Jackson Hole XXXV

Everyone keeps asking about this year’s Jackson Hole monetary conference and how it compared with the first. Well, I wrote about the first on my way to this conference, and I have to say the thirty fifth lived up to its billing as “monetary policy frameworks for the future.” JACKSON HOLE XXXVOne speaker after another proposed new frameworks—some weird, some not so weird—while discussants critiqued and central bankers and economists debated from the floor, and later on the hiking trails. Steve Liesman’s scary but unsurprising CNBC pre-conference survey demonstrated the timeliness of the topic: 60% of Fed watchers don’t think the Fed even has a policy framework.

Fed Chair Janet Yellen led off. Most of the media commentary—including TV interviews—focused on whether or not she signaled an increased probability of an interest rate rise. But mostly she talked about the theme of the conference: a monetary policy framework for the future. The framework that she put forward centered on a policy rule for the interest rate—a Taylor rule with an equilibrium rate of 3 percent—and in this sense the framework is rules-based with well-known advantages over discretion. Research at the Fed indicates that the rule would work pretty well without an inflation target higher than 2% or a mechanism for negative interest rates. But for an extra big recession when a zero lower bound might be binding for a long time, Chair Yellen suggested adding two things to the rule.

First, she would add in some “forward guidance” in which the Fed would say that the interest rate would stay at zero for a time after the rule recommended positive following a very deep recession during which the rule would otherwise call for a negative rate.  The forward guidance would be time consistent with the actual policy, so in this framework the Fed would not be saying one thing and doing another. You can see this in the upper left panel of this chart which was part of her presentation. Yellen chart JH

Note that the federal funds rate with forward guidance is actually quite close to the constrained rule without forward guidance.  This framework essentially follows the suggestion of Reifschneider and Williams (1999) to embed the Taylor rule into a “mega rule,” so in this respect also the framework is rules-based.

Second, Chair Yellen would augment the policy rule with a massive ($2 trillion) quantitative easing in an effort to bring long-term interest rates down. Here her chart suggests big effects on long-term interest rates, though empirical evidence for this is very weak. This is a “QE forever” framework. It would require a large balance sheet going forward with the funds rate determined administratively by setting interest on excess reserves, with the size of the quantitative easing determined in a discretionary rather than a rule-like fashion. The chart indicates only a small improvement in the unemployment rate, and there is a danger that such a discretionary policy could itself help cause instability and high unemployment as in the great recession. It is good, however, that the discretion is measured relative to a policy rule with an implicit understanding of a return to the rule.

Many other speakers talked about the size of the central bank’s balance sheet, and views were all over the place.  Ulrich Bindseil of the ECB argued for eventually returning to a “lean” balance sheet. This is a good goal because the central bank would then remain a limited purpose institution which is appropriate for an independent agency of government. Simon Potter of the New York Fed argued for a large balance sheet so the Fed had more room for interventions. Jeremy Stein, Robin Greenwood, and Samuel Hanson made a good case for more short-term Treasuries to satisfy a liquidity demand, but a much less convincing case that a large balance sheet at the Fed rather than additional Treasury issuance was the way to achieve this. In his lunch time talk Chris Sims also noted the problem with the Fed having a large footprint extending into fiscal policy where an independent agency of government is not appropriate.  My Stanford colleagues Darrell Duffie and Arvind Krishnamurthy warned about diminished pass-through from policy rates to other interest rates in the current regulatory environment with supplementary liquidity and capital requirements; they did not see the pass-through any faster or complete with lean balance sheet.

Ricardo Reis argued in favor of a balance sheet more bloated than the lean proposal of Bindseil but not as big as the current one in the US with the Fed following a Taylor rule by changing interest on reserves. Benoít Coeuré of the ECB spoke about the continued QE and growing balance sheet at the ECB; while recognizing international spillovers, he argued that the policy was working. Haruhiko Kuroda of the Bank of Japan made the case for QE as well, though the economic impact in Japan is hard to find. The sole representative of emerging markets on the program, Agustín Carstens, Governor of the Bank of Mexico, made the case for a classic inflation targeting framework, and showed that it was working just fine in Mexico.

