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Why Financial Markets’ New Exuberance Is Irrational
Nov 20, 2019 NOURIEL ROUBINI
Owing to a recent easing of both Sino-American tensions and monetary policies, many investors seem to be betting on another era of expansion for the global economy. But they would do well to remember that the fundamental risks to growth remain, and are actually getting worse.

NEW YORK – This past May and August, escalations in the trade and technology conflict between the United States and China rattled stock markets and pushed bond yields to historic lows. But that was then: since then, financial markets have once again become giddy. US and other equities are trending toward new highs, and there is even talk of a potential “melt-up” in equity values. The financial-market buzz has seized on the possibility of a “reflation trade,” in the hope that the recent global slowdown will be followed in 2020 by accelerating growth and firmer inflation (which helps profits and risky assets).

The sudden shift from risk-off to risk-on reflects four positive developments. First, the US and China are likely to reach a “phase-one” deal that would at least temporarily halt any further escalation of their trade and technology war. Second, despite the uncertainty surrounding the United Kingdom’s election on December 12, Prime Minister Boris Johnson has at least managed to secure a tentative “soft Brexit” deal with the EU, and the chances of the UK crashing out of the bloc have been substantially reduced.1

Third, the US has demonstrated restraint in the face of Iranian provocations in the Middle East, with President Donald Trump realizing that surgical strikes against that country could result in a full-scale war and severe oil-price spike. And, lastly, the US Federal Reserve, the European Central Bank, and other major central banks have gotten ahead of geopolitical headwinds by easing monetary policies. With central banks once again coming to the rescue, even minor “green shoots” – such as the stabilization of the US manufacturing sector and the resilience of services and consumption growth – have been taken as a harbinger of renewed global expansion.

Yet there is much to suggest that not all is well with the global economy. For starters, recent data from China, Germany, and Japan suggest that the slowdown is still ongoing, even if its pace has become less severe.

Second, while the US and China may agree to a truce, the ongoing decoupling of the world’s two largest economies will almost certainly accelerate again after the US election next November. In the medium to long term, the best one can hope for is that the looming cold war will not turn hot.

Third, while China has shown restraint in confronting the popular uprising in Hong Kong, the situation in the city is worsening, making a forceful crackdown likely in 2020. Among other things, a militarized Chinese response could derail any trade deal with the US and shock financial markets, as well as push Taiwan in the direction of forces supporting independence – a red line for Beijing.

Fourth, although a “hard Brexit” may be off the table, the eurozone is experiencing a deepening malaise that is not related to the UK’s impending departure. Germany and other countries with fiscal space continue to resist demands for stimulus. Worse, the ECB’s new president, Christine Lagarde, will most likely be unable to provide much more in the way of monetary-policy stimulus, given that one-third of the ECB Governing Council already opposes the current round of easing.

Beyond challenges stemming from an aging population, weakening Chinese demand, and the costs of meeting new emissions standards, Europe also remains vulnerable to Trump’s oft-repeated threat to impose import tariffs on German and other European cars. And key European economies – not least Germany, Spain, France, and Italy – are experiencing political ructions that could translate into economic trouble.

Fifth, with crippling US-led sanctions now fueling street riots, the Iranian regime will see no other choice but to continue fomenting instability in the wider region, in order to raise the costs of America’s current approach. The Middle East is already in turmoil. Massive protests have erupted in Iraq and Lebanon, a country that is effectively bankrupt and at risk of a currency, sovereign-debt, and banking crisis. In the current political vacuum there, the Iranian-backed Hezbollah could decide to attack Israel. Turkey’s incursion into Syria has introduced many new risks, including to the supply of oil from Iraqi Kurdistan. Yemen’s civil war has no end in sight. And Israel is currently without a government. The region is a powder keg; an explosion could trigger an oil shock and a renewed risk-off episode.

Sixth, central banks are reaching the limits of what they can do to backstop the economy, and fiscal policy remains constrained by politics and high debts. To be sure, policymakers could turn to even more unconventional policies – namely, monetized fiscal deficits – whenever another downturn occurs, but they will not do so until the next crisis is already severe.1

Seventh, the populist backlash against globalization, trade, migration, and technology is worsening in many places. In a race to the bottom, more countries may pursue policies to restrict the movement of goods, capital, labor, technology, and data. While recent mass protests in Bolivia, Chile, Ecuador, Egypt, France, Spain, Hong Kong, Indonesia, Iraq, Iran, and Lebanon reflect a variety of causes, all are experiencing economic malaise and rising political resentment over inequality and other issues.

Eighth, the US under Trump may become the biggest source of uncertainty. Trump’s “America First” trade foreign policies risk destroying the international order that the US and its allies created after WWII. Some in Europe – like French President Emmanuel Macron – worry that NATO is now comatose, while the US is provoking rather than supporting its Asian allies, such as Japan and South Korea. At home, the impeachment process will lead to even more bipartisan gridlock and warfare, and some Democrats running for the party nomination have policy platforms that are making financial markets nervous.

Finally, medium-term trends may cause still more economic damage and disruption: demographic aging in advanced economies and emerging markets will inevitably reduce potential growth, and restrictions on migration will make the problem worse. Climate change is already causing costly economic damage as extreme weather events become more frequent, virulent, and destructive. And while technological innovation may expand the size of the economic pie in the long run, artificial intelligence and automation will first disrupt jobs, firms, and entire industries, exacerbating already high levels of inequality. Whenever the next severe downturn occurs, high and rising private and public debts will prove unsustainable, triggering a wave of disorderly defaults and bankruptcies.

The disconnect between financial markets and the real economy is becoming more pronounced. Investors are happily focusing on the attenuation of some short-term tail risks, and on central banks’ return to monetary-policy easing. But the fundamental risks to the global economy remain. In fact, from a medium-term perspective, they are actually getting worse.

he Economic Consequences of Automation

Sep 18, 2019 ROBERT SKIDELSKY

Economic theory does not provide a clear answer regarding the overall impact of technological progress on jobs. And even if automation has traditionally been beneficial in the long run, policymakers should never ignore its disruptive short-term effects on workers.

LONDON – While Brexit captures the headlines in the United Kingdom and elsewhere, the silent march of automation continues. Most economists view this trend favorably: technology, they say, may destroy jobs in the short run, but it creates new and better jobs in the longer term.

The destruction of jobs is clear and direct: a firm automates a conveyor belt, supermarket checkout, or delivery system, keeps one-tenth of the workforce as supervisors, and fires the rest. But what happens after that is far less obvious.

The standard economic argument is that workers affected by automation will initially lose their jobs, but the population as a whole will subsequently be compensated. For example, the Nobel laureate economist Christopher Pissarides and Jacques Bughin of the McKinsey Global Institute argue that higher productivity resulting from automation “implies faster economic growth, more consumer spending, increased labor demand, and thus greater job creation.”

But this theory of compensation is far too abstract. For starters, we need to distinguish between “labor-saving” and “labor-augmenting” innovation. Product innovation, such as the introduction of the automobile or mobile phone, is labor-augmenting. By contrast, process innovation, or the introduction of an improved production method, is labor-saving, because it enables firms to produce the same quantity of an existing good or service with fewer workers.

