This is quite possibly the worst-researched Slow Boring post I've ever read. While I appreciate the general argument that government officials should work harder to achieve full employment and be less scared about inflation, your understanding of macroeconomics is clearly faulty and your criticisms miss the mark. Three quick points:
1) Fundamentally, I you seem to misunderstand the underlying concept of "potential output". Your post implies that when the economy exceeds potential, we should be seeing runaway inflation and exceedingly tight labor markets. In some sense, this is right. But exceeding potential is not a switch that is turned to "On" or "Off". Instead, it's like a dimmer switch. If we exceed potential output by a little bit, inflation will accelerate a little bit. If we exceed potential output by a lot of bits, then we're likely to get runaway inflation. Now, we can argue what constitutes a little bit vs. a lot of bits, but my view is that a 1% gap between GDP and potential is not a lot. Consistent with that view, inflation was a little higher in 2018-2019 than it was in preceding years but not radically higher.
Put another way, you should not think of potential output as a limit that cannot be exceeded for fear of runaway inflation. Rather, you should think of it as the maximum output an economy can produce without generating ~inflationary pressure~.
2) Your post implies that you have no idea how CBO constructs its estimate of potential output. This is a weird take, given that their methodology is publicly viewable in a document written by Shackleton (2018). Basically, CBO uses a supply-side model in which they estimate potential labor hours, potential capital services, and potential labor/capital productivity. Those factors are estimated by looking at historical trends in each series. It's fair to quibble over specific modeling assumptions, but I'm not sure you've actually read through their methodology. Here's a link: https://www.cbo.gov/publication/53558
3) Before you accuse CBO's forecasting of being "bad", I'd encourage you to read CBO's Economic Forecasting Record (2019). The report examines two-year and five-year forecasts made between 1980 and 2017. It compares forecasts made by CBO, OMB, and the Blue Chip consensus of private sector forecasters. The report finds that CBO's forecasts are generally more accurate than OMB's forecasts and roughly comparable to the private sector forecasters. This finding extends to the agency's interest rate forecasts, which seem no better and no worse than those produced by other organizations. Essentially, forecasting interest rates is highly challenging, and this is especially true in our anomalous interest rate environment. Instead of dunking on the CBO, you should understand the inherent difficulty of their task. Here's a link to the forecast accuracy report: https://www.cbo.gov/publication/55505
I'll conclude with my own thoughts on this issue. I think Larry Summers and the CRFB are being overly cautious with regards to the need for more fiscal stimulus. I'm much more closely aligned with Janet Yellen, who argues that the risks of a too-small stimulus far outweigh the risks of a too-big stimulus. But your decision to criticize a nonpartisan bureaucracy for making average to above-average forecasts is an odd way to channel your frustration. Instead, you should direct your ire toward the people who are ~actually~ calling for less stimulus instead of scapegoating the CBO.
I know nothing about economics, but I have absorbed the message that the "anomalous interest rate environment" baffles economists of all stripes and that it underpins a lot of the "wrong" projections and models. My cynical assumption is that it will take another financial crisis to figure it out, similar to the "obivous systemic risks" of mortgage backed securities and whatnot that everyone saw *after* the Great Recession.
I agree that CBO shouldn't be singled out for being wrong but I believe Matt's point is that CBO has unique purchase in policy and political discussions compared to others who have gotten those same forecasts wrong. The CBO is seen as a definitive and nonpartisan voice in these discussions, which gives it a responsibility to either get better at its forecasts (harder said than done, given the zero-rate environment) or more forcefully acknowledge the inherent uncertainty for the current and past forecasts in its communications and statements.
Contra Matt who wrote "it’s not always clear what practical value" the CBO has as an anchor , I think the CBO is gravely important for the 'liberal' part of a liberal democracy and part of that relies on credibility from all sides of the aisle. Unfortunately, it means grappling with how to mitigate the fact that sometimes your forecasts are off in a way that appears to favour one side of a highly partisan and consequential debate. Perhaps, Matt should know better than to put fuel to the fire but I think that its just part of the CBO's job of maintaining technocratic credibility.
I was coming to highlight point #3. The Fed, markets (forward rates) and sell side banks have all gotten this wrong as well. It’s not right to single out the CBO.
1) I agree with you that we should run the economy a bit hotter to try and attain greater full employment, but policy to achieve this should not come at the expense of government fiscal situation.
2) More to the point, having just recently lived through the great recession, why would you be willing to trust the market's perception of risk so completely? I would completely back allowing the fed to run hot for a couple of years, but would want the US budget to be improving in the process (lowering debt/GDP). Running them both to the max seems like setting ourselves up to run off a cliff with no safety net. Your argument here sound very much like the motivated reasoning that republican's give when they talk about their tax cuts paying for themselves. They have the solution they want regardless of whether it matches the problem.
3) In a very specific instance, I want a government that is trying to find good solutions to problems it can solve. I don't want a government where the parties are competing over who hands out more cash. That is ripe for horrific results and terrible government. $1,400 checks to people who aren't unemployed and especially to people who make over the national median income is appallingly bad policy.
4) More broadly, many progressives hold up the example of the Nordic countries as the social democracy they are aiming for and rebut suggestions that they are Venezuela or Argentina. One of biggest differences between the two is that the Nordic countries are willing to pay for the benefits. The the SA countries experience severe economic pain from wild spending that wreck their budgets but they are unable to stop spending because they have to buy votes.
Certainly agree with you on 4) that progressives have to usually find a way to pay for stuff. The Nordics also have far less progressive taxes. The problem with transitioning to higher taxes on more people is that people don't like paying taxes....it's more popular to just increase the deficit and bump the problem to a later time
*****I would completely back allowing the fed to run hot for a couple of years, but would want the US budget to be improving in the process (lowering debt/GDP).*****
We will be "improving the budget" once this package is behind us. I don't think anybody's suggesting Congress will enact another $1.9 trillion stimulus in FA 22. Spending should be coming down sharply and revenues should be growing briskly moving forward (starting by, say, this coming autumn, or whenever we've reached functional herd immunity). There really are a lot of analogs to WW2, and one of them is that the end of the war on the pandemic should be followed by a precipitous drop in federal borrowing.
Are you suggesting that this is the big spending bill that progressives will pass in the next two years? Cause if so, then maybe it won't be that big of an issue even if the spending is very poorly designed. However, as I understand it, this is not close to the limit of spending that progressives want to do in the next 2-10 years.
And that's additional spending. The deficit was ~$3.7 trillion in 2020 because of the pandemic, but Matt wants to get back to the halcyon days of 2019 when the deficit was only $1.1 trillion. If we are spending money on things that improve productivity, that makes sense. Spending a couple hundred of billion dollars to send checks to people (like me!) who are still employed and have income seems like a terrible precedent to set.
More broadly, what is the limiting principle of what we can spend on debt before bad stuff happens. And if bad stuff starts to happen, are we as a country in a good space to deal with it, or have we created a populace that expects to get cash from the government instead of being willing pay for the services we want?
In the late 90s and early 2000s, information wanted to be free and the internet made it so - 20 years later most news organizations are still suffering because they can't get people to pay for what people expect to be free.
I would like to know more about room to grow the economy. There's a lot of worry about the deficit and debt but, ultimately, it matters whether we are investing in the future. We shouldn't burn a trillion bucks but a trillion bucks into industry could make us better off.
Regarding point 2, I have been going back-and-forth between reading Obama's memoir and Matt Taibbi's Substack. The former makes a very long and convincing argument about the Wall Street bailouts that boils down to: they are delicate little snow flakes and if they had decided to take their ball (private investment) and go home we'd have screwed even worse. The latter argues that the market's perception of risk includes the huge caveat that they ("big banks") will always be bailed out if they eff things things up too badly because of the reasons outlined by the former.
I find both of them persuasive, which is even more depressing when combined with Ezra Klein's recent column that summed up the status quo as: a super-majority to do anything to help regular people (because of the filibuster), but a bare majority to help the rich and powerful (because you can shovel unlimited cash to them using reconciliation).
Substantively, I totally agree with you about motivated reasoning and the wisdom of listening to the market --- sure, they have a profit motive and lots of resources at their disposal, but their assessment of risk is questionable given the combination of what Obama, Taibbi and Klein wrote. But I also agree with the motivated reasoning of using budget reconciliation to get as much money to regular people as possible if for no other reason than to make them ever so slightly less cynical about who the government actually works for.
