Confessions of a Supply-Side Liberal

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David Beckworth: “Miles and Scott’s Excellent Adventure”

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Link to the post on David Beckworth’s blog

David Beckworth was kind enough to give me permission to mirror this post as a guest post on this blog. Here it is:

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A journalist recently reminded me of how important the blogosphere has become for shaping conversations on macroeconomic policy. Everything from TARP to shadow banking to quantitative easing have been vetted in the blogosphere over the past few years. Often these conversations have influenced policymaking. Paul Krugman recently commented on this development:

[T]here has been a major erosion of the old norms. It used to be the case that to have a role in the economics discourse you had to have formal credentials and a position of authority; you had to be a tenured professor at a top school publishing in top journals, or a senior government official. Today the ongoing discourse, especially in macroeconomics, is much more free-form…at this point the real discussion in macro, and to a lesser extent in other fields, is taking place in the econoblogosphere…

Alex Tabarrok made a similar point at an AEA meeting when he said the blogosphere has become the “first place for policy debate and policy development.” There are many examples of this, but here I want to recognize two potential solutions to the zero lower bound (ZLB) problem that got a wide hearing because of the blogosphere. These solutions were not new, but because of blogging and the personalities behind them, they became more widely understood and influenced policy.

The two solutions are implementing negative policy interest rates via electronic money and nominal GDP level targeting (NGDPLT). Miles Kimball pushed the former while Scott Sumner was behind the latter. Both individuals first pushed these ideas in the blogosphere. Miles Kimball’s idea spread rapidly from his blog to other media outlets to central banks where he made multiple presentations to monetary authorities. Arguably, the Fed and ECB officials began talking more seriously about negative interest rates because of his efforts. Scott Sumner’s relentless efforts for NGDPLT also began on his blog and are considered by many to be the reason the Fed finally did QE3, a large scale-asset purchasing program tied to the state of the economy.  Miles and Scott’s success is a testament to their hard work, but also to disruptive technology that is the blogosphere.

I bring up their contributions, because they provide a nice conclusion to my previous two posts that looked at the ZLB. In those posts I looked at the claim that slump has persisted for so long because the nominal short-term natural interest rate has been negative while the actual short-term interest rate has been stuck near zero. It is stuck near zero because individuals would rather hold paper currency at zero percent than to invest their money at a negative interest rate. The ZLB is preventing short-term interest rates from reaching their output-market clearing level. The long slump is the result. Miles and Scott both have a solution for this problem. Unsurprisingly, both view the ZLB as a self-imposed constraint that can be easily fixed.

There are two key parts to Miles Kimball’s solution. The first part is to make electronic money or deposits the sole unit of account. Everything else would be priced in terms of electronic dollars, including paper dollars. The second part is that the fixed exchange rate that now exists between deposits and paper dollars would become variable. This crawling peg between deposits and paper currency would be based on the state of the economy. When the economy was in a slump and the central bank needed to set negative interest rates to restore full employment, the peg would adjust so that paper currency would lose value relative to electronic money. This would prevent folks from rushing to paper currency as interest rates turned negative. Once the economy started improving, the crawling peg would start adjusting toward parity. More details on his proposal can be found here.

There is much to like about his proposal. It is effectively how a free-banking, profit maximizing system would solve the ZLB, as shown by JP Koning. Holding risk constant, it would move all interest rates down and maintain spreads so that financial intermediation would not be disrupted. It would also eliminate the illusion that liquid short-term debt contracts are risk-free. Most importantly, it would allow short-tern nominal interest rates to better track their natural interest rate level.1

The figure below shows how how Miles Kimball’s solution would provide an escape route from the ZLB problem. It shows a situation where there is a negative output gap and a  negative short-turn nominal natural interest rate. Miles would have the Fed would lower its policy interest rate down to the natural interest level at time t. The output gap would start to close and consequently, the natural interest rate would start to rise. The Fed would follow suit and start raising its policy interest rate in line with the natural rate. Eventually, the economy would return to full employment and the nominal interest rates would settle at their long-run values (which typically are positive). The escape from the ZLB would be complete.

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Scott Sumner’s solution to the ZLB provides another escape route from the ZLB. His approach is to “shock and awe” the economy with a regime change to monetary policy that would catalyze a sharp recovery. This recovery would pull the natural interest rate back into positive territory and eliminate the ZLB problem. Scott would implement his “shock and awe” program by having the Fed announce a NGDPLT (or total dollar spending target) and credibly committing to do whatever it takes to make it happen. 

This amounts to the Fed committing to a permanent expansion of the monetary base, if needed. That is, a NGDPLT creates the expectation that if the market itself does not self correct through a higher velocity of base money, then the Fed will raise the  amount of monetary base as needed to hit higher level of NGDP. If credible, this becomes a self-fulfilling expectation with the market itself doing most of the heavy lifting. In other words, the regime changewould spark a major portfolio rebalancing away away from highly liquid, low-yielding assets towards less liquid, higher yielding assets. The portfolio rebalancing would raise asset prices, lower risk premiums, increase financial intermediation, spur more investment spending, and ultimately catalyze a robust recovery in aggregate demand. It would be similar in spirit to what monetary policy portion of Abenomics is now doing in Japan. 

