A time for nuance

Macroeconomics is really complicated.  I would consider myself a supply and demand-sider, a rational expectations and efficient markets guy, and a market monetarist.

So it’s not surprising that I am often misunderstood, just as more famous bloggers like Paul Krugman are often misunderstood.  When things are far out of whack, as in 2009, it’s much easier to be understood.  You simply need to pound the “monetary stimulus” theme with a sledgehammer.  No nuance required.  As the economy gets closer and closer to the natural rate of unemployment (and we are only about 6 months away), the issues get more and more complicated. Here are some things I find that I need to continually address in comment sections:

1.  Real shocks matter, even when demand is a problem.  If someone with cancer gets stabbed by a mugger on the way to the hospital, they have multiple problems.  Which problem is worse?  Well the stab wound is more acute, but the cancer is a bigger problem in the long run.  A demand shortfall may be more acute, but like a stab wound is more easily treated than structural problems. When an economy has severe structural flaws, a policy of monetary stimulus will not fix the country’s problems.  It will just fix one of them, leaving the more severe problems in place.

2.  Contrary to the recent claim of the New York Times, the definition of a recession is not 2 consecutive quarters of falling RGDP.  The US had a recession in 2001, but we did not have two consecutive quarters of falling RGDP, whereas Japan may have recently seen two consecutive quarters of falling RGDP, but is not in recession.  Economists look at many factors before determining whether a recession has occurred.  Recessions are periods where output falls well below trend.  It matters a lot whether the trend rate of RGDP growth is 7% (China) or zero percent (Japan.)

3.  Monetary offset works by adjusting the long run expected rate of growth in nominal aggregates (such as inflation or NGDP) to offset the effect of fiscal actions.  It is not capable of smoothing out high frequency fluctuations due to real shocks.  A sudden change in government spending, sales tax rates, or a natural disaster, will affect RGDP in the near term, even if monetary policy is offsetting any effects on NGDP 12 or 24 months out in the future.

4.  A failure to achieve RGDP growth and a failure to achieve NGDP growth are logically distinct events.  Don’t confuse them. Many economists use the wrong data when evaluating policy success. If you are making the Keynesian argument that monetary stimulus is incapable of boosting AD, you use NGDP data.  If you are making the Real Business Cycle (RBC) argument that monetary stimulus will not boost output you use RGDP data.  Many Keynesians seem to be oblivious to the distinction between a change in aggregate demand and a changed in the aggregate quantity demanded (caused by a supply shock.) For instance, the April 1 sales tax increase sharply depressed Japanese RGDP in Q2, leaving NGDP almost unchanged.  Keynesians don’t seem to realize that when they complain about slow RGDP growth in a country with high inflaiton (like Britain a few years back) they are making a RBC argument, which tends to discredit the Keynesian model.  There are lots of ways that policy can “fail.”  If you don’t know the right data to cite to make your point, no serious economist will pay attention to your arguments.

Furthermore, the EMH says the efficacy of policy is evaluated at the point it is announced (if a surprise) not after the fact.  There is no “wait and see to ascertain whether Abenomics worked.”  It was obvious from the get go that it would “work” in a limited sense, but fail to achieve the announced goals.  And it has.  If Japan wants to boost trend RGDP growth, then they need to adopt supply-side reforms.  Printing money doesn’t solve that problem, especially in a country with 3.6% unemployment.

5.  Rational expectations theory says that monetary policy cannot be evaluated in isolation, but rather must be considered in the context of a clearly spelled out policy regime.  Admittedly, when things are clearly far off course, (as in 2009) you can assume monetary policy is too tight under any plausible policy regime.  But not today.  For instance, I could easily construct plausible arguments for money being either too easy or too tight:

a.  Too tight:  Because we are likely to hit the zero bound in the next recession, policy should be more expansionary, to promote a trend rate of NGDP growth high enough to keep us away form the zero bound.

b.  Too easy.  NGDP growth is likely to average a bit over 3% over the next few decades, given the Fed’s inflation target.  In recent years it has run a bit over 4% per year.  If it keeps that up it will later have to be offset with sub-3% NGDP growth, perhaps leading to recession.  Inflation should be low during booms and high during recessions.  Yet Janet Yellen seems to be determined to raise inflation up to 2%, probably getting there near the peak of the business cycle.

Which do I believe?  Neither.  I don’t know what’s optimal until I’m told what sort of objective the Fed has in the long run.  Tell me their long run NGDP target, and I’ll tell you whether money is too easy or too tight today.

It’s much better to live in a place like Switzerland where the problems are complex and the solutions are unclear, rather than North Korea where the problems are simple and the solutions are straightforward.

Were market monetarists wrong about Japan?