True, new jobs created by product innovation may be offset by a “substitution effect,” as the success of a new product causes the labor employed in producing an old one to become redundant. But the biggest challenge comes from process innovation, because this only ever displaces jobs, and does not create new ones. Where process innovation is dominant, only compensatory mechanisms can help to prevent rising unemployment, or what the British economist David Ricardo called the “redundancy” of the population.1

There are several such mechanisms. First, increased profits will lead to further investment in new technology, and hence new products. In addition, competition between firms will lead to a general reduction in prices, increasing demand for products and hence labor. Finally, the reduction in wages caused by initial technological unemployment will increase demand for labor and induce a shift back to more labor-intensive methods of production, soaking up the redundant workers.2

How quickly these compensation mechanisms operate will depend on how easily capital and labor move between occupations and regions. The introduction of labor-saving technology will result in lower prices, but it will also reduce consumption by workers who are made redundant. It is then a question of which effect is faster. Keynesian economists argue that the fall in demand for goods resulting from unemployment will precede, and thus dominate, the reduction in prices resulting from automation. This will lead to a further increase in joblessness, at least in the short run.

Moreover, even if such job losses were only a short-run phenomenon, the cumulative effect of a series of labor-saving innovations over time could create long-term unemployment. Furthermore, an effective price-adjustment mechanism presumes the general prevalence of competition. But in an oligopolistic market, a firm may use its cost savings to boost profits rather than reduce prices.

Such considerations buttress the contemporary view that the benefits of automation are long term, with “redundancy” set to rise during a “transitional period.” But when the transition may last for decades, as a recent McKinsey Global Institute report acknowledges, it is hardly surprising that workers are skeptical of this slew of compensation arguments.

Karl Marx argued that no such compensatory processes existed, either in the short or long run. The story he told therefore has no happy ending for the workers – at least not under capitalism.

Marx said that competition forces individual firms to invest as much of their profits as possible in labor-saving – that is, cost-cutting – machinery. But increased mechanization doesn’t benefit capitalists as a class. True, the first mover enjoys a temporary advantage by “rushing down on declining average-cost curves,” as Joseph Schumpeter put it in his History of Economic Analysis, and annihilating weaker firms in the process. But competition then diffuses the new technology and rapidly eliminates any temporary super-profit.

Restoring the rate of profit, Marx argued, requires an increasingly large “reserve army of the unemployed.” Thus, he wrote, mechanization “threw laborers on the pavement.” For Marx, unemployment is essentially technological in nature. And although the reserve army is temporarily absorbed into the labor force during bursts of high prosperity, its continued existence leads to ever-increasing pauperization in the long run.

For Marx, therefore, the long-run sequence of events was exactly the opposite of the orthodox view: mechanization creates febrile prosperity in the short run, but at the cost of long-term degradation.

The distributional effects of technological change have long featured prominently in discussions among economists. In his 1932 book The Theory of Wages, John Hicks developed the idea of induced innovation. He argued that higher wages, by threatening the profit rate, would impel businesses to economize on the use of labor because this factor of production was now relatively more expensive. Automation of the economy is therefore not simply the result of increased computing power, à la Moore’s Law, but depends on changes in the relative cost of labor and capital.

These are technically complicated arguments. But economic theory evidently does not provide a clear answer regarding the long-term effect of technological progress on employment. The best conclusion we can draw is that the impact will depend on the balance between product and process innovation, and on factors such as the state of demand, the degree of competition in the market, and the balance of power between capital and labor.

These are all important areas in which governments can intervene. Even if automation has traditionally been beneficial in the long run, policymakers should not ignore its disruptive short-run effects. The short run, after all, is where historical horrors happen.

The Fall of the Berlin Wall and Social Democracy

Nov 13, 2019 DARON ACEMOGLU

The fall of the Berlin Wall heralded not only the collapse of communism in Europe, but also the destruction of a broader – and far more constructive – social-democratic compact. To prevent a return to extremism and instability, that compact must be refashioned for the twenty-first century.

CAMBRIDGE – It was already clear 30 years ago that the fall of the Berlin Wall would change everything. But precisely what that change will mean for world politics in the twenty-first century still remains to be seen.

By 1989, the Soviet Union, and communism generally, had condemned tens of millions of people to poverty, and had clearly failed to compete with the Western economic model. Over four decades, the Cold War had taken millions of lives in various theaters around the world (where the conflict was much hotter than its name suggests), and created a pretext for repression and elite dominance in dozens of countries across Latin America, Africa, and Asia.

Yet for all its positive implications, the post-Cold War era also upended the Western social-democratic compact: the system of safety nets, regulations, universal public services, redistributive tax policies, and labor-market institutions that had long protected workers and the less fortunate. According to the political scientist Ralf Dahrendorf (as quoted by the late Tony Judt), that policy consensus had signified “the greatest progress which history has seen so far.” Not only had it limited and then reduced inequality in most advanced economies; it also contributed to decades of sustained growth.

The economic growth of the post-war era was born of broadly competitive markets, which had been created through regulations to break the backs of monopolies and powerful conglomerates. It also depended on a generously supported system of public education and government-funded innovation. The proliferation of high-paying good jobs during this period was the result of labor-market institutions that prevented employers from wielding excessive powers over their employees; without such constraints, firms would have generated low-wage jobs with harsh working conditions.

Social democracy played an equally important role in politics. Its redistributive institutions and welfare-state programs could not have survived without non-elites wielding political power. Broad-based political participation was achieved through reforms to expand the franchise and deepen democratic processes. It was supported by powerful political parties, such as the Swedish Workers’ Party, and trade unions. And it was driven by universalist ideas that motivated people to support and defend democracy.

In many ways, the United States was no different from its Western European counterparts. Throughout the New Deal and post-war eras, it enthusiastically busted trusts and reined in the political influence of the wealthy. It instituted government-administered old-age and disability pensions (Social Security), unemployment benefits, and redistributive taxation, and adopted various anti-poverty measures. While deploying anti-socialist language, it nonetheless adopted social democracy with American characteristics – which meant, among other things, that its social safety net was weaker than in other countries.

None of this can be understood in the absence of communism. After all, social-democratic movements emerged from communist parties, many of which – including the Social Democrats in post-war Germany and the French Socialist Party – did not abandon socialist rhetoric until well into the 1960s, or even the 1980s. While the parties that proved most successful in creating new labor-market institutions, securing high-quality public services, and reaching a broad social consensus, such as the Swedish Workers’ Party or the British Labour Party, had typically repudiated their earlier Marxism, they still spoke the same language as their Marxist cousins.

More to the point, elites themselves embraced the social-democratic compact as a means of preventing communist revolution. It was this anti-communist mode of social democracy that motivated intellectuals such as the economist John Maynard Keynes, one of the architects of the post-war order, and political leaders from Presidents Franklin D. Roosevelt to John F. Kennedy and Lyndon B. Johnson in the US. Similarly, the threat of communism (from North Korea) drove South Korean leaders to pursue ambitious land reforms and investments in education, while tolerating some degree of union activity despite their desire to keep wages low.

But when communism collapsed – both as an economic system and as an ideology – it knocked the legs out from under the social-democratic stool. Suddenly faced with the need to invent a new, equally inclusive, equally universalist ideology, the left proved unequal to the task. And at the same time, the leaders of an already ascendant right interpreted the collapse of communism as a signal (and an opportunity) to roll back social democracy in favor of the market.

Yet, for a number of reasons, the embrace of this agenda in much of the West was mistaken. For starters, it ignored the contribution that the welfare state, labor-market institutions, and government investments in research and development had made to post-war growth. Second, it failed to anticipate that dismantling social-democratic institutions would weaken democracy itself, by further empowering incumbent politicians and the wealthy (who would become much wealthier in the process). And, third, it ignored the lessons of the interwar years, when the absence of broad-based economic opportunities and strong safety nets had created the conditions for the rise of left- and right-wing extremism.