Set aside the package’s size. How much do you think it matters *where* that $2 trillion goes? Because I think part of the critique here is that $1,200 checks + no-strings-attached state gov’t funding just aren’t that great a use of limited resources, at least at this juncture. (As opposed to more targeted relief measures, like child tax credits and extended UI.)
I realize reconciliation prevents Ds from putting whatever they want into this bill. But given that Ds probably won’t get another chance in Biden’s first term to drop $2 tril, is there an argument for making this bill smaller to make room for other, more productive spending legislation? Like infrastructure, climate-change investments, etc.
In other words, spend $2 tril, just with multiple component parts.
There are a lot of considerations in the mix that I think it's hard to reconcile.
The state/local fiscal aid, for example, is "too much" money. But for the states and cities who've been hit hardest by pandemic-related revenue shortfalls it's just enough money. From an optimal targeting viewpoint, New York and Florida should get a lot of money and Texas should only get a small amount of money and California should get no money at all (but San Francisco should get money). But there's no way congress is going to do that. What they've hit upon is giving Florida enough money, which will be too little for New York but too much for California and Texas. That seems better to me than the alternative but it is a little bit wasteful.
On the checks, look, one can debate the wisdom of this but the fact of the matter is Democrats have their majority thanks to GA senate races in which the candidates promised to deliver on these checks. Biden stood by that promise. And now they have to deliver.
There is something a little unseemly about "Vote for me and I will give you $1,400" being widely accepted as a winning message. I understand something like this has always been implicit...but making it explicit just seems like a bad step.
I see what you mean but, ultimately, politicians being elected on verifiable promises of tangible gains is better than culture war BS and demonization of minorities.
Honestly, how is this any different than promising a tax decrease that will net $1400, which has been a common promise for decades, except this goes to everyone, not just the well off and wealthy?
Its not different. Just like if the government taxed everyone at 100% and then gave everyone a living wage, that wouldn't be any different than what we have now except that more money would go to everyone and not just the well off and the wealthy.
I mean, this is a very strange use of the word bribe. If candidate X is opposed to the capital gains tax, and campaigns on reducing the capital gains tax, and you vote for that candidate because you also think there should be a lower capital gains tax, did candidate X bribe you? Pre-2015, I voted for for candidates because they supported gay marriage; were they bribing me with the promise of my being able to get married?
People voting for the candidates who promise to enact policies they like is called democracy, not bribery, IMO.
Here's my read of the student loan cancellation policy ... It promises a financial windfall to a narrow set of historically low turnout, overwhelming dem voters. It's an explicit one-time financial transaction. It doesn't address the systemic causes of education costs. It doesn't address the debt levels for future students. My comment was in response to John's about the unseemly nature of explicit dollar promises. Maybe bribe was too strong, but I really struggle with viewing the student loan cancellation in any other way.
I don't find this a convincing distinction as to just about any other financial change favored by any interest group that votes, which is a hallmark of democracy. Or is the idea that only special interest businesses can change the tax code to their liking, but individuals are shut out?
Not everyone who owes student loans is a college graduate. There's a fairly significant percentage of the population that took out to start college & then dropped out (or only got an associate degree). As Matt has pointed, there are various ways of improving the targeting so that rich professionals don't get a windfall.
It certainly could. I'd just argue with unemployment rates for non-college educated 2x those with a degree - I'd greatly prioritize our efforts on those in pain.
That's fair. If there is a hard cap on the amount of money Biden can throw around then it should be directed more at people who need it. I just think we are in a moment where we can go big. Also, I think student loans should be forgiven or reduced on principal - education shouldn't be as expensive as it is.
My understanding of Biden's position was the $1400 target came with a similar income cut off point as the initial round. Unless I missed something, I didn't think they were targeting everyone for checks.
Why is that unseemly? How is it different from "Vote for me and I'll bring a new library to Mapleton" or "Bring to me and I'll keep the economy hot" or "Vote for me and I'll go to war with the hated Germans"?
That's pretty much what politics is. Smart politicians give people what they want, but also try to look beyond the time horizons of ordinary (and busy) people to make sure that those short-term benefits don't lead to longer-term damage.
I dunno, it's sort of like Apple promising to give you a great iPhone if you give them your money. Or marrying someone because (in part!) you think in exchange for loving them they'll help you be happy.
Why CAN'T aid to states and local governments be targeted to revenue shortfalls? We means test aid to people, why not political jurisdictions? And as for differential needs, why not target according to local unemployment, or pandemic cases, or something?
What if Joe Manchin et al refuse to support final passage unless the 1400 is trimmed back in favor of more state aid? Then Biden and other Dems can claim they kept their word?
Also, I want the swing Democrats to have victories they can point to, to show they are tough and independent, to make it easier for them to hopefully support ending the filibuster later.
The best policy argument for checks rather than greater UI or another benefit I've seen is that anything with a bureaucratic element leads to part of the intended audience falling through the cracks. A straight check picks up the people who didn't claim or were erroneously told they don't qualify for unemployment, or who screw up their taxes and don't claim the CTC, and gives them a measure of relief.
Yeah, I find this really persuasive. There's still people who are struggling who aren't getting UI, altho to be fair I think we should do both. More money to more people is better, as far as I'm concerned
Seems like most of the people complaining about the non-optimality of the package components (and giving money to people who truly don't need it isn't Pareto optimal, to be sure) are also complaining about the size of the package, though I could be wrong.
In any event "sub optimal" hardly means "package as a whole doesn't pass cost/benefit analysis" (not saying you're arguing this, mind you, just pointing out that even an imperfect bill will probably do a world of good).
But here's another thing: As someone who doesn't need another check but is probably going to get one depending on how the income levels are written...I'm going to spend that money on something I wouldn't have bought otherwise. This past year has been good for me financially and I've gotten things in order to the point if the government gives me another couple grand I'm basically going to go out and spend it because I have nothing else to do with it.
Totally anecdotal but to back up this take... I am a habitual saver. If I get an unexpected bonus at work or something, I save it all. But not so with these stimulus checks. I honestly feel guilty about getting them (I'm just under the cutoff for AGI, wouldn't be if I didn't contribute heavily to a 401K, and definitely don't "need" it). I also have been very intentional about spending it on things I wouldn't have otherwise. But I'm probably a little weird in being so self-conscious about being a countervailing force against what I know are the intended keynesian effects.
No, because reconciliation prevents Dems from passing multiple bills. You only get a few bites at the apple so when you take one it should be big. Ideally, yes...you get GOP votes and don't need reconciliation and then can do more targeted bills but that's not happening.
For now. I think at this point the Byrd Rule is inevitably going to be extended by a “Manchin rule” that makes it possible for Joe to say he didn’t eliminate the filibuster but did make it possible for the senate to actually work again.
You can do up to three reconciliation bills annually per the rules if they're targeting different areas (say, one is a spending bill and one focuses on cuts, or what have you). The GOP-majority House passed two reconciliation bills in 2017, one to cut taxes, and one to repeal Obamacare. The latter didn't make it through the Senate. There's also the option to do another reconciliation bill the following year (fiscal not calendar, IIRC, which means Dems could do a second reconciliation bill starting in October).
This is a supply-side recession, completely unlike 2008-09 or any other modern one. There is plenty of savings and pent up demand, so if and when the pandemic is sufficiently controlled the economy will come roaring back. There is no need for fiscal "stimulus", though there is obviously still need for fiscal relief for the unemployed and state/local gov'ts, etc. The fact that inflation expectations are on target doesn't really say much about the appropriateness of the size of the fiscal package since if is too big the Fed will simply offset it with tighter monetary policy. It's reasonable for the bond market to expect this to happen.
In the vien of conspiratorial thinking from last week's topic, today's topic is my borderline conspiracy. I know it's less of a conspiracy than a massive overrepresentation of business interests in Washington, but JESUS TAPDANCING CHRIST the CBO is always wrong in the same direction! How does this not get more attention?!? How do we not see through this? And the desired outcome of the powers that be is incredibly obvious - 3 or more workers for every job opening.
