Sunday, September 2, 2018

Secular Stagnation, Myth and Reality

I ran into an article by the usually excellent Joseph Stiglitz on secular stagnation, entitled "The Myth of Secular Stagnation," see here. The gist of the article appears to be that the idea of secular stagnation is some sort of a ploy to absolve policy makers from responsibility of the slow recovery from the Great Recession. I think this view is so fundamentally wrongheaded that it seems worthwhile waking this little blog up from the dead to offer a brief comment on this notion.

I suppose I should disclose some relevant biases before going further. When Larry Summers first mused about the secular stagnation idea in a speech at the IMF in the fall of 2013, Neil Mehrotra and I wrote a little paper a couple of months later, see here, which as far as I know was the first attempt to formalize it in a modern DSGE model. Later, with the help of our graduate student Jake Robbins, we moved beyond a simple theoretical illustration to explore a quantitative version of the hypothesis, see here, in a paper that is coming out in American Economic Journal: Macroeconomics. In the meantime, I have written a series of paper with said Larry Summers, and various co-authors, that have explored several aspects of this idea, see here, here and here. Admittedly, it comes as a surprise, if I had unwittingly been participating in some enterprise that supposedly absolved policymakers of any responsibility for the slow recovery!

The biggest, and perhaps most obvious, problem with Stiglitz argument, is the following: If the secular stagnation hypothesis is correct, this does not in any way absolve policy makers from responsibility for a slow recovery. Instead, it does exactly the opposite. If correct, the secular stagation hypothesis implies that policymakers should have done much more in 2008 than existing theories suggest.

What is the secular stagnation idea anyway? In prior work, the way most people, myself included, had thought about the crisis of 2008 when the US and most of the rest of the world hit the zero lower bound, was that it was due to some temporary forces, such as being generated by a debt deleveraging cycle (see e.g. my work with Paul Krugman here) or being driven by problems in the banking sector (see e.g. joint work with Del Negro, Ferrero and Kiyotaki, see here). But in any case, most of these theories where ones in which the forces leading to ZLB were temporary, and thus one strategy for policy (for example if the cost of policy intervention was considered very high) was one of just waiting it out, as "soon all would be well" using Stiglitz words.

What separated Larry's secular stagnation hypothesis from much of the earlier work was that he suggested that the forces that might be driving the fall in the natural rate of interest, triggering the ZLB, might not be temporary after all but instead ones that would not necessarily revert themselves. The literature has identified several plausible candidates, such as demographic change, fall in productivity, global savings glut, rise in inequality and so on, essentially any force that might trigger the relative supply of savings and investment to be such that the natural rate of interest is permanently (or very persistently) negative. What was sort of interesting about modeling the secular stagnation hypothesis was that one needed to do both an open heart surgery on the aggregate demand side of traditional DSGE models (to allow for permanently negative interest rates) and also do a radical change on the supply side to allow for the possibility of a permanent demand recession (a big no-no in traditional macro which typically assumes long run neautrality). In any case, the bottom-line of this research, contrary to what Stiglitz appears to think, is that the secular stagnation hypothesis gives an even stronger case for aggressive intervention, e.g. in 2008. Thus far from being "just an excuse for flawed policies" the hypothesis gives a compelling reason to believe that more should have been done in 2008.

It is hard to end this little note, without responding briefly to Stiglitz's notion that events of last year have "put a lie to this idea" but Stiglitz suggests that the the fiscal expansion under Trump is responsible for some of the current recovery (a suggestion I will take for granted for the purpose of this argument, but one that could be contested). It is odd to suggest that current events put a "lie to the idea" of secular stagnation, for a recovery based on fiscal expansion is precisely the prediction of the secular stagnation theory: With low interest rates there is more room than usual for a fiscal stimulus, i.e. it is less likely to call for rapid offsetting increase in interest rates by the Federal Reserve than usual due to the absence of inflationary pressures created by the fiscal expansion (which so far, seems pretty much on the mark, as inflation remains subdued in spite of the large fiscal expansion). So here, Stiglitz, seems to get things exactly upside-down. At the end of the day, I suspect that the implication of a secular stagnation diagnostic of 2008 is -- after all -- very much in line with the view Stiglitz expresses here and often elsewhere, that the "fallout from the financial crisis was more severe, and massive redistribution of income and wealth toward the top had weakened aggregate demand" and that "the downturn was likely to be deep and long" and that what was needed was "stronger and different from what Obama proposed". Indeed, the secular stagnation hypothesis puts structure on those very arguments which I am quite sympathetic to. 