US President Ronald Reagan and British Prime Minister Margaret Thatcher may have envisioned a world with more efficient markets and less bureaucratic controls. But the political revolution they launched has culminated in the presidency of Donald Trump in the US and a Boris Johnson-led government in the United Kingdom.

The social-democratic compact now needs to be refashioned for the twenty-first century.

To that end, we need to recognize the problems facing advanced economies, from uncontrolled deregulation and finance run amok to the structural changes brought about by globalization and automation. We also need to form a new political coalition that is broad enough to include industrial workers, who remain among the most politically active segments of the population, even as their numbers have fallen.

But, most important, we must recognize that curtailing the power of big companies; providing universal public services, including health care and high-quality education; protecting workers and preventing the rise of low-wage, precarious employment; and investing in R&D are not just policies that should be evaluated in terms of their economic consequences. They are the essence of the social-democratic project, and the foundation of a prosperous and stable society.

Is Post-Brexit London Really Doomed?

Oct 3, 2019 HOWARD DAVIES

Despite the likelihood of a harder-than-expected Brexit, and the certain loss of the so-called passport, which would allow financial services to be sold freely across the EU, the feared large-scale exodus of firms and financiers from London does not seem to be under way. Why?

EDINBURGH – It is now well over three years since the United Kingdom voted, by a narrow but significant margin, to leave the European Union. Yet we still have no idea what kind of economic relationship the UK will have with the 27 countries it leaves behind. (Some of the debate in London recalls in its insularity the apocryphal 1930s headline: “Fog in Channel: Continent Cut Off.”) Insofar as one can hazard a guess, the most likely outcome seems to be a more remote relationship than “Leave” supporters talked about in the referendum campaign and than most commentators envisaged shortly after the vote.

But, despite that change of direction, and the certain loss of the so-called passport, which would allow financial services to be sold freely across the EU, the feared large-scale exodus of firms and financiers from London does not seem to be under way. The French bakeries and German sausage shops are still doing a roaring trade. Why?

Two very recent pieces of evidence give a sense of what is happening on the ground, while politicians continue to argue. The accounting firm EY has monitored firms’ declared intentions in response to Brexit over the last three years. The latest survey, published in mid-September, indicates that 40% of firms plan to move some of their operations and staff out of London, while 60% of larger firms have announced such moves.

But the number of jobs that are to be moved from London to another European city is now only 7,000, far lower than estimates made a couple of years ago. Interestingly, the two locations that, according to EY, have benefited most so far are Dublin and Luxembourg. That is good news for London, because both are niche centers and unlikely to emerge as powerful rivals across the full spectrum of financial activities. Had Paris and Frankfurt been the principal beneficiaries, the long-term consequences could be far more threatening. Their marketing campaigns are so far yielding only modest returns.

There is, however, some more worrying news for London in the survey. Firms confirm that they are likely to move assets out of the UK on a large scale. The latest estimate is that around £1 trillion ($1.2 trillion) of assets under management may move to other centers when the UK leaves the EU. Many employees who are responsible for these assets will remain in London for now, but that could change over time.

And a second data point suggests that London’s reputation is beginning to suffer. A consultancy called Z/Yen has published a Global Financial Centres Index every six months for more than a decade. The latest ranking, in mid-September, showed that while London remains second only to New York globally, its relative position has been slipping. New York’s lead has more than doubled in the last six months. London’s relative decline has been sharper than any other of the top centers, and Paris has moved up.

Indeed, the gap between London and Paris has fallen to 45 points from 88 points in March (the top mark is just below 800). The European Banking Authority’s move to Paris, and Bank of America’s decision to relocate its euro trading there, are probably the main factors behind that change of perception.

Moving from survey to anecdote, managers say they have found it harder than expected to persuade senior staff to move. Even Italians and French who have been asked to relocate back to Milan or Paris are often reluctant to agree. Their children are settled in school, their spouse or partner has a non-mobile job in London, or they can’t bear to find themselves so close again to Mom and Dad!

More significantly, perhaps, a global market is a complex ecosystem. The traders may move, but will the IT infrastructure and support be as sophisticated elsewhere as it is in London? Will skilled consultants and lawyers be available on demand, as they are in the Square Mile?

These factors are making firms hesitant about large-scale moves. Instead, many have been looking for workarounds to overcome the regulatory problems they will certainly encounter once the UK leaves the single market.

Moreover, the politics of Brexit remain fraught and complex, and there is a small chance that the UK will hold another referendum and reverse course, which would render nugatory the £4.2 billion that the government vowed to spend on contingency plans. But the most likely outcome is that the UK stumbles toward the exit and falls untidily over the threshold, without a structural new relationship or a lengthy transition period.

Thereafter, we will see how Europe’s financial markets evolve. But the central expectation, given what we have seen so far, must be that Europe will migrate to a multi-polar financial model, with different centers, small and large, exploiting their respective comparative advantages. Dublin and Luxembourg will strengthen their positions, especially in asset management. The European Central Bank will act as a pole of attraction for Frankfurt. Euro-denominated transactions will increasingly take place in the eurozone, while London looks likely to remain, for the foreseeable future, Europe’s window on the wider world.

There will be a price to pay for users of financial services, as a dominant single center is almost certainly more efficient and cheaper. But, after Brexit, that solution will no longer be available in London, and there is certainly no consensus among the other 27 countries on a single alternative.

China’s Quest for Legitimacy

Dec 3, 2019 ROBERT SKIDELSKY

The conventional Western view is that China faces the alternatives of integrating with the West, trying to destroy it, or succumbing to domestic violence and chaos. But the Chinese scholar Lanxin Xiang instead proposes a constitutional regime based on a modernized Confucianism.

LONDON – Liberal democracy faces a legitimacy crisis, or so we are repeatedly told. People distrust government by liberal elites, and increasingly believe that the democracy on offer is a sham. This sentiment is reflected in the success of populists in Europe and the United States, and in the authoritarian tilt of governments in Turkey, Brazil, the Philippines, and elsewhere. In fact, liberal democracy is not only being challenged in its European and American heartlands, but also has failed to ignite globally.

Democracies, it is still widely believed, do not go to war with each other. Speaking in Chicago in 1999, the United Kingdom’s then-prime minister, Tony Blair, averred that, “The spread of our values makes us safer,” prompting some to recall Francis Fukuyama’s earlier prediction that the global triumph of liberal democracy would spell the end of history. The subsequent failure of Russia and China to follow the Fukuyama script has unsurprisingly triggered fears of a new cold war. Specifically, the economic “rise of China” is interpreted as a “challenge” to the West.

On this reading, peaceful transfers of international power are possible only between states that share the same ideology. In the first half of the twentieth century, therefore, Britain could safely “hand over the torch” to the US, but not to Germany. Today, so the argument goes, China poses an ideological as well as a geopolitical challenge to a decaying Western hegemony.

This perspective, however, is vigorously contested by the Chinese scholar Lanxin Xiang. In his fascinating new book The Quest for Legitimacy in Chinese Politics, Xiang shifts the spotlight from the crisis of rule in the West to the crisis of rule in China.

In one sense, this is familiar territory. Western political scientists have long believed that constitutional democracy is the only stable form of government. They therefore argue that China’s one-party state, imported from Bolshevism, is doomed, with the current protests in Hong Kong foreshadowing the mainland’s fate.

Xiang’s contribution lies in challenging the conventional Western view that China faces the alternatives of integrating with the West, trying to destroy it, or succumbing to domestic violence and chaos. Instead, he proposes a constitutional regime with Chinese characteristics, based on a modernized Confucianism.