It doesn't get more attention because it's not a CBO phenomenon. Instead, it's a forecasting phenomenon. If you read CBO's Economic Forecasting Record from 2019 (https://www.cbo.gov/publication/55505), you'll see that CBO's interest rate forecasts are totally in line with forecasts made by OMB and the Blue Chip consensus of private forecasters. Matt's framing of the issue as CBO-specific is highly misleading and ignores the reality that we are in an anomalous low-interest rate environment that is difficult for everyone to predict.
But interest rates have been falling since the '80s across the entire developed world and are likely to remain low. It's no longer anonymous and not difficult to predict. They (whoever they are) should update their models!
The thing about models is they need to be *models*. They're based on some underlying metrics and math on them, not just eyeballing current trends and saying they'll continue indefinitely.
So you can be in a situation where your model does not forecast well, but not understand what metrics and what math you should add to it to forecast well. That's what we mean by "anomalous." We don't have an understanding of why inflation rates are so low, and so we don't know what to add to the model to make it forecast better.
There's a good set of comment threads on Matt's initial post on this but my non-conspiracy take is that: (1) the currency war with China in the 2000s was operating outside their model inputs and amplifying downward rate pressure and (2) once competing macro-currency rates go negative ... all bets are off as the models simply broke.
I recall reading an article that pointed out the CBO is infamous for this. One of the reasons congress used to keep forcing the USPS to save insane amounts for employees benefits is because the CBO kept predicting doom and gloom for the USPS, but the post office ALWAYS beat the CBO estimates.
The conspiracy minded person might start wondering if the CBO is entirely staffed by Republicans who hate government and routinely predict against it.
It not just Republicans though, it's Democrats too. Similar to the consensus around imperialism, virtually all of Washington's foundational economic thought is inflation should be prevented at all costs, and businesses having to compete for workers is bad.
Common wisdom is that inflation just destroyed Carter and no one wants that to happen to them. Over the CBO's existence, half the Democrats have also moved toward the view of "cultural progressivism is good, but people who don't go to college deserve what they get" which aligns them economically with the classic Republican "workers should be grateful to have any job" view.
Two quick points: 1) Paul Krugman comes to the same conclusion for different reasons; and 2) one of the unexplained changes in American society is the disappearance of on-the-job training. I hazard the guess that training came to be seen as a cost center in our financial culture with its public obsession with profits and silent obsession with executive salaries.
That's an excellent point, increased shareholder scrutiny is sold as being good because it reduces managers' ability to hide the less-visible costs of things with visible benefits. The downside is that it eliminates anything with visible costs but less-visible benefits like on-the-job training.
As a certified Old™ who can actually remember the 1970s, I think that the age skew of politicians is an underrated part of the dynamic here. We may have largely forgotten what conditions of full employment actually look like -- even the 1999 peak was a brief one and was quickly followed by a market crash and recession -- but anyone over the age of 65 in this country (which is to a first approximation everyone in the senate) is likely to have _vivid_ memories of stagflation, and they in turn were raised by parents with equally vivid memories of what runaway inflation did to the _world_ in the 1930s. Mountains of corpses tend to make an impression.
Inflation is genuinely dangerous: Baumol Cost Disease eats societies slowly, but runaway inflation can burn them to ashes in an instant.
To be clear I don't think you're wrong on the facts: inflation is low now and it stayed low throughout the Obama years and QED we under-targeted the Obama stimulus. But for a politician, the risk of over-forecasting inflation is near-zero (a slower-than-possible recovery is bad but not in a headline-grabbing, job-losing way) whereas the risk of under-forecasting inflation is huge and terrifying: losing your job is the very least of it. And so all of the incentives line up for the CBO to err strongly on the side of pessimism.
I was born in the 1970's, yet the horrors of the Great Depression and stagflation were regularly discussed when I was growing up. Given that most of the senate is closer to my parents' ages than mine, what you write makes a lot of sense to me.
What runaway inflation did to the world in the 1930s was precisely nothing. There wasn't any. A catastrophic Great Depression, on the other hand, with its millions of unemployed, was very helpful in leading to those mountains of corpses.
{{{{{{for a politician, the risk of over-forecasting inflation is near-zero (a slower-than-possible recovery is bad but not in a headline-grabbing, job-losing way}}}}}}
I think the experience of Democrats in 2010, 2014 and 2016 is pretty strong evidence against this assertion.
My unpopular take is that I really hate the stimulus checks and all the focus on them. This isn't an argument to spend less, I would rather take the money that makes up the checks, increase the UI benefit, maybe put money into modernizing our UI systems, and basically make it more targeted. But, that ship has sailed and I think that they have to push forward the checks since people like it and as this group knows, it does what it says on the tin.
You are so right to beat up on the CBO here. And to beat up on anyone that is happier to leave people unemployed than to risk a little inflation. Even better, to have us all (Especially the Fed!!) focused on the market estimates of future inflation. The concepts of potential output and NAIRU have their uses, but not for making monetary and fiscal policy. Since the Fed has basically undershot its target for the last 13 years, it's important to overshoot this time. It shouldn't begin tightening until both actual PCE inflation and the predicted 5 year inflation are over 2%. Actually, even a little higher to make up for the past undershooting and to make the market really believe that it's really focusing on a 2% average going forward.
I know nothing about economics, but people who do like to make the argument that the economic problems stemming from inflation / debt / deficit / etc. happen "very slowly and then all of a sudden."
The idea seems to be that if the Fed blows off the CBO and throws its weight behind employment, inflation risks to be damned, *when* inflation finally kicks in, it will be too late and we'll be trapped in some kind of exponentially expanding crisis, like Mexico (except not like Japan)... or whatever, because MMT.
It all seems to me like people using acronyms and fancy charts to distract us from the fact they they are just making educated guesses based on their pet theories. So I like the idea of policy makers listening to institutions like the CBO that nominally operate in the public interest, even if they are "wrong", because the scenario of one school / ideology (the solution is always tax cuts for the rich!) completely taking over terrifies me. Am I naive?
I don't think you're naive. I think that mindset is a good place to start from. I don't think the CBO, the Fed or the FDA (as a non-economic example) is trying to do anything bad. I think articles like what Matt has written hopefully pushes them to improve. The incentives for a bureaucracy can lead to persistent errors in one particular direction.
Regarding a cliff-like point where inflation kicks in, it's possible but not likely at this time. The Fed should listen to what the markets say (they do listen, actually) and not what pundits say. Not from MSNBC and not from Fox. Oh, and the final pre-pandemic months that Matt mentions are what makes me hopeful that the Fed does not believe that the economy was beyond potential in 2019 either. I am pretty optimistic about where this will go.
That's a good point --- it's not about "the CBO is wrong" or "listen to the markets", it is the tension between them that serves the public interest. Markets keeps bureaucracies from becoming sclerotic and institutions like the CBO modulate the worst impulses of the motivated-reasoning-private-markets-congressional-complex. (And we can all agree that pundit hot-takes are empty calories.)
My uninformed opinions tell me that we should just ignore all three, since no one is really saying that $1.9 trillion is going to end the world, and just cut people checks to make good on campaign promises.
PS - I really think that the Fed should get more blame for the slow growth since 2008. They hide very effectively around "rates are so low", but they have used various ways to tighten that get less scrutiny and public resistance. Interest on reserves (which increases the demand for money) is higher today than at any time from 1913 to October 2008. And most of the time, the banks get higher IOR for their overnight deposits with the Fed than you or I get for buying a 3-month T-Bill. They didn't have to taper QE until employment was full. They didn't have to start raising the Fed funds rate in December of 2015 when NGDP growth was at a new, post-2009, low. I could go on, but you get the picture.
I would keep my eyes on both the current PCE (in 2022 for instance) and the 5 year breakeven. If the then-current PCE is rising at a 4% rate AND the 5 year breakeven hits 3%, I would start tightening. Tightening can be done gradually and doesn't have to really speed up until the breakevens hit say 3.25%. Start by tapering purchases, then letting the balance sheet shrink, then by selling securities. State clearly that the tightening will continue until 2% AIT is met.
How does that work in an environment where the government is funding 50% of its spending with debt and if the fed stops buying, interest rates start going up pretty fast?
I would be surprised if that happened. However, if the Fed works to meet its dual mandate of stable prices, which they now define as PCE averaging 2% over some timeframe, and full employment, then high interest rates are a very small problem. And they're not really the Fed's problem. The market sets interest rates to equalize savings and investment. This will sound like semantics, but the "is funding" will change rather quickly to "was funding". The high inflation in the 70s was accompanied by deficits that were pretty small as a % of GDP and the ratio of debt to GDP was falling.
