Several related strands have come together in the last week of work and thinking. Today…
Regular readers will know that for the last few years I have been documenting the way that the dominant paradigm in macroeconomics (New Keynesianism) is slowly disintegrating as the dissonance between its empirical predictions and reality becomes too great to ignore and justify. The once-in-a-century pandemic hasn’t given us much to celebrate in 2020. One cause for optimism, perhaps, is that we might finally jettison the mainstream economics fictions about government deficits and debt, which have hampered prosperity over several decades. Last week (August 27, 2020), the US Federal Reserve Bank Chairman, Jerome Powell made a path breaking speech – New Economic Challenges and the Fed’s Monetary Policy Review – at the annual economic policy symposium sponsored by the Federal Reserve Bank of Kansas City at Jackson Hole. On the same day, the Federal Reserve Bank released a statement – Federal Open Market Committee announces approval of updates to its Statement on Longer-Run Goals and Monetary Policy Strategy. We have now entered a new phase of the paradigm shift in macroeconomics.
German physicist Max Planck wrote in his 1950 publication Scientific Autobiography and other Papers that (pp.33-34):
A new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents eventually die, and a new generation grows up that is familiar with it …
Max Planck’s observation is often shortened to “Science progresses one funeral at a time”.
For macroeconomics, we might think of progress as occurring one crisis at a time, because it is the sequence of crises – 1991 recession, the Global Financial Crisis (GFC) and, now the COVID-19 pandemic – that has generated an accumulated awareness of the failure of mainstream macroeconomics.
This has progressively opened the door for Modern Monetary Theory (MMT), the emerging rival paradigm.
The conjecture here is that while some want to hang on to the debt and deficit scaremongering that has cruelled policy choices and left a trail of human damage over the last four decades, it is increasingly obvious to people that there is little substance in those narratives.
Jerome Powell’s speech at Jackson Hole was described by a Reuters’ report (August 28, 2020) – With new monetary policy approach, Fed lays Phillips curve to rest – in this way:
One of the fundamental theories of modern economics may have finally been put to rest.
The Phillips curve is the framework that claims there is a trade-off between unemployment and inflation. The nature of that trade-off has defined the macroeconomics debate over the last 60 years or so.
My PhD work was on this topic and one of the motivations I had in developing ideas such as the Job Guarantee, which I argue is one of the differentiating features of Modern Monetary Theory (MMT).
I wrote about that topic most recently in this blog post – Flattening the curve – the Phillips curve that is (April 7, 2020).
The dominant usage of the Phillips curve framework among mainstream economists is to, perhaps, allow for a short-run trade-off, but deny that governments can exploit such a policy choice continuously.
They claim that ultimately there is only one unemployment rate (the ‘natural rate’) that is consistent with stable inflation and attempts by government to reduce that unemployment rate via aggregate demand policy (spending and taxation) only results in accelerating inflation.
This view has dominated since the 1970s, and, is one of the lynch pins of the resistance to active fiscal policy and the reliance on monetary policy as the primary counter-stabilisation tool.
The empirical record hasn’t been kind to the mainstream conception.
During the 1990s, for example, unemployment was driven down in many nations with no increase in the inflation rates.
Again, pre-pandemic, US unemployment fell to levels not seen since the 1960s, and again there was no increase in inflation rates.
If there was a trade-off, it was clearly so flat as to be not worthy of policy consideration.
The Federal Reserve Chairman was releasing the Bank’s new monetary policy approach which reflects on the taboo against monetary authorities directly buying government debt.
That taboo is breaking down as central banks continue purchasing large proportions of debt, effectively eliminating the charade that private bond investors provide the funding for government spending in excess of its taxation take.
Jerome Powell told his audience that:
1. The fear of “high and rising inflation”, which dominated public debate “Forty years ago” no longer applies.
2. The dominance of ‘inflation-first’ monetary policy has led to situations where “expansions had been more likely to end with episodes of financial instability, prompting essential efforts to substantially increase the strength and resilience of the financial system.”
3. The need to review the conduct of monetary policy is driven by the failures to achieve their dual goals of “maximum-employment and price-stability”.
4. This failure is demonstrated by:
– “assessments of the potential, or longer-run, growth rate of the economy have declined … since January 2012, the median estimate of potential growth from FOMC participants has fallen from 2.5 percent to 1.8 percent …”
– “More troubling has been the decline in productivity growth, which is the primary driver of improving living standards over time … the Fed has less scope to support the economy during an economic downturn by simply cutting the federal funds rate.”
– Maintaining elevated levels of unemployment means that “the costs of such outcomes likely falling hardest on those least able to bear them”.
– Even so, “The unemployment rate hovered near 50-year lows for roughly 2 years, well below most estimates of its sustainable level … the labor force participation rate flattened out and began rising even though the aging of the population suggested that it should keep falling.”
– “the historically strong labor market did not trigger a significant rise in inflation. Over the years, forecasts from FOMC participants and private-sector analysts routinely showed a return to 2 percent inflation, but these forecasts were never realized on a sustained basis” – this is a serious indictment of the mainstream theoretical framework.
– “The muted responsiveness of inflation to labor market tightness, which we refer to as the flattening of the Phillips curve, also contributed to low inflation outcomes.”
– This is not a US-centric issue given that: “Other advanced economies have also struggled to achieve their inflation goals in recent decades.”
– Now, the claim that inflationary expectations fed on themselves to push accelerating inflation is working in the reverse – “inflation that is persistently too low can pose serious risks to the economy. Inflation that runs below its desired level can lead to an unwelcome fall in longer-term inflation expectations, which, in turn, can pull actual inflation even lower, resulting in an adverse cycle of ever-lower inflation and inflation expectations.”
– Which then causes interest rates to fall further and monetary policy has “less scope to cut interest rates to boost employment during an economic downturn”.
