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Thursday, April 11, 2024

My r* Concerns

I recently wrote about r*, which is now the preferred way to refer to the “neutral” or “natural rate” of interest (in real terms). Although my concerns appear hand-wavy, there is a way of expressing them mathematically. I have discussed this in the past, but I hope this version is cleaner.

The first thing to note is that there are multiple ways of estimating r*. I am not too concerned about which one is used, since the ones that I have seen share an important property, which I will shortly describe.

Thursday, April 4, 2024

BIS r* Paper

The BIS Quarterly Review had a recent paper on r* (the preferred term for the “natural rate of interest”) by Benigno, Gianluca, Boris Hofmann, Galo Nuño Barrau, and Damiano Sandri. “Quo vadis, r*? The natural rate of interest after the pandemic.

This paper is an example of why I have largely given up on the DSGE literature. From my perspective, the contents may be summarised as:

  1. The authors describe r*, which is a necessary empirical complement to the dynamic stochastic general equilibrium (DSGE) literature. The DSGE literature assumes that the policy rate (and its expected path) are a key driver to macroeconomic dynamics. The value of r* is required to both assess the accuracy of the models, as well as to provide a guidepost to policy.

  2. They then look at a variety of estimates of r*, and note that they have all moved dramatically as a consequence of the pandemic and the monetary policy response to it.

  3. They discuss various theories as to why r* may have gone up, or possibly down.

  4. They then note that the uncertainty about r* should be taken into account when looking at policy.

Wednesday, April 3, 2024

In Defence Of Discrete Time Models

Steve Keen recently wrote “I’m not Discreet, and Neither is Time” in which he discusses the alleged defects of discrete time models as opposed to continuous time ones.

(In discrete time, the model state is defined on a time axis that can be labelled as integers: step 1, step 2, etc. In a continuous time, a model’s time axis is the real axis. A discrete time model can be thought of as being defined by difference equations, while continuous time is normally defined by differential equations.)

Thursday, March 28, 2024

Comments On Asset Prices And Inflation Targeting

This is an unedited manuscript excerpt, from a chapter that discusses how asset price changes relate to inflation.

Even if one believes that asset price increases represent inflation, the general reaction among North American central bankers would be to think you are crazy if you think asset prices should be included within an inflation target mandate. (I am less sure about the reaction of Continental European central bankers.) Although they might accept that exuberance in financial markets should be toned down, targeting asset prices directly poses many problems.

Tuesday, March 26, 2024

Late Central Bank Comments

Since I am still chugging away with edits, I have not been spending much time watching developments in markets. I just wanted to off some brief comments on events from central banks last week. I have a longer manuscript section for publication later this week.

Monday, March 18, 2024

Macro N Cheese Podcast - Inflation

I was recently on a podcast with Steven D. Grumbine to discuss inflation. Link:

The podcast description from the webpage is.

“Inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”

Milton Friedman

This quote by the grandaddy of neoliberal economics is from 1963. Some in the mainstream have been dining out on it ever since.

According to our guest, author and blogger Brian Romanchuk, neoclassical economics relies on mathematical models and fail to capture the complexity of real-world inflation. He highlights the importance of understanding the supply and demand dynamics in setting prices and explains that inflation can be influenced by factors such as supply chain shocks and changes in the labor market.

Brian also points out that it’s not enough to blame inflation on corporate greed; after all, corporations are always driven to maximize profits. He mentions the Cantillon effect, which suggests that the first recipients of newly created money benefit from inflation as prices go up, while the poor and working class bear the brunt of higher prices down the road.

Brian and Steve discuss inflation constraints on fiscal policy. Brian argues that while extreme fiscal policies could lead to inflation, most of the time, fiscal policy is relatively moderate and does not have a significant impact on inflation. They criticize the government for not trying to set prices and argue that the government often follows the private sector’s lead, making things worse.

This is a discussion of some topics around inflation. Although some of the discussion related to the concerns of my book, a lot of it relates to some of the recent political economy controversies with inflation. It was fun, although I am not sure how well suited I am to the podcast format.

Otherwise, I have been plugging away at fixing weak points in my inflation manuscript. Rather than waste reader’s time by rushing out some random comment, you are encouraged to get your dose of Romanchuk (and Grumbine) content via the podcast.