Xiang is a Chinese patriot, but not a blinkered supporter of President Xi Jinping. The most interesting part of the book examines how the West has consistently disparaged the Chinese achievement. Xiang shows how the seventeenth-century Jesuit-inspired effort to reconcile Christianity and Confucianism (in the “Rites Debate”) foundered in the face of Protestant opposition to any form of idolatry. In his account, the harmonizing path of “co-evolution” through “virtuous government” was permanently shut down by the Enlightenment – which he interprets as a secular expression of crusading Protestantism. China had no such crusading zeal: it was satisfied to be where it was. As former US Secretary of State Henry Kissinger once noted, “the Promised Land is China. And the Chinese are already there.”

Leading Enlightenment thinkers contributed to a “universalist” critique of China. For example, Montesquieu’s doctrine of the separation of powers was consciously promoted as the only alternative to “Asiatic despotism.” Hegel rejected the Chinese system on teleological grounds, arguing that China’s lack of awareness of “Spirit” doomed it to stasis and stagnation (a view later endorsed by Karl Marx). And Adam Smith said that China had made no economic progress since the twelfth century because it lacked free institutions.

By the 1800s, these various currents had merged into a social Darwinist view of progress that arranged races in a hierarchical ladder of achievement – an outlook significantly influenced by the West’s military superiority in its encounters with “inferior” races. This universalist approach underpinned the West’s condescending, patronizing, and contemptuous view of China. Western economists and philosophers regarded the Chinese system of rule not as a contribution to the global stock of human wisdom, but as a cause of the country’s “backwardness.” Their verdict that the West was superior to China in every way, except in the manufacture of porcelain, left no room for cultural accommodation.

Yet, this negative view ignored China’s extraordinary record of stability under the doctrine of the Mandate of Heaven. Outsiders misinterpreted this system – “built on a clearly defined scheme,” as Xiang describes it, with “blood-line royal legitimacy at the top” and “the scholar gentry to administer affairs of state” – as a recipe for stagnation.

Xiang argues that China’s recent economic rise is simply a “restoration” of the success the country enjoyed before nineteenth-century Western intrusions disrupted its harmonious system. But the late Angus Maddison’s estimates of historical GDP per capita suggest that China’s economic “retardation” started well before its encounter with the West. Between 1500 and 1870, per capita income barely moved from $600, while the UK’s quadrupled (from $714 to $3,190), and even Spain’s doubled.

China’s political stability and relative absence of violence were thus achieved at the expense of economic dynamism, not in harmony with it. The West’s economic ascendancy, on the other hand, was based precisely on a rejection of the organic unity of morals, politics, and economics that Xiang values so highly.

Xiang is vague about how Confucianism can be fitted into a world order created by the West. He thinks that China’s leaders are deluded in hoping that Marxist rhetoric will sustain the regime’s legitimacy, given “the moral decay of the ruling elite whose appetite for wealth accumulation knows no bounds and legal limits.” China, he says, “does need some Western idea of democratic procedures,” and a civil society that can serve as an alternative to rebellion.

Finally, Xiang looks to the Roman Catholic church to seize a historic opportunity to reignite the old Jesuit efforts at accommodation with Confucianism. If Protestant America represents a new Rome, he writes, then the European Union might somehow become “a secular version of the unifying Catholic Church prior to the Reformation” – an intriguing conclusion to an engrossing book.

A Living Wage for Capitalism

Nov 14, 2019 JIM O'NEILL

Higher nominal wages for low-paid workers can boost real earnings, increase consumer spending, and help make housing more affordable. And insofar as raising the minimum would increase companies’ wage bill, it would create a stronger incentive to replace labor with capital, which could lay the foundation for renewed productivity growth.

LONDON – At 3.6%, unemployment in the United States remains near its lowest level since the late 1960s. There are even signs that people who had previously dropped out of the labor force are being attracted back into it as employers scour a tight labor market for the marginal employee. Consistent with this news, US Federal Reserve Chair Jay Powell has pointed out that wage gains are finally accruing to lower-paid workers.

In another nod to lower-paid workers, in July, the US House of Representatives passed a bill to boost the federal minimum wage from $7.25 per hour to $15 per hour (an increase that would be phased in over seven years). But the legislation has no chance of passing the Republican-controlled Senate. Moreover, the Congressional Budget Office estimates that a $15 minimum wage would lead to job losses for 1.3 million lower-paid workers.

One heard similar objections in the United Kingdom back in the spring of 2016, when then-Prime Minister David Cameron’s government introduced its National Living Wage policy. Yet, over the past three years, there have been no signs of a reversal of employment gains. And in recent months, wage growth has started to pick up after a decade of stagnation, with the Resolution Foundation now predicting that real (inflation-adjusted) average weekly earnings in the UK could exceed their August 2007 peak of £513 ($660).

While the topic has yet to feature explicitly in the UK election debate, both Labour and the Conservatives are pursuing programs to boost minimum wages further (they also seem to share the goal of increasing infrastructure spending). In late September, Chancellor of the Exchequer Sajid Javid announced that the minimum wage of £8.21 per hour for workers over 25 would be expanded to include all workers over 21. He also promised that by 2024, the minimum wage will have risen to two-thirds of median earnings. Not to be outdone, Labour has vowed to hike the minimum wage to £10 per hour if elected.

Predictably, these statements from both parties raised eyebrows in business circles, and led to warnings of future job losses. And yet I find myself thinking that a higher minimum wage might deliver benefits beyond what is captured in the traditional economic calculus. Given capitalism’s growing crisis of credibility, business leaders would do well to consider embracing such policies more enthusiastically.

As I have pointed out before, despite strong headline employment figures in the US, the UK, and other Western economies over the past decade, business investment spending has remained stubbornly weak, as have productivity and wage growth. These trends have coincided with a period of strong corporate profits and macroeconomic conditions that, in theory, should be favorable for investment.

Indeed, low interest rates, strong profits, and reduced corporate taxation would seem to be a perfect recipe for significantly higher investment spending. But instead, we have witnessed an acute increase in actual and perceived inequality, and a popular backlash against both capitalism and democracy across Western countries. Companies have not responded to the textbook stimuli for investment, either because they don’t see the long-term economic rationale for it, or because they are in less capital-intensive industries and simply do not think that they need any more buildings and equipment. The problem, of course, is that without investment, productivity is not likely to increase. And without productivity growth, there is little reason to expect sustainable wage growth.

Whatever the reasons for lagging investment, it is clear that public policy has a role to play here. If what we are witnessing is a market failure, it is both reasonable and appropriate for the state to step in and provide the needed investment spending – as both the Tories and Labour are suggesting they will do if they win the UK election.

But policymakers can also change the risk-reward calculus for business, and one way to do that is by significantly increasing the minimum wage. Higher nominal wages for low-paid workers can boost real earnings, increase consumer spending, and help make housing more affordable. And insofar as raising the minimum would increase companies’ wage bill, it would create a stronger incentive to replace labor with capital. That could result in reduced output and higher prices, but it could also lay the foundation for renewed productivity growth.

In any case, to those who would counter that companies cannot afford to accommodate such a policy-driven change, I would point out that since 2015, aggregate demand has remained strong enough for them to absorb wage increases easily enough. Should such a policy make companies realize that they have a social purpose that is greater than merely boosting next quarter’s earnings, so much the better.

The Monetarist Era Is Over

Oct 31, 2019 ANATOLE KALETSKY

Central bankers have been the first to recognize that the effectiveness of monetary policy in managing demand and stabilizing economic cycles has reached its limits. The problem is that many politicians and academic economists remain in denial.