– Again, not a US-centric issue given that: “We have seen this adverse dynamic play out in other major economies around the world and have learned that once it sets in, it can be very difficult to overcome.”
So what does this all mean for the conduct of monetary policy?
1. “Our new statement explicitly acknowledges the challenges posed by the proximity of interest rates to the effective lower bound. By reducing our scope to support the economy by cutting interest rates, the lower bound increases downward risks to employment and inflation.22 To counter these risks, we are prepared to use our full range of tools to support the economy.”
2. “our revised statement emphasizes that maximum employment is a broad-based and inclusive goal” – in other words, they will try to do more to increase employment in the knowledge that the mainstream view that it would increase inflation is incorrect.
3. They will no longer tighten monetary policy as employment growth strengthens before there are inflationary effects – that is, they are rejecting all the ‘forward-looking’ bias that mainstream theory imparted that policy had to kill off employment growth before unemployment had fallen significantly.
Now: “going forward, employment can run at or above real-time estimates of its maximum level without causing concern … Of course, when employment is below its maximum level, as is clearly the case now, we will actively seek to minimize that shortfall by using our tools to support economic growth and job creation.”
A big shift.
4. On its conception of price stability:
… if inflation runs below 2 percent following economic downturns but never moves above 2 percent even when the economy is strong, then, over time, inflation will average less than 2 percent. Households and businesses will come to expect this result, meaning that inflation expectations would tend to move below our inflation goal and pull realized inflation down. To prevent this outcome and the adverse dynamics that could ensue, our new statement indicates that we will seek to achieve inflation that averages 2 percent over time. Therefore, following periods when inflation has been running below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.
Which, in the historical context amounts to an admission of total failure.
The Bank of Japan, the Bank of England, the ECB and the Federal Reserve Bank have publicly stated they have been trying to lift inflation rates towards their conception of inflation stability – usually around 2 per cent per annum.
They have all failed.
But think about what they have been doing in pursuit of those goals.
They have produced zero or negative interest rates.
They have bought massive quantities (and proportions) of government debt, effectively taking the private bond markets out of the picture – thus abandoning the taboo that neoliberalism exploited to prevent central banks buying government debt.
And despite these major shifts in monetary policy conduct – as far back as the 1990s in Japan – inflation has been benign and hovering around deflationary levels.
So while the Federal Reserve statement declares failure it also continues to hang onto the notion that it can actually push inflation rates above the 2 per cent level to achieve a long-term ‘average’ of 2 per cent.
The next step will be for policy makers to abandon that delusion.
But we are making progress.
And, if you scanned the textbook market in macroeconomics looking for guidance to all of this, then you would find only ONE offering that allows you to understand all of this – yes – Macroeconomics (William Mitchell, L. Randall Wray and Martin Watts).
Small sales pitch – but that is the fact.
None of the mainstream textbooks allow students to understand any of these developments.
What the statement means is that the obsession with the ‘natural rate’ of unemployment, or, as it is more commonly known – the Non-Accelerating-Inflation-Rate-of-Unemployment (NAIRU) – is being abandoned.
The US central bank is now not going to start pushing rates up as unemployment falls to low levels, while inflation remains low.
What this means is that instead of being ‘pre-emptive’, the bank will be ‘reactive’, which means that unemployment can be pushed much lower than average levels over the last several decades.
Of course, as noted above, much of this is moot in actual policy conduct, because the Bank’s interventions have not been very effective for a long period.
Recognising that reality is the next step in the paradigm shift.
Related to this discussion, I was invited to join by the British public policy magazine – Prospect.
My antagonist in the debate was Jonathan Portes, who was a key player in designing the British Labour Party’s Fiscal Credibility Rule. I was a strong critic of that rule, given its neoliberal overtones and its unworkable constraints.
The Labour Party didn’t advertise it widely, but just before last December’s general election they altered the Rule, abandoning aspects that I had pointed out as being unviable, against much resistance from the likes of Jonathan Portes and others.
So it was interesting that we were invited to participate in this debate.
The question was: Are tax rises now inescapable?
And the question was clearly in the British context.
The format began with the Yes position (Jonathan) leading the way, and then my response, with three, alternating interventions overall.
The full debate was published over the weekend – The duel: are tax rises now inescapable? (August 29, 2020).
Several people commented after the publication suggesting that there wasn’t much difference between the two positions expressed.
The debate really highlights the differences between the mainstream New Keynesian framework, within which Jonathan works and Modern Monetary Theory (MMT).
For a New Keynesian, rising interest rates and inflation rates are inevitable consequences of continuous fiscal deficits that are matched (‘funded’ in their framing) through debt issuance.
An MMT economist refutes that inevitability. History supports our position. A New Keynesian cannot explain the last three decades of Japanese monetary history, for example. MMT has consistently been able to explain that history.
Sadly, the British Labour Party still hasn’t understood any of this.
I woke up this morning to this article in the UK Guardian (August 31, 2020) – Ditching tax on tech firms will mean less money for key workers, says Labour.
The Shadow Chancellor was out there claiming that:
… if the UK Treasury scraps a tax on technology companies such as Facebook, Google and Amazon it would mean losing out on enough money to pay for tens of thousands of key workers in Britain.
She has been tweeting her head of about this.
Basically, just signalling to everyone that the Labour Party remains unelectable.
Whoever is giving them economic advice should be sacked. But the Labour Party has ‘laboured’ with the poor advice it has been getting.
It lost the last election because it was not believed by the electorate, and, abandoned a significant number of communities over Brexit.
They do not seem capable of shifting out of this moribund economic mindset.
I will write further about other elements in this on-going paradigm shift.
That is enough for today!
(c) Copyright 2020 William Mitchell. All Rights Reserved.