John Cochrane on the 1982 Fiscal Restraint ???

Has John Cochrane fallen off the cliff again with:

What if we got the sign wrong on monetary policy?

He is motivated by post from Stephen Williamson on Phillips curves and monetary policy that starts off sensibly enough. Even this die hard believer that Keynes had a point is willing to concede that Milton Friedman got a lot of things right. Williamson is even willing to note this:

If we think there is an episode where monetary factors were important, then we should see the Phillips curve over that period, as monetary shocks tend to move inflation and the unemployment rate in opposite directions in the short run. So, consider the period of time between fourth quarter 1980 and third quarter 1982, when Paul Volcker was using monetary policy to bring the rate of inflation down.

Williamson later notes what Irving Fisher taught us about the effect on nominal interest rates in the long-run:

So, over the long run, there's a clear positive correlation between the nominal fed funds rate and the pce inflation rate. Irving Fisher taught us that, in credit markets, borrowers and lenders care about real rates of return. Thus, there should be an inflation premium built into the observed nominal interest rate - if the inflation rate is higher, the nominal interest rate should be higher. This just compensates lenders for the decline in purchasing power they experience between the time a loan is extended and when it is paid back. Indeed, some mainstream models, including New Keynesian models (which are basically neoclassical growth models with sticky prices and wages) have the feature that the long-run real interest rate is a constant, determined by the subjective rate of time preference of the people who live in the model.

All of this seems fine until Williamson starts musing over this:

So, suppose I am Paul Volcker, and I'm faced with a situation at point A where the inflation rate is high and the nominal interest rate is high. The curve SRLE1 is the short-run tradeoff I face. I can reduce inflation in the short run by increasing the nominal interest rate, thus moving to B. But that won't work to reduce inflation in the long run, so after increasing the nominal interest rate, I have to begin reducing it.

At this point one might be best advised to stop reading as we old timers would cut in and say that the prolonged large out gap during the 1980’s was what was responsible for the dramatic reductions in inflation, which sort of became a semi-permanent feature of the US economy. But silly me had to read Cochrane’s take on this which included:

To be sure, I left the grand Volcker stabilization out of the picture here, where a sharp spike in interest rates preceded the sudden end of inflation. And to be sure, there is a standard story to explain negative causation with positive correlation. But there are other stories too -- the US embarked on a joint fiscal-monetary stabilization in 1982, then under the shadow of an implicit inflation target gradually lowered inflation and interest rates.

Did Cochrane and I live on different planets some 30 plus years ago? My recollection was that Reagan’s fiscal policy was quite stimulative working contrary to Voclker’s tight monetary policy. Which is why real interest rates during the 1980’s shot up dramatically and stayed high even as inflation and nominal interest rates fell. Yea – there are “other stories too”. Stories that don’t fit the reality of the period.

Bullard Leads The Fed

Janet Yellen may be about to replace Ben Bernanke as Fed Chair, but the decisionmaker there who seems to be calling what will be happening in the future is St. Louis Fed President, Jim Bullard.  After the initial foray to talk about tapering in May, he dissented at the June meeting on the dovish side, despite being prez of one of the traditionallhy most monetarist Feds.  He argued that they needed more data supporting an end to the taper to go for it, particularly on the inflation side. In September the FOMC surprised the markets by essentially following Bullard's advice, pulling back from a taper and declaring that more data was needed to support a taper.

Now he has done it again.  At the meeting concluded yesterday, the Fed announced a "tiny taper," cutting securities purchases from $85 billion per month to $75 billion per month.  Who was the first to publicly call for such a move?  Yep, Jim Bullard, on December 9 in a public statement, indeed, using the term "tiny taper" for what he thought they should do, and now they have done it.

So, things may change with the leadership transition, but anybody wanting to watch what the Fed is likely to do in the near future is advised to keep an eye on the public statements by Bullard.

Barkley Rosser

Taxes And Income Distribution: The Way It Was And The Way It Is

Got invited on to the local TV station today to discuss income distribution thanks to the recent statements about the matter by President Obama and Pope Francis, only to upset the local anchorman by telling him things he had not known previously, such as the shocking fact that someone making $115,000 per year pays the same in fica/Social Security taxes as someone making $115 million per year, although, well, that must be just fine because "that is the way it has always been, right?"  As it was I advocated raising the income cap on fica and taxing capital gains as income, just as was put into place back in 1986 under Ronald Reagan.  In the very conservative Shenandoah Valley this is how one must pose such radical proposals.