Finally a little figure and some reflections on the future. The figure above shows the cut in the Feds Fund rate in response to past three recessions as identified by NBER (in gray bars in the figure). In the early 1990's the Fed had room to cut rates from 10 to 3 (700 basis points), in early 2000 from 6.5 to 1 (550 basis points) and in 2008 from 5.25 to 0 (525 basis points). The secular stagnation hypothesis entertains the possibility that the observed fall in real interest rate (evident in the figure by the downward trend in long-term rates shown in red) over the past decades is "secular" which implies that come next recession, the Fed may have much less room to cut rates than it has had before, smaller than on the last 3 occasions. As much as I would like to hope that this will turn out NOT to be the case, it seems to me to be exceedingly likely the Fed may run out of room yet again when the next shoe drops, especially if the current recovery ends in tears in the next year or two as many now appear to be suggesting. With somewhat limited options to do monetary expansion at that point, this suggests we should be thinking hard about what fiscal policy can do the next time around. I suspect Stiglitz would agree on this point with those of us that have been entertaining the secular stagnation hypothesis. 

Tuesday, January 19, 2016

Oil and the paradox of toil

I think it was in the fall of 2009 that I first stumbled upon what I coined the "paradox of toil", see e.g. a 2010 WP version here, sort of playing on the old paradox of thrift, that if everybody tries to save, there will be less aggregate savings.
The point was really pretty simple. It was that in economies stuck at the zero lower bound (ZLB), then what really matter is aggregate demand not aggregate supply, so you want to focus on things that increases demand. If the problem is that people are not buying enough things, it's not really going to help adding production capacities if the existing ones are not even being used (if a farmer that can't sell all his products, what is the point of adding a new tractor or a new worker?).
There was another perhaps somewhat more subtle point the paper made, hence he paradox in the title. It was that if you increase factors of production under these conditions -- e.g. if everybody wakes up and want to work more -- then you may in fact end up reducing equilibrium production -- i.e. everybody works less in equilibrium.
The logic is straight forward in most monetary models, and since then has been found to apply pretty broadly (when stating the paradox I left it open if this was a bug or a feature of New Keynesian models). At the ZLB the real interest rate is too high, i.e. it is above the natural rate of interest. Stuff that increases supply will tend to reduce marginal costs of firms (e.g. wages in the example above if everybody wants to work more) and thus trigger deflationary pressures, thus increasing the real interest rate, which is exactly what you don't want because the natural rate of interest is negative and the central bank can't cut rates. Higher interest rate reduce people incentive to spend and invest. So there you have it: Everybody wanting to work more then implies less actual work in equilibrium. This is the paradox of toil.
I talked about many other examples in my old paper that may have such an effect, most notably temporary drop in oil prices. Looking at the world today, it hard to think that the recent fall in oil prices has been particularly helpful for the world economy. People have typically focused on the disruption these drops have on the oil producing firm, and the banks that are lending them. Surely, these consideration are quite important.
The paradox of toil, however, points to a more general problem, namely that these fall in oil prices are generating an overall pull downward in current and expected inflation, thus effectively making monetary policy more restrictive around the world by increasing real interest rates. It seems that inflation expectation are falling across the board in industrialized countries, at least by some measures. It is hard to see how further deflationary pressure are helpful at this stage. So perhaps the current collapse in oil prices will prove to be a nice laboratory experiment for the paradox of toil (although as always in economics, there are a lot of things happening in the same time, so it's not that we have a clean identification here).