Negative interest rates were also a frequent topic. Marvin Goodfriend made the case with a simple neoclassical model and suggestions for dealing with cash, and Miles Kimball intervened several time to support the case.  Kuroda showed that the BOJ’s recent sub-zero foray had a large effect on the long term rate and gave a good explanation why, but he lamented the lack of an effect on the Japanese economy.  However, Chair Yellen and other Fed participants showed little interest at this time, which made sense to me.

A Framework that Works

One monetary policy framework that was not on the program for Jackson Hole XXXV (but rangers at Jackson Lake Lodgewas emerging at Jackson Hole I) was the framework in operation during the 1980s, 1990s and until recently—during Volcker’s and much of Greenspan’s time as chair. It was a monetary policy framework that worked according to historians and econometricians until the Fed went off it and things did not work so well. That suggests it would be a good candidate for a future framework.

Posted in Monetary Policy

A Less Weird Time at Jackson Hole?

I’m on my way to join the world’s central bankers at Jackson Hole for the 35th annual monetary-policy conference in the Grand Teton Mountains. I attended the first monetary-policy conference there in 1982, and I may be the only person to attend both the 1st and the 35th.  I know the Tetons will still be there, but virtually everything else will be IMG_1732different. As the Wall Street Journal front page headline screamed out on Monday, central bank Stimulus Efforts Get Weirder. I’m looking forward to it.

Paul Volcker chaired the Fed in 1982. He went to Jackson Hole, but he was not on the program to give the opening address, and no one was speculating on what he might say. No other Fed governors were there, nor governors of any other central bank. In contrast, this year many central bankers will be there, including from emerging markets. Only four reporters came in 1982 — William Eaton (LA Times), Jonathan Fuerbringer (New York Times), Ken Bacon (Wall Street Journal) and John Berry (Washington Post). This year there will be scores. And there were no television people to interview central bankers in 1982 (with the awesome Grand Teton as backdrop).

It was clear to everyone in 1982 that Volcker had a policy strategy in place, so he didn’t need to use Jackson Hole to announce new interventions or tools. The strategy was to focus on price stability and thereby get inflation down, which would then restore economic growth and reduce unemployment. Some at the meeting, such as Nobel Laureate James Tobin, didn’t like Volcker’s strategy, but others did. I presented a paper  at the 1982 conference which supported the strategy.

The federal funds rate was over 10.1% in August 1982 down from 19.1% the previous summer. Today the policy rate is .5% in the U.S. and negative in the Eurozone, Japan, Switzerland, Sweden and Denmark. There will be lot of discussion about the impact of these unusual central bank policy rates, as well the unusual large scale purchases of corporate bonds and stock, and of course the possibility of helicopter money and other new tools, some of which greatly expand the scope of central banks.

I hope there is also a discussion of less weird policy, and in particular about the normalization of policy and the benefits of normalization. In fact, with so many central bankers from around the world at Jackson Hole, it will be an opportunity to discuss the global benefits of recent proposals to return to a rules-based international monetary system along the lines that Paul Volcker has argued for.


Posted in International Economics, Monetary Policy

CBO’s New Way to Evaluate Fiscal Consolidation Plans

In its recently released budget outlook, the Congressional Budget Office projects that this year’s federal deficit will increase by 35% from last year to $590 billion, and that the debt will rise from $14 trillion to $23 trillion by 2026, or from 77% to 86% of GDP. Clearly it’s time for a fiscal consolidation plan.

Yet we’re not hearing about any such a plan on the campaign trail. If anything candidates are proposing more, not less, federal government spending because many people think reducing the deficit is bad for the economy, even though modern economic models show this need not be the case. It would help the political debate if CBO would employ such state-of-the-art models, as I recommended here based on research with John Cogan, Volker Wieland and Maik Wolters.

Actually the CBO might be getting closer to such a recommendation. This year the CBO estimated the impact of a fiscal consolidation plan proposed by the House Budget Committee. The plan, which was used in developing a budget resolution, would reduce the deficit mainly by reducing non-interest spending as a share of GDP compared to the baseline (from 22% to 17% by the year 2040), while increasing revenues as a share of GDP by a much smaller amount (.2%).  Here is a graph showing the multi-year plan for non-interest spending (labeled Budget Resolution); it is unclear how much is discretionary versus mandatory spending, but based on the 2016 budget resolution (see summary here) it is mainly mandatory.