But, it got me to thinking about what I should have said, particularly if I had more time, which one rarely has on TV, especially local TV.  So, when the anchorman, who really is reasonably smart and well-intentioned, asked me if it had always been this way, that people above a certain income level (really, wage and salary level) pay no more in fica taxes than those at that level, I should have reminded him of how things used to be.  Yes, that is the way it has always been, but in other areas of the tax code, things have changed so as to really help out those at the top end of the income hierarchy, even if they have not been made to pay their fair share for our rising Social Security expenditures (and I noted that if one raised the income cap and was revenue neutral, one could cut the overall rate, thus lowering taxes for the bottom 96% of the income distribution, sort of like how closing loopholes back in 1986, such as the special break for capital gains, allowed a general cut in income tax rates for Mr. Reagan).

In particular I should have mentioned that from 1940 to 1965 we had a top marginal federal income tax rate that exceeded 90% in the U.S., which has since been drastically lowered.  Since 1986 that rate has not exceeded 40%, but somehow the economy grew more rapidly and produced more jobs during that earlier period than it has since that top rate was so sharply reduced.  In discussing the reintroduction of the special treatment of capital gains income under Bush, Jr., I noted that it was supposedly justified by the top 1/10 of 1% of the income distribution, who have gotten something like a third of the income increases since 2009, being those who would provide jobs for the rest of our society.  I asked perhaps a bit too sarcastically, "Where are those jobs?  They sure are not doing a good job of providing them," which brought a vigorous nod and chuckle from the crusty weatherman who was standing nearby.  Uh oh, now I am in deep doo doo, with a storm brewing.

What really strikes me is how successfully this very upper sliver has been able so to cow the media that one never hears these sorts of facts discussed.  We hear repeatedly about how "47% do not pay federal income taxes," but nobody talks about how fica taxes simply do not increase at all above a certain cutoff.  Occasionally someone will mention the special treatment of capital gains, but this is quickly dismissed because of the need to keep those "job creators" happy.  It is a hard fact that the group that pays the highest percentage of their income in taxes overall is actually around the 96-98 percentile, with that percentage falling steadily and firmly as income rises above that, because of the limit on fica taxes and the higher percentage of income earned as capital gains and also the regressive nature of sales taxes, the largest source of revenue for state governments nationwide, another point almost never discussed, except for in GOP states where they want to shift more to those sales taxes and away from income taxes so that those job creators will get helped more.

My bottom line was to say that I did not support "confiscatory taxation of the rich," but that I simply wanted to see them pay some of the same rates that others pay.  That seems fair, doesn't it?  But this is shocking, shocking, in today's environment.

Barkley Rosser

Robert Samuelson Whines About Muddling Through

Oh, I cannot resist piling on, even though good old Dean Baker has already pretty much done the dirty job of once again showing how misguided and fixated on silly things Robert J. Samuelson is with his latest column in the Washington Post, 12/16/13, "The luxury of muddling through," although my effort to link to Dean's excellent post does not seem to be working.  In any case, the abysmal RJS complains that the latest budget deal is just "muddling through" and does not deal with "the central issue" of longer term deficits, which he sees as mostly a matter of not cutting retiree benefits, although he does note that Republicans do not wish to raise taxes, which he seems to accept as an unbudgeable given.  He does not note that this new budget cuts unemployment insurance and food stamps (SNAP), even as he whines about this muddling through. While this budget clearly "sucks," as Nancy Pelosi put it, at least it does mean that we are not likely to have a government shutdown or debt ceiling crisis for the next two years (although debt ceiling crisis is not completely off the table).

Dean accurately points out that RJS makes no allowance for the collapse in revenues due to the Great Recession and how our failure to get back to where we were is the main reason for the deficit.  He also  notes that for all RJS's whining about Medicare costs, he does not even mention once that the cost curve on medical care costs has been bent.  In all this RJS continues to follow the line of WaPo editorial page editor, Fred Hiatt, that cutting Social Security and Medicare is this very high priority that must be done ASAP, a line that many other WaPo columnists who are nominally liberal  Dems such as Ruth Marcus also spout.  Dean also argues that if SS and Medicare really were to get into serious trouble in the future, voters would probably support tax increases to support these popular programs.  Polls show even Republicans supporting such tax increases for these programs.

