still possible to buy and sell human beings. The idea that a national government would enforce the property rights of a slave owner is, to today's sensibilities, abhorrent. It is entirely possible that a system of property rights that allows a factory owner to close down a large manufacturing plant without consulting the workers whose livelihoods depend on its continued operation, will, in another two hundred years, appear to be equally abhorrent.
You can read more about these ideas in my new book, Prosperity for All.
Should we Target NGDP?
In my last post, The UK and Europe, the Way Forward, I wrote that
"The Bank of England should make clear that a catastrophic drop in the financial markets will not be permitted. I recommend a statement that the Bank will, if necessary, buy shares in an exchange traded fund to support the value of the FTSE and that it will pay for those shares by selling short-term treasury securities. As I argued here, if necessary, the Treasury should support that action by providing the Bank with the authority to borrow on its behalf."
Thomas Hutcheson, commenting on my blog writes,
"This is fine so far as it goes, but we should deal as well with the policy response of the ECB and the Fed, as well. Whatever long term damage may occur from slightly less free trade (including investment to trade) cannot be prevented by central banks, but they can prevent the damage that comes from uncertainty about the future course of NGDP. It is expectations about that they should seek to stabilize."
Here is my response.
I am in broad agreement with the proposal to stabilize expectations of future NGDP growth and, in the simple models that guide my thinking, stabilizing asset price growth and stabilizing expectations of NGDP growth amount to the same thing. The question is: how to achieve that goal?
If central banks simply substitute NGDP targeting for inflation targeting, and if they continue to try to achieve their objective by adjusting short term interest rates, not much will have been achieved. Scott Sumner has proposed instead, that central banks should trade NGDP futures. Robert Shiller goes further and advocates that national governments finance their borrowing requirements by issuing equity-like instruments that pay a trillionth of GDP: Shiller calls these 'trills'. I wholeheartedly endorse both of these proposals. Creating a market for nominal GDP futures, and actively trading trills for Tbills would have much the same effect as stabilizing asset price growth.
I differ from Scott in one important respect. Whereas Scott sees NGDP targeting as a substitute for inflation targeting, for me, it is a complement. Central banks should set interest rates to target inflation, and they should set the growth rate of some other object, be it asset prices, NGDP futures, or the price path for trills, to target the unemployment rate.
You can read more about these ideas in my new book, Prosperity for All.
The UK and Europe: The Way Forward
I am British, I am American, and I am continental European. I was born and raised in Britain and I am a British citizen by birth. I have lived in the United States for thirty years and I am an American citizen through naturalization. I am a continental European through my two year stint of teaching economics in Italy where centuries of European culture seeped into my pores by osmosis and took up residence in my bones.
The British people have voted to leave the European Union. You may, or may not, have strong views about the outcome of that vote. All of us, wherever we are located in this existential adventure that we call the planet earth, will be affected by it. Now is the time for those of us most directly affected, whether British or Continental European, to come together and help to forge a future in which all of us can prosper. That may not look much like the vision of Jean Monnet for a European Federation, but I am confident that it will not lead to a return to the Europe of fractured nationalisms that ended in two world wars.
I did not join the chorus of economic experts who threatened Armageddon if the vote were to turn out in favour of leave. There were persuasive arguments to be made for significant economic costs of leaving the EU. Some suggested that these costs would be long-term. That is a hard case to make. Economists cannot accurately predict what will happen six months from now. If you want a long-term prediction I hear that reading entrails was effective for the Emperor Augustus.
That is not to say we can avoid short-run economic costs. But those costs will be a great deal worse for all involved if we allow an atmosphere of panic to take hold in the financial markets. Mark Carney, Governor of the Bank of England, has promised to support UK financial institutions. That was a good start and it will, I believe, prevent a further slide in the exchange value of the pound.
I am not overly concerned by the decline in the value of the pound that has occurred to date. I am more concerned by its cause. The pound fell because international investors pulled money from UK asset markets and fled to gold and to US treasuries. So far, with the possible exception of the French stock market, international asset markets have been volatile but they have not gone into free fall. A persistent free fall in the financial markets will, if allowed to occur, cause a major recession.
The Bank of England should make clear that a catastrophic drop in the financial markets will not be permitted. I recommend a statement that the Bank will, if necessary, buy shares in an exchange traded fund to support the value of the FTSE and that it will pay for those shares by selling short-term treasury securities. As I argued here, if necessary, the Treasury should support that action by providing the Bank with the authority to borrow on its behalf.