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(c) Brian Romanchuk 2024

Thursday, March 7, 2024

"The Debt Crisis Is Here": The Conference Board Is At It Again

The Committee for Economic Development (CED) of Conference Board recently put out “Explainer: The National Debt” which is pretty much a greatest hits of debt scare mongering. Other than the references to recent events and data, it is timeless: the authors could have put out the same report in any year since the mid-1980s and not much of the contents would have changed. Anyone who thinks that the MMT debate would improve things just needs to read the report to see that progress in conventional economics is largely illusionary.

The shtick of the “explainer” is that “the fiscal crisis is here.” The evidence is everybody’s favourite time series: the debt/GDP ratio (above).

I will immediately note that the United States does face a crisis: its ability to govern itself appears to have collapsed. Getting the budget process to work when one party of a two party system wants to burn the system to the ground is obviously difficult. What type of dysfunction the United States will have after November depends upon the electoral results (and whether a certain party would accept those results).

The “Analysis”

The report runs through the basics of fiscal policy, and the various categories of spending.

Comparing the national debt to GDP (Figure 5) produces a ratio that reveals the United States’ ability to pay down its debt. The debt-to-GDP ratio shows the burden of the national debt relative to the country’s total economic output and can provide greater context than looking at total debt numbers alone. Based on examples from international financial institutions, the recent past, and econometric analysis, CED recommends a public debt-to-GDP ratio of no higher than 70 percent as a stable and sustainable level of debt burden. The European Union requires member states to limit government debt to 60 percent of GDP as a condition for joining the euro, and a World Bank analysis finds 77 percent as the threshold at which debt begins to impede economic growth in developed countries. CED’s recommendation is roughly in the middle of this reference frame.

The CED thus declares the U.S. debt unsustainable based on (a) a number pulled out of the nether regions of Eurocrats and (b) a number from a report that undoubtedly reversed the causality between high debt/GDP ratios and low nominal GDP growth rates.

When we compare the magic “unsustainable 70% debt/GDP limit” to Japan’s history, we see an immediate problem. Of course, the authors of the report explain this as being due to high personal savings rates, and Japanese growth was slow. Given the rather low levels of JGB yields, it is hard to see how the debt levels impeded growth.

Yeah, The 1980s

What stands out to me is the following passage.

After the economic turmoil of the 1970s, President Reagan entered office in 1981 promising to tackle inflation and the budget deficit. While inflation did come down, the Federal government also ran high deficits because of tax cuts and significant increases in military spending that were not matched by cuts in other areas of discretionary or mandatory spending. Nevertheless, economic growth was relatively strong, which tempered the rise of the debt-to-GDP ratio in the 1980s to 39 percent of GDP by 1989.

If we look at the chart I provide at the top of the article, we get a somewhat different view of the debt/GDP situation in that era. The debt/GDP ratio hit its lowest level during the peak inflation period around 1980. Rapid nominal GDP growth crushes the debt/GDP ratio courtesy of how division works.

If we accept the MMT premise that the sustainability risk associated with fiscal policy is inflation, then the debt/GDP ratio is an anti-indicator: it falls when inflation rises.

Interest Costs

The discussion of interest costs also underlines the incoherence of conventional thinking: interest costs are rising because the central bank is raising rates because it wants lower inflation. Yet those rate hikes represent an inflation risk.

Outlook Is Concerning Because the U.S. Federal Government is Adrift

Hand-wringing about discretionary versus non-discretionary spending is just political cover for fiscal conservatives to demand cuts to the welfare state. To the extent that there is a fiscal problem, tax hikes are also a solution. The inability of the U.S. Federal Government to run a budgetary process in a sane fashion is always going to be an issue.

Fiscal policy was forced into extraordinary measures by the unusual nature of the pandemic. There was an inflationary bump — but no lost decade afterward. If fiscal policy is structurally loose, there might be future tightening measures needed. However, it is unlikely that the U.S. can approach that prospect in a sane fashion.

Concluding Remarks

It is very easy to respond to such reports by fiscal conservatives. They keep publishing the same report, and I keep publishing the same response.

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(c) Brian Romanchuk 2024