Let me just add a few more points to this drubbing that Dean missed.  One is that in fact the deficit has come down substantially over the last few years.  It is simply not in any dangerous state that would lead to the sort of crisis that RJS suggests in the column may be coming if muddling through is all that happens.  Furthermore, as Dean has noted in the past, but did not this time, the real measure of the burden of the debt is the interest payments on it measured as a percent of GDP.  That percentage is now only half of what it was 20 years ago.  We are simply nowhere near any sort of crisis point on all this.

What continues to be annoying about RJS, besides his fixation on wanting to cut these programs, is how ignorant he is of economics, although somehow he has been given this position of being the main regular economics columnist of WaPo.  This is best seen in the horror that he expresses in this column that the likely outcome of this budget is that "the current [upward] trajectory of the debt would not change."  Really.  Somehow he seems unaware that in the vast majority of years in US history we have run federal budget deficits, which means that the debt has risen in most years without any fiscal catastrophe ever happening.

Since WW II, there have been only a handful of years when the budget has run a surplus, most recently at the end of the 1990s, with that reflecting both rapid GDP growth and the tax increase Clinton put through in 1993, unsupported by even one Republican who loudly forecast imminent recession whereas instead we had rapid GDP growth, which brought us those surpluses, just as our current low GDP and growth is the main source of our current deficit.  There is simply no reason to aim at budget surpluses as a policy goal.  Again, it is the ratio of the debt to GDP that matters, and more importantly the ratio of the interest payments to the GDP that matter even more, and those are very far from what they were even quite recently when they did not trigger any sort of crisis.   Robert J. Samuelson's whining is simply completely out of touch with reality, but at least he is unlikely to lose his job at WaPo as long as the current editorial page editor continues to have his.

Barkley Rosser

Persistently High Long-Term Unemployment Rates.

In case you were wondering about how bad the U.S. job situation is, here's estimates of the unemployment rate for those who have been jobless (but still seeking jobs) for more than a half of a year, as a percentage of the total civilian labor force. The labor force is the total number of workers who are willing and able to work, as indicated by their either having jobs or actively seeking them. Even though the numbers are down in recent years compared to at the end of the "Great Recession," they are still much higher than during previous recessions in the U.S. (indicated by the vertical gray lines). -- Jim Devine

Website for Nonlinear Economic Dynamics Society (NEDS)

I want to announce that the Nonlinear Economic Dynamics Society (NEDS) that I founded some years ago now has a website at NEDS, folks.

Barkley Rosser

Being an Economist Means Not Having to Have Any Actual Knowledge of What You’re Talking About, Exhibit 37: Occupational Safety and Health

Robert Frank’s column in this morning’s New York Times is about the economics of occupational safety and health, or more precisely, about Robert Frank’s one obsession with economic theory, invidious comparisons of well-being.  Frank has gone totally hedgehog over the tendency to evaluate one’s condition in relation to others; it has been the subject of virtually all of his writing for the past decade or so.  To better highlight this one wrinkle, he has embraced the most orthodox of orthodoxies in every other respect, which means that his treatment of policy topics has become little more than an exercise in deduction from axiomatic principles.

To see what I mean, take a look at this latest piece on “the price of danger”.  Here is his summary of the issue as seen through the lens of economic theory:

Consider the familiar trade-off between wages and workplace safety. Because safety devices are expensive, additional safety means lower wages. Reducing risk to zero is impossible, so the practical question must always be this: How much safety is enough? Since Adam Smith’s day, classical economic theory has held that well-informed workers in competitive markets will navigate this trade-off sensibly. They will accept additional risk in return for higher pay only if the satisfaction resulting from their additional buying power is greater than the corresponding loss in satisfaction from reduced safety. Regulations that mandate higher safety levels make workers worse off by forcing them to buy safety they value at less than its cost.

Of course, as Frank notes, workers have clamored for safety regulation, and some degree of standard-setting and monitoring is universal in industrialized countries.  Hence the theory must be wrong.  Why?  The answer is—surprise!—the tendency to evaluate our well-being in relation to others.  Income is a rat race, so trading off risk against income makes workers worse off.  And that’s it—end of story.

Does it matter that every single point that Frank raises is contradicted by the evidence?  He apparently doesn’t care, since evidence doesn’t get any space.  Having a clever idea is enough.  If Frank were the only economist with this frame of mind, we could safely ignore him; alas, he has a lot of company.  Pick up any economics textbook and you will find sweeping judgments about all sorts of issues of law and policy based entirely on deductive theory, without any consideration of the history of the topic or factual details that people on the ground have regarded as important.  (Exhibit 1 would have to be rent control.)

