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Tuesday, November 27, 2012

Taylor Rule (the book) Now Near Zero Bound with Forward Guidance

Like the Fed, the Hoover Press is experimenting with an extraordinary and unprecedented policy. It’s setting a key price very close to the zero lower bound and holding it there for a while.

To be specific, the Press is having a special anniversary sale of the book The Taylor Rule and the Transformation of Monetary Policy edited by Evan Koenig (Dallas Fed), Robert Leeson (University of Notre Dame, Australia), and George Kahn (Kansas City Fed). The sale marks the 20th anniversary of the first presentation of the paper proposing that rule back in November 1992.

88% OFF!

The ebook version—available on Amazon—is on sale for $2.88, or 88% off the usual ebook list price of $24.95. Like the federal funds rate, it’s tough to go much lower!

Also, for orders that are made directly through the Hoover Press and use the promotion code taylor20, the hardcover edition is on sale for $7.50, which is a huge 79% off the list price of $34.95.

Forward Guidance

Taking due account of market expectations, the Hoover Press has made it very clear that the sale will last for 5 weeks through the end of December 2012. This is calendar-based, not outcome-based, forward guidance, and it’s a firm commitment without contingencies.

Monday, November 26, 2012

A Way to Avoid the Fiscal Cliff without Creating Another One

So far the fiscal cliff debate has mainly been about whether tax revenues should be on or off the table with little mention of spending. But the economics of the debate—as distinct from the raw politics—make no sense without considering spending. And whenever spending is mentioned, it’s in terms of gargantuan ten-year totals like 2 or 3 trillion dollars, which are meaningless to most people and sweep under the rug key questions about the size of government and the speed of adjustment.

So consider an alternative way to present and discuss spending proposals. It involves the following chart, and while not everyone likes to use charts, this one is far more digestible than those multitrillion dollar sums thrown around. And it suggests away to avoid the fiscal cliff.

Starting on the lower left of the chart a history line shows the sharp rise in federal spending as a share of GDP from the year 2000 to the present. It then splits into four lines corresponding to different year-by year spending paths which were proposed in the months leading up to the budget deal of last year:
  • The top line is the Administration’s spending proposal made in February 2011.
  • The next line shows the result of the budget deal of the summer of 2011, but it does not include the additional sequestration reductions that were part of the deal.
  • The third line is the Simpson-Bowles spending proposal which was put forth in their December 2010 report.
  • The fourth line is a “pro-growth” proposal made by Gary Becker, George Shultz and me in the Wall Street Journal on April 4, 2011.
  • Two other proposals worth noting on the chart:
    • spending with sequester cuts from the 2011 deal; it’s close to Simpson-Bowles
    • the House Budget resolution of March 2012; it’s close to the pro-growth line.
Note that although federal spending as a share of GDP declines for the pro-growth and Simpson-Bowles paths, actual spending rises at 3.3 % per year and 4.8% per year respectively.

When looked at in this way, the logic of the pro-growth proposal jumps out at you:
  • First, the proposal simply reverses the recent spending surge by bringing spending to 2007 shares of GDP, still well above levels at the end of the Clinton Administration.
  • Second, the reversal is very gradual; substantially more gradual than the rapid run up in spending. This gives people a chance to adjust. In fact, macro model simulations show that this gradual spending reduction will increase economic growth even in the short run.
  • Third, the spending reduction will lead to a balanced budget without tax increases, because the budget was nearly in balance in 2007. This is why it’s called the pro-growth path, and it also allows for static revenue neutral tax reform which will raise growth further.
For those who want a bigger government than implied by the pro-growth path, the chart points to a good way to avoid the fiscal cliff without creating another:
(1) Agree now, during the lame duck session, to spending as in the Simpson-Bowles proposal. That is sequester spending levels without the damaging cliff-like sequester. Most members of Congress are familiar with the proposal making it easier to pass during the lame duck session.
(2) Postpone all scheduled income tax increases until a negotiation over tax reform is completed in the next Congress. There the key issue will be whether to increase taxes to pay for the higher spending levels in Simpson Bowles, or to keep spending at 2007 levels as a share of GDP without tax increases, or somewhere in between. Agreeing to the Simpson Bowles spending levels now in order to avoid the cliff shouldn't give either side additional bargaining power after the cliff.

Wednesday, November 21, 2012

A Simple Rule for Monetary Policy After 20 Years

It was 20 years ago today at a conference in Pittsburgh that I first presented what is now called the Taylor rule. Here’s the November 1992 Stanford working paper. It’s nearly impossible to predict which ideas will be picked up by policy makers and which won’t, and I certainly didn’t predict in 1992 that the Fed and other central bankers would still be referring to the idea in 2012.