PS. These events remind me that perhaps it is time for me to actually try to publish this paper. I think the path this paper took is a classic example of the dis-functionality of our profession (and to some extent a reflection of my own procrastination). I submitted it to what we refer to as a top five journal way way back -- where it sat for about two years -- ultimately to be rejected on first round. As I got it back about two years later, there was already a modestly lively literature that had grown about the paradox, in order to prove it or disprove it in different setting, ranging from things like arguing non-linearities matter and make the paradox disappear, that the price setting assumptions in the paper was driving it, or on the empirical side that seasonal fluctuations, oil price variation or earthquakes proved it wrong. Ironically, I think some of that work was even published in the journal that rejected the first paper in the first place. But in any event, the enormous lags we have in the profession in terms of reviewing (which I am afraid I contribute to as a slow reviewer myself), just meant that when I finally got it back I clearly needed to address the growing literature the paper had generated (some of which I had in fact contributed to and published myself by analyzing contractionary effect of tax cuts (2010 NBER Macro Annual), the expansionary effect of the New Deal (AER) and structural reforms in Europe (JME)) and I felt most objections could be addressed in a straight forward way. But at that point, I had several other things cooking, so I never got back to it. Perhaps it is time now.

Monday, January 27, 2014

Econ 1225

It looks like this page may come alive again, as now I'm going to start teaching Econ 1225 again this spring.

Last year I created this site to communicate to students, as you can see by the number of post below it was an experiment that did not exactly take off -- I think mostly because I forgot the password and did not bother to figure out to sign in again, preferring the "canvass system" here at Brown.

Anyway, we are on again, and here is a preliminary syllabus. Perhaps I will keep this use this site more than last year.


Spring 2014
Brown University
Advanced Macroeconomics for undergraduate students
Gauti B. Eggertsson

Monetary and Fiscal Economics and Stabilization Policy

This course is about macroeconomic policy with special focus on the recent economic crisis. Questions will be addressed such as: How does monetary policy affect the economy? What is the effect of government spending and tax cuts? What should the government do in the event of a financial crisis?

The main objective of the course is to introduce students to the type of models and methods used in current research in macroeconomics both in the scholarly literature but also in the practice of central banks and major policy institutions.  The current financial crisis and the economic recession of 2007-2009 will serve to illustrate the challenges confronted by macroeconomic analysis. Empirical analyses will complement the understanding of some important features of US macro and financial data.

Students are assumed to have already completed intermediate-level courses in microeconomic theory, macroeconomic theory, and econometrics, and to be familiar with the fundamentals of multivariate calculus and linear algebra.

The main reference for this class are lecture notes that will be posted prior or right after each lecture.

A reference textbook for the course is Jordi Gali, Monetary Policy, Inflation and the Business Cycle, Princeton University Press, 2008 along with Michael Woodford’s Interest and Prices, Princeton University, 2003. These books will be supplemented with additional readings, often providing applications of the theory. Many of the additional readings are available online, and most of those that are not will be available electronically on the course website.

The required work for the course will consist of several problem sets (some analytical and some applied), a midterm and a final.

Below I have added several references and added stars to those reading that are essential. Some of the material includes much more technical details than I expect the students to master, the lecture notes and problems sets will give a better idea of the appropriate level of detail students should be familiar with.

I.  Monetary Policy and Economic Stabilization

Lecture 1 Introduction to the class

Lecture 2 Introduction to basic Time Series Methods
            * Main reference: Class Notes.
James D. Hamilton, “Time Series Analysis,” Princeton University Press. Chapter 1-3.

Lecture 3 Evidence on the Real Effects of Monetary Policy
            *Christiano, Lawrence J., Martin Eichenbaum, and Charles L. Evans, “Monetary Policy Shocks: What Have We Learned and To What End?” in J.B. Taylor and M. Woodford, eds., Handbook of Macroeconomics, vol. 1A, Elsevier, 1999.
            Christiano, Lawrence J., Martin Eichenbaum, and Charles L. Evans, “Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy,” Journal of Political Economy 113: 1-45 (2005).
            Sims, Christopher A., “Macroeconomics and Reality,” Econometrica, January 1980.
            Milton Friedman and Anna Jacobson Schwartz. 1963. “A Summing Up.” Chapter 13 of A Monetary History of the United States, 1867-1960 (Princeton: Princeton University Press for NBER): 676-700.
            Romer, C. and Romer, D. 1989, “Does Monetary Policy Matter? A New Test in the Spirit of Friedman and Schwartz”, NBER Macroeconomic Annual.
Fran├žois R. Velde. 2009. “Chronicle of a Deflation Unforetold.” Journal of Political Economy (August): 591-634.
Steinsson, J and Nakamura, “Five Facts about Prices,” Quarterly Journal of Economics, 125(3), 961-1013, August 2010.

Lectures 4 & Lecture 5: Nominal Price Level Determination
            *Gali, chap. 2.
            Woodford, chap 2.