Right now the fed is essentially monetizing the federal deficit. In doing so it is increasing money supply at fast rate. General agreement that this is fine so long as inflation is low. The question becomes how long can the fed keep doing that and inflation stay low AND what happens when inflation picks up.
If the fed has to stop increasing money supply, it will no longer be able to buy treasuries. If the # of buyers for treasuries is cut in half, then the prices (aka the interest rates) should increase. If the interest rate for the debt increases from right at 1% to 4% then the cost of interest for the treasury increases from 500 billion to two trillion or more. (though not immediately).
If that happens, what is the expected action? At what point does the government need to at least get close to eliminating the primary deficit and how does it get there? Everyone is in spend mode now, but how long can it go and what do we do when it stops?
The thing is that those same arguments were made about QE's 1, 2 and 3. Yet each time the Fed stopped or even tapered, rates didn't rise, they fell. Essentially the demand for the Treasuries increased faster due to the tightening policy than the supply from the sales.
But like you said, at some point, the deficit will have to fall below the rate of growth of NGDP.
Definitely "not immediately" since the average maturation of Treasury securities is close to five and a half years. (And the maturity has been rising.) Interest rates rising to 4% would definitely hike up interest payments, but much stronger economic growth over that time period would also help cushion that blow.
Also worth noting that over two-thirds of the debt is held by Americans, so in a sense we're just recirculating the money.
:-) My recollection of the fall of 2008 is the Fed saying something like "the 5 years, five year forward remains well anchored so clearly we've done enough". At this point, if they don't want to be stuck at the ZLB for 2 more decades, they need to push until that measure clearly shows that they've overshot a bit and not rush to get it back in line.
Can you speculate a bit on why the CBO estimates are consistently biased (in your view) in one direction? Usually, that happens when there’s some outside pressure that prefers that bias to exist, but it’s not obvious to me what that pressure is for the CBO. Why are they not adjusting? I’m sure you have some theories!
CBO's forecasts are not motivated by political bias. Instead, it seems like the current low-interest rate environment caught everyone by surprise. For proof, take a look at this forecast accuracy report produced by the CBO in 2019 (Link: https://www.cbo.gov/publication/55505). You'll see that CBO, OMB, and the Blue Chip consensus of private forecasters all failed to anticipate the long-term decline in interest rates, and all forecasters missed the mark by similar margins. So it isn't really a CBO phenomenon; it's more of a forecasting phenomenon.
"Bias" here presumably just means in the statistical sense, of consistently having one type of error rather than the other type of error, and not the political sense.
The mistake is seeing a secular change as a cyclical or stochastic one in which current conditions will revert to the long-term mean. That's inherent to most forecasting methods.
Inflation phobia is one of those classic Krugman-style zombie ideas. Not only do we have a long trend of low inflation, but the factors that girded the last burst of inflation, in the late 70s/early 80s, no longer exist: the connection between oil prices and inflation (and the resultant huge impact of the oil crises) has been broken; the union power to tie wage increases to inflation, resulting in a permanent ratcheting, is gone too.
And yet so many people still have inflation fear -- fear itself — nameless, unreasoning, unjustified terror which paralyzes needed efforts (h/t FDR!). That's what the CBO's underestimated output gap is. It's behind the mindless invocations of Weimar hyperinflation and the rise of the Nazis (when the story is the opposite: inflation didn't help the Nazis, but the catastrophic depression the early 30s most certainly did).
I don't know if $1.9T is the right number, and I'm suspicious of simplistic beliefs in the ability of the government to easily replace true economic production (i.e., the "output gap") by writing checks. And if the number is eventually $1.5T, I'll be fine with that too. But what I'm more concerned with is the underlying bias in the system that pushes us to take actions to prevent *any* movement toward higher prices, seeing that as the greater threat than unemployment, underemployment, and lagging wage growth and economic opportunity especially for those who have been most left out of that opportunity.
"... As transfer payments surged in the second quarter and the shutdown curtailed personal-consumption expenditures, pent-up purchasing power spiked. Quarterly savings rose by almost $800 billion. The historical savings rate of 7% to 8% of income reached an astonishing 26% in the second quarter. Preliminary data for 2020 show total savings for 2020 was $1.6 trillion higher than in 2019. And that was before the $900 billion stimulus.
"President Biden now wants another $1.9 trillion bill, which would further swell potential purchasing power and impede production by more than doubling the minimum wage and paying more than half of unemployed people more than they make working. Assuming this new spending occurs by September, when the vaccination process should be largely complete and the economy largely open, the Biden plan and the December stimulus would add another $311 billion a month in purchasing power into the fall.
"The monetary-stimulus machinery is also beginning to smoke. Since January 2020, Federal Reserve assets have risen 78%; in dollar terms, the Fed has acquired more assets in one year than in the six years after quantitative easing began in 2008. But unlike then, Fed asset purchases are adding to the money supply rather than only being parked as excess reserves in the banking system.
"Though economic activity remains depressed in the new shutdown and low monetary velocity is now muting its effect, M2 money supply is still up by 28.3% over the past 12 months. And that’s before the Fed monetizes the next wave of stimulus. For comparison, money-supply growth peaked at 13.8% in the high-inflation era of the 1970s. It may sound old-fashioned in the brave new world of 'Modern Monetary Theory,' but is there not the need for some caution here?"
Prices in the wholesale and retail automotive markers supports this over-heated concern.
From May - Sept., used retail prices spiked at +12% YoY and used vehicle demand spiked at +30% YoY in mid-June. In the wholesale salvage market, Q3 prices were +30% YoY. The growth is coming from the low end the market.
Color me maximally skeptical an increase in used car prices means the economy's overheating. We saw something similar as the economy emerged from the Great Recession. Dollars to doughnuts it's a combination of lower wage workers being forced to economize (by eschewing the new car market in favor of pre-owned) and new work-from-home workers doing the same (a pristinely reliable new car isn't the necessity it used to be once you've ditched your 50 mile commute).
Auto is the second largest US market and we're seeing double digit YoY price increases. I think it's fair to be skeptical but I wouldn't discount the risk it poses or its canary-in-the-coal-mine potential of the broader economy.
On the potential causes ... work I've done and seen indicates it's coming from the low end of the market (e.g., 6+ years old vehicles, <$10k) and tied to the discretionary boost from the expanded UI benefits. There's some consumer down shift from new to used but that was mostly a function of new vehicle supply chains shutting down and new vehicle inventory bleeding down to <20 days of supply. Total supply of newer model used vehicles (MY 2018-2020) remains up YoY.
Other than that, I agree with everything in this post. I remember in the late 90s boom thinking that this is what the labor market should be like all the time.
I’m no expert on the topic, but that first chart sure looks like we’re on a path toward soaring inflation. We’re pumping trillions into an economy that is only partially slow, while other parts of it are on fire. If you haven’t looked at the price of sports cards lately, head over to eBay and be amazed. It seems obvious that fiscal injections of this size would ultimately result in inflation, but Matt and others (who admittedly are much smarter than me) say not to worry. I hope they’re right, but I can’t help but wonder if they are outsmarting themselves...
This is quite possibly the worst-researched Slow Boring post I've ever read. While I appreciate the general argument that government officials should work harder to achieve full employment and be less scared about inflation, your understanding of macroeconomics is clearly faulty and your criticisms miss the mark. Three quick points:
1) Fundamentally, I you seem to misunderstand the underlying concept of "potential output". Your post implies that when the economy exceeds potential, we should be seeing runaway inflation and exceedingly tight labor markets. In some sense, this is right. But exceeding potential is not a switch that is turned to "On" or "Off". Instead, it's like a dimmer switch. If we exceed potential output by a little bit, inflation will accelerate a little bit. If we exceed potential output by a lot of bits, then we're likely to get runaway inflation. Now, we can argue what constitutes a little bit vs. a lot of bits, but my view is that a 1% gap between GDP and potential is not a lot. Consistent with that view, inflation was a little higher in 2018-2019 than it was in preceding years but not radically higher.
Put another way, you should not think of potential output as a limit that cannot be exceeded for fear of runaway inflation. Rather, you should think of it as the maximum output an economy can produce without generating ~inflationary pressure~.
