Photo: US Air Force
First of all, let’s be clear. The biggest tragedy in the economy is the 8.1% unemployment rate, and the rising number of people on food stamps.This post is about economics, the field of academics and policy that’s of far less significance than the economy.
Last week at the Jackson Hole Economic Symposium, the world’s foremost monetary economist Michael Woodford presented a groundbreaking paper on ways the Fed could better accomplish its mission of stimulating the economy and getting to full employment.
Woodford’s argument — that the Fed should target a nominal GDP — was actually a synthesis of a lot of work that’s been done by several economists in the last few years on how monetary policy works when interest rates hits 0% (what economists call the Zero Lower Bound).
In fact, there’s a lot of pretty exciting academic work being done in this area, and it definitely feels as though this is where the monetary policy profession is going on. Other economists like Scott Sumner of Bentley College and David Beckworth of Western Kentucky have been really vocal on this idea, using their blogs to promote this idea.
But unfortunately, it appears that the Fed is moving in the monetary direction.
First, it’s doubling down on existing ideas.
Bernanke’s Jackson Hole speech was not about new ideas for what to do at the Zero Lower Bound, but rather, why the old ideas (like QE) were preferable. Also, generally, it seems that monetary practitioners have been downplaying their capabilities.
Earlier this summer, the Bank for International Settlements wrote in its annual report that central banks had basically reached the end of their ropes, and that from there on out, it was all up to fiscal authorities to stimulate the economy. Ryan Avent of The Economist demolished the paper.
The tragedy is that at a time when the economy needs new ideas, and at a time when people are coming up with robust ideas (not just on monetary policy, but also on fiscal policy), those in charge seem as reticent as ever.
Paul Krugman has written a lot about how Bernanke has failed to live up to his own past theory, back when he was purely an academic telling Japan what it should to do get out of its deflationary trap.
In an email, he shared three reasons for new academic theories not getting through:
First, in general you don’t expect policy to be based on current research – realistically, would you really want to rely on politicians to assess the quality of econometric exercises? In a better world we would have come into the crisis with well-established results from years of work. It so happens that we didn’t in this case; given that, the failure of recent research to matter much for policy isn’t surprising.
Yet it’s a shame: as you said, we’ve been quickly developing a lot of evidence that fiscal policy works, with very little effect on policy discussion.
Also, policy makers have been awfully quick to seize on research that suits their preconceptions – the Alesina/Ardagna stuff on expansionary austerity, the Reinhart/Rogoff stuff on doom when debt exceeds 90 per cent of GDP.
And I blame older economists, who have behaved a lot like the politicians, seizing on results they like and ignoring those they don’t. How can we expect politicians to evaluate empirical results fairly, let alone base policy on those results, when half the macro profession is busy defending the doctrines that failed in the crisis?
Michael Woodford, himself, chalked it up to the character and state of central bankers.
We asked him about the theory/policy gap:
I agree with you about the gap. Part of it is simply the fact that central bankers are, as a character type, generally fairly cautious — and we usually want them to be. (I think that is mainly why I have had trouble getting these ideas accepted, despite pressing similar points for more than a decade now.) But there is also another very important factor right now, and that is the intense political pressure under which the Fed must operate. They know they are going to be shot at no matter what they do, but the anticipation probably inclines one toward a more defensive posture. Experimentation with new ideas can seem very risky under those conditions.
Even at Jackson Hole, there was a split in how his paper went over.
In a followup, he told us:
Many people in the audience expressed appreciation for the paper (at least to me!). I would say the reaction of Fed officials, to the extent that I could discern it, was a lot cooler.
That. Is. Depressing.
It’s also possible that Woodford is being too charitable to Bernanke, and that the problem is not all central bankers, but rather Ben himself.
Professor David Beckworth thinks the lack of policy gumption is partly a result of the man in charge right now.
He told us:
As you know, monetary policy has become very politicized on the right and the Fed may fear it would jeopardize some of its freedoms by changing to something like a NGDP target before the election. However, I believe the more important factor is Bernanke’s leadership. Ben Bernanke is a nice guy, almost to a fault. The academic Bernanke who lectured Japan got snuffed out by the consensus-building, let’s-all-get-along management style with which Bernanke runs the Fed. In normal times consensus building may work; it the heat of the battle a general who calls the shots is needed. Alan Greenspan, for all his flaws, was a decisive general. What we need now is an Alan Greenspan decisiveness combined with an academic Ben Bernanke understanding of aggregate demand deficiency.
On the other hand, there are defenders who think that realistically the Fed is doing the right thing.
In a phone call, Harvard Professor Jeffrey Frankel explained that it’s just not politically feasible to do anything inflation-generating in a real world with politics: “I understand why Bernanke won’t set an inflation target of 4%…know where the reticence comes from.” He added: “They don’t want to be reasonable for a target they can’t hit.”
Frankel did not buy the premise here that the Fed was giving up, though he did think they could do more on asset purchases, and at least as a first step have each Fed governor spell out their own Nominal GDP forecasts.
And it’s worth noting that the innovation in academia isn’t limited to monetary policy. There’s a burgeoning group of adherents to Modern Monetary Theory (many of them located at the University of Missouri Kansas City) arguing that any notion of a debt crisis is absurd, and more aggressive deficit spending is clearly the way forward.
Economist Stephanie Kelton of the University of Missouri Kansas City relayed some of the problems getting through to policymakers on this front:
There is certainly a willingness to listen. For example, a white house insider recently contacted me after a buddy of his sent him this piece from NEP. It blew his mind. We exchanged several emails and then he asked if we could speak by phone. He was gearing up for a meeting with the new head of OMB, Jeff Zients, and he wanted to find a way to get some of our ideas/proposals on the table. I wrote a bunch of talking points, ran some numbers, talked to him for 2 hrs on his drive into DC, etc. He was pumped! Until he left the meeting (which took place in the White House). Everyone was fixated on deficit reduction and only wanted to talk about how to “sell the Obama budget” in light of Simpson-Bowles. I’ve been there I’ve been there dozens of times myself — Senators, Congressmen, Fed officials, etc. They don’t dispute our arguments. They nod, affirm, etc. and then respond, “I can’t say that.” Here’s an example I got straight from Robert Eisner (now deceased). He was a Professor of Economics at Northwestern. He was Clinton’s teacher at one point. Once in the W.House, Clinton invited Eisner to visit. Eisner told this story at a conference in front of a huge audience many years ago. I will never forget it.
CLINTON: So, Bob, what do you think of my economic policies?
EISNER: On the whole, not bad. But you’ve got to know your dead wrong on Social Security. [Eisner wrote a lot on SocSec, including the single best statement I have ever read. For him, there was not and could never be a “solvency” problem since the issuer of the currency can always pay. As Greenspan later told Paul Ryan!!!!]
CLINTON: I know Bob, but you’ve got to understand. This is politics.
Those words are indelibly etched in my memory. Here I was, naive and dedicated to policy-oriented research, thinking that if we just worked hard to teach/explain things to those in power, that they would do the right thing. How quaint.
That’s the tragedy of economics. And unfortunately that’s feeding into the tragedy of the economy.
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