Lecture 6:  Sticky Prices and the Real Effects of Monetary Policy: The case of IS-LM
            * Main reference here is lecture notes and blackboard derivation
*Gali, chap. 3.
            Woodford, chap 3.

Lecture 7: Sticky Prices and the Real Effect of Monetary Policy: The basic New Keynesian model
            * Main reference here is lecture notes and blackboard derivation
* Gali, chap. 3.
*Gali, J. chap 4.
            Woodford, chap 3.
Taylor, John B., “A Historical Analysis of Monetary Policy Rules,” in J.B. Taylor, ed., Monetary Policy Rules, Chicago: Univ. of Chicago Press, 1999.
Clarida, Richard, Jordi Gali, and Mark Gertler, “Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory,” Quarterly Journal of Economics 115: 147-180 (2000).
Orphanides, Athanasios, “Monetary Policy Rules, Macroeconomic Stability and Inflation: A View from the Trenches,” Journal of Money, Credit and Banking 36: 151-175 (2004).

Lecture 8: Nominal Frictions and Optimal Monetary Policy under Commitment and Discretion
*Main reference here is lecture notes and blackboard derivation
*Clarida, Richard, Jordi Gali, and Mark Gertler, “The Science of Monetary Policy: A New Keynesian Perspective,” Journal of Economic Literature 37: 1661-1707 (1999).
Kydland, Finn E., and Edward C. Prescott, “Rules Rather than Discretion: The Inconsistency of Optimal Plans,” Journal of Political Economy 85: 473-491 (1977).
Gali, chap. 5.
Walsh, chap. 8, and sec. 11.3.
Woodford,  I&P, chap. 7, secs. 1, 2, and 5.

Lecture 9: Medium scale estimated macroeconomic models
* Sbordone, A. Tambalotti, A, Rao, K, and K. Walsh, (2010) “Policy Analysis using DSGE Models: An Introduction.” FRBNY Economic Policy Review.
Smets, Frank, and Rafael Wouters. 2007. "Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach." American Economic Review, 97(3): 586–606.
Christiano, Lawrence J., Martin Eichenbaum, and Charles L. Evans, “Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy,” Journal of Political Economy 113: 1-45 (2005).

II.  Stabilization Policy During Financial Crises

Lecture 11.  The Liquidity Trap, Japan and the Great Depression
            *Eggertsson, Gauti B., and Michael Woodford, “The Zero Bound on Interest Rates and Optimal Monetary Policy,” Brookings Papers on Economic Activity 2003-1: 139-235. [Also available at]
*Eggertsson, Gauti B., “Great Expectations and the End of the Depression,” American Economic Review 98: 1476-1516 (2008).
Krugman, Paul R., “It’s Baaack: Japan’s Slump and the Return of the Liquidity Trap,” Brookings Papers on Economic Activity 1998-2: 137-206. [Also available at
Ben S. Bernanke and Vincent R. Reinhart, “Conducting Monetary Policy at Very Low Short-Term Interest Rates,” American Economic Review [Papers and Proceedings] 94(2): 85-90 (2004). 
Lecture 12.  Non-standard Monetary Policy in a “Liquidity Trap”: Is “Quantitative Easing” or Credit Easing Effective?
Curdia, Vasco, and Michael Woodford, “The Central-Bank Balance Sheet as an Instrument of Monetary Policy,” Journal of Monetary Economics, forthcoming. [Available online at]
            Keister, Todd, and James McAndrews, “Why Are Banks Holding So Many Excess Reserves?” Federal Reserve Bank of New York Staff Report no. 380, July 2009.
            Del Negro, M, Eggertsson, G, Ferrero, A and N. Kiyotaki, “The Great Escape? A Quantitative Evaluation of the Fed’s Liquidity Facilities”, mimeo [Available on my homepage]

Lectures 13 Is Fiscal Stimulus Effective?
* Eggertsson, Gauti B., “What Fiscal Policy is Effective at Zero Interest Rates?” NBER Macroeconomics Annual 2010, forthcoming. [Available on my webpage]
* Denes, Matthew, Gilbukh, Sonia and Eggertsson, Gauti, “Deficits, Public Debt Dynamics and Tax and Spending Multipliers,” Economic Journal, 123 (566), 133-163, 2013 [Available on my webpage]
            Woodford, Michael, “Simple Analytics of the Government Expenditure Multiplier,” American Economic Journal: Macroeconomics 3: 1-35 (2011)
            Christiano,  Lawrence, M. Eichenbaum, and S. Rebelo, “When Is the Government Spending Multiplier Large?” NBER Working Paper no. 15394, October 2009.