2) Your post implies that you have no idea how CBO constructs its estimate of potential output. This is a weird take, given that their methodology is publicly viewable in a document written by Shackleton (2018). Basically, CBO uses a supply-side model in which they estimate potential labor hours, potential capital services, and potential labor/capital productivity. Those factors are estimated by looking at historical trends in each series. It's fair to quibble over specific modeling assumptions, but I'm not sure you've actually read through their methodology. Here's a link: https://www.cbo.gov/publication/53558
3) Before you accuse CBO's forecasting of being "bad", I'd encourage you to read CBO's Economic Forecasting Record (2019). The report examines two-year and five-year forecasts made between 1980 and 2017. It compares forecasts made by CBO, OMB, and the Blue Chip consensus of private sector forecasters. The report finds that CBO's forecasts are generally more accurate than OMB's forecasts and roughly comparable to the private sector forecasters. This finding extends to the agency's interest rate forecasts, which seem no better and no worse than those produced by other organizations. Essentially, forecasting interest rates is highly challenging, and this is especially true in our anomalous interest rate environment. Instead of dunking on the CBO, you should understand the inherent difficulty of their task. Here's a link to the forecast accuracy report: https://www.cbo.gov/publication/55505
I'll conclude with my own thoughts on this issue. I think Larry Summers and the CRFB are being overly cautious with regards to the need for more fiscal stimulus. I'm much more closely aligned with Janet Yellen, who argues that the risks of a too-small stimulus far outweigh the risks of a too-big stimulus. But your decision to criticize a nonpartisan bureaucracy for making average to above-average forecasts is an odd way to channel your frustration. Instead, you should direct your ire toward the people who are ~actually~ calling for less stimulus instead of scapegoating the CBO.
I know nothing about economics, but I have absorbed the message that the "anomalous interest rate environment" baffles economists of all stripes and that it underpins a lot of the "wrong" projections and models. My cynical assumption is that it will take another financial crisis to figure it out, similar to the "obivous systemic risks" of mortgage backed securities and whatnot that everyone saw *after* the Great Recession.
I agree that CBO shouldn't be singled out for being wrong but I believe Matt's point is that CBO has unique purchase in policy and political discussions compared to others who have gotten those same forecasts wrong. The CBO is seen as a definitive and nonpartisan voice in these discussions, which gives it a responsibility to either get better at its forecasts (harder said than done, given the zero-rate environment) or more forcefully acknowledge the inherent uncertainty for the current and past forecasts in its communications and statements.
Contra Matt who wrote "it’s not always clear what practical value" the CBO has as an anchor , I think the CBO is gravely important for the 'liberal' part of a liberal democracy and part of that relies on credibility from all sides of the aisle. Unfortunately, it means grappling with how to mitigate the fact that sometimes your forecasts are off in a way that appears to favour one side of a highly partisan and consequential debate. Perhaps, Matt should know better than to put fuel to the fire but I think that its just part of the CBO's job of maintaining technocratic credibility.
I was coming to highlight point #3. The Fed, markets (forward rates) and sell side banks have all gotten this wrong as well. It’s not right to single out the CBO.
This falls apart for me in a couple of ways.
1) I agree with you that we should run the economy a bit hotter to try and attain greater full employment, but policy to achieve this should not come at the expense of government fiscal situation.
2) More to the point, having just recently lived through the great recession, why would you be willing to trust the market's perception of risk so completely? I would completely back allowing the fed to run hot for a couple of years, but would want the US budget to be improving in the process (lowering debt/GDP). Running them both to the max seems like setting ourselves up to run off a cliff with no safety net. Your argument here sound very much like the motivated reasoning that republican's give when they talk about their tax cuts paying for themselves. They have the solution they want regardless of whether it matches the problem.
3) In a very specific instance, I want a government that is trying to find good solutions to problems it can solve. I don't want a government where the parties are competing over who hands out more cash. That is ripe for horrific results and terrible government. $1,400 checks to people who aren't unemployed and especially to people who make over the national median income is appallingly bad policy.
4) More broadly, many progressives hold up the example of the Nordic countries as the social democracy they are aiming for and rebut suggestions that they are Venezuela or Argentina. One of biggest differences between the two is that the Nordic countries are willing to pay for the benefits. The the SA countries experience severe economic pain from wild spending that wreck their budgets but they are unable to stop spending because they have to buy votes.
Certainly agree with you on 4) that progressives have to usually find a way to pay for stuff. The Nordics also have far less progressive taxes. The problem with transitioning to higher taxes on more people is that people don't like paying taxes....it's more popular to just increase the deficit and bump the problem to a later time
*****I would completely back allowing the fed to run hot for a couple of years, but would want the US budget to be improving in the process (lowering debt/GDP).*****
We will be "improving the budget" once this package is behind us. I don't think anybody's suggesting Congress will enact another $1.9 trillion stimulus in FA 22. Spending should be coming down sharply and revenues should be growing briskly moving forward (starting by, say, this coming autumn, or whenever we've reached functional herd immunity). There really are a lot of analogs to WW2, and one of them is that the end of the war on the pandemic should be followed by a precipitous drop in federal borrowing.
Are you suggesting that this is the big spending bill that progressives will pass in the next two years? Cause if so, then maybe it won't be that big of an issue even if the spending is very poorly designed. However, as I understand it, this is not close to the limit of spending that progressives want to do in the next 2-10 years.
And that's additional spending. The deficit was ~$3.7 trillion in 2020 because of the pandemic, but Matt wants to get back to the halcyon days of 2019 when the deficit was only $1.1 trillion. If we are spending money on things that improve productivity, that makes sense. Spending a couple hundred of billion dollars to send checks to people (like me!) who are still employed and have income seems like a terrible precedent to set.
More broadly, what is the limiting principle of what we can spend on debt before bad stuff happens. And if bad stuff starts to happen, are we as a country in a good space to deal with it, or have we created a populace that expects to get cash from the government instead of being willing pay for the services we want?
In the late 90s and early 2000s, information wanted to be free and the internet made it so - 20 years later most news organizations are still suffering because they can't get people to pay for what people expect to be free.
I would like to know more about room to grow the economy. There's a lot of worry about the deficit and debt but, ultimately, it matters whether we are investing in the future. We shouldn't burn a trillion bucks but a trillion bucks into industry could make us better off.
Regarding point 2, I have been going back-and-forth between reading Obama's memoir and Matt Taibbi's Substack. The former makes a very long and convincing argument about the Wall Street bailouts that boils down to: they are delicate little snow flakes and if they had decided to take their ball (private investment) and go home we'd have screwed even worse. The latter argues that the market's perception of risk includes the huge caveat that they ("big banks") will always be bailed out if they eff things things up too badly because of the reasons outlined by the former.
I find both of them persuasive, which is even more depressing when combined with Ezra Klein's recent column that summed up the status quo as: a super-majority to do anything to help regular people (because of the filibuster), but a bare majority to help the rich and powerful (because you can shovel unlimited cash to them using reconciliation).
Substantively, I totally agree with you about motivated reasoning and the wisdom of listening to the market --- sure, they have a profit motive and lots of resources at their disposal, but their assessment of risk is questionable given the combination of what Obama, Taibbi and Klein wrote. But I also agree with the motivated reasoning of using budget reconciliation to get as much money to regular people as possible if for no other reason than to make them ever so slightly less cynical about who the government actually works for.
Set aside the package’s size. How much do you think it matters *where* that $2 trillion goes? Because I think part of the critique here is that $1,200 checks + no-strings-attached state gov’t funding just aren’t that great a use of limited resources, at least at this juncture. (As opposed to more targeted relief measures, like child tax credits and extended UI.)
I realize reconciliation prevents Ds from putting whatever they want into this bill. But given that Ds probably won’t get another chance in Biden’s first term to drop $2 tril, is there an argument for making this bill smaller to make room for other, more productive spending legislation? Like infrastructure, climate-change investments, etc.
In other words, spend $2 tril, just with multiple component parts.
There are a lot of considerations in the mix that I think it's hard to reconcile.
The state/local fiscal aid, for example, is "too much" money. But for the states and cities who've been hit hardest by pandemic-related revenue shortfalls it's just enough money. From an optimal targeting viewpoint, New York and Florida should get a lot of money and Texas should only get a small amount of money and California should get no money at all (but San Francisco should get money). But there's no way congress is going to do that. What they've hit upon is giving Florida enough money, which will be too little for New York but too much for California and Texas. That seems better to me than the alternative but it is a little bit wasteful.