The figure below shows how Scott’s solution would provide an escape route from the ZLB. Like before, the figure shows a negative output gap and short-run nominal natural interest rate that is negative. At time t, Scott would have the Fed introduce NGDPLT. The output gap would begin shrinking and put upward pressure on the natural interest rate. Eventually the natural interest rate would broach zero and the Fed would have to start raising its policy rate in line with it. Finally the economy would return to full employment and the natural interest rate to its long-run positive value. The escape from the ZLB would be complete.2

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So these are the two solutions to the ZLB problem. They have received a wide hearing and to some extent influenced policymaking because of Miles and Scott’s efforts in the blogosphere. Thanks to this disruptive technology and the conversations it started the world is a better place.

1Bill Woolsey has a similar proposal. He would  transfer paper currency production to private banks and allow them to determine whether they want to produce paper money. Private banks would then determine the exchange rate between deposits and paper currency. 

2To be clear, Scott Sumner would do away with interest rate targeting altogether and his push for NGDPLT is more than about escaping the ZLB. It is about setting up a credible and effective target for monetary policy. I too am a big proponent of NGDPLT for this reason.

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Noah Smith: Heroes of Blogging

This was a very interesting post by Noah, even before he added me, as explained in these two tweets.

Noah says some very nice things about me. I thought about copying them out here, but that thought triggered (at least temporarily) even my sorely underdeveloped inhibitions about bragging; so you will have to click the link in the post title to see them, along with Noah’s other Heroes of blogging. 

Let me say conversely that Noah is definitely one of my blogging heroes. In fact, there is no blog I would rather read than Noah’s.  

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Dylan Matthews: The Only Kid’s Book You Need to Understand the Federal Reserve

I was delighted to see Dylan Matthews featuring in Wonkblog the children’s monetary policy storybook Donna D’Souza and I put together. Dylan accompanied the storybook with these very kind words:

Miles Kimball is one of the most consistently creative economists working these days, and so it’s our luck that he’s taken to writing for a popular audience. His latest work is a foray into kid’s lit, summarizing the basics of how central banks respond to economic downturns in a children’s coloring book (see above).

I have made an effort to promote our storybook in a new medium: with my daughter Diana’s technical assistance, I made and posted three YouTube videos of the storybook:

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The Red Banker on Supply-Side Liberalism

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Icon for the Red Banker blog (which also appears in Wikipedia article on the "Commercial Revolution")

Frederic Mari blogs as the Red Banker. He gives a positive take on my first post "What is a Supply-Side Liberal?" in his post "Supply Side Liberalism: The Interesting Case of Dr. Kimball and Mr. Miles." However, Frederic questions whether limited government is politically possible, saying

People oppose government spending but support all of its public good provision.

Here I wished he had discussed my central proposal for keeping the burden of taxation down while providing abundant public goods: a public contribution system that raises taxes rates, but lets people avoid 100% of the extra taxes by making charitable donations focused on doing things the government might otherwise have to do. These two posts lay out how a public contribution system would work: 

Also, my post 

is best understood in this context.  

I discuss a few other ideas for how to reduce the burden of taxation based on the ways in which human psychology departs from over-simplified views of homo economicus in this popular post: 

The bottom line is this: In my book, it isn’t Supply-Side Liberalism without a serious effort to lower the burden of taxation for any given level of revenue, using everything we know about human nature. 

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Top 200 Influential Economics Blogs: Aug 2013 | Onalytica Indexes

Confession of a Supply-Side Liberal is ranked 61st in this list of influential economics blogs. That seem pretty good to me, since the readership of my columns on Quartz itself would not be counted. On that score, note that at the end of June 2012, just a month after I started blogging, Confessions of a Supply-Side Liberal was ranked 31st. 

On the decline in ranking since the last list, Andreea Moldovan makes this note:

We have recently added some very well-known and influential blogs such as EconomixFT Alphaville and Vox, causing most blogs to go down in ranking.

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Noah Smith Joins My Debate with Paul Krugman: Debt, National Lines of Credit, and Politics

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Paul Krugman’s graph of the debt/GDP ratio against interest rates

Update: You can see what I have to say in the wake of Thomas Herndon, Michael Ash and Robert Pollin’s critique of Carmen Reinhart and Ken Rogoff’s work on national debt and growth in my column "An economists mea culpa: I relied on Reinhart and Rogoff." (You can see my same-day reaction here.) Also, on the substance, see Owen Zidar’s nice graph in his post "Debt to GDP & Future Economic Growth." I sent a query to Carmen Reinhart and Ken Rogoff about whether any adjustments are needed to the two figures from the paper with Vincent Reinhart that I display below, but have not yet received a reply to that query. I think that covers most of the issues that recent revelations raise. 

Note that I have revised "What Paul Krugman got wrong about Italy’s economy." This post is now the go-to source for what I originally said there, relying on “Debt Overhangs, Past and Present” (which has Vincent Reinhart as a coauthor along with Carmen Reinhart and Ken Rogoff). My original passage is in an indented block a little above the colorful pictures your eye will be drawn to below.

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In a world where people wrote frankly, Noah Smith has written the response to my Quartz column "What Paul Krugman got wrong about Italy’s economy" that Paul Krugman should have written: 

instead of what Paul actually wrote in response to my column:

(The brief summary of my column is that electronic money could help the UK and the Federal Lines of Credit could help both Italy and the UK stimulate their economies without the problems that might arise from adding substantially to their debt by a simple increase in government spending, as indicated by my original title: “How Italy and the UK Can Stimulate Their Economies Without Further Damaging Their Credit Ratings.”)

Read more …

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