LONDON – A mood of foreboding dominated this month’s annual meetings of the International Monetary Fund and World Bank in Washington, DC. But fear of a global recession was not the real cause. Although the latest update of the IMF’s World Economic Outlook showed economic activity slowing this year to its weakest level since 2009, the projected global growth rate of 3% is still far above levels associated with past recessions and would be consistent with decent economic conditions in most parts of the world – not a bad outcome for the 11th year of a sustained global expansion. And for next year, the IMF predicts that growth will accelerate to 3.4%, very close to the 3.6% estimate of the world economy’s long-run sustainable trend.

One might argue that the IMF’s forecast of a growth rebound next year merits limited credence, simply because all econometric models are designed in such a way that they tend to revert to long-term average trends. But the numbers for 2019 are different and much more credible. By this time of the year, the 2019 “projections” mostly reflect data that have already been collected. The numbers, therefore, largely reflect existing facts, such as the US-China trade war, the collapse of German car production, and fears of a no-deal Brexit.

The 2019 projections confirm the relatively benign picture of the global economy I described after the previous iteration of the IMF data. Despite their trade war, neither the US nor China has experienced any real weakening: growth in both countries has been downgraded by a statistically insignificant 0.1% since last October. Japan’s performance has also remained unchanged, and the rest of Asia has slowed only marginally. The main problem area in the world economy this year has been Europe, with projected growth in the eurozone revised downward by more than one-third, from 1.9 % to 1.2%, and from 1.9% to a near-recessionary 0.5% in Germany.

The bad news is that the relatively benign conditions still prevailing in the world economy will genuinely deteriorate at some point, even if not in 2020 or even 2021. At that point, central bankers will have to admit that they can no longer manage business cycles and moderate economic downturns. The less bad news is that most of these policymakers now recognize that other, more effective tools exist, and that only outdated political ideology and economic dogma are preventing them from being used.

Forty years after the 1979 election of Margaret Thatcher confirmed the ascendancy of various forms of monetarism, the intellectual pendulum is swinging back to the Keynesian idea that fiscal policy – decisions about government spending, taxation, and borrowing – offers the most effective instruments for managing demand and stabilizing economic cycles. Central bankers have been the first to recognize that monetary policy has reached its limits, while many politicians and academic economists remain in denial about the paradigm shift now taking place.1

Milton Friedman’s famous dictum that “inflation is always and everywhere a monetary phenomenon” was refuted by empirical studies long ago. But the much more radical challenge is that there may be no relationship whatsoever between monetary expansion and inflation. This is still an intellectual taboo, even though central banks everywhere have printed previously unimaginable quantities of new money with no inflationary consequences at all.

Even more persistent is monetarism’s most important negative injunction: fiscal policy cannot stimulate economic growth, because higher government spending crowds out private investment and higher public borrowing is equivalent to higher taxes. The various theories that fiscal policy was “ineffective,” because government borrowing would increase interest rates, inflationary expectations, or future taxation, have all turned out to be wrong.

In the past 10-15 years, public borrowing and debt have increased enormously in all advanced economies. But investors, far from panicking about inflation or punishing this supposed profligacy by demanding a higher risk premium, have lent governments money at the lowest interest rates in history. In many countries, they are even accepting guaranteed losses through negative rates. Yet the idea that fiscal expansion is irresponsible or ineffective, and that monetary policy should therefore continue to be the main tool of macroeconomic management, still prevails, especially in Europe.

The big story of this year’s IMF annual meeting is that this anti-Keynesian bias has completely vanished among central bankers. The main message of the keynote address by Kristalina Georgieva, the IMF’s new Managing Director, was an appeal for “fiscal policy to play a more central role.” Almost all of the background discussions revolved around this theme as well. Even in Europe, the consensus may be shifting. The new European Commission’s members who are responsible for enforcing the European Union’s outdated fiscal rules, written in the heyday of late-twentieth-century monetarism, have begun to admit publicly the need for less restrictive budget policies. And the permanent head of the EU department responsible for assessing national budgets has called for a “more balanced policy mix,” involving more expansionary fiscal policy “right here and right now.”

In short, central bankers and senior economic officials now almost unanimously believe that monetary policy has reached its limits and that fiscal policy should be reinstated as the main tool for managing business cycles and supporting economic growth. But many politicians, especially in Europe, still refuse to recognize that the monetarist era is over and that Keynesian demand management is the only alternative. Let us hope that changes before the next recession arrives.

Are Europe’s Economic Prospects Brighter Than They Appear?

Oct 1, 2019 ANATOLE KALETSKY

Despite all the lurid headlines about the trade war causing a recession in the United States or some kind of collapse in China and its Asian neighbors, recent economic data reveal a very different picture: the main victim has been Europe. But, fortunately for the European economy, overdependence on foreign trade is not the whole story.

LONDON – In the year since US President Donald Trump escalated America’s trade war with China, policymakers and financial markets have been obsessed with the dangers to both countries’ economies. Yet the real threat the conflict poses to the global economy lies elsewhere.

Despite all the lurid headlines about the trade war causing a recession in the United States or some kind of collapse in China and its Asian neighbors, recent economic data reveal a very different picture: the US and Chinese economies have performed quite decently and in line with trends that were already well established before the escalation of the trade war. The main victim has been an innocent bystander: Europe.

The unexpected distribution of damage can be clearly seen in the International Monetary Fund’s quarterly revisions of its economic projections. The latest revisions, published in late July, forecast 3.2% global growth in 2019, down from 3.7% in the IMF’s October 2018 projection. But this downward revision was attributable to neither the US nor China. The Chinese economy is expected to grow by 6.2%, exactly the rate predicted a year ago. The forecast for US growth is 2.6%, up 0.1 percentage points from a year ago. The projections for Japan and other Asian economies are also essentially unchanged. This leaves Europe responsible for almost the entire global slowdown.

The IMF now expects eurozone growth to reach 1.3% this year, down 0.6 percentage points from its forecast a year ago, and German growth is expected to amount to just 0.7%, compared to the 1.9% rate predicted a year ago. Thus, if any region will soon pull the world into recession, it is Europe, and specifically Germany, not the US, China, or Asia.

There are three reasons why the European economy has suffered far more this year than either of the belligerents in the US-China conflict. For starters, Europe is extremely vulnerable to collateral damage from a trade war, because it is more dependent on trade. Exports account for 28% of the eurozone’s GDP, compared to only 12% for the US and 19% for China.

Moreover, Europe’s policy response to economic shocks is almost always wrong. When the US or China experience a shock that threatens to reduce economic growth, they generally respond with a pre-emptive and counter-cyclical demand stimulus. In response to the trade war, the US Federal Reserve Board almost immediately reversed its monetary-policy course and began cutting interest rates. China has expanded monetary, fiscal, and credit policies to ensure that consumption, housing construction, and infrastructure spending compensate for lost exports and private investment. In Europe, by contrast, the policy response to weak demand tends to be pro-cyclical: When growth falters, instead of expanding fiscal policy, European governments raise taxes and cut public spending to “control” budget deficits. And financial regulators tighten credit conditions by forcing banks to build up their capital and increase their provisions for risky loans.

Third, Europe has been hit by two internal political shocks that were even more damaging than the US-China trade war. Last summer’s budget clash between the European Commission and Italy’s new populist government revived fears of a currency and banking collapse even worse than the euro crisis that erupted a decade ago. And in March, just as the Italian risk subsided, a no-deal Brexit suddenly emerged as a serious threat. Because the EU exports almost twice as much to the United Kingdom as it does to China, a sudden stop in commercial relations with the UK could be as damaging as the sudden stop in finance that occurred in 2008.