So let’s make a list of some of the things that people who study occupational safety and health know and Frank omits from his analysis:

1. Safety is expensive, but so are accidents.  There is an enormous literature that documents that firms frequently fail to take measures on their own initiative to prevent accidents even though they would pass a cost-benefit test.  Not all such measures would pass, but many would.

2. Adam Smith’s theory of compensating wage differentials was highly disputed during the nineteenth and twentieth centuries.  John Stuart Mill believed that, in times of involuntary unemployment, higher risk would be accompanied by lower wages—the sweatshop effect.  The institutional economists identified with legal realism in the early twentieth century agreed.  True, there was a period of theoretical monoculture in economics during the 1970s to 1990s in which compensating differentials became the hegemonic view, but that perspective declined with changes in labor market analysis post-1990 or so.  Take a look, for instance at Labor Economics, the graduate textbook by Cahuc and Zylbergerg; their skepticism toward the model that Frank identifies with “economic theory” is palpable.

3. Frank simply assumes that wage bargains are not affected by the prior allocation of rights—that it makes no difference whether workers have no right to safe jobs and must give up wage demands to get them, or whether they do have this right and have to be bribed with hazard pay to accept greater risk.  Of course, in the real world willingness to pay and to accept are vastly different, and workers understandably want all sorts of mandated job rights, beginning with health and safety.  To be effective, such rights have to be codified and enforced.  I have not made up this point; you can find it in legal reasoning during the period at the turn of the twentieth century when courts began to find in favor of injured workers.  (My source for this was Atiyah’s Rise and Fall of Freedom of Contract.)

4. Wage compensation for risk will be incomplete if the threat of dismissal is used to control worker effort, the so-called efficiency wage approach to wage-setting.

5. The literature on the behavioral aspects of risk perception and response is a thick stew.  Workers tend to respond asymmetrically to safety norms, as suggested by prospect theory.  They often retreat into denial of unpleasant truths about the risks they face, as suggested by cognitive dissonance theory.  Workers are human beings, not cost-benefit machines.

6. The empirical record for compensating wage differentials, despite what its proponents (like Kip Viscusi) claim, is mixed at best.  Positive coefficients on occupational risk in wage-risk regressions depend on the choice of control variables; they show up in some subsamples, such as unionized workers, and not others.  They are different for white workers compared to black, men compared to women, and these differences fluctuate from one sample to the next.

But why get bogged down in all this detail, specific to the economics of occupational risks, when the point is to show how you can solve the world’s problems with a single, all-purpose axiomatic model?

How To Depoliticize The Fed

I must congratulate Heritage Action on their principled move to "score" votes of US Senators on the confirmation of Janet Yellen to become Chair of the Board of Governors of the US Federal Reserve System.  They are doing this in order to register their protest against the "politicization" of the Fed and to fight against it.  Surely, there is no better way to depoliticize the Fed than to threaten any Senator (particularly a GOP one) with facing a well-funded teabag opponent in a primary if they dare to vote for the appointment of Yellen.  I must applaud Heritage Action on its sagacity and wisdom in this move (hack, cough)...

Barkley Rosser

Bibi And GOP Whine While Stock Market and Spooks Love Iran Nuke Deal

Yesterday the Wall Street Journal top headline told us that there was much opposition to the Iran nuclear deal that Sec. State John Kerry has pulled off with Iran and the P5+1 in Geneva.  Israeli PM Bibi Netanyahu is loudly denouncing it as a horrible mistake, and many Republkicans in Congress are joining in with his denunciation, despite 2 to 1 public opinion poll support in the US.

However, it looks like Bibi is out of step with some important opinion makers in Israel itself on this matter, who seem to view the matter in a much more favorable light.  One is the Israeli stock market, reaching new highs in the wake of the agreement, and more silently but there nevertheless, the Israeli military-intelligence security establishment, whom Bibi likes to ignore in order to enflame his political backers and undercut Obama, whom he is very annoyed he failed to have Romney defeat last year in the US election, darn it!

Sorry.  Bad links; for the second one, try .  The one I linked to is Stratfor that does not get it and still thinks the Saudis are upset. They are not.  For the first one, there are lots of sources out there about the Israeli stock market booming on the news.