On the checks, look, one can debate the wisdom of this but the fact of the matter is Democrats have their majority thanks to GA senate races in which the candidates promised to deliver on these checks. Biden stood by that promise. And now they have to deliver.
There is something a little unseemly about "Vote for me and I will give you $1,400" being widely accepted as a winning message. I understand something like this has always been implicit...but making it explicit just seems like a bad step.
I see what you mean but, ultimately, politicians being elected on verifiable promises of tangible gains is better than culture war BS and demonization of minorities.
Honestly, how is this any different than promising a tax decrease that will net $1400, which has been a common promise for decades, except this goes to everyone, not just the well off and wealthy?
Its not different. Just like if the government taxed everyone at 100% and then gave everyone a living wage, that wouldn't be any different than what we have now except that more money would go to everyone and not just the well off and the wealthy.
I find it hard to view the student loan cancellation commitment as anything other than a bribe to increase turnout.
I mean, this is a very strange use of the word bribe. If candidate X is opposed to the capital gains tax, and campaigns on reducing the capital gains tax, and you vote for that candidate because you also think there should be a lower capital gains tax, did candidate X bribe you? Pre-2015, I voted for for candidates because they supported gay marriage; were they bribing me with the promise of my being able to get married?
People voting for the candidates who promise to enact policies they like is called democracy, not bribery, IMO.
Here's my read of the student loan cancellation policy ... It promises a financial windfall to a narrow set of historically low turnout, overwhelming dem voters. It's an explicit one-time financial transaction. It doesn't address the systemic causes of education costs. It doesn't address the debt levels for future students. My comment was in response to John's about the unseemly nature of explicit dollar promises. Maybe bribe was too strong, but I really struggle with viewing the student loan cancellation in any other way.
I don't find this a convincing distinction as to just about any other financial change favored by any interest group that votes, which is a hallmark of democracy. Or is the idea that only special interest businesses can change the tax code to their liking, but individuals are shut out?
Not everyone who owes student loans is a college graduate. There's a fairly significant percentage of the population that took out to start college & then dropped out (or only got an associate degree). As Matt has pointed, there are various ways of improving the targeting so that rich professionals don't get a windfall.
I like the idea that it would be stimulus. It could lead to more economic activity.
It certainly could. I'd just argue with unemployment rates for non-college educated 2x those with a degree - I'd greatly prioritize our efforts on those in pain.
https://www.bls.gov/charts/employment-situation/unemployment-rates-for-persons-25-years-and-older-by-educational-attainment.htm
That's fair. If there is a hard cap on the amount of money Biden can throw around then it should be directed more at people who need it. I just think we are in a moment where we can go big. Also, I think student loans should be forgiven or reduced on principal - education shouldn't be as expensive as it is.
I think this is exactly wrong. What was said is, "Vote for me and I will give EVERYONE $1400." This is exactly the way government is supposed to work.
My understanding of Biden's position was the $1400 target came with a similar income cut off point as the initial round. Unless I missed something, I didn't think they were targeting everyone for checks.
My understanding is that about 200 million people would get them. That's not "everyone" but its definitely not targeted in any meaningful way.
That's all I was saying. It's not a universal policy.
Agreed, that message should be reserved solely for delivering highly regressive federal income tax cuts.
Oops, you beat me to the point. :)
A difference in degree, not in kind.
Why is that unseemly? How is it different from "Vote for me and I'll bring a new library to Mapleton" or "Bring to me and I'll keep the economy hot" or "Vote for me and I'll go to war with the hated Germans"?
That's pretty much what politics is. Smart politicians give people what they want, but also try to look beyond the time horizons of ordinary (and busy) people to make sure that those short-term benefits don't lead to longer-term damage.
I dunno, it's sort of like Apple promising to give you a great iPhone if you give them your money. Or marrying someone because (in part!) you think in exchange for loving them they'll help you be happy.
Why CAN'T aid to states and local governments be targeted to revenue shortfalls? We means test aid to people, why not political jurisdictions? And as for differential needs, why not target according to local unemployment, or pandemic cases, or something?
What if Joe Manchin et al refuse to support final passage unless the 1400 is trimmed back in favor of more state aid? Then Biden and other Dems can claim they kept their word?
Also, I want the swing Democrats to have victories they can point to, to show they are tough and independent, to make it easier for them to hopefully support ending the filibuster later.
They should ditch the filibuster so they can control the agenda and extract more.concessions for their voters.
The best policy argument for checks rather than greater UI or another benefit I've seen is that anything with a bureaucratic element leads to part of the intended audience falling through the cracks. A straight check picks up the people who didn't claim or were erroneously told they don't qualify for unemployment, or who screw up their taxes and don't claim the CTC, and gives them a measure of relief.
Yeah, I find this really persuasive. There's still people who are struggling who aren't getting UI, altho to be fair I think we should do both. More money to more people is better, as far as I'm concerned
Seems like most of the people complaining about the non-optimality of the package components (and giving money to people who truly don't need it isn't Pareto optimal, to be sure) are also complaining about the size of the package, though I could be wrong.
In any event "sub optimal" hardly means "package as a whole doesn't pass cost/benefit analysis" (not saying you're arguing this, mind you, just pointing out that even an imperfect bill will probably do a world of good).
But here's another thing: As someone who doesn't need another check but is probably going to get one depending on how the income levels are written...I'm going to spend that money on something I wouldn't have bought otherwise. This past year has been good for me financially and I've gotten things in order to the point if the government gives me another couple grand I'm basically going to go out and spend it because I have nothing else to do with it.
Totally anecdotal but to back up this take... I am a habitual saver. If I get an unexpected bonus at work or something, I save it all. But not so with these stimulus checks. I honestly feel guilty about getting them (I'm just under the cutoff for AGI, wouldn't be if I didn't contribute heavily to a 401K, and definitely don't "need" it). I also have been very intentional about spending it on things I wouldn't have otherwise. But I'm probably a little weird in being so self-conscious about being a countervailing force against what I know are the intended keynesian effects.
The Democrats will get another shot at reconciliation (for infrastructure, presumably) either late this year or early next year, so it could be fine.
No, because reconciliation prevents Dems from passing multiple bills. You only get a few bites at the apple so when you take one it should be big. Ideally, yes...you get GOP votes and don't need reconciliation and then can do more targeted bills but that's not happening.
For now. I think at this point the Byrd Rule is inevitably going to be extended by a “Manchin rule” that makes it possible for Joe to say he didn’t eliminate the filibuster but did make it possible for the senate to actually work again.
West Virginia senators have an outsize role in the history of rules of the Senate.
What about this idea that you can "revise" a reconciliation bill and essentially do a second package? I still don't understand how feasible that is
You can do up to three reconciliation bills annually per the rules if they're targeting different areas (say, one is a spending bill and one focuses on cuts, or what have you). The GOP-majority House passed two reconciliation bills in 2017, one to cut taxes, and one to repeal Obamacare. The latter didn't make it through the Senate. There's also the option to do another reconciliation bill the following year (fiscal not calendar, IIRC, which means Dems could do a second reconciliation bill starting in October).
This is a supply-side recession, completely unlike 2008-09 or any other modern one. There is plenty of savings and pent up demand, so if and when the pandemic is sufficiently controlled the economy will come roaring back. There is no need for fiscal "stimulus", though there is obviously still need for fiscal relief for the unemployed and state/local gov'ts, etc. The fact that inflation expectations are on target doesn't really say much about the appropriateness of the size of the fiscal package since if is too big the Fed will simply offset it with tighter monetary policy. It's reasonable for the bond market to expect this to happen.
In the vien of conspiratorial thinking from last week's topic, today's topic is my borderline conspiracy. I know it's less of a conspiracy than a massive overrepresentation of business interests in Washington, but JESUS TAPDANCING CHRIST the CBO is always wrong in the same direction! How does this not get more attention?!? How do we not see through this? And the desired outcome of the powers that be is incredibly obvious - 3 or more workers for every job opening.