Now for the good news. Two of the three reasons for Europe’s poor performance – misguided macroeconomic policies and conflict with Italy or Britain – are moving toward resolution. And although excessive exposure to global trade – especially in Germany – continues, at least Europe’s overdependence on exports is starting to be recognized as a structural vulnerability, not a sign of “competitiveness” or fundamental economic health.

Starting with macroeconomics, an easing of fiscal policy is now being seriously debated in almost every European country, within the incoming European Commission, and at the European Central Bank. While opposition to any significant fiscal expansion remains strong in Germany, the largest eurozone economy, resistance there is likely to crumble under the combined pressure of weak economic growth, fears of populist parties, demands for green investment, and increasingly pointed criticism from the European Commission and the ECB. And even if Germany sticks to fiscal retrenchment for another year or two, the rest of Europe will move toward lower taxes and higher public spending for a reason that is not widely recognized: the interaction between monetary and fiscal policy.

The ECB’s recent decision to resume quantitative easing and maintain negative interest rates without any time limit guarantees that debt-service costs will fall drastically for highly indebted governments such as those in Italy, Spain, Belgium, and France. Lower interest payments will give these governments more budgetary space to cut taxes or increase public spending. This is especially true for Italy, whose interest costs currently exceed 3.5% of GDP.

This easier fiscal environment has ended Italy’s conflicts with the EU over budget rules, which seemed to threaten a euro breakup a few months ago. At the same time, the UK Supreme Court’s decision striking down Prime Minister Boris Johnson’s suspension of Parliament has virtually eliminated the risk of a no-deal Brexit.

With the political and macroeconomic climate improving, Europe should be able to overcome the structural handicap of excessive exports and avoid recession. Germany may be less fortunate, because it cannot be cured of its export addiction until it abandons its misguided budget consolidation. Until then, Germany will be stuck in its unfamiliar new role as the laggard of Europe.

For the rest of the world, however, this may not matter. What matters for the global economy is whether Europe as a whole enjoys a strong recovery. The chances of that are considerably better now than they were a few months ago.

How to Rethink Capitalism

Oct 1, 2019 SIMON JOHNSON

The 2008 financial crisis, together with failed efforts to combat climate change and sharply rising inequality, has frayed the neoliberal consensus that has prevailed in the United States and much of the West for more than two generations. Three issues must be considered in weighing what comes next.

WASHINGTON, DC – The United States Business Roundtable, an organization of CEOs of large US companies, recently issued a statement that caused quite a stir in some circles. Rather than focusing primarily or exclusively on maximizing shareholder value, America’s corporate titans argued, companies should attach more weight to the wellbeing of their broader stakeholder community, including workers, customers, neighbors, and others.1

As CEOs of large companies are hired and fired mostly on the basis of their contributions to profits, such statements merit a certain amount of cynicism. Unless and until incentives created by financial markets change, we should expect the short-term profit motive to prevail.

The Business Roundtable’s views are part of broader attempts to reimagine capitalism – the topic now of high-profile courses at Harvard Business School, Brown University, and elsewhere. In his recent book The Economists’ Hour, Binyamin Appelbaum, an influential New York Times journalist, argues that economists are to blame for tilting too much of the world excessively toward profits. And Democratic presidential candidates are putting forward ideas that range from modest reform to a more substantial overhaul of how markets work.

There are three main issues to consider when thinking about how to adjust the role of markets in the modern American economy in a sensible way.

The first issue is that market incentives are actually positive in some contexts. If you are an entrepreneur and want to raise capital, appealing to a broader social good will get you very little. To transform an industry – and challenge the incumbents represented on the Business Roundtable – you need a business model that promises future profits. For example, private venture capital financed the process of converting research on the human genome into life-saving drugs over the past two decades.

Second, a balance obviously needs to be struck between public and private (profit-seeking) efforts. Appelbaum’s strongest argument is that leading economists denigrated public action and, at least since the 1960s, viewed private business through rose-tinted glasses. As James Kwak (my co-author on other matters) correctly points out, powerful interests lay behind the development and dissemination of these ideas (although his own book, Economism, also highlights how policymakers distort sensible economic analysis to bolster the naive view that business is infallible).

Third, the private sector typically does not consider positive and negative externalities – actions that affect other people but not the actor. For example, in Jump-Starting America, Jonathan Gruber and I argue that the public sector has a robust role to play in investing in basic science, because the general knowledge that results affects many people, in ways that are hard to predict. This was exactly the rationale behind the very successful government backing provided to the human genome project; it also motivates the broader funding provided to the National Institutes of Health. Almost all modern drugs emerge from a process supported, at its early stages, by the NIH.

The private sector is also not generally good at regulating itself, again mainly because of externalities. For example, financial sector firms lobby hard to relax regulation – allowing them to make higher profits but also to take greater risks. No individual firm cares enough about risks to the entire system. Similarly, energy companies want to extract more natural resources. Their CEOs are not paid to worry about climate change.

The long-prevailing model for the US economy was to allow the market to organize most economic activity and then regulate or redistribute relative to the outcomes. But the 2008 financial crisis, together with failed efforts to combat climate change and disappointing longer-term economic outcomes for most Americans (while some rich people have become much richer), has frayed the consensus underlying this model.1

Can we have a more inclusive form of capitalism that yields better outcomes? Yes, according to Senator Elizabeth Warren, who is running for the Democratic presidential nomination on a pro-reform platform. Warren, who made a political name for herself by advocating for stronger consumer protection for financial products, is not at all anti-market. Rather, she argues that designing market structures differently will lead to different (and better) outcomes. Many of her various proposals amount to rethinking what is allowed in terms of market structures and firm behavior, as well as how to limit the influence of money in politics.

The market is not necessarily good or bad. What you get out of capitalism depends on how you shape it. If you rely on wealthy people and already powerful businesses to make the key decisions, you will mostly get what you already have – a highly unequal economy, prone to crises, rushing headlong toward a climate catastrophe.

Did Dudley Do Right?

Sep 10, 2019 BARRY EICHENGREEN

The New York Federal Reserve's immediate past president recently caused controversy by calling on the Fed to make it “abundantly clear" that President Donald Trump will bear "the consequences" of his fiscal and trade policies. But what does "abundantly clear" entail?

HANALEI, HAWAII – William Dudley, the immediate past president of the Federal Reserve Bank of New York, recently stirred up a hornet’s nest when he called for the Fed to consider the impact of its policies on the 2020 presidential election. In fact, Dudley performed a valuable public service by observing that Fed policy can influence politics, sometimes with profound implications for the course of the United States. But that doesn’t mean his recommendations were on target.

Dudley’s logic was straightforward. If the Fed cuts interest rates in response to Donald Trump’s disruptive trade-policy actions, the president may be encouraged to resort to more of the same. Trump believes that the US and China are locked in a trade war to the death. But he also has acknowledged that the stock market reacts negatively to his tariff threats, that trade-related uncertainty weakens growth, and that this damages his reelection prospects.

The worry is that if the Fed loosens policy, thereby minimizing an uncertainty-induced slowdown in investment and growth, Trump will feel free to escalate his China-focused trade attacks. As Dudley put it, the Fed should make “abundantly clear that Trump will own the consequences of his actions.”

The question is what exactly making it “abundantly clear” entails. Federal Reserve officials can explain that the president’s actions are forcing them to lower interest rates in order to fulfill their dual mandate of stable inflation and maximum employment. They can warn of the collateral damage of low interest rates, which harm Americans living on fixed incomes and raise financial stability risks by encouraging investors to stretch for yield. The Fed should flag these undesirable consequences without hesitation.