Last week, for example, the Taylor rule served as a reference point for two very different talks by two members of the FOMC. In a speech in Berkeley, Vice Chair Janet Yellen talked about forward guidance. She argued that the federal funds rate should stay below the Taylor rule for a while longer and even below a “Modified Taylor rule” with a higher response to the output gap. She said that “times are by no means normal now, and the simple rules that perform well under ordinary circumstances just won’t perform well with persistently strong headwinds restraining recovery and with the federal funds rate constrained by the zero bound.” So that means more discretion, and, in my view, more drag on the economy.

Philadelphia Fed President Charles Plosser also spoke about forward guidance last week, but he saw no reason not to use a policy rule under current circumstances, and he recommended setting interest rates according to one of those policy rules. That would bring a more rules-based policy, which experience over the past 30 years shows would be better for the economy, as I argued in a talk at the same conference where Charlie spoke.

New research by Kansas City Fed economist George Kahn provides highly relevant econometric evidence on the issue. In an article forthcoming in the Kansas City Fed’s Economic Review, he estimates simple policy rules over relatively well-performing periods. He finds that the estimated parameters over these periods are very close to those of the rule I proposed 20 years ago, though with a different constant term implying a higher equilibrium federal funds rate.

Sunday, November 11, 2012

Milton Friedman and the Power of Monetary Ideas

Last Friday the University of Chicago hosted a wonderful Centennial Celebration of Milton Friedman and the Power of Ideas. All of the speakers, especially Jim Heckman, Kevin Murphy, Bob Lucas, and Gary Becker chose to focus on how amazingly well Milton integrated data, theory, and policy in inseparable ways in his research and writings, and that this was the key to the power of his ideas.

That well-documented facts and sound economic theory informed his policy views in practice is very evident in the case of monetary policy, which was the focus of the session where Bob Lucas, Allan Meltzer and I spoke and Lars Hansen moderated.

Lars asked me to address these two questions in my remarks for the session
-- How do you see Fed behavior at this juncture?
-- To what extent has monetary policy alone run out of gas in nurturing a more healthy macroeconomic recovery?

Because I had given the opening talk at Milton Friedman’s 90th birthday conference in Chicago exactly ten years ago in November 2002, I found that the best way for me to answer these questions was to begin my presentation at the Centennial by returning to that 2002 talk and bringing back some of the charts

From the vantage point of 2002 I was very positive about Fed behavior because of its greater reliance on steady rule like behavior in the 1980s and 1990s, and I gave credit to Milton for that change at the 90th birthday. The result was solid economic performance especially in comparison with the economic mess of the 1970s when discretion dominated.

But the steadier monetary policy and good economic performance did not last. Little did I know in November 2002 that the Fed would soon do it again. It went back to the types of discretionary actions it had used in the past. The results have not been good.

The obvious implication is that a change in policy would lead to improved economic performance.In this sense, I do not think it is correct to say that monetary policy has run out of gas: A return—a steady gradual return—to the type of steady-as-you-go policies we had in the 1980s and 1990s and until recently would be as big a positive for the economy as it was in those decades.

Tuesday, November 6, 2012

Strengthening of America

Many have been asking me to write more about the fiscal cliff.  As we watch the election returns today, I would keep two straightforward things in mind.

First, the fiscal cliff was not created by aliens from outerspace.  It is another poor government economic policy created in Washington. But the good news is that, like other bad economic policies in recent years, it can be fixed by a change in government policy.

Second, it will take a bipartisan policy effort, but the policy ingredients are ready.  One of the best examples is the work of former Senator Sam Nunn and Pete Domenici who have created a bipartisan group of former members of Congress who have had a series of hearings with economists and other experts. The initiative is called the Strengthening of America--Our Children's Future and is supported by these organizations and think tanks:

The Concord Coalition
The Bipartisan Policy Center
The Center for Strategic and Interantional Studies
The American Business Conference
The James A. Baker III Institute for Public Policy at Rice University.
The Hoover Institution at Stanford
Harvard’s Belfer Center for Science and International Affairs
Woodrow Wilson International Center for Scholars

I had the opportunity to be on a policy panel with Alice Rivlin. There were also panels with Martin Feldstein and Lawrence Summers and with Robert Rubin and James Baker.

Sunday, November 4, 2012

Stagnation or Real Progress?

As the presidential election campaign reaches its final crucial hours, the main issue remains the economy—unemployment, jobs, growth—and what the economic policy can do about it. Campaigning in Ohio and other swing states, President Obama says his policies have meant “real progress” and wants to stick with them, while Governor Romney says they have meant “stagnation” and wants to change them. If you have been monitoring this blog since it started three plus years ago—long before the political season began—you probably know that my view is that it’s “stagnation,” not “real progress,” and that policy is the problem.