The CBO estimated the impact of this multi-year fiscal consolidation plan by combining a short-run Keynesian modeling approach with a long-run growth modeling approach.  The Keynesian approach captures demand-side effects while the growth model captures supply-side effects due to changes in the capital stock and labor supply.  As far as I can tell neither model is forward looking, but at least CBO’s approach to combining the models is clearly specified: Estimated output effects for the 1st, 2nd, 3rd, and 4th years of the consolidation plan have weights of 1.00, 0.75, 0.50, and 0.25, respectively, on the short-run model with the remaining weight on the long-run model. Estimates for the fifth year and beyond are based entirely on the long run model. (See the CBO report for more information). Obviously the weights are rather arbitrary, and I would prefer a single model which combines these effects in a consistent way and takes account of incentive effects. But at least it is a step in the right direction.

The results in terms of real GNP per person are shown here:


and percentage change from the baseline is shown here:


According to the CBO estimates, there is a negative demand-side effect in the short-run, but it is quite small especially compared with the larger and continuing longer-run supply side effects. Recall that in the Cogan, Taylor, Wieland, Wolters model, the short-run effects are all positive due largely to expectation effects.  In any case, even the CBO finds the overall impact of fiscal consolidation to be, on balance, very positive for economic growth.


Posted in Budget & Debt, Fiscal Policy and Reforms

The Staying Power of Staggered Wage & Price Setting in Macro

The new Handbook of Macroeconomics is now in production as all 34 chapters have been submitted (by 74 different authors).  It will be out later this year. Harald Uhlig and I edited the book, and we each contributed a chapter. My chapter (a draft appears as an NBER Working Paper) is on the staggered price and wage setting model.

The staggered wage and price setting model has had remarkable staying power.  Originating in the 1970s before the advent of real business cycle models, it has been the theory of choice in generation after generation of monetary business cycle models used for policy analysis as Volker Wieland, Elena Afanasyeva, Meguy Kuete, and Jinhyuk Yoo show in their review of over sixty macroeconomic models in their chapter for the Handbook.

But in recent years “Big Data” style research projects have radically expanded knowledge of the microeconomics of wage and price setting behavior from a few salient facts about magazine prices or personal salary experiences into complex data sets with millions of observations. These data sets provide new evidence to test and discriminate between different types of models.

There is new evidence that prices are set at a fixed level for six months or more, especially if sales and reference prices are accounted for properly. There is new evidence that wages are set a fixed level for longer periods and that there is a peak in the estimated hazard function at one year that precludes certain popular simplifications. There is new evidence that both wage and price decisions are staggered or unsynchronized over time, and that this staggering creates a contract multiplier which converts short spells of rigidity at the micro level into longer persistence at the macro level.  There is more evidence of time-dependence than state-dependence. But in each of these dimensions—length, degree of staggering, shape of the hazard function, degree of state-dependence—there is a great deal of heterogeneity across countries, types of product, types of employment, and types of industry structure.

This heterogeneity is not simply a nuisance; it has major implications for aggregate dynamics, and it has been offered as a response to criticism of the models, much of which came after the financial crisis.  Often that criticism applied to a particular simple staggered contract model that does not capture the regularities mentioned above, and the criticism isn’t valid when heterogeneity is taken into account.

In this sense, the implication of this chapter is similar to what Tom Sargent has said about the entire Handbook “This remarkable collection belies uninformed critics who assert that modern macroeconomics was wrong footed by the 2007-2009 financial crisis.”


Posted in Teaching Economics

Desperately Needed:  Reforms to Raise Productivity Growth

The data released this week on labor productivity growth are really terrible. The growth rate has been negative now for three quarters in a row, and it was – .4 percent over the past year. Unfortunately, these data are reinforcing a pronounced negative trend in recent years which implies declining income growth and lower standards of living.