Fed officials should also emphasize that monetary loosening cannot fully neutralize the effects of trade-policy uncertainty. Many investments, once undertaken, are reversible only with difficulty, to the extent that they’re reversible at all. Investments predicated on the existence of global supply chains will be rendered worthless by a full-blown trade war. Equally, investments in local production, predicated on ongoing trade conflict, can turn out to be costly mistakes if commercial peace unexpectedly breaks out.

When trade policy is uncertain, miscalculations like these are unavoidable. Companies therefore have an incentive to delay investing until that uncertainty is resolved – whatever the level of interest rates. The central bank needs to remind Trump that it can’t entirely offset the macroeconomic impact of his trade war, no matter how much he wishes this to be so.

Dudley’s most provocative remark was that “there’s even an argument that the election itself falls within the Fed’s purview.” Seeming to suggest that the Fed should seek to influence electoral outcomes, this comment ignited ferocious criticism, and Dudley subsequently walked it back. Fed officials “should never be motivated by political considerations or deliberately set monetary policy with the goal of influencing an election,” he clarified.

But Fed policies do influence elections, and this indisputable fact has consequences for the central bank. Policy-rate reductions that head off an impending recession make Trump’s reelection more likely. In turn, his reelection implies slower growth in the medium term, insofar as it means continued erratic policies, commercial conflict, and uncertainty. How should a Federal Reserve, whose mandate extends to ensuring “maximum employment,” trade off short-term employment gains against longer-term employment losses?

This is a difficult question, not least because the Humphrey-Hawkins Act, which gives the Fed its mandate, specifies no timeframe for achieving it or a discount rate at which current gains can be weighed against future losses. But that conversation is unavoidable. Or at least it should be.

Much of this discussion can take place in private. But imagine now that the Democrats nominate a 2020 candidate with very different trade-policy predilections. Fed staff and governors will then have to formulate economic forecasts that describe two different paths for the economy depending on the outcome of the election. The Fed, as an agency accountable to the Congress, will face pressure to make these forecasts public. One can well imagine the resulting tweetstorm of opprobrium accusing the central bank of partisanship and worse.

Should the Fed suppress or fudge its forecasts in order to appear apolitical? Doing so would be a dereliction of duty, which is to forecast economic scenarios and formulate policy accordingly.

The Bank of England faced an analogous dilemma when opining on the implications of Brexit for the British economy, and it was subjected to withering political attacks. Political flak and discomfort are part of the job description – and unavoidable when making public forecasts under such circumstances. Politicians will impugn central bankers’ impartiality. Unavoidably, controversy and reputational damage will follow.

In speaking out, Dudley conveyed another important message: the brickbats are worth bearing. Were the Fed to pull its punches about the obvious risks US fiscal and trade policies now pose to the US economy, the reputational damage it would suffer would be infinitely worse.

Stop Inflating the Inflation Threat

Oct 29, 2019 J. BRADFORD DELONG

Given the scale and severity of inflation in America in the 1970s, it is understandable that US monetary policymakers developed a deep-seated fear of it. But, nearly a half-century later, the conditions that justified such worries no longer apply, and it is past time that we stopped denying what the data are telling us.

BERKELEY – In light of current macroeconomic conditions in the United States, I’ve found myself thinking back to September 2014. That month, the US unemployment rate dropped below 6%, and a broad range of commentators assured us that inflation would soon be on the rise, as predicted by the Phillips curve. The corollary of this argument, of course, was that the US Federal Reserve should begin rapidly normalizing monetary policy, shrinking the monetary base and raising interest rates back into a “normal” range.

Today, US unemployment is 2.5 percentage points lower than it was when we were all assured that the economy had reached the “natural” rate of unemployment. When I was an assistant professor back in the 1990s, the rule of thumb was that unemployment this low would lead to a 1.3 percentage point increase in inflation per year. If this year’s rate of inflation was 2%, next year’s would be 3.3%. And if unemployment remained at the same general level, the inflation rate the following year would be 4.6%, and 5.9% the year after.

But the old rule of thumb no longer applies. The inflation rate in the US will remain at about 2% per year for the next several years, and our monetary-policy choices should reflect that fact.

To be sure, the conventional wisdom among economists back in the 1990s was justified. Between 1957 and 1988, inflation responded predictably to fluctuations in the rate of unemployment. The slope of the simplest possible Phillips curve, when accounting for adaptive expectations, was -0.54: each percentage point decline in unemployment below the estimated natural rate translated into a 0.54 percentage point increase in inflation the following year.

The estimated negative slope of the Phillips curve – that -0.54 figure – between the late 1950s and the late 1980s was drawn largely from six important observations. In 1966, 1973, and 1974, inflation rose in a context of relatively low unemployment. Then, in 1975, 1981, and 1982, inflation fell amid conditions of relatively high unemployment.

Since 1988, however, the slope of the simplest possible Phillips curve has been effectively zero, with an estimated regression coefficient of just -0.03. Even with unemployment far below what economists have presumed was the natural rate, inflation has not accelerated. Likewise, even when unemployment far exceeded what economists presumed was the natural rate, between 2009 and 2014, inflation did not fall, nor did deflation set in.

Although the past 30 years have not offered any analogues to the data points furnished by the 1950s-1980s era, there are many who still believe that monetary policymakers should remain focused on the risk of rapidly accelerating inflation, implying that inflation poses a greater threat than the possibility of recession. For example, three very sharp economists – Peter Hooper, Frederic S. Mishkin, and Amir Sufi – recently published a paper suggesting that the Phillips curve in America is “just hibernating,” and that estimates showing a near-flat curve over the past generation are unreliable, owing to the “endogeneity of monetary policy and the lack of variation of the unemployment gap.”

I do not understand why they came to this conclusion. After all, the computer tells us that the 1988-2018 estimates are probably around three times more precise than the 1957-1987 estimates. And besides, the window captured in standard specifications of the Phillips curve is too short to allow for any substantial monetary-policy response.

Yes, an outbreak of inflation could be a threat. But the single-minded focus on that risk is the product of a different era. It comes from a time when successive US administrations (those of Lyndon Johnson and Richard Nixon) were desperate for a persistently high-pressure economy, and when the Fed chair (Arthur Burns) was eager to accommodate presidential demands. Back then, a cartel that controlled the global economy’s key input (oil) was capable of delivering massive negative supply shocks.

If all of these conditions still held, we might be justified in worrying about the return of 1970s-level inflation. But they don’t.

It is past time that we stopped denying what the data are telling us. Until the structure of the economy and the prevailing economic-policy mix changes, there is little risk that the US will face excessive inflation over the next five years. Monetary policymakers would do well to direct their attention to other problems in the meantime.

Stop Inflating the Inflation Threat

Oct 29, 2019 J. BRADFORD DELONG

Given the scale and severity of inflation in America in the 1970s, it is understandable that US monetary policymakers developed a deep-seated fear of it. But, nearly a half-century later, the conditions that justified such worries no longer apply, and it is past time that we stopped denying what the data are telling us.

BERKELEY – In light of current macroeconomic conditions in the United States, I’ve found myself thinking back to September 2014. That month, the US unemployment rate dropped below 6%, and a broad range of commentators assured us that inflation would soon be on the rise, as predicted by the Phillips curve. The corollary of this argument, of course, was that the US Federal Reserve should begin rapidly normalizing monetary policy, shrinking the monetary base and raising interest rates back into a “normal” range.

