But we'll have fun, fun, fun, ... ... Until Daddy takes the T-bird way
All in all, this is a post worth reading carefully. This is indeed where we are going, and this is a nice effort to put economic logic to it. If you find the logic wanting, well, then you know more surely that it will end badly.
Capital Thinking · Issue #804 · View online
Marginal revolution links to a great read on contemporary macroeconomics from J.W. Mason.
It’s mostly wrong, I think, but very thoughtfully puts together the wrong ideas behind contemporary policy macroeconomics.
Briefly, debt doesn’t matter and there are no effective supply constraints. Borrow, spend without limit is the key to prosperity.
Back to the 60s.
John H. Cochrane | The Grumpy Economist:
The fact that the Biden administration not only managed to push through an increase in public spending of close to 10 percent of GDP, but did so without any promises of longer-term deficit reduction, suggests a fundamental shift.
The fact that people like Lawrence Summers have been ignored in favor of progressives like Heather Boushey and Jared Bernstein, and deficit hawks like the Committee for a Responsible Federal Budget have been left screeching irrelevantly from the sidelines, isn’t just gratifying as spectacle. It suggests a big move in the center of gravity of economic policy debates.
It really does seem that on the big macroeconomic questions, our side is winning.
I have noticed the same thing. Few Republicans mention the idea that today’s spending has to be paid by tomorrow’s taxes, and consequently today’s stimulus must be repaid by tomorrow’s prosperity.
His “side” won. Until the well runs dry. (I also resist the assertion that economics must have political “sides,” rather than an objective truth.)
But my interest in this particular post is to think about what it says about how thinking about economic policy is shifting, and how those shifts might be projected back onto economic theory.
The post is brilliant for systematizing the emerging view of economics in the Biden Administration, in much of the Fed, and its academic allies.
The conventional view
Mason is captures refreshingly well the other “side,” conventional macroeconomic wisdom that emerged after the debacle of the 1970s:
Over the past generation, macroeconomic policy discussions have been based on a kind of textbook catechism that goes something like this: Over the long run, potential GDP grows at a rate based on supply-side factors — demographics, technological growth, and whatever institutions we think influence investment and labor force participation.
Over the short run, there are random events that can cause actual spending to deviate from potential, which will be reflected in a higher or lower rate of inflation. [and also temporarily higher or lower output] These fluctuations are more or less symmetrical, both in frequency and in cost. The job of the central bank is to adjust interest rates to minimize the size of these deviations.
That’s an excellent description of post 1970s, Lucas, Prescott, Sargent, Friedman macroeconomics. Unlike some other commenters from the “left,” one cannot accuse him of ignorance.“Catechism” is a deliberate insult, as the view came from substantial theory and evidence, but let’s leave that alone. Here’s a graphical version.
In the 1960s, macroeconomists thought that recessions were just “shortfalls” of “aggregate demand.” The point of policy was to fill the valleys with aggregate demand, as indicated by the dashed line of the top graph.
In the conventional reading, they tried it in the 1970s, and got inflation. They discovered that economies can run too hot as well. Thus, the objective shifted, as in the bottom graph.
Now the job is to stabilize output, if not in the middle, at least below the top.
As one way of thinking about it, the dashed lines represent “supply.” That’s a bad word, as it is really the combined supply and demand of an economy working normally.
How can an economy run “too hot?” Well, if your boss asked you to work 7 days a week 12 hours a day with no vacations to finish a special project, you could. But you would not want to do that forever.
The economy as a whole can similarly push above what is long-run sustainable for a little while.
But at the same time, economists realized that the growth rate of “supply” is not a given, but instead heavily influenced by policy. So we should put more attention into the incentives for long-run growth, which all comes form the “supply” side – capital, technology, productivity, efficiency.
Mason continues on the standard “catechism”
at any given moment, there’s a minimum level of unemployment consistent with price stability.
Milton Friedman, 1968. And that level is not zero. Try to push it too low, and you get inflation.
Smoothing out these fluctuations has real short run benefits, but no effects on long-term growth.
i.e. the best “demand” policy can do is the black dashed line in my lower graph.
large fiscal deficits may be very costly. Finally, while it may be necessary to stabilize overall spending in the economy, this should be done in a way that minimizes “distortions” of the pattern of economic activity and, in particular, does not reduce the incentive to work.
Correct again. To us, that pesky growth comes from incentives and lack of distortions.
The new view
But that’s all over.
John H. Cochrane
Photo credit: Marifer on Unsplash