Barkley Rosser

Dean Baker v. Greg Mankiw on Wage Inflation

I may have been too nice to Greg Mankiw per something Dean Baker notes with support from Paul Krugman. Dean notes:

if we use the broader measure of wage growth for all workers, we don't see any evidence of acceleration at all. Wage growth has been hovering around 2.0 percent for the last two and a half years. It had been somewhat lower in 2010 (@ 1.6 percent), but there certainly is no upward pattern in this series.

Paul adds:

One of these numbers, wages of production and nonsupervisory workers, shows a modest uptick, the others not. All three remain well below their pre-crisis rates of increase. Is this the kind of evidence on which you want to base a major policy change? Not in my world.

Whether we examine the growth in average hourly earnings for production and nonsupervisory workers, the growth in average hourly earnings for all employees, or the employment cost index, wages seem to be rising by only 2% per year. If this increase in nominal wages is matched by an increase in productivity, one would think that unit labor costs would not be rising. The Bureau of Labor Statistics publishes the change in unit labor costs on a national basis every quarter. Unit labor costs actually fell by 3.7% in 2010 and have barely increased since. Call me old school – but why are we worried about a modest increase in nominal wages when unit labor costs are basically flat?

Former Romney Economic Advisors on the State of the Labor Market

While the Washington Republican leaders keep pushing austerity and complain about the Federal Reserve pursuing expansionary monetary policy, it is refreshing to see what Greg Mankiw is saying about the choices Janet Yellen will have to face:

In her recent testimony before the Senate Banking Committee, Janet L. Yellen, the eminently qualified nominee to lead the Fed, made clear she didn’t think the time for an exit had come. With inflation running below the Fed target of 2 percent and continued weakness in the labor market, she argued, the economy needs all the help the central bank can provide. Many of the numbers back up that diagnosis.

Mankiw note only cites the continuing high unemployment rate but also the low employment to population rate. Yet, Mankiw did note some contrary evidence:

Seven years ago, the vacancy rate was a bit over 3 percent. It fell to a low of 1.6 percent in July 2009, a month after the official trough of the recession. The most recent reading puts it at 2.8 percent. So according to this measure of labor-market tightness, the economy is almost back to normal. Data on wage inflation also suggest that the labor market has firmed up. Over the past year, average hourly earnings of production and nonsupervisory employees grew 2.2 percent, compared with 1.3 percent in the previous 12 months. Accelerating wage growth is not the sign of a deeply depressed labor market.

John Taylor, however, thinks the labor market is still incredibly weak:

Research by Christopher Erceg and Andrew Levin is providing solid evidence that the decline in the labor force participation rate since 2007 has been due to cyclical factors–the recession and slow recovery–rather than to demographic factors. In other words, the fact that such a large number of people have dropped out of the labor force is associated with the weak economy rather than to their reaching their retirement years–or some other typical demographic trend. Because the unemployment rate does not count the people who dropped out of the labor force it no longer gives a good reading of the state of the labor market. The unemployment rate would be much higher without this large decline in labor force participation.

Taylor shows the Erceg-Levin chart with unemployment adjusted for a “normal” labor force participation rate, which suggests an adjusted rate near 11%. He concludes:

There is no longer debate that the labor market performance in this recovery–and the recovery itself–is unusually weak. The debate is now over why. I have argued that it is the economic policy.

This is all fine but he didn’t say what economic policy should be doing. Does he still believe that Quantitative Easing should have been discontinued three years ago?

Minimum Wages and Macroeconomic Silliness

Mark Perry has a silly argument against raising the minimum wage, which thankfully David Cooper has ably addressed. The gist of Perry’s argument is captured by his title:

In Western Europe, the average jobless rate is twice as high in countries with a minimum wage vs. those with no minimum

Cooper replies:

First of all, as we learned in Statistics 101, there’s a difference between correlation and causation. Even if there appeared to be some pattern between minimum wages and unemployment, that wouldn’t mean that one is in any way causing the other. The only way to try to identify causality is to isolate as many—ideally all—other factors that might play a role in the suspected relationship through statistical regression methods … take a look at the countries that do have minimum wages. If minimum wage laws do lead to higher joblessness, as Perry suggests, one would expect that the higher the minimum wage, the higher the jobless rate. According to this table, that’s not the case in Western Europe. The figure below is a simple scatterplot of the minimum wage rates and the jobless rates from the table. As you can see, under the superficial approach that Dr. Perry is viewing these data, higher minimum wages actually imply lower jobless rates.