Today, US unemployment is 2.5 percentage points lower than it was when we were all assured that the economy had reached the “natural” rate of unemployment. When I was an assistant professor back in the 1990s, the rule of thumb was that unemployment this low would lead to a 1.3 percentage point increase in inflation per year. If this year’s rate of inflation was 2%, next year’s would be 3.3%. And if unemployment remained at the same general level, the inflation rate the following year would be 4.6%, and 5.9% the year after.

But the old rule of thumb no longer applies. The inflation rate in the US will remain at about 2% per year for the next several years, and our monetary-policy choices should reflect that fact.

To be sure, the conventional wisdom among economists back in the 1990s was justified. Between 1957 and 1988, inflation responded predictably to fluctuations in the rate of unemployment. The slope of the simplest possible Phillips curve, when accounting for adaptive expectations, was -0.54: each percentage point decline in unemployment below the estimated natural rate translated into a 0.54 percentage point increase in inflation the following year.

The estimated negative slope of the Phillips curve – that -0.54 figure – between the late 1950s and the late 1980s was drawn largely from six important observations. In 1966, 1973, and 1974, inflation rose in a context of relatively low unemployment. Then, in 1975, 1981, and 1982, inflation fell amid conditions of relatively high unemployment.

Since 1988, however, the slope of the simplest possible Phillips curve has been effectively zero, with an estimated regression coefficient of just -0.03. Even with unemployment far below what economists have presumed was the natural rate, inflation has not accelerated. Likewise, even when unemployment far exceeded what economists presumed was the natural rate, between 2009 and 2014, inflation did not fall, nor did deflation set in.

Although the past 30 years have not offered any analogues to the data points furnished by the 1950s-1980s era, there are many who still believe that monetary policymakers should remain focused on the risk of rapidly accelerating inflation, implying that inflation poses a greater threat than the possibility of recession. For example, three very sharp economists – Peter Hooper, Frederic S. Mishkin, and Amir Sufi – recently published a paper suggesting that the Phillips curve in America is “just hibernating,” and that estimates showing a near-flat curve over the past generation are unreliable, owing to the “endogeneity of monetary policy and the lack of variation of the unemployment gap.”

I do not understand why they came to this conclusion. After all, the computer tells us that the 1988-2018 estimates are probably around three times more precise than the 1957-1987 estimates. And besides, the window captured in standard specifications of the Phillips curve is too short to allow for any substantial monetary-policy response.

Yes, an outbreak of inflation could be a threat. But the single-minded focus on that risk is the product of a different era. It comes from a time when successive US administrations (those of Lyndon Johnson and Richard Nixon) were desperate for a persistently high-pressure economy, and when the Fed chair (Arthur Burns) was eager to accommodate presidential demands. Back then, a cartel that controlled the global economy’s key input (oil) was capable of delivering massive negative supply shocks.

If all of these conditions still held, we might be justified in worrying about the return of 1970s-level inflation. But they don’t.

It is past time that we stopped denying what the data are telling us. Until the structure of the economy and the prevailing economic-policy mix changes, there is little risk that the US will face excessive inflation over the next five years. Monetary policymakers would do well to direct their attention to other problems in the meantime.

Argentina was one of the world’s richest economies in the first few decades of the twentieth century, but subsequently became a cautionary tale of how a wealthy country can lose its way. By peddling policies that bring about short-term highs at a huge long-run cost, US President Donald Trump risks taking America down a similar path.

ITHACA – There is a growing belief that the United States is heading for a recession, possibly before the 2020 presidential election. Current economic data and statistical trends indicate that many parts of the US economy are apparently under strain. It is not evident to me, however, that a recession is around the corner. In fact, the real danger for America is more serious, and is best described as the “Argentina risk.”

During the first few decades of the twentieth century, Argentina was one of the world’s fastest-growing economies. It also had talent flowing in, with more immigrants per capita than virtually any other country. As a result, Argentina was among the world’s ten richest countries, ahead of Germany and France.

That all changed in 1930, with a military coup led by Lieutenant General José Félix Uriburu. Over the next few years, amid rising right-wing hyper-nationalism, immigration stalled and tariff wars began. Between 1930 and 1933, the country almost doubled its average import tariff. What followed was not so much a recession as a slow-motion slowdown, the scars of which are visible even today. Argentina thus became a cautionary tale of how a wealthy country can lose its way.

The American economy remains globally dominant. But we have not, in recent times, seen the US as polarized and bitter as it is today. Watching this downward spiral, my mind drifts back a quarter-century, to 1994, when I moved with my family from India to the US. My wife and I worried about how we would fit into a new society and alien culture, and whether our children would be accepted in their new schools.

The reassurance came early. New and eager to explore, we saw an announcement for a music festival in the local newspaper and dashed off to downtown Ithaca to join in. It soon became clear that we had made a mistake: This was basically a gathering for gay couples. We stood out like sore thumbs – Grant Wood’s Indian Gothic – father, mother, son, and daughter. There was no way to pretend we were like everybody else. But we got a surprise. Seeing our visible awkwardness, people came up to us, laughing, joking, and chatting with the children. It was wonderful to realize that we were in an open, tolerant society.

So, what has happened to America since then? At the level of individual behavior, nothing. The country is just the same: open, civil, and polite. You see this when chatting with Uber drivers, cafe waiters, and roadside vendors – not to mention on National Public Radio, where when you ask a bad question, you are told, “That’s a great question,” and when you give a bad answer, “That’s fantastic.” Clearly, Americans instinctively realize what the economist Paul Samuelson once advised: there are social situations in which one must not speak as though one were under oath.

What has changed is politics. The puzzle is why ordinary Americans – though by no means the majority of them – support US President Donald Trump, who, unlike them, seems to have little interest in kindness, civility, and empathy, and little concern for the marginalized and the different.

To understand Trump’s popularity, we have to recognize that the world is going through a technological churn of a kind last seen during the Industrial Revolution. For the ordinary worker, life has become harder. Jobs are scarce, pay is poor, and benefits are negligible. One reason why the US unemployment rate is low is that many people are too discouraged to look for work. On the economist’s definition of unemployment – without work and looking for a job – such people are not included. Many of the homeless people Americans see on the streets do not count as unemployed.

In economically distressing times like these, people look for strong leaders in the hope that they will push through policy reforms. In the US, Trump is peddling policies that provide a short-term economic high at a huge long-run cost. Tax cuts for the rich, for example, can temporarily boost demand and, consequently, production. But in the long run, the fiscal strains caused by the cuts will offset that effect.

Trump’s insistence on low or even negative interest rates is similar. Initially, low rates boost demand, because people have less incentive to save. But when low interest rates persist, people worry about having enough money for retirement. This prompts them to save more, and consumption stalls.

Furthermore, when a cluster of countries holds down interest rates, the first one to raise rates will experience currency appreciation and an export slowdown. As a result, no one moves, and all are caught in a low-interest trap. The US has provided global leadership by resisting such short-sighted policies. It will be unfortunate if it changes course now.

Finally, by stoking fear of immigrants and foreigners, Trump is encouraging something alien to American society, and, like Argentina’s leaders in the 1930s, is undermining the basis of the country’s success.

At a turning point such as now, no one can be certain which policies will work. But it is critical to avoid obvious mistakes. The safeguard is to have leaders with the “moral intention,” the desire to do good: compassion for the common person, the urge to help those who need it most, empathy for the other.

Unfortunately, Trump seems to fall outside that category, and it is not surprising that few global leaders of stature seek to ally with him. It will be a tragedy, not just for America but for the world, if the US persists with policies that greatly increase its Argentina risk.