If there has been any blogger more accurate than me in their claims about Japan in recent years, please send me all his/her relevant posts, so I can can give him/her some praise.

Just to review:

1.  I predicted the BOJ would be able to depreciate the yen, if it choose to do so.  I’ve been proved right again and again.  Paul Krugman had doubts.

2.  I predicted monetary stimulus would boost inflation, but that they’d fail to hit their 2% target (excluding taxes).  I was right.  Krugman’s been all over the map, hostile to fiscal stimulus in the late 1990s, then too pessimistic about the possibilities for monetary policy before Abe, then (perhaps) too optimistic.  And now?  I can’t tell.

3.  I predicted the monetary stimulus would boost growth, but that growth would remain low as the working age population is falling fast.  I was proved right. (Krugman agrees it boosted growth.)

4.  I predicted a growth surge before the April 1 tax increase and a growth slump afterwards.  I was right.  BTW, this has nothing to do with “monetary offset.”  And Japan is not in a “recession.”

I mention this in response to a recent post by Paul Krugman, who has totally forgotten about the outcome of his earlier 2013 “test” of market monetarism, and started claiming that monetary offset doesn’t hold:

The bad growth news shows, pretty clearly, that the consumption tax hike was a big mistake. It also shows, by the way, how weak the market monetarist argument — which is that fiscal policy doesn’t matter, because central banks can always achieve the nominal GDP they want — really is; do you seriously want to contend that Kuroda likes what he sees, that he isn’t trying as hard as he can to boost Japan out of deflation?”

This is Krugman being Krugman—making it seem like his opponents are making idiotic claims.

BTW, Kuroda is engaged in monetary offset (the yen has recently fallen from 109 to 118), just as market monetarists would expect, and no, he is not doing all he can.  For instance, he could do MORE, and in all likelihood will do MORE when he discovers that he needs to do MORE to hit his target.

Perhaps some day Krugman can explain to us how events that we predicted accurately somehow disprove the market monetarist view.  Does he believe that market monetarists claimed that Japanese consumers would be indifferent between buying a car on March 31 and April 1st, after the tax rise?   It sounds like an April Fools Day joke.

The real problem with the sales tax increase is that the money is being used to finance additional government spending.  A few years back the Keynesians told us that taxes didn’t matter very much, it was all about spending.  Well Japan is ramping up its government spending.  Now Keynesians seem to have suddenly discovered that it’s taxes that matter, not spending.

PS.  Just three weeks ago Krugman did a post showing that inflation expectations in Japan have risen to almost 2%.  I doubt that, but let’s say Krugman’s right.  If inflation expectations have risen to close to 2%, then how could the tax increase have had a major impact on the prospects for growth going forward?  Is Krugman making an Art Laffer-style supply-side argument that tax increases reduce growth without reducing inflation? Is he now an inflation optimist and a growth pessimist for Japan?  Where’s the model?  When conservatives used to make that argument he would ridicule it.  BTW, I’m a moderate on this question—call me a supply and demand-sider.

HT:  Michael Darda

At the other extreme . . .

A quick follow up to my previous post.  Australia has seen 3% RGDP growth over the past 12 months, and 2.7% the year before, and 3.6% the year before.  Great news eh?  Here’s Australia’s unemployment rate over Screen Shot 2014-11-18 at 9.56.23 AMthe past 12 months:

That’s what happens when you have a high trend RGDP growth rate.


The USA doesn’t have any debatable recessions. That’s about to change

The US has a really weird economy.  All our recessions are 100% clear-cut.  Either we have a recession or we don’t.  Normal countries have borderline recessions.  Not us.  Either our unemployment rate rises far too little to be viewed as a recession, or so much that 100% of economists agree it’s a recession.  I don’t know why that is. And I don’t know why other economists don’t view it as really weird.  Maybe people just notice things that happen, not things that don’t.  Not dogs that don’t bark.

I believe this weird pattern is about to end, and very soon we’ll have debatable recessions.  This post is partly motivated by my previous post on Japan.  I don’t think people realize how much changes when your trend rate of RGDP growth becomes zero, or even negative.  Some pointed to the fact that Japan is “weird” because unemployment rose very little in the 2007-09 recession. Sorry, but Japan is now pretty normal; it’s the US that is weird.  Here’s some crude data using annual changes in RGDP and the rise in unemployment from the 2007 low to the 2009 high.  Note that Germany’s recession was confined to 2008-09:

Japan:  Drop in RGDP = 6.5%,  Rise in unemployment = 2%

Germany:  Drop in RGDP = 5%, Rise in unemployment  = 2%

Britain:  Drop in RGDP = 5.5%,  Rise in Unemployment = 2.8%

USA:  Drop in RGDP only 3%, Rise in Unemployment = 5.5%

Quarterly data would be slightly better, but wouldn’t change the overall pattern.  A relatively large fall in RGDP in other countries doesn’t lead to much extra unemployment.  That’s partly lower trend RGDP growth (Germany and Japan have falling populations) and partly the more flexible US labor market.