Sadly, there is little public discussion of what to do about it.  Many say that policy reforms—whether tax reform, regulatory reform, budget reform, or monetary reform—will not work because the stagnation is “secular,” and we are in a new era of permanently lower growth. Others say that productivity data are not reliable and should not influence public policy.  Still others say that supply-side reforms will not work because we have a demand-side problem; rather we need another short-term economic stimulus.

The chart suggests otherwise. It shows productivity growth since the 1960s smoothed in two different ways—a five-year moving average and a Hodrick-Prescott trend. Both show major swings in productivity over this period. I have highlighted the swings with the green arrows.

Productivity Growth

Clearly there is nothing permanent or secular here.  Productivity growth fell in the 1970s and then picked up in the 1980s and 1990s.  Clearly it is not demand related: Virtually all schools of macroeconomics argue that demand deficiency periods are the length of the business cycle not decades or more.

In my view, as explained here, it is a policy-performance cycle because one can see changes in economic policy that are closely associated with the changes in growth.  So what we need is a public discussion—inside and outside of the political campaigns—on practical policy reforms to turn productivity growth around, including a clear explanation of why any proposed reform will, in fact, raise productivity growth.

Posted in Fiscal Policy and Reforms, Regulatory Policy, Slow Recovery

Economic Exasperation Continues

With today’s disappointing GDP release for the second quarter and downward revisions for the previous two quarters, the U.S. economy completes 7 years of economic expansion with a whimper. And with an average annual growth rate of only 2.1 percent over the 28 quarters from 2009Q3 to 2016Q2, the economic expansion is more aptly called economic exasperation.  I have been pointing to poor government economic policy as the main reason for this poor performance from the start, explaining the defects with each alternative explanation as it has arisen over time, including “it’s not so weak” and then “weak recoveries just happen after deep recessions” and then “it’s just secular stagnation.”  People’s exasperation about the economy and Washington policy is seen in this presidential election season.  The slow economic recovery is a tragedy for many people, especially when you combine it with the great recession that went before it. Policy must change. You would think that reports of three more quarters of disappointing growth would spur people into action.

Here is an update of a graph I have been using to compare the exasperation period with the much stronger expansion period of the 1980s:


and an updated list of links to posts on this subject on EconomicsOne.com which also include pro-growth policy reforms.

Posted in Slow Recovery

An Economic and Security Policy Blueprint for America

A timely new policy book, Blueprint for America, edited by George P. Shultz, is being released today online for the first time. The release coincides with the start of platform writing by Republicans this week and Democrats the following week, and then by national political conventions and the general Presidential campaign.  But the book is purposely meant to be non-partisan as ten contributors with experience in economics, national security, finance, health care, energy, and education join Shultz in laying out novel and practical reforms for governing as well as for campaigning during the election.Shultz_Blueprint_cover

In my view, the book is worth a serious look because it endeavors to bring a greater focus to economic and security policies than we have seen in the campaign. It candidly describes and diagnoses the serious economic and security problems America now faces, and it offers solutions to those problems.  Importantly it combines practical ideas on economics and national security, stressing the importance of getting back to long-term strategic thinking with the goal of improving people’s lives.

The book consists of 12 chapters (all online here)

  • The Domestic Landscape by Michael J. Boskin
  • Entitlements and the Budget by John F. Cogan
  • A Blueprint for Tax Reform by Michael J. Boskin
  • Transformational Health Care Reform by Scott W. Atlas
  • Reforming Regulation by Michael J. Boskin
  • National and International Monetary Reform by John B. Taylor
  • A Blueprint for Effective Financial Reform by John H. Cochrane
  • Education and the Nation’s Future by Eric A. Hanushek
  • Trade and Immigration by John H. Cochrane
  • Restoring Our National Security by James O. Ellis Jr., James N. Mattis, and Kori Schake
  • Redefining Energy Security by James O. Ellis Jr.
  • Diplomacy in a Time of Transition by James E. Goodby

cleverly interspersed with four insightful essays by George Shultz on why out-of-control entitlement spending is a problem, on human resources, on a world awash in change, and on the art and practice of governance. Shultz reflects on his time as secretary of state in these essays, writing that “I worry about the sorry state of the world and my instinct is to say something constructive about the problems.”  A good way to get into the book is to read Shultz’s poignant essays first, and then go on to study the reform proposals in individual pieces.  Here is a quick overview of some of those proposals.