It doesn't get more attention because it's not a CBO phenomenon. Instead, it's a forecasting phenomenon. If you read CBO's Economic Forecasting Record from 2019 (https://www.cbo.gov/publication/55505), you'll see that CBO's interest rate forecasts are totally in line with forecasts made by OMB and the Blue Chip consensus of private forecasters. Matt's framing of the issue as CBO-specific is highly misleading and ignores the reality that we are in an anomalous low-interest rate environment that is difficult for everyone to predict.
But interest rates have been falling since the '80s across the entire developed world and are likely to remain low. It's no longer anonymous and not difficult to predict. They (whoever they are) should update their models!
The thing about models is they need to be *models*. They're based on some underlying metrics and math on them, not just eyeballing current trends and saying they'll continue indefinitely.
So you can be in a situation where your model does not forecast well, but not understand what metrics and what math you should add to it to forecast well. That's what we mean by "anomalous." We don't have an understanding of why inflation rates are so low, and so we don't know what to add to the model to make it forecast better.
There's a good set of comment threads on Matt's initial post on this but my non-conspiracy take is that: (1) the currency war with China in the 2000s was operating outside their model inputs and amplifying downward rate pressure and (2) once competing macro-currency rates go negative ... all bets are off as the models simply broke.
I recall reading an article that pointed out the CBO is infamous for this. One of the reasons congress used to keep forcing the USPS to save insane amounts for employees benefits is because the CBO kept predicting doom and gloom for the USPS, but the post office ALWAYS beat the CBO estimates.
The conspiracy minded person might start wondering if the CBO is entirely staffed by Republicans who hate government and routinely predict against it.
It not just Republicans though, it's Democrats too. Similar to the consensus around imperialism, virtually all of Washington's foundational economic thought is inflation should be prevented at all costs, and businesses having to compete for workers is bad.
Common wisdom is that inflation just destroyed Carter and no one wants that to happen to them. Over the CBO's existence, half the Democrats have also moved toward the view of "cultural progressivism is good, but people who don't go to college deserve what they get" which aligns them economically with the classic Republican "workers should be grateful to have any job" view.
Two quick points: 1) Paul Krugman comes to the same conclusion for different reasons; and 2) one of the unexplained changes in American society is the disappearance of on-the-job training. I hazard the guess that training came to be seen as a cost center in our financial culture with its public obsession with profits and silent obsession with executive salaries.
That's an excellent point, increased shareholder scrutiny is sold as being good because it reduces managers' ability to hide the less-visible costs of things with visible benefits. The downside is that it eliminates anything with visible costs but less-visible benefits like on-the-job training.
As a certified Old™ who can actually remember the 1970s, I think that the age skew of politicians is an underrated part of the dynamic here. We may have largely forgotten what conditions of full employment actually look like -- even the 1999 peak was a brief one and was quickly followed by a market crash and recession -- but anyone over the age of 65 in this country (which is to a first approximation everyone in the senate) is likely to have _vivid_ memories of stagflation, and they in turn were raised by parents with equally vivid memories of what runaway inflation did to the _world_ in the 1930s. Mountains of corpses tend to make an impression.
Inflation is genuinely dangerous: Baumol Cost Disease eats societies slowly, but runaway inflation can burn them to ashes in an instant.
To be clear I don't think you're wrong on the facts: inflation is low now and it stayed low throughout the Obama years and QED we under-targeted the Obama stimulus. But for a politician, the risk of over-forecasting inflation is near-zero (a slower-than-possible recovery is bad but not in a headline-grabbing, job-losing way) whereas the risk of under-forecasting inflation is huge and terrifying: losing your job is the very least of it. And so all of the incentives line up for the CBO to err strongly on the side of pessimism.
I was born in the 1970's, yet the horrors of the Great Depression and stagflation were regularly discussed when I was growing up. Given that most of the senate is closer to my parents' ages than mine, what you write makes a lot of sense to me.
What runaway inflation did to the world in the 1930s was precisely nothing. There wasn't any. A catastrophic Great Depression, on the other hand, with its millions of unemployed, was very helpful in leading to those mountains of corpses.
Yeah. That one was a bit of a head-scratcher.
{{{{{{for a politician, the risk of over-forecasting inflation is near-zero (a slower-than-possible recovery is bad but not in a headline-grabbing, job-losing way}}}}}}
I think the experience of Democrats in 2010, 2014 and 2016 is pretty strong evidence against this assertion.
The post '29 depression (driven by disaterous, contractionary monetary policies) had a lot more to do with WW2 than German hyperinflation
My unpopular take is that I really hate the stimulus checks and all the focus on them. This isn't an argument to spend less, I would rather take the money that makes up the checks, increase the UI benefit, maybe put money into modernizing our UI systems, and basically make it more targeted. But, that ship has sailed and I think that they have to push forward the checks since people like it and as this group knows, it does what it says on the tin.
You are so right to beat up on the CBO here. And to beat up on anyone that is happier to leave people unemployed than to risk a little inflation. Even better, to have us all (Especially the Fed!!) focused on the market estimates of future inflation. The concepts of potential output and NAIRU have their uses, but not for making monetary and fiscal policy. Since the Fed has basically undershot its target for the last 13 years, it's important to overshoot this time. It shouldn't begin tightening until both actual PCE inflation and the predicted 5 year inflation are over 2%. Actually, even a little higher to make up for the past undershooting and to make the market really believe that it's really focusing on a 2% average going forward.
I know nothing about economics, but people who do like to make the argument that the economic problems stemming from inflation / debt / deficit / etc. happen "very slowly and then all of a sudden."
The idea seems to be that if the Fed blows off the CBO and throws its weight behind employment, inflation risks to be damned, *when* inflation finally kicks in, it will be too late and we'll be trapped in some kind of exponentially expanding crisis, like Mexico (except not like Japan)... or whatever, because MMT.
It all seems to me like people using acronyms and fancy charts to distract us from the fact they they are just making educated guesses based on their pet theories. So I like the idea of policy makers listening to institutions like the CBO that nominally operate in the public interest, even if they are "wrong", because the scenario of one school / ideology (the solution is always tax cuts for the rich!) completely taking over terrifies me. Am I naive?
I don't think you're naive. I think that mindset is a good place to start from. I don't think the CBO, the Fed or the FDA (as a non-economic example) is trying to do anything bad. I think articles like what Matt has written hopefully pushes them to improve. The incentives for a bureaucracy can lead to persistent errors in one particular direction.
Regarding a cliff-like point where inflation kicks in, it's possible but not likely at this time. The Fed should listen to what the markets say (they do listen, actually) and not what pundits say. Not from MSNBC and not from Fox. Oh, and the final pre-pandemic months that Matt mentions are what makes me hopeful that the Fed does not believe that the economy was beyond potential in 2019 either. I am pretty optimistic about where this will go.
That's a good point --- it's not about "the CBO is wrong" or "listen to the markets", it is the tension between them that serves the public interest. Markets keeps bureaucracies from becoming sclerotic and institutions like the CBO modulate the worst impulses of the motivated-reasoning-private-markets-congressional-complex. (And we can all agree that pundit hot-takes are empty calories.)
My uninformed opinions tell me that we should just ignore all three, since no one is really saying that $1.9 trillion is going to end the world, and just cut people checks to make good on campaign promises.
PS - I really think that the Fed should get more blame for the slow growth since 2008. They hide very effectively around "rates are so low", but they have used various ways to tighten that get less scrutiny and public resistance. Interest on reserves (which increases the demand for money) is higher today than at any time from 1913 to October 2008. And most of the time, the banks get higher IOR for their overnight deposits with the Fed than you or I get for buying a 3-month T-Bill. They didn't have to taper QE until employment was full. They didn't have to start raising the Fed funds rate in December of 2015 when NGDP growth was at a new, post-2009, low. I could go on, but you get the picture.
Couldn’t agree more and I’m surprised this is not more commonly discussed / accepted in policy circles.
If PCE jumps to 4% in 2022, what should be the response?
I would keep my eyes on both the current PCE (in 2022 for instance) and the 5 year breakeven. If the then-current PCE is rising at a 4% rate AND the 5 year breakeven hits 3%, I would start tightening. Tightening can be done gradually and doesn't have to really speed up until the breakevens hit say 3.25%. Start by tapering purchases, then letting the balance sheet shrink, then by selling securities. State clearly that the tightening will continue until 2% AIT is met.
How does that work in an environment where the government is funding 50% of its spending with debt and if the fed stops buying, interest rates start going up pretty fast?