Note that Greece’s minimum wage is quite low and it has a 27.2% unemployment rate. On the other hand, Luxembourg has a very high minimum wage but its unemployment is quite modest. If we are playing this game, we could also look at the real minimum wage in the U.S. over time comparing it to our unemployment rate. After all – the real minimum wage peaked in 1968, which was also a year where the unemployment rate dropped to 3.4%. David Cooper is not suggesting that higher minimum wages tend to lower unemployment rate, but we are saying that Dr. Perry’s little exercise is silly.

Taylor Rule Follow-up: Core CPI Is Not Biased

Paul Krugman made a valuable contribution on measuring inflation in light of my post on the latest from John Taylor:

Or at least it seems to be a new rule — namely, pick whatever price index makes the point you want, even if it’s not at all the price index you would normally use … Um, the inflation rate for the “GDP price index”? That’s the GDP deflator, which the Fed very carefully does not use as a policy indicator. Why? Because it contains things like grain and oil prices, which fluctuate a lot, so that it’s an unstable measure that is highly unreliable as an indicator of underlying inflation. The Fed prefers the consumption deflator excluding food and energy.

Taylor has a heated reply but alas it is all heat and no light:

Rather than taking out food and energy price inflation I controlled for price volatility in that rule by averaging overall inflation over time. Simply taking out food and energy price inflation can lead to policy errors especially when such inflation lasts for more than a short time. And it is not only the overall GDP price level. The CPI inflation rate was also rising, not falling, during this period. In any case, the increase rather than a decrease in overall inflation was only one part of my assessment that this was not a slack period. I also discussed the unemployment rate—which got quite low (4.4%) rather than high as in slack periods—and the huge housing boom with high housing price inflation.

OK – inflation rose but only slightly. A 4.4% unemployment rate was certainly not low in comparison to what we witnessed in the late 1990’s. And it is odd that Dr. Taylor refused to acknowledge my point that the FED had already been increasing interest rates before the labor market got moderately over the Bush recession. As far as the housing boom – which President Bush used to brag about – a lot of the blame should go to unwise financial market deregulation – but I guess it would be political suicide for a Republican economist to acknowledge that. In my view, Krugman reader JCB had a more interesting – albeit invalid (as I will explain) – set of comments:

Does eliminating the most volatile categories of consumer expenditure such as food, energy, and home prices from the calculation of the year-on-year rate of inflation make it possible to ignore them as important elements of the long term standard of living? I mean, why tacitly assume that the most volatile prices will sum to zero in the long run? ... The cumulative divergence between all-consumer prices and "underlying inflation" increases between 2000-2013

JCB provided us with his evidence, which was a chart showing how core CPI rose by a cumulative amount of 32% over the 2000 to 2013 period whereas CPI (including food and energy) rose by a cumulative amount of 38% during this same period. This period has often been described as the great commodities boom as noted by Pedro Conceição and Heloisa Marone:

The trough, since when the 21st century boom started, took place in late 2001. In real terms (using the US CPI to deflate the nominal price series), the boom remains impressive, with indices more than doubling in real terms. However, real prices were still below the average prices of the 1970s and earlier decades (Figure 2).

If one compared core CPI to overall CPI for the period from 1979 to 2001, core CPI rose faster than the overall consumer price index. Over the entire period, both series have increased by about 228%. If JCB was trying to suggest a long-term bias in the use of core CPI, I don’t see it. Rather – I just see more volatility in the use of an index that includes food and energy prices.

John Taylor on Monetary Policy and Inflation

If you were expecting John Taylor to address what Barry Ritholtz noted about that 2010 prediction of inflation, stop holding your breath. Taylor instead tried a rebuttal to the latest from Lawrence Summers. Taylor’s summary of Summer’s argument starts with this:

In the years before the crisis and recession, easy money and related regulatory policies should have shown up in demand pressures, rising inflation, and boom-like conditions. But the economy failed to overheat and there was significant slack.

Taylor of late has been saying that our current mess was created by a deviation from the Taylor rule. Here’s his evidence:

Inflation was not steady or falling during the easy money period from 2003-2005. It was rising. During the years from 2003 to 2005, when Fed’s interest rate was too low, the inflation rate for the GDP price index doubled from 1.7% to 3.4% per year. On top of that there was an extraordinary inflation and boom in the housing market as demand for homes skyrocketed and home price inflation took off, exacerbated by the low interest rate and regulatory policy. Finally, the unemployment rate got as low as 4.4% well below the natural rate, not a sign of slack.