My recommendation is based on empirical research that shows a stable persistent connection between the value of financial assets and the unemployment rate. My own research was conducted on US data. Studies conducted at the Bank of England and at Hamburg University have replicated my findings on UK data and on German data.
Some economists have called for lower interest rates, perhaps even moving into negative territory. I do not think that is the right answer. Interest rate control was effective for more than twenty years as a tool to control inflation. We need a new approach to deal with financial crises. That approach should, in my view, take the form of a direct intervention in the asset markets by the Bank of England, to prevent the excess volatility that is caused by fear of the unknown. It is the job of policy makers to contain that fear. It is the responsibility of journalists and opinion makers to refrain from exacerbating it.
We should refrain from pouring petrol onto the fire of volatile financial markets by speculating that the sky is falling. It isn’t: Yet. Words are powerful and may become self-fulfilling prophecies. Let us choose them carefully.
I discuss these ideas, and many more, in my forthcoming book, Prosperity for All.
Confidence is not a fairy and it is not an illusion
Figure 1: The IS-LM-NAC Model
My coauthor, Konstantin Platonov, and I, have recently completed a working paper, “Animal Spirits in a Monetary Economy”. In this paper, we introduce a framework we call the IS-LM-NAC model that, we hope, will replace the Hicks-Hansen IS-LM model as a way of thinking about the impact of economic policy on output and employment. Figure 1 depicts the graphical apparatus we use in that paper.
The IS-LM model originated with a paper by Sir John Hicks, "Mr. Keynes and the Classics", that simplified the major ideas from Keynes' General Theory. Hicks’ simplification of the General Theory can be summarized by two curves in interest-rate output space. The downward sloping IS curve presents points where Investment equals Savings, hence I and S. The upwards sloping LM curve presents points where preference for Liquidity equals the supply of Money hence, L and M.
Importantly, the position of the IS curve depends on the animal spirits of investors; aka confidence, and on the fiscal and monetary policy instruments of government. The position of the LM curve depends on the balance sheet of the central bank and on the price level which, in Hicks’ world, is historically given. This graph was widely seen as a tool for understanding how the short-run equilibrium positions of output and interest rates are influenced by fiscal and monetary policy.
I first introduced confidence as an independent driver of the steady-state unemployment rate here. My work with Konstantin adds money to that framework. Our model also has an IS and LM curve and they play very similar roles to the IS and LM curves of Hicks’ theory. But we do not see them as short-run curves. They represent possible long-run equilibria positions for the interest rate and output. In our IS-LM-NAC framework, there is a third curve, the NAC curve which represents a No Arbitrage Condition. At every point on the NAC curve, the people in our model are indifferent between holding the stock market and holding government bonds.
Shifts in animal spirits, aka confidence, cause shifts in the NAC and the IS curves. Following a shift in confidence, the price level is initially ‘sticky’, but this has nothing to do with artificial costs of changing prices, as in modern new Keynesian theories. In contrast, it simply reflects the way that people form their beliefs. Eventually, after price adjustment has occurred, the LM curve comes to rest at a point that intersects the NAC and IS curves. How quickly this happens depends on a new fundamental, the belief function, a concept that I introduced in 1993 in the first edition of my book, the Macroeconomics of Self-fulfilling Prophecies.
In the paper with Konstantin, we conduct two experiments. We show that an increase in confidence, or an increase in the money supply, may each lead to a self-fulfilling increase in output and employment. Interestingly, the long run impact of monetary policy depends on how people form their beliefs.
Paul Krugman, quoting a piece from Brad Delong, has doubled down on the confidence fairy. They assert that a big fiscal expansion is the right way to cure a depression. I have read the same empirical papers as Paul and Brad and, as I explained back in January of 2010, I am not convinced.
In my view, confidence is not a fairy, nor is it an illusion: It is very real. "Animal Spirits in a Monetary Economy" explains why belief formation matters, in the context of monetary policy. In an earlier piece I wrote with Dmitry Plotnikov, we show that, if private sector confidence remains depressed, fiscal spending can crowd out private sector spending. Our argument does not depend on whether the interest rate is, or is not, at the zero lower bound.
Confidence is not a fairy, nor is it an illusion. If businesses refuse to invest because their confidence is low, the outcome will be just as bad for output and employment as a supply-side shock like a hurricane. As I explain in my forthcoming book, Prosperity for All, the right way to prevent another Great Depression, is by active intervention in the asset markets. You can pre-order my book from OUP, here.