Michael Boskin starts off by documenting the need for general government reform asking, for example, why we have “forty-six job-training programs, sprawling over nine government agencies.” He also considers the need for tax reform, demonstrating why lowering rates and broadening the base will raise growth and create simplicity, and for regulatory reform, proposing an overall regulatory budget cap and a requirement stating that an old regulation of comparable cost must be removed for every new regulation imposed, as a means of balancing of benefits and costs.

John Cogan offers proposals to reform social security and other entitlements arguing that “returning the welfare system to the states is long overdue.” Addressing impediments to reform he notes that “discussions about welfare are too often ideological.” He shows that “reformers are incorrectly cast as heartless people who are unwilling to help the less fortunate. State governments are erroneously cast as uncaring entities…. An effective welfare reform… improves the actual outcomes for the targeted citizens. Welfare reform should be judged on such results.”

Scott Atlas proposes a novel six-part health care reform plan that “restores the original purpose of health insurance: to protect against the risk of significant and unexpected health care costs.” He shows how the Affordable Care Act “has made private insurance less affordable and pushed health insurance reform in the wrong direction. It has furthered the erroneous view that insurance should subsidize the entire gamut of medical services, including routine medical care.” In contrast he shows that his plan “enhances the availability and affordability of twenty-first century medical care for all Americans, ensures continued innovation, and reduces health care costs by trillions of dollars over the decade.”

Rick Hanushek gives a comprehensive overview of the problems in K-12 education and then delves into the role of the federal government versus state and local governments. He puts forth the important principle that “The federal government is in the best position to specify what needs to be produced, but it is quite unprepared to direct what 100,000 schools should do to accomplish this. The states should be given the ‘how’ role.”

John Cochrane offers reforms to deal with financial crises and the too-big-to-fail problem including a novel proposal for equity-financed run-free banks. He also makes a refreshingly unabashed case for free trade backed up by history and basic economics, and he shows the rule of law and immigration benefit America.

In an essay on monetary policy I make the case for a proposal for domestic monetary reform that has already been written into legislation passed by the House of Representatives, and I show how this reform can be extended to create a rules-based international monetary system.

The book then shifts to national security policy with a thoughtful chapter by James Ellis, James Mattis and Kori Shacke that proposes several key strategic reforms. They argue that the current approach to developing a National Security Strategy is too unfocused: “Rather than cataloguing every interest, strategy should consist of decision rules that allow for application to events as they unfold,” a statement that would equally apply to economic policy proposals in the book.  They also emphasize that America needs a “strategy of security and solvency, showing that “economics are integral to military power. In fact, they are dispositive: no country has ever long retained its military power when its economic foundation faltered.” This is also theme that is echoed through the book.  Stressing the need for alliances they argue that a strategy which America adopts “must, foremost, be ally-friendly,” suggesting a simple guide that “those countries that are not against us are for us.”

James Ellis then reviews energy policy. He describes how dramatically circumstances have changed for US energy policy, noting that “The US energy situation today is by almost all accounts better than it has been for decades.” He documents that in 2014, “just 16 percent of our country’s net petroleum use was imported from OPEC. That is now less than 6 percent of our total energy consumption, putting OPEC behind the total energy supplied by, for example, the state of Pennsylvania (7 percent) and just ahead of Colorado (4 percent).” Nevertheless, he argues that energy policy still has problems to deal with including the need to reduce carbon emissions and maintain a diversified portfolio of energy supply.

In the chapter on diplomacy, James Goodby summarizes an interview with George Shultz on governance of foreign policy in the state department, and offers proposals for a range of reforms, including better training and a greater focus on improving the foreign services.

In the concluding essay of the book, George Shultz puts these proposals into perspective observing that the American people have dealt with similar problems in the past and arguing that they can deal with today’s problems if they work at it, reminding us that “democracy is not a spectator sport.”

Posted in Budget & Debt, Financial Crisis, Fiscal Policy and Reforms, International Economics, Monetary Policy, Regulatory Policy