Wow – hyperinflation! No one during the Bush Administration – its advisors (which included Taylor) nor its critics – were saying back then that the employment to population ratio had become dangerously high. The 4.4% unemployment rate – which corresponds to a 63.4% employment to population ratio – was not reached until late 2006. By then, we had seen two years of rising short-term interest rates. Now had Taylor and his fellow Bush economic advisors were very concerned about excessive aggregate demand – why did we not seen calls for fiscal restraint back then? If Taylor thinks this is a serious rebuttal to what Summers said, it is no surprise he has yet to acknowledge that 2010 forecast of inflation from QE.

The Consol Solution To The Debt Ceiling Crisis

Yeah, I know.  It is not currently a crisis.  That is Obamacare, blah blah blah.  But that website will get fixed and those who lost their crappy insurance policies will get them extended, blah blah blah.  The remaining serious crisis that could still plunge the world economy into a massive economic plunge, even with the very wise and capable Janet Yellen at the helm of the US Fed, would be a US default on its debt following a failure to raise the debt ceiling in time, with the most likely scenario for this being increasingly delusional Congressional GOPsters out to destroy the economy so they can get elected blaming it all on socialist Obamacare, blah blah blah.  Probably wise heads, or at least not completely delusional ones, will prevail, but the fury and delusions in the weird sub-media bubble of the teabags seems to be intensifying.

Now quite a few of us, including such folks as Bill Clinton, Bruce Bartlett, me, and a lot of others, have said that how Barack Obama should deal with this once and for all for all future presidents and the US and world economies, is to declare this motherfucker of a debt ceiling unconstitutional, which it is, even if a GOP dominated SCOTUS might disagree.  But one of them might realize the threat and support reason on it, if faced with the prospect of a massive global economic collapse as bad as anything ever seen.  In any case, Obama has not followed our advice, and given that he pulled off the latest crisis with only the most minor of market blips may be making him complacent, as well as his enemies, who likewise given the lack of market fear (for once ratex worked; they forecast the ceiling would be raised and it was), may not be held back and may take us over the brink.  It is much more likely than most today think.

So, in yesterday's (Nov. 15) Washington Post in its Friday forum, there is an innovative and interesting column on this issue by James Leitner and Ian Shapiro, "A new tool to avert a debt crisis," and I completely agree with them and wish to publicize this alternative tool to those that Obama has rejected (there is also the goofy trillion dollar platinum coin alternative, which both the Treasury and Fed have publicly declared they will not go along with).  This solution is to issue consols if the Congress foolishly refuses to raise the debt ceiling in the nest round of this silliness coming up early next year.

The column taught me things I did not know.  The term "consol" is short for "consolidated," and sometime in the 1700s the UK consolidated a bunch of long-term bonds. Then in the 1800s they began to issue the actual consols, bonds with infinite maturity, public "annuities" if you will.  They just pay interest forever.  Quite a few were issued in the heyday of British domination of the world economy in the Pax Brittanica of 1815-1914.  Some were retired, but according to Leitner and Shapiro some still exist in the UK government portfolio, still paying their interest.  Of course in fin econ textbooks they are the real world example for that nice simple back of the envelope formula that is also relevant for real estate that says that PV = NR/r, where PV is present value, NR is a constant real net return forever, and r is the real interest rate or discount rate for this most basic of present value calculations.

Anyway, Leitner and Shapiro point out a curious detail of how the US legally measures the national debt: only bonds with finite maturities add to it.  So, if the debt ceiling is hit, the US Treasury could issue consols that will not legally add to the national debt.  The US Treasury will be able to continue to borrow money and pay bills and avoid defaulting while not legally adding to the national debt.

OK OK, there is a dark side, and I give them credit for recognizing it.  These consols may require higher interest rates than other US government securities, in violation of the usual pattern that longer term securities provide lower yields.  They suggest that if Obama is forced to issue these at higher than usual interest rates he publicize how much these are costing taxpayers and blame it publicly and loudly on the reprobate Congresstrolls.  The only further thing they suggest is that the Treasury get at issuing a few soon to get a target interest rate and prepare everybody.  I completely agree.