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.
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.
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.
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.
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.
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.
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.
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!
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?"
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.
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.
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.
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.
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.
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.
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.
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!
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
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.
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...