The High Unemployment is a Tragedy

This “stagnation versus real progress” debate came up in several TV shows I did on Friday, and in each case the networks chose headlines that reflect my view well:

Our Unemployment Number is a Tragedy, Bloomberg TV
(30 second video pull quote) Unemployment a Tragedy, We Can Do Better
We Could Be Doing Better, CNN
Slow Growth Is Biggest Economic Challenge Facing Incoming President, (paired up with Austan Goolsbee), PBS NewsHour

Jeffrey Brown was the interviewer on Newshour and asked at the opening: “What is the problem that most needs to be addressed by whoever is the next president?” I answered: “That unemployment rate. It's too high. It shouldn't be this high. And it has increased a bit. But it's increased even more in states like -- I think Pennsylvania went up from 7.4 to 8.2 over the last few months. And the reason is the weak economy. We shouldn't be growing this slowly. We have an economy which can do much better. It's done better in similar periods in the past. And with the right policies, it can do much better, get the unemployment down much further. And there's also people dropping out of the labor force. You know, in Ohio, since the recovery began, 194,000 people just dropped out of the labor force, stopped looking for work. That's another bad sign that I think people should be very concerned about. It's really depressing what's happening with respect to the labor market right now in this country.”

In my view, it’s also a concern that some people have begun talking as if the unemployment problem does not exist. I know this is hard to believe, but if you search, for example, the 20 page glossy brochure on the economy recently distributed by the Administration, you will not find the word “unemployment.” If one does not discuss a problem—its magnitude, its causes—how is one ever going to fix it?

Now consider what is happening in the Swing States


Yesterday, The New York Times argued that “Mr. Obama was right when he talked about ‘real progress’ in the economy during a campaign swing in Ohio, where the state unemployment rate has declined from 8.6 percent a year ago to 7 percent recently.”

But the Times skips over the reason why unemployment fell in Ohio, and it’s “stagnation,” not real progress: Virtually all of the decrease in unemployment in Ohio has been caused by unemployed people dropping out of the labor force—discouraged not to find a job after many months of search. There has been virtually no increase in the number of jobs during the recovery. Worse, 33,000 jobs have been lost in the past four months.

By the official definition of the Bureau of Labor Statistics, unemployment in Ohio fell by 218,000 persons since the national recession ended and so-called recovery began in June 2009. But the vast amount of the decrease in unemployed was due to 194,000 persons leaving the labor force. There were only 24,000 additional jobs. In other words, 9 of 10 workers who had been counted as unemployed are no longer counted as unemployed simply because they are no longer looking for work. Were it not for this decline in the labor force, the unemployment rate would be around 10% rather than the 7% mentioned by the Times.

The two charts below tell the tragic story: With few jobs, people are dropping out of the labor force and are no longer even looking for work. Here is a picture of how employment has actually declined in Ohio.


In an oped in the Cedar Rapids Gazette today, Tad Lipsky and I wrote about why there was employment stagnation in Iowa, and even worse than in Ohio. The chart below shows that employment is actually lower than at the start of the recovery or the day the Obama Administration began.

Colorado, New Hampshire, and Wisconsin

The recent employment drop off in Ohio and Iowa is also occurring in Colorado, New Hampshire, and Wisconsin. In Colorado, the number of people employed has fallen by over 17,000 since March. In New Hampshire, the number of people employed has fallen by nearly 8,000 since April. And in Wisconsin, the number of people employed has fallen by over 30,000 since May.


This post is already too long. I conclude with chart of the unemployment rate in Pennsylvania which speaks for itself.

Thursday, November 1, 2012

A Slow and Declining Growth Rate Delays Prosperity

In his article “A Slow but Steady Climb to Prosperity” in today’s Wall Street Journal, Alan Blinder argues that “The U.S. economy is improving.” I wish he were right, but the data—even much of the data he mentions—do not support that view.

First, he admits that real GDP growth—the most comprehensive measure we have of the state of the economy—is declining; that’s not an improvement.

Second, he admits that, according to the payroll survey, job growth isn’t faster in 2012 than 2011; that’s not an improvement either.

Third, he mentions that the household survey shows employment growth is faster, but that growth must be measured relative to a growing population. If you look at the employment to population ratio, it is the same (58.5%) in the 12 month period starting in October 2009 (the month he chooses as the low point) as in the past 12 months. That’s not an improvement.

Fourth, he shows that the unemployment rate is coming down. But much of that improvement is due to the decline in the labor force participation rate as people drop out of the labor force. According to the CBO, unemployment would be 9 percent if that unusual and distressing decline--certainly not an improvement--had not occurred.

He then goes on to consider forecasts, saying that there are promising signs, such as the housing market. The problem here, however, is that growth is weakening even as housing is less of a drag, because other components of GDP are flagging.

If you want to look at forecasts, consider this chart of the Fed’s (Federal Open Market Committee’s) forecast for real GDP growth in 2012. It is a depressing picture of a worsening outlook, meeting after meeting, not an improving outlook.