III.  Financial Stability and Economic Stability

Lectures 14  Financial Factors in Business Fluctuations
* Diamond, D. and Philip Dybvig, (1983), "Bank Runs, Deposit Insurance, and Liquidity", Journal of Political Economy, Vol. 91, No. 3. (Jun., 1983), pp. 401-419.
* Eggertsson, Gauti, B. and Paul Krugman, “Debt, Deleveraging and the Liquidity Trap: A Fisher-Minsky-Koo Approach,” Quarterly Journal of Economics, forthcoming. [Available at]
Bernanke, B. and M. Gertler (1989), "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, Vol. 79. No.1, p. 13-31.
Kiyotaki, N. and J. Moore, (1997), "Credit Cycles," Journal of Political Economy, vol. 105, no.2.
            Hall, Robert E., “The High Sensitivity of Economic Activity to Financial Frictions,” Economic Journal, forthcoming 2011. [Available at]
            Gilchrist, Simon, Vladimir Yankov, and Egon Zakrajsek, “Credit Market Shocks and Economic Fluctuations: Evidence from Corporate Bond and Stock Markets,” NBER Working Paper no. 14863, April 2009.

Bernanke, Ben S., Mark Gertler, and Simon Gilchrist, “The Financial Accelerator in a Quantitative Business Cycle Framework,” in J.B. Taylor and M. Woodford, eds., Handbook of Macroeconomics, vol. 1C, Elsevier, 1999.

Thursday, April 4, 2013

Abenomics and FDR

Perhaps the most noteworthy thing to happen in economic policymaking over the past several months is that the Bank of Japan and the Japanese government have decided to explicitly "coordinate" monetary and fiscal policy to end deflation. Many have started calling this "Abenomics" after the new Japanese Prime minister. The goal is to achieve an annual inflation of about 2 percent after many years of deflation. Host of actions have been outlined to achieve this end.

The policy statement about policy coordination was issued in January here.

And today more actions were outlined by the Bank of Japan here.

The motivation for these actions is clear. First, an increase in inflation expectation from deflationary expectation to inflationary ones will reduce real interest rate and thus make spending today more attractive relative to future spending. This should increase demand in a similar way monetary policy always does. Second, some healthy dose of inflation is likely to reduce the debt burden of borrowers, which may also help stimulate demand, especially in a severely depressed economy where some agents have piled up excessive amount of debt and need to "deleverage".

Interestingly enough very similar policy were tried in 1933 by Franklin D. Roosevelt (FDR) once he became President of the US. Most elements of the policy regime are the same, now as then, except that FDR promised a more sustained increase in the price level (he promised to reflate to pre-depression levels which implied quite a bit of inflation, see my 2008 paper here). My overall sense is that this element of the "New Deal" was a great success and helped generate a sharp recovery in 1933-37 (although these policies were abandoned during the "Mistake of 1937" leading to the second phase of the Great Depression). My guess is that the policy announced by the Japanese government will also be very helpful to stimulate growth. Perhaps my biggest worry is that the number, 2 percent inflation, is a bit on the low side. But we shall see ... I think the most important thing is that the government has made a priority of "reflation" just as FDR did and has been explicit -- just as he was-- that they will do whatever it takes to get there.

Below is an "advertisement" for inflation that was released following these policy innovation of FDR that we looked at in last class. You will see that the two key rationales for inflation both appear in the ad (the first channel is a key theme is much of my earlier work such as  here and in joint paper with Mike Woodford here, but the redistribution channel is studied in my paper with Paul Krugman here (Students in Advanced macro at Brown: All these papers are on the reading list for the class.)

The ad:

Blog experiment

I have decided to experiment with an economic blog diary. The purpose of the blog is to try to keep track of economic events as they come along. I thought writing down some reactions might be helpful to clarify my thinking and perhaps help guide my students to some interesting material as it relates to the things we talk about. I have no idea if I will update this frequently or not, or even at all. Time will only tell.