I would be surprised if that happened. However, if the Fed works to meet its dual mandate of stable prices, which they now define as PCE averaging 2% over some timeframe, and full employment, then high interest rates are a very small problem. And they're not really the Fed's problem. The market sets interest rates to equalize savings and investment. This will sound like semantics, but the "is funding" will change rather quickly to "was funding". The high inflation in the 70s was accompanied by deficits that were pretty small as a % of GDP and the ratio of debt to GDP was falling.
Right now the fed is essentially monetizing the federal deficit. In doing so it is increasing money supply at fast rate. General agreement that this is fine so long as inflation is low. The question becomes how long can the fed keep doing that and inflation stay low AND what happens when inflation picks up.
If the fed has to stop increasing money supply, it will no longer be able to buy treasuries. If the # of buyers for treasuries is cut in half, then the prices (aka the interest rates) should increase. If the interest rate for the debt increases from right at 1% to 4% then the cost of interest for the treasury increases from 500 billion to two trillion or more. (though not immediately).
If that happens, what is the expected action? At what point does the government need to at least get close to eliminating the primary deficit and how does it get there? Everyone is in spend mode now, but how long can it go and what do we do when it stops?
The thing is that those same arguments were made about QE's 1, 2 and 3. Yet each time the Fed stopped or even tapered, rates didn't rise, they fell. Essentially the demand for the Treasuries increased faster due to the tightening policy than the supply from the sales.
But like you said, at some point, the deficit will have to fall below the rate of growth of NGDP.
Definitely "not immediately" since the average maturation of Treasury securities is close to five and a half years. (And the maturity has been rising.) Interest rates rising to 4% would definitely hike up interest payments, but much stronger economic growth over that time period would also help cushion that blow.
Also worth noting that over two-thirds of the debt is held by Americans, so in a sense we're just recirculating the money.
Probably better to keep the 10 year TIPS at 2.3% (the CPI equivalent of 2% PCE) but allow the 5-year to exceed 2.3%.
Good point. With the caveat that I would really like to see them overshoot and then gradually get back to their AIT from above, not below.
I was trying to say that. :)
:-) My recollection of the fall of 2008 is the Fed saying something like "the 5 years, five year forward remains well anchored so clearly we've done enough". At this point, if they don't want to be stuck at the ZLB for 2 more decades, they need to push until that measure clearly shows that they've overshot a bit and not rush to get it back in line.
Can you speculate a bit on why the CBO estimates are consistently biased (in your view) in one direction? Usually, that happens when there’s some outside pressure that prefers that bias to exist, but it’s not obvious to me what that pressure is for the CBO. Why are they not adjusting? I’m sure you have some theories!
CBO's forecasts are not motivated by political bias. Instead, it seems like the current low-interest rate environment caught everyone by surprise. For proof, take a look at this forecast accuracy report produced by the CBO in 2019 (Link: https://www.cbo.gov/publication/55505). You'll see that CBO, OMB, and the Blue Chip consensus of private forecasters all failed to anticipate the long-term decline in interest rates, and all forecasters missed the mark by similar margins. So it isn't really a CBO phenomenon; it's more of a forecasting phenomenon.
"Bias" here presumably just means in the statistical sense, of consistently having one type of error rather than the other type of error, and not the political sense.
The mistake is seeing a secular change as a cyclical or stochastic one in which current conditions will revert to the long-term mean. That's inherent to most forecasting methods.
Inflation phobia is one of those classic Krugman-style zombie ideas. Not only do we have a long trend of low inflation, but the factors that girded the last burst of inflation, in the late 70s/early 80s, no longer exist: the connection between oil prices and inflation (and the resultant huge impact of the oil crises) has been broken; the union power to tie wage increases to inflation, resulting in a permanent ratcheting, is gone too.
And yet so many people still have inflation fear -- fear itself — nameless, unreasoning, unjustified terror which paralyzes needed efforts (h/t FDR!). That's what the CBO's underestimated output gap is. It's behind the mindless invocations of Weimar hyperinflation and the rise of the Nazis (when the story is the opposite: inflation didn't help the Nazis, but the catastrophic depression the early 30s most certainly did).
I don't know if $1.9T is the right number, and I'm suspicious of simplistic beliefs in the ability of the government to easily replace true economic production (i.e., the "output gap") by writing checks. And if the number is eventually $1.5T, I'll be fine with that too. But what I'm more concerned with is the underlying bias in the system that pushes us to take actions to prevent *any* movement toward higher prices, seeing that as the greater threat than unemployment, underemployment, and lagging wage growth and economic opportunity especially for those who have been most left out of that opportunity.
Counterpoint:
"... As transfer payments surged in the second quarter and the shutdown curtailed personal-consumption expenditures, pent-up purchasing power spiked. Quarterly savings rose by almost $800 billion. The historical savings rate of 7% to 8% of income reached an astonishing 26% in the second quarter. Preliminary data for 2020 show total savings for 2020 was $1.6 trillion higher than in 2019. And that was before the $900 billion stimulus.
"President Biden now wants another $1.9 trillion bill, which would further swell potential purchasing power and impede production by more than doubling the minimum wage and paying more than half of unemployed people more than they make working. Assuming this new spending occurs by September, when the vaccination process should be largely complete and the economy largely open, the Biden plan and the December stimulus would add another $311 billion a month in purchasing power into the fall.
"The monetary-stimulus machinery is also beginning to smoke. Since January 2020, Federal Reserve assets have risen 78%; in dollar terms, the Fed has acquired more assets in one year than in the six years after quantitative easing began in 2008. But unlike then, Fed asset purchases are adding to the money supply rather than only being parked as excess reserves in the banking system.
"Though economic activity remains depressed in the new shutdown and low monetary velocity is now muting its effect, M2 money supply is still up by 28.3% over the past 12 months. And that’s before the Fed monetizes the next wave of stimulus. For comparison, money-supply growth peaked at 13.8% in the high-inflation era of the 1970s. It may sound old-fashioned in the brave new world of 'Modern Monetary Theory,' but is there not the need for some caution here?"
https://www.wsj.com/articles/the-risks-of-too-much-stimulus-11612307861?mod=opinion_lead_pos5
The Wall Street Journal is more concerned about possible inflation than unemployment.
Got it.
The authors are concerned about the fiscal health of the federal government. And they probably disagree with Matt's opinion about the situation.
Prices in the wholesale and retail automotive markers supports this over-heated concern.
From May - Sept., used retail prices spiked at +12% YoY and used vehicle demand spiked at +30% YoY in mid-June. In the wholesale salvage market, Q3 prices were +30% YoY. The growth is coming from the low end the market.
Color me maximally skeptical an increase in used car prices means the economy's overheating. We saw something similar as the economy emerged from the Great Recession. Dollars to doughnuts it's a combination of lower wage workers being forced to economize (by eschewing the new car market in favor of pre-owned) and new work-from-home workers doing the same (a pristinely reliable new car isn't the necessity it used to be once you've ditched your 50 mile commute).
Auto is the second largest US market and we're seeing double digit YoY price increases. I think it's fair to be skeptical but I wouldn't discount the risk it poses or its canary-in-the-coal-mine potential of the broader economy.
On the potential causes ... work I've done and seen indicates it's coming from the low end of the market (e.g., 6+ years old vehicles, <$10k) and tied to the discretionary boost from the expanded UI benefits. There's some consumer down shift from new to used but that was mostly a function of new vehicle supply chains shutting down and new vehicle inventory bleeding down to <20 days of supply. Total supply of newer model used vehicles (MY 2018-2020) remains up YoY.
Good post! I've always been frustrated with employers that complain about finding workers but never consider raising wages. Ridiculous!
F*** that was a great read..
Once I turned 50, I decided I don’t like the phrase “prime-age adults” to refer to people ages 25-54.
Other than that, I agree with everything in this post. I remember in the late 90s boom thinking that this is what the labor market should be like all the time.
I’m no expert on the topic, but that first chart sure looks like we’re on a path toward soaring inflation. We’re pumping trillions into an economy that is only partially slow, while other parts of it are on fire. If you haven’t looked at the price of sports cards lately, head over to eBay and be amazed. It seems obvious that fiscal injections of this size would ultimately result in inflation, but Matt and others (who admittedly are much smarter than me) say not to worry. I hope they’re right, but I can’t help but wonder if they are outsmarting themselves...