And now it looks like the US trend rate of RGDP growth will fall from 3% to barely over 1%.  After we “recover” it will no longer be unusual to see two straight quarters of falling RGDP.  But will they be true recessions?  Or the sort of phony “recession” that people think they are seeing in Japan, and that was reported in the UK a couple years ago, which later vanished with revisions in the data? (I’m referring to Britain’s triple dip; even the double dip was very debatable, with only a 1/2% rise in unemployment.)

Is it possible I’ll be wrong about the US trend growth?  Sure, a change in immigration policy, or supply side reforms to boost the LFPR could help, but I don’t see much sign of that happening. The prime age workforce will soon stop growing, and productivity growth is slowing as well.  Get ready for lots of phony “recession” stories, especially when the party in power is not well liked by the intelligentsia. (Which party would that be in America?)

PS.  I believe I was the first blogger to blow the whistle on the phony 2011 tsunami “recession” in Japan.  I’m still waiting for the delayed unemployment effect from the tsunami . . .

Japan has supposedly been in recession for 7 months—I’m sure their unemployment rate will soar any day now.  Especially with Japanese firms complaining they can’t find enough workers to fill the job openings.

Update:  For those that have trouble understanding why there are no debatable recessions, consider the following graph.  During an actual recession, unemployment rises by at least 2%. When there is no recession the biggest rise was 0.8% in 1959 (nationwide steel strike) and that was really brief.  Look at that tiny spike in 1959, then look at the actual recessions, and marvel at the vast difference.

Note how different it is from a random walk graph (like the stock market) where you see small, medium and large fluctuations.  All we see are small and large, no medium.

Screen Shot 2014-11-18 at 10.38.56 AM


Is Japan in recession?

The media says yes.  I say if Japan is in recession it’s time to redefine the term. Here is the Japanese unemployment rate over the past few years:

Screen Shot 2014-11-16 at 8.59.24 PMThe unemployment rate in Japan is currently 3.6%, one of the lowest figures in decades.  It’s true that the Japanese unemployment statistics are a bit peculiar, but so are all their other data.  And when they are unquestionably in recession, as during 2008-09, the unemployment rate in Japan rises just as in any other country.

Welcome to the new world of business cycles.  Japan is a country with low productivity growth and a working age population that is shrinking by 1.2% per year.  The trend rate of RGDP growth is somewhere near zero, perhaps negative.  Japan will have lots more “recessions” during the 21st century.

A few months back I very reluctantly supported the sales tax increase, as their debt situation is so scary.  That was probably a mistake.  For some strange reason I thought that a country engaged in monetary expansionary to try to boost growth, that was also raising sales taxes by 300 basis points, must have been raising the sales taxes for the purpose of reducing the budget deficit.  Silly me:

The government approved a 5.5 trillion yen extra budget in December to help the economy weather April’s tax hike. Finance Minister Taro Aso has signaled readiness to boost stimulus and Abe said last week he would consider compiling an extra budget depending on the economy.

(OK, commenter dtoh, you win.)  So let me get this straight.  You raise the sales tax by 3 percentage points to reduce the budget deficit, and simultaneously raise spending by about 1% of GDP?  And the goal of all that activity is what?

In any case, Japanese stocks are still doing well, which suggests that Abenomics is still on track. (But on track to where?)  Adverse factors that have a multiyear impact on RGDP lead to higher unemployment.  The global recession of 2008-09 is a good example.  On the other hand temporary growth pauses don’t raise unemployment—the 2011 tsunami is an example.  This looks like a temporary pause, like 2011, as unemployment is not rising.  Even so, with zero or negative trend growth in Japan, expect many more negative quarters, many more “recessions.”  And that public debt? I have no idea what they plan to do about it.

This line from the Lewis Carroll classic seems relevant, in a reverse sort of way:

“When you say ‘hill’” the Queen interrupted, “I could show you hills, in comparison with which you’d call that a valley.” 

BTW, here’s a story that you would not have seen 6 years ago:

Kuroda last month led a divided BOJ board to step up asset purchases, with the aim of delivering 2 percent inflation. [Deutsche Bank’s chief economist for Japan] Matsuoka says there is more the central bank should do to rebuild the economy. He suggests “level targeting,” in which policy makers pledge to keep stimulative monetary policy until the inflation index or nominal GDP resemble what they looked like in the late 1990s.

HT:  Stephen Kirchner

PS.  This graph shows what the recessions of 2001 and 2008 looked like:

Screen Shot 2014-11-16